Napco Security Technologies, Inc. ($NSSC)

Good morning. Ladies and gentlemen, and welcome to the NAPCO Security Technologies Fiscal Q3 2026 Earnings Conference Call. [Operator Instructions] This call is being recorded on Monday, May 4, 2026. I would now like to turn the conference over to Francis Okoniewski, Vice President of Investor Relations. Please go ahead.

Thank you, Matthew, and good morning, everyone. This is Fran Okoniewski, Vice President of Investor Relations for Napco Security Technologies. Thank you all for joining today's conference call to discuss financial results for our fiscal third quarter 2026. By now, all of you should have had the opportunity to review our earnings press release discussing our quarterly results. If you have not, a copy of the release is available in the Investor Relations section of our website, www.napcosecurity.com. On the call today are Dick Soloway, our Chairman and CEO of Napco Security Technologies; Kevin Buchel, President and Chief Operating Officer and Chief Financial Officer, Andrew Vuono. Before we begin, let me take a moment to read the forward-looking statement as this presentation contains forward-looking statements that are based on current expectations, estimates, forecasts and projections of future performance based on management's judgment, beliefs, current trends and anticipated product performance. These forward-looking statements include, without limitation, statements relating to growth drivers of the company's business, such as school security products recurring revenue services, potential market opportunities, the benefits of our recurring revenue products to customers and dealers, our ability to control expenses and costs and expected annual run rate for our Software as a Service reoccurring monthly revenue. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, such risk factors described in our SEC filings, including our annual report on Form 10-K. Other unknown or unpredictable factors or underlying assumptions subsequently proving to be incorrect could cause actual results to differ materially from those in the forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. You should not place undue reliance on these forward-looking statements. All information provided in today's press release in this conference call are as of today's date unless otherwise stated, and we undertake no duty to update such information except as required under applicable law. Throughout the presentation, management will address certain non-GAAP financial results. We encourage you to refer to our reconciliation between GAAP and non-GAAP results, which you can find in our press release. I'll turn the call over to Dick in a moment. But I'd first like to highlight our upcoming Investor Relations engagement plans. We're actively building out our Investor Relations calendar with a series of non-deal road shows and conference appearances. Investor outreach remains a top priority for NAPCO and I want to thank everyone who helped support these efforts. We're looking ahead to a full and dynamic schedule this quarter. Later this week, will participate in Oppenheimer's 21st Annual Industrial Growth Conference, followed by a virtual non-deal roadshow with KeyBank on Thursday, May 7. On May 13, we'll be in New York City for Needham's 21st Annual Technology, Media and Consumer Conference. And later in May, we'll attend Cowen's 54th Annual Global TMT Conference also in New York. In June, we'll participate in Robert W. Baird's 2026 Consumer Technology and Services Conference in New York City. We'll wrap up this stretch at the Wells Fargo Industrials and Materials Conference in Chicago on June 11. These events provide value opportunities, valuable opportunities to share our story, strengthen our relationships with the investment community and continued building momentum around our strategy and performance. With that out of the way, let me turn the call over to Dick Soloway, Chairman and CEO of NAPCO Security Technologies, who will make a brief introductory comment after which our President and COO, Kevin Buchel, will make a comment on some operational and financial performance highlights. Following Kevin's remarks, our CFO, Andrew Vuono, will go through the financials in more detail, and then Kevin will return to delve deeper into NAPCO's strategies and market outlook. Dick, the floor is yours.

Good morning, everyone. Thank you for joining. Kevin Buchel will take you through the highlights of fiscal Q3. Kevin, the floor is yours.

