NAPCO SECURITY TECHNOLOGIES, INC - FORM 10-Q

Attached files

file	filename
EX-32.1 - EXHIBIT 32.1 - NAPCO SECURITY TECHNOLOGIES, INC	tm205407d1_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - NAPCO SECURITY TECHNOLOGIES, INC	tm205407d1_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - NAPCO SECURITY TECHNOLOGIES, INC	tm205407d1_ex31-1.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: DECEMBER 31, 2019

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________.

Commission File number:

0-10004

	NAPCO SECURITY TECHNOLOGIES, INC.
	(Exact name of Registrant as specified in its charter)

Delaware		11-2277818
(State or other jurisdiction of incorporation of organization)		(IRS Employer Identification Number)

333 Bayview Avenue
Amityville, New York		11701
(Address of principal executive offices)		(Zip Code)

	(631) 842-9400
	(Registrant’s telephone number including area code)


	(Former name, former address and former fiscal year if changed from last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class		Trading Symbol(s)		Name of each exchange on which registered
Common Stock, par value $0.01 per share		NSSC		Nasdaq Stock Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company x Emerging growth company ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

Number of shares outstanding of each of the issuer’s classes of common stock, as of: January 31, 2020

COMMON STOCK, $.01 PAR VALUE PER SHARE 18,482,784

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

			Page
PART I:	FINANCIAL INFORMATION

	ITEM 1.	Financial Statements

		NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES INDEX –DECEMBER 31, 2019

		Condensed Consolidated Balance Sheets December 31, 2019 (unaudited) and June 30, 2019	3

		Condensed Consolidated Statements of Income for the Three Months ended December 31, 2019 and 2018 (unaudited)	4

		Condensed Consolidated Statements of Income for the Six Months ended December 31, 2019 and 2018 (unaudited)	5

		Condensed Consolidated Statements of Stockholders Equity for the Six Months ended December 31, 2019 (unaudited)	6

		Condensed Consolidated Statements of Stockholders Equity for the Six Months ended December 31, 2018 (unaudited)	7

		Condensed Consolidated Statements of Cash Flows for the Six Months ended December 31, 2019 and 2018 (unaudited)	8

		Notes to Condensed Consolidated Financial Statements (unaudited)	9

	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

	ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	26

	ITEM 4.	Controls and Procedures	26

PART II:	OTHER INFORMATION

	ITEM 1A.	Risk Factors	26

	ITEM 6.	Exhibits	26

SIGNATURE PAGE			27

PART I:

FINANCIAL INFORMATION

Item 1. Financial Statements

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	December 31, 2019 (unaudited)			June 30, 2019
	(in thousands, except share data)
CURRENT ASSETS

Cash and cash equivalents	$	11,778		$	8,028

Accounts receivable, net of allowance for doubtful accounts of $127 and $88 at December 31, 2019 and June 30, 2019, respectively		23,098			25,970
Inventories		34,740			29,576
Prepaid expenses and other current assets		1,662			1,881
Total Current Assets		71,278			65,455
Inventories - non-current		7,166			5,262
Property, plant and equipment, net		8,151			7,694
Intangible assets, net		7,100			7,232
Operating lease right-of-use asset (Note 11)		7,406			--
Other assets		259			265
TOTAL ASSETS	$	101,360		$	85,908

CURRENT LIABILITIES
Accounts payable	$	6,534		$	5,135
Accrued expenses		5,962			6,273
Accrued salaries and wages		2,461			2,416
Accrued income taxes		123			548
Total Current Liabilities		15,080			14,372
Deferred income taxes		563			72
Accrued income taxes		292			292
Operating lease liabilities, net (Note 11)		7,123			--
Total Liabilities		23,058			14,736
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common Stock, par value $0.01 per share; 40,000,000 shares authorized; 21,227,094 shares issued; and 18,477,784 shares outstanding		212			212
Additional paid-in capital		17,428			17,103
Retained earnings		77,729			70,924
Less: Treasury Stock, at cost (2,749,310 shares)		(17,067	)		(17,067	)
TOTAL STOCKHOLDERS' EQUITY		78,302			71,172
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	101,360		$	85,908