Thank you, Dick. Good morning, everyone. I'd like to focus my remarks on the operational drivers behind our performance this quarter, with particular emphasis on the continued growth of our recurring service revenue, improvements in product margins and the strong expansion in profitability metrics that demonstrate the effectiveness of our business model. During the quarter, total company sales grew nearly 12% year-over-year, reflecting steady demand across both our recurring services and hardware product lines. This level of growth combined with disciplined cost management allowed us to deliver meaningful expansion in profitability and operating leverage. Our recurring service revenue once again delivered outstanding performance, increasing more than 15% and year-over-year and representing approximately 51% of total company sales. The scale of this business is particularly important as it now reflects an annualized run rate of over $100 million. Just as important, the quality of this revenue remains exceptional with gross margins once again exceeding 90%, providing strong visibility and predictability to our financial results. The continued expansion of recurring services as a percentage of total revenue is one of the most significant achievements for the company. This shift towards a higher proportion of recurring revenue strengthens the overall margin profile of the business and enhances long-term earnings stability. It also reflects the growing installed base of connected devices and the increasing adoption of our subscription-based solutions by security dealers and integrators. In our hardware business, we also achieved solid performance and meaningful margin improvement. Equipment revenue grew over 8% year-over-year, predominantly driven by continued demand for our locking products. At the same time, equipment gross margins improved to approximately 29%, reflecting disciplined pricing, favorable product mix and continued operational efficiencies within our manufacturing operations. Our teams executed exceptionally well in managing materials, labor and overhead expenses, while maintaining consistent product quality and delivery performance. These efforts allowed us to expand overall gross margins to approximately 60% and for the quarter, and that represented a significant improvement from the prior year period and demonstrates the effectiveness of our operational discipline. From a bottom line perspective, we delivered particularly strong growth in profitability. Non-GAAP net income increased nearly 37% and year-over-year, reflecting the combined impact of revenue growth, margin expansion and disciplined expense management. This level of earnings growth demonstrates the scalability of our business model and the benefits of our increasing mix of high-margin recurring revenue. We also generated impressive growth in adjusted EBITDA, which increased more than 20% compared to the prior year. Our adjusted EBITDA margin expanded to over 32%, highlighting improved operating leverage and the strength of our core operations. These results demonstrate our ability to convert revenue growth into meaningful earnings and cash flow. Cash flow generation remain another key strength of the business. Free cash flow increased more than 20% during the quarter, providing the financial flexibility to invest in innovation, support growth initiatives and returning capital to shareholders through our dividend program which continues with this morning's announcement of another dividend of $0.15 per share, payable on July 3, 2026, to shareholders of record on June 12, 2026. As was noted in our press release, we recorded a charge of $16 million in connection with the settlement of outstanding litigation. We are pleased to have that uncertainty behind us and the distractions it presents. Operationally, we continue to focus on execution across the organization. Our manufacturing and supply chain teams maintained reliable production levels and ensured product availability for our customers. Our sales and technical support organization remain highly engaged with dealers and distributors, helping them deploy our solutions efficiently and expand their use of our recurring service offerings. Looking ahead, our priorities remain clear. We will continue to drive growth in recurring service revenue further improved product margins through operational discipline and efficiency initiatives and maintain a strong focus on profitability and cash generation. We believe these priorities position us well to deliver consistent financial performance and long-term value for our shareholders. This quarter demonstrated the strength of our operating model and the dedication of our employees across the organization. Their commitment to execution, innovation and customer service is what enables us to achieve strong financial results and continue building momentum. I will now turn the call over to our Chief Financial Officer, Andy Vuono, to review the financial details, Andy?