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)

	Three Months ended December 31,
	2019			2018
	(in thousands, except share and per share data)
Net sales:
Equipment revenues	$	20,045		$	20,685
Service revenues		5,784			4,144
		25,829			24,829
Cost of sales:
Equipment related expenses		12,602			13,203
Service related expenses		1,100			955
		13,702			14,158
Gross Profit		12,127			10,671

Research and development		1,823			1,762
Selling, general, and administrative expenses		6,310			5,615

Operating Income		3,994			3,294
Other (income) expense:
Interest (income) expense, net		(9	)		6

Income before Provision for Income Taxes		4,003			3,288
Provision for Income Taxes		431			419

Net Income	$	3,572		$	2,869

Income per share:
Basic	$	0.19		$	0.15
Diluted	$	0.19		$	0.15

Weighted average number of shares outstanding:
Basic		18,478,000			18,603,000
Diluted		18,538,000			18,649,000

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)

	Six Months ended December 31,
	2019			2018
	(in thousands, except share and per share data)
Net sales:
Equipment revenues	$	40,966		$	40,275
Service revenues		11,148			7,930
		52,114			48,205
Cost of sales:
Equipment related expenses		26,240			26,210
Service related expenses		2,229			1,765
		28,469			27,975
Gross Profit		23,645			20,230
Research and development		3,572			3,507
Selling, general, and administrative expenses		12,470			11,670
Operating Income		7,603			5,053
Other (income) expense:
Interest (income) expense, net		(2	)		13
Income before Provision for Income Taxes		7,605			5,040
Provision for Income Taxes		800			667
Net Income	$	6,805		$	4,373

Income per share:
Basic	$	0.37		$	0.23
Diluted	$	0.37		$	0.23

Weighted average number of shares outstanding:
Basic		18,478,000			18,665,000
Diluted		18,537,000			18,713,000

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (unaudited)

	Six months ended December 31, 2019 (in thousands, except share data)
	Common Stock						Treasury Stock
	Number of Shares Issued		Amount		Additional Paid-in Capital		Number of Shares			Amount			Retained Earnings		Total
Balances at June 30, 2019		21,227,094	$	212	$	17,103		(2,749,310	)	$	(17,067	)	$	70,924	$	71,172
Net income		--		--		--		--			--			3,233		3,233
Stock-based compensation expense		--		--		17		--			--			--		17
Balances at September 30, 2019		21,227,094	$	212	$	17,120		(2,749,310	)	$	(17,067	)	$	74,157	$	74,422
Net income		--		--		--		--			--			3,572		3,572
Stock-based compensation expense		--		--		308		--			--			--		308
Balances at December 31, 2019		21,227,094	$	212	$	17,428		(2,749,310	)	$	(17,067	)	$	77,729	$	78,302

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (unaudited)

	Six months ended December 31, 2018 (in thousands, except share data)
	Common Stock						Treasury Stock
	Number of Shares Issued		Amount		Additional Paid-in Capital		Number of Shares			Amount			Retained Earnings			Total
Balances at June 30, 2018		21,204,327	$	212	$	16,890		(2,475,245	)	$	(13,069	)	$	59,420		$	63,453
Net income		-		-		-		-			-			1,504			1,504
Implementation of ASC606 (see Note 2)		-		-		-		-			-			(719	)		(719	)
Repurchase of Treasury Shares		-		-		-		(39,163	)		(549	)		-			(549	)
Stock Options Exercised		2,500		-		15		-			-			-			15
Stock-based compensation expense		-		-		5		-			-			-			5
Balances at September 30, 2018		21,206,827	$	212	$	16,910		(2,514,408	)	$	(13,618	)	$	60,205		$	63,709
Net income		-		-		-		-			-			2,869			2,869
Repurchase of Treasury Shares		-		-		-		(147,230	)		(2,089	)		-			(2,089	)
Stock Options Exercised		12,515		-		9		-			-			-			9
Stock-based compensation expense		-		-		147		-			-			-			147
Balances at December 31, 2018		21,219,342	$	212	$	17,066		(2,661,638	)	$	(15,707	)	$	63,074		$	64,645