Thank you, Kevin, and good morning, everyone. Net revenue for the quarter ended March 31, 2026, increased 11.8% to $49.2 million as compared to $44 million for the same period a year ago. Net revenue for the 9 months ended March 31, 2026, increased 11.9% to $146.5 million as compared to $130.9 million for the same period 1 year ago. Recurring monthly service revenue in Q3 grew 15.4% to $24.9 million as compared to $21.6 million for the same period last year and recurring monthly service revenue for the 9 months ended March 2026 increased 13% to $72.2 million as compared to $63.9 million last year. Our recurring service revenue now has a prospective annual run rate of approximately $101 million based on April 2026 recurring revenue which compares to $99 million based on January 2026 recurring service revenue, which we reported back in February. The increase in service revenues for the 3 and 9 months was due to the increase in number of our cellular radio communication devices put into service and activated. Equipment revenue for the quarter increased 8.4% to $24.2 million as compared to $22.4 million last year. Equipment revenue for the 9 months increased 10.9% to $74.3 million as compared to $67 million for the same period last year. The increase in net equipment revenue for the quarter and for the 9 months was primarily due to increased volume of our door locking products and the impact of price increases in both locking and door intrusion and access products. Gross profit for the 3 months ended March 2026 increased 17.4% to $29.5 million with a gross margin of 60% as compared to $25.1 million with a gross margin of 57.2% for the same period last year. Gross profit for the 9 months increased 15.3% to $85.6 million with a gross margin of 58.4% as compared to $74.2 million with a gross margin of 56.7% a year ago. Gross profit as a percentage of service revenue was consistent in both the quarter and the 9 months ended March 2026 as compared to the prior year. Gross profit for recurring service revenue for the quarter increased 14.8% to $22.5 million, with a gross margin of 90.4% as compared to $19.6 million with a gross margin of 90.8% last year. Gross profit for recurring service revenue for the 9 months increased 12% to $65.2 million with a gross margin of 90.3%, as compared to $58.2 million with a gross margin of 91.1% last year. Gross profit from equipment revenue in Q3 increased 26.4% to $6.9 million with a gross margin of 28.7% as compared to $5.5 million with a gross margin of 24.6% last year. Gross profit from equipment revenue for the 9 months increased 27% to $20.4 million with a gross margin of 27.4% as compared to $16 million with a gross margin of 23.9% for the same period last year. The 280 and 170 basis point increase in overall gross margin for the quarter and the 9 months ended March 2026 is due to the substantial profitability of recurring revenue, but the overall improved margins on our equipment revenue. The increase in gross profit percentage from equipment revenue for the quarter and the 9 months was primarily a result of product sales mix, increased volume on unlocking products, which improved the absorption rate of our fixed overhead costs and certain price increases that went into effect during fiscal 2026 and reduction in sales discounting during the periods. Research and development expense for the quarter increased 7.3% to $3.4 million or 7% of net revenues as compared to $3.2 million or 7.2% of net revenues for the same period a year ago. Research and development costs for the 9 months ended March 2026 increased 8.4% to $10.1 million was 6.9% of net revenues as compared to $9.3 million or 7.1% of net revenue for the same period a year ago. Increase for the 3 and 9 months primarily resulted from annual compensation and benefit increases and hiring of additional resources. Selling, general and administrative expenses for the quarter increased 4.3% to $11.3 million or 22.9% of net revenues as compared to $10.8 million or 24.6% of net revenues for the same period last year. SG&A expenses for the 9 months ended March 2026 increased 5%, the $32.2 million or 22% of net revenue as compared to $30.7 million or 23.5% of revenue for the same period last year. The increase for the 3 and 9 months was primarily attributable to increases in trade share-related expenses, the ISC West show occurred in Q3 this year as compared to Q4 of last year, wages, bonuses, compensation and benefits, sales commissions and related expenses and insurance expense, which was offset by decreases in professional fees and legal fees. As Kevin previously mentioned, for the 3 and 9 months ended March 2026, we recorded a litigation settlement expense of $16 million as a result of settling existing litigation subsequent to the end of Q3. Non-GAAP operating income for the quarter increased 32.9% to $14.8 million as compared to $11.1 million for the same period last year. Non-GAAP operating income for the 9 months ended March 2026 increased 26.4% to $43.2 million as compared to $34.2 million for the same period last year. Other income for the quarter increased 14.4% to $986,000 as compared to $862,000 last year for the 9 months, other income increased 1.3% to $3 million as compared to $2.9 million last year. The increases for both the 3 and 9 months ended March 2026 was due to increased interest income from larger deposit [indiscernible]. As a result of the aforementioned litigation settlement, the provision for income taxes for the quarter was $200,000 as compared to $1.9 million last year. For the 9 months, the provision for income taxes was $4.9 million, which represents an effective tax rate of 16.3% as compared to $5.2 million for the same period last year with an effective tax rate of 14.4%. The company's effective tax rate for the 9 months ended March 2026 increased as a result of the increase in the portion of taxable income allocated to the United States as a result of the litigation settlement offset by windfall benefits from the exercise of employee stock options during the period. Non-GAAP net income for the quarter increased 36.9% to $13.9 million or $0.39 per diluted share as compared to $10.1 million or $0.28 per diluted share for the same period last year and represented 28.2% of net revenue as compared to 23% for the same period last year. Non-GAAP net income for the 9 months ended March increased 24.4% to $39.5 million or $1.10 per diluted share as compared to $31.8 million or $0.86 per diluted share for the same period last year and represents 27% of net revenue as compared to 24.3% for the same period last year. Adjusted EBITDA for the quarter increased 20.2% to $15.8 million or $0.44 per diluted share as compared to $13.2 million or $0.36 per diluted share for the same period a year ago and equates to an adjusted EBITDA margin of 32.2% as compared to 29.9% for the same period last year. Adjusted EBITDA for the 9 months ended March 2026 increased 21.7% to $46.1 million or $1.28 per diluted share as compared to $37.9 million or $1.03 per diluted share for the same period last year and equates to an adjusted EBITDA margin of 31.5% as compared to 28.9% for the same period last year. Free cash flows for the quarter increased 20.3% to $16 million as compared to $13.3 million for the same period a year ago and equates to a free cash flow margin of 32.6% this year compared to 30.3% last year. Free cash flow for the 9 months increased 13.4% to $42 million as compared to $37 million for the same period a year ago and equates to a free cash flow margin of 28.7% this year compared to 28.3% last year. Moving on to our balance sheet. As of March 2026, the company had $125 million in cash and cash equivalents and marketable securities as compared to $99.1 million as of June 2025. The company had no debt as of March, working capital. As of March 2026, was $153.8 million as compared to working capital of $138.4 million as of June 2025. Our current ratio was 4.9:1 as of March 2026 as compared to 6.8:1 as of June 2020. CapEx for quarter was $734,000 as compared to $65,000 in the prior year and $1.5 million for the 9 months as compared to $1.9 million last year. That concludes my formal remarks, and I would like to turn the call back to Kevin.

Thank you, Andy. As you've heard today, our fiscal third quarter 2026 results reflect another strong period of execution and meaningful progress against our long-term strategy. These results reinforce that our business model is working exactly as intended. Our inclusion in the S&P Small Cap 600 is an important milestone for NAPCO Security Technologies and it reflects the progress we've made in scaling the business and delivering consistent results. While this enhances our visibility and broadens our shareholder base, our focus remains firmly on execution and long-term value creation. At the core of our strategy is our recurring service revenue platform, which continues to deliver consistent high-margin growth. Recurring service revenue exceeded 50% of our total Q3 sales, supported by sustained gross margins above 90%, with an annualized run rate exceeding $100 million. This provides a predictable, high-quality revenue stream that drives strong cash generation and long-term value creation. A key contributor to this performance is our Starling commercial fire radio platform, which has firmly established itself as the industry standard for commercial fire alarm communicators. Demand remains healthy across both new installations and our growing installed base, and we continue to see meaningful runway ahead. particularly as the transition away from legacy copper phone lines to cellular connectivity accelerates. With connectivity across AT&T, Verizon and now T-Mobile networks, StarLink is well positioned to capture additional market share across millions of commercial buildings that have not yet converted to a cellular solution. We also saw a strong validation of that demand at ISC West 2026 at the end of March, which was a tremendous success for us and generated a record number of leads across all NAPCO platforms. Our sales and marketing teams are now actively qualifying and pursuing these opportunities, building a robust pipeline that supports continued growth. On the equipment side, we are equally encouraged by the continued momentum driven by door locking installations and in our intrusion and on product segments. Pricing actions, more disciplined discounting and rebate practices and favorable mix have led to significantly improved equipment gross margins, and we believe more improvements can be made. Profitability remains a major strength of the company. Non-GAAP operating income, net income and adjusted EBITDA all grew significantly faster than revenue, demonstrating continued strong operating leverage, with EBITDA margins exceeding 30%, we're generating substantial cash flow while continuing to invest in innovation, infrastructure and growth initiatives. Our balance sheet further differentiates us with $125 million in cash and marketable securities and no debt. which gives us exceptional financial flexibility and enables us to invest organically, pursue strategic opportunities and continue returning capital to shareholders. Operationally, our team continues to execute at a very high level. We're managing inventory tightly while investing in product development, compliance automation and infrastructure, all while maintaining a debt-free balance sheet. Our manufacturing facility in the Dominican Republic remains a key competitive advantage, providing cost efficiency, stable logistics and lower tariff exposure as compared to many competitors operating in higher tariff regions. We're also driving a new phase of commercial expansion by entering the architectural and engineering specification market, positioning us so the specification-driven opportunities across the entire NAPCO portfolio. In parallel, we continue to broaden our distribution footprint through new and expanding channel partnerships. These initiatives are expanding our reach across a broader branch network and enhancing product availability in the field. Innovation remains central to our strategy. We continue to enhance our MVP cloud-based access control platform, incorporating customer-driven features based on continual customer feedback. MVP represents a meaningful step forward introducing a subscription-based revenue model for both NAPCO and our locking and access control dealers. We believe MVP has the potential to be a game changer, extending our leadership into the hosted access control market, while reinforcing our strategy of pairing innovative hardware with cloud-based services to drive high-margin recurred revenue. In addition, our new smart and interconnected dead bolt platform positions both the company and our dealers to capitalize on the fast-growing U.S. multifamily market, expanding beyond traditional security hardware into unit level access control and scale. Beyond access control, our Alarm Lock and Marks hardware lines continue to grow across key verticals, including health care, retail, multi-dwelling housing, airport infrastructure and especially school security, where our integrated solutions are viewed favorably alongside enterprise scale access control systems. NAPCO platforms are secure, scalable and aligned with the partner alliance for safer schools guidelines. I mean ongoing market and geopolitical uncertainty we remain grounded in what we can control our strategy, our execution and our commitment to creating sustainable shareholder value. Looking ahead, we remain optimistic about the remainder of fiscal 2026 and beyond. Demand, of course, our product portfolio remains strong. Our recurring revenue base continues to expand and our operating discipline remains firmly in place. Dick and I would like to thank you all for your continued support and confidence in NAPCO. Our formal remarks are now concluded and we would now like to open the call up for the Q&A session. Operator, please proceed.