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

	Six Months ended December 31,
	2019			2018
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	6,805		$	4,373
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		744			668
Provision for (recovery) doubtful accounts		39			(13	)
Deferred income taxes		491			100
Stock-based compensation expense		325			152
Changes in operating assets and liabilities:
Accounts receivable		2,833			4,671
Inventories		(7,068	)		(4,608	)
Prepaid expenses and other current assets		218			565
Other assets		--			(11	)
Accounts payable, accrued expenses, accrued salaries and wages, accrued income taxes		426			449
Net Cash Provided by Operating Activities		4,813			6,346
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant, and equipment		(1,063	)		(1,119	)
Net Cash Used in Investing Activities		(1,063	)		(1,119	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from stock option exercises		--			24
Cash paid for purchase of treasury stock		--			(2,638	)
Net Cash Used in Financing Activities		--			(2,614	)
Net Change in Cash and Cash Equivalents		3,750			2,613
CASH AND CASH EQUIVALENTS - Beginning		8,028			5,308
CASH AND CASH EQUIVALENTS - Ending	$	11,778		$	7,921
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid	$	18		$	17
Income taxes paid	$	734		$	258

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

DECEMBER 31, 2019

NOTE 1 - Nature of Business and Summary of Significant Accounting Policies

Nature of Business:

Napco Security Technologies, Inc. and Subsidiaries (the "Company") is a diversified manufacturer of security products, encompassing access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products for commercial and residential use. The Company also provides wireless communication service for intrusion and fire alarm systems. These products are used for commercial, residential, institutional, industrial and governmental applications, and are sold worldwide principally to independent distributors, dealers and installers of security equipment.

The Company's fiscal year begins on July 1 and ends on June 30. Historically, the end users of the Company's products want to install its products prior to the summer; therefore sales of its products historically peak in the period April 1 through June 30, the Company's fiscal fourth quarter, and are reduced in the period July 1 through September 30, the Company's fiscal first quarter. In addition, demand is affected by the housing and construction markets.

Significant Accounting Policies:

Principles of Consolidation

The unaudited condensed consolidated financial statements of the Company, including these notes, have been prepared by the Company in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations promulgated by the U.S. Securities and Exchange Commission (the “SEC”). Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been omitted or condensed. However, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended June 30, 2019 and the notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on September 13, 2019. Results of consolidated operations for the interim periods are not necessarily indicative of a full year’s operating results. The unaudited condensed consolidated financial statements include the accounts of Napco Security Technologies, Inc. and all of its wholly-owned subsidiaries. All inter-company balances and transactions have been eliminated in consolidation.

Accounting Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent gains and losses at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Critical estimates include management's judgments associated with reserves for sales returns and allowances, allowance for doubtful accounts, inventory reserves, intangible assets and income taxes. Actual results could differ from those estimates.

Fair Value of Financial Instruments

The methods and assumptions used to estimate the fair value of the following classes of financial instruments were: Current Assets and Current Liabilities - The carrying amount of cash and cash equivalents, certificates of deposits, current receivables and payables and certain other short-term financial instruments approximate their fair value as of December 31, 2019 and June 30, 2019 due to their short-term maturities.

Cash and Cash Equivalents

Cash and cash equivalents include approximately $460,000 of short-term time deposits at December 31, 2019 and June 30, 2019. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company has cash balances in banks in excess of the maximum amount insured by the Federal Deposit Insurance Corporation (“FDIC”) and other international agencies as of December 31, 2019 and June 30, 2019. The Company has not historically experienced any credit losses with balances in excess of FDIC limits.

Accounts Receivable

Accounts receivable is stated net of the allowances for doubtful accounts of $127,000 as of December 31, 2019 and $88,000 at June 30, 2019. Our allowances for doubtful accounts are subjective critical estimates that have a direct impact on reported net earnings. These allowances are based upon the evaluation of our accounts receivable aging, specific exposures, sales levels and historical trends.

Inventories

Inventories are valued at the lower of cost or net realizable value, with cost being determined on the first-in, first-out (“FIFO”) method. The reported net value of inventory includes finished saleable products, work-in-process and raw materials that will be sold or used in future periods. Inventory costs include raw materials, direct labor and overhead. The Company’s overhead expenses are applied based, in part, upon estimates of the proportion of those expenses that are related to procuring and storing raw materials as compared to the manufacture and assembly of finished products. These proportions, the method of their application, and the resulting overhead included in ending inventory, are based in part on subjective estimates and actual results could differ from those estimates.

In addition, the Company records an inventory obsolescence reserve, which represents any excess of the cost of the inventory over its estimated realizable value, based on various product sales projections. This reserve is calculated using an estimated obsolescence percentage applied to the inventory based on age, historical trends, requirements to support forecasted sales, and the ability to find alternate applications of its raw materials and to convert finished product into alternate versions of the same product to better match customer demand. In addition, and as necessary, the Company may establish specific reserves for future known or anticipated events. There is inherent professional judgment and subjectivity made by both production and engineering members of management in determining the estimated obsolescence percentage.

The Company also regularly reviews the period over which its inventories will be converted to sales. Any inventories expected to convert to sales beyond 12 months from the balance sheet date are classified as non-current.

Property, Plant, and Equipment

Property, plant, and equipment are carried at cost less accumulated depreciation. Expenditures for maintenance and repairs are charged to expense as incurred; costs of major renewals and improvements are capitalized. At the time property and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are eliminated from the asset and accumulated depreciation accounts and the profit or loss on such disposition is reflected in income.

Depreciation is recorded over the estimated service lives of the related assets using primarily the straight-line method. Amortization of leasehold improvements is calculated by using the straight-line method over the estimated useful life of the asset or lease term, whichever is shorter.

Intangible Assets

Intangible assets determined to have indefinite lives are not amortized but are tested for impairment at least annually. Intangible assets with definite lives are amortized over their useful lives. Indefinite-lived intangible assets are reviewed for impairment at least annually at the Company’s fiscal year end of June 30 or more often whenever there is an indication that the carrying amount may not be recovered.

The Company’s acquisition of substantially all of the assets and certain liabilities of G. Marks Hardware, Inc. (“Marks”) in August 2008 included intangible assets recorded at fair value on the date of acquisition. The customer relationships are amortized over their estimated useful lives of twenty years. The Marks trade name was deemed to have an indefinite life.

Changes in intangible assets are as follows (in thousands):

	December 31, 2019							June 30, 2019
	Cost		Accumulated amortization			Net book value		Cost		Accumulated amortization			Net book value
Customer relationships	$	9,800	$	(8,600	)	$	1,200	$	9,800	$	(8,468	)	$	1,332
Trade name		5,900		--			5,900		5,900		--			5,900
	$	15,700	$	(8,600	)	$	7,100	$	15,700	$	(8,468	)	$	7,232

Amortization expense for intangible assets subject to amortization was approximately $66,000 and $79,000 for the three months ended December 31, 2019 and 2018, respectively. Amortization expense for intangible assets subject to amortization was approximately $132,000 and $157,000 for the six months ended December 31, 2019 and 2018, respectively. Amortization expense for each of the next five fiscal years is estimated to be as follows: 2020 -$264,000; 2021 - $223,000; 2022 - $188,000; 2023 - $159,000 and 2024 - $134,000. The remaining weighted average amortization period for intangible assets was 8.6 years and 9.6 years at December 31, 2019 and 2018, respectively.

Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets in question may not be recoverable. Impairment would be recorded in circumstances where undiscounted cash flows expected to be generated by an asset are less than the carrying value of that asset.

Leases

Effective July 1, 2019, in accordance with Accounting Standards Codification (“ASC”), Topic 842, Leases at the inception of a contract, we