[Operator Instructions] And your first question comes from Matt Summerville of D.A. Davidson.

I apologize for background noise in the airport, but I was curious how we should be thinking about pricing actions for 2020 or fiscal '27? And ultimately, how you're balancing your discounting programs in that if discounted is coming down, that would theoretically have an impact on equipment volume, which would then theoretically have a downstream impact the growth rate in RSR. How should I be thinking about that dynamic? And then I have a follow-up.

Last year at this time, we had 2 price increases we announced. We announced a tariff one and a general one and that drove a lot of business into Q4 as the distributors try to avoid these increases. This year, we have a general price increase. And so we don't have as much of pricing increases this year as we did last year, but we still have a general one. So it's not going to be the same from that point of view. And also, we are much more disciplined in our discounting now than we've ever been. And the good part of that is our margins go up, and they did go up this quarter to close to 29%. And we're going to continue to be disciplined like that. What we want to do is generate more hardware sales but also not give away margin along the way. So we're working hard to have both. And so as we're into this fourth quarter that we're in now, it might be a little different than it was a year ago. But from a profitability point of view, it should be better than it was a year ago.

Got it. And then can you talk about whatever or not you're starting to see any traction, discernable traction in revenue and recurring from MVP and how we should be thinking about kind of uses of cash M&A-wise over the next 6 months.

So MVP, we have said -- it's an 18 -- give it 18 months. I started the clock from ISC West last year, 18 months puts us about October of this year. That's when we expect meaningful recurring revenue to begin. That's what I expect we can talk to you about it. It gives you say, hey, it's x percent of our total recurring or it's X dollars. So we're not there yet. We're encouraged to those of you who were at the show, you saw a mix in our booth wanting to see MVP getting a lot of great interest. We're doing a lot of training. We don't want to screw this thing up. We want to do it right, get everybody's feedback and then we think it will be super successful. And so give it a few more months, Matt, and then I think we'll start to feel it. And then with regard to M&A activity, we and have a lot that's being served up to us. We have a lot of bankers who are interested in working with us. We have a couple that particularly we're interested in, nothing imminent. But as you guys know, we have the cash to do it. It's a good time. The last one we did was many years ago. And at that time, we had lots of debt, minimal cash. It's a much different story now. So -- we're in a good position to do something. But as we've said, got to be right. We're not going to just do one for the sake of doing it. It's got to check all the boxes of things like being accretive from day 1 paying a fair multiple, utilizing our Dominican factory, so we can get the leverage from the factory. Pay a fair multiple, wanted to stick in our lane. It has those things. We're interested -- there's a couple that we've got our eye on, and we'll keep you posted as things develop.

And your next question comes from the line of Jim Ricchiuti of Needham and Company.

I'm curious on the door locking side of the business. What kind of activity are you seeing both from the standpoint of school security and then the efforts you've been talking about each quarter now about potentially larger project, architectural engineering related parts of the business. How are we thinking about that area of the business?

The school segment remains strong. We always are asked, and I'm sure you asked us as well. Well, how much is it of your locking? And I wish we could tell you, we sell, as you know, to distributors for the most part and the distributors are the ones that's out of the schools. In some cases, we'll sell directly to the integrator who will do the installation at a live school and we know about those, but it's hard for us to tell you exactly how much is school security. But we know it's been very strong. It's very good. Our locking sales, which you guys will see when you look at the Q and you see the breakout between our segments, locking was very strong once again this quarter. It's a reflection of all of these areas, whether it's airports, hospitals, schools, all of them. It's clicking on all cylinders. There are some big projects when we can tell you about it, we will. Sometimes there's a hesitation. They don't want it publicized, but there are some that are out there that we expect to be contributors in the future, and we'll keep you posted on that. And generally speaking, we are very happy with the way the locking area is going, and there's more work to be done. We want to get locking to be even stronger. We want the radio business to get stronger. The radio business contributes to the recurring revenue. We want MVP to start to contribute as MPP gives us more recurring revenue. So each of these areas, we're focused heavily on, Jim.

Got it. Yes, the recurring service revenue margins have remained elevated, which I'm assuming, I think you guys have said so, is being helped by mix. How much of that is associated with fire radios versus, say, a year ago? Are you able to give us that?

Yes, we can. So we started the recurring revenue journey 10 years ago roughly. At that time, when we first started, we didn't even have a fire radio, in the first few years was just Burberry radio. Maybe 3 years in fire radio came out, and it has become the dominant piece of the pie. We have roughly 1 million radios active out there. And I'd say 75% of them are fire radios. That's why you see the margins, the strong margins because we get more money for the fire radios and it's keeping up. I was very happy to see 15.4%. That was a higher increase than we've seen in a while. Very happy to see the 90% plus margin. It actually went up a bit to 90.4%. That's all very good. We expect it to continue, and there's lots more buildings that have not yet converted to copper -- away from copper to cellular. As you remember, with the 3G sunset by the dealers wait for the end, they wait to the bidder end by 2029, 2030, they're going to have to convert because the carriers are not going to fix it anymore. So we're seeing steady growth. It'll probably be a big push few years from now. But in the meantime, steady growth, lots of radios. And also just to remind everybody, we sell fire panels with the radio built in. So that's for new work. So it's for existing who wants to convert away from copper and it's also for new. But this has been going on now for a while. It remains strong. It remains a key part of our future.

- And your next question comes from Jaeson Schmidt of Lake Street.

Kevin, just curious if you could comment on what you're seeing from the distributor channel and kind of what sell-through stats you saw in this past quarter?

Distributor channel seems stable. As you know, it has its ups and downs. Sometimes they're too light. Sometimes, they're too heavy. They're in a good spot now. and we'd like to keep it that way. Sometimes when we do these big deals with these distributors give big discounts -- they carry too much inventory from their point of view. They forget that we gave them an incentive to do that, to discount. Without giving huge discounts, it's kind of nice. The channel seems smooth, nice I hope it stays that way. It could even tell, but right now, it's in a good spot, Jaeson.

Okay. That makes sense. And then just following up on that, as you noted, kind of you're doing less discounting and seeing some nice margin on that equipment revenue line. When you think about the path back to sort of 30% plus gross margins on equipment, what are going to be the primary drivers there?

Well, you need volume besides doing less discounting, you need volume. The reason you need volume is you get overhead absorption from the Dominican Republic Factory. The more goods that flows through the Dominican Republic factory, the higher the margins go. Because if you think about it, we have the facility, the facility in the DR to do $300 million of revenue. So the facility could handle additional volume. We have lots of machines that could handle the volume. We have supervision. They can handle the volume, you have to add more direct labor. Luckily, in the DR, we can get all the labor we want, and they all want to work for us. compared to others, other companies down there. So if you're only adding direct labor, and that's it, the margins expand that helps us get into the 30s. So that less discounting and mix. Remember, you get more money for a locking product than you do for a radio -- now radio, we love because it gives us the recurring revenue. But from a hardware point of view, it makes modest profit locking, access. They do bet. So you need a good mix -- you need less discounting, you need volume, you get all of that. We're in the 30s, pushing to 40.

And your next question comes from Jeremy Hamblin of Craig-Hallum Capital Group.

Congrats on the strong results and the record gross margins. I wanted to just get into the cost side of the equation a little bit. And just in terms of a little bit of noise in the quarter, obviously related to the litigation settlement -- but in terms of the underlying OpEx of the business, whether it's your R&D, the SG&A side of your business, I know you had, I think, ISC West expenses really in the March quarter. I think next year, that shifts into Q4 and fiscal '27. But in terms of the hiring that you might need to do on the R&D portion of your team and then in terms of kind of the corporate staffing and the rest of your SG&A. Can you just give us a sense for what you might be looking to build out here over the next 4 or 5 quarters?

Well, the biggest thing we could comment on with regard to this quarter that we're in is what you mentioned that ISC West was in Q3, March. We had it. It's already reflected in the numbers. As we -- in Q4 now on fiscal '26, we won't have that. Last year, we did. So that's a nice favorable comparison -- it's in the range of, I don't know, $700,000 to $800,000, something like that. So that's a big plus. And next year, we'll be in April. Usually, it is in April this year because of the calendar and the holidays it fell in March. In general, we do not anticipate any huge increases in SG&A. The things that drive SG&A higher commissions, you have higher sales, you're going to have more commissions. You might have higher freight costs also. There's salary increases that you give out every year. The wildcard within SG&A is legal. Now settling this lawsuit is good. It will put more predictability into our the legal portion of the SG&A. On the R&D side, we try to keep the R&D as a percentage of sales somewhere in the 7% to 7.5% range. Our sales obviously are growing, and so is our -- number of our engineers. We are expanding as fast as we can. We're adding more engineers all the time, what we want, more products, get them to market faster get products to market faster than have recurring revenue. And so we want to be the first guy out there with the new product, not the second or the third guy. So hence, add more people. But we watch it, it's not just higher wildly. We're still -- even though we've added many more engineers, we're still in the 7% to 7.5% of sales range, and I expect it to stay in that range.

Got it. And then I wanted to ask a question on tariffs. So -- in terms of -- we've got some change since you guys last reported with the Supreme Court ruling the DR, we run a trade surplus with the DR. And then I think that under the current kind of tariff guidelines being applied, it looks like those would expire at the end of July, if no new tariffs are slapped on. Can you give us a sense for what, on an annual basis, kind of the range of what you're paying in terms of tariffs under the kind of the current rate, what you paid? And then whether or not you expect to recover some of what you might have paid here in the last year or so.

I refer to my tariff expert to Andy. Okay.

So Jeremy, just from a tariff perspective, so I mean we're at 10% now. We were preruling EBIT rates were 10% for us. We were the baseline range. We can't predict what, if anything, will happen legislatively with Congress if they're going to make any of these existing tariffs permanent. We are going through the process of the refund claim like many companies are. So the portal opened up, I believe, a week or so ago, so we're in the process of submitting our plans. On average, our TAV cost was running about just under $2 million, I would say, on an annual basis at that 10% level. We have -- the bulk of our tariff is the movement of goods from the DR up to the U.S. We have to a less extent, importing directly into the U.S. since most of the manufacturing happens in the DR. But as of now, we wouldn't expect our TAF exposure to increase from where it is today. And some legislation potentially the deal to go back to where we were pre-liberation day to zero. So let's wait and see for us.

And your next question comes from Lance Vitanza of TD Cowen.

Let me start just to go back to the equipment revenue and the discounting. And I understand that the discounting is great, not just for the margin, but for gross profit dollars, but -- is it going to create a drag on recurring service revenues in either Q4 or next year? I feel like we've kind of been talking around this question, but I just want to ask you real direct.

No. It won't. The discounting -- whatever discounting we've done or haven't done, it's never around radios. Radios is what gives us the recurring it's almost unaffected. Radio, people want them. No, that's not an issue in the least.

Okay. So just a couple of questions on cash flow. The first is I've consistently been overestimating your working capital as a use of cash. And it's surprising, just given the growth that we're seeing in the business, right? Normally, I would expect working capital to build more quickly given the growth that we're seeing here. So the question is, should we expect sort of like a catching up like a big uptick in working capital in either the fourth quarter of this year or perhaps next year?

Andy, you want to take that one?

Yes. I'm not sure I'm following that it's not growing at a rate we're expecting. Lance, I'm not sure what the...

Correct, right? I mean, so the working capital has been relatively flat. It's really not been consuming much cash. And so my question is, do you expect there to be a big bump up in the amount of working capital such that your cash flow is going to be negatively impacted in the fourth quarter of next year.

No, because I think we have done a much better job in the last 12, 18 months of managing inventory. So we're trying to manage the levels of inventory. We've worked out our inventory substantially from going back at tight probably 2 years ago. So from a use of cash perspective, I would expect us to not eat into our cash will continue to grow.

Okay. Great. And then last question for me, just again on the cash flow side of the settlement. I'm very glad that you got it behind you. I was surprised by the size of the [ payout ] given the lack of merit in these claims question. Does this sort of $16 million outflow, which I assume is coming in the current quarter. Does this put any pressure on the dividend or your ability to continue increasing the dividend or or given the reduction maybe in litigation expense going forward, is it kind of a wash?

We have $125 million in cash. So we could afford this. We don't love it, who loves it. It's -- in the end, it's good to get rid of it, but we can afford it. No, it's not going to affect our ability to do dividends. The 1 thing we did, we didn't increase it this round. You've been with us for a while. We've increased the amount of the dividend 3, 4, 5x already. We kept it the same but there will be more increases down the road and this company generates a lot of cash, so there's no issue on continuing dividends.

And last question, I'm going to squeeze one more in. Someone earlier had asked about your stance towards M&A going forward. What about your stance towards share repurchase, given, as you point out, you got $125 million of cash.

We don't like to mess with the float. But as you know, we've done it before, depending upon where the stock is, we could do it again. We have authorization, we have the money, but we don't need to do it. The stock is performing well, and I don't want to force anything I like where our float is at and so do a lot of our investors.

[Operator Instructions] And there are no further questions at this time. I'd now like to turn the call back over to Kevin Buchel, President and Chief Operating Officer, for closing comments.

Thank you, Matt. Thank you, everybody, for participating in today's conference call. As always, should you have any further questions, feel free to call Dick, Andy, Fran or myself for further information. We thank you for your interest and support and we look forward to speaking to you all again in a few months to discuss NAPCO's fiscal Q4 and full year results. Thanks again.

Ladies and gentlemen, this concludes today's conference. We thank you for participating and ask that you please disconnect your lines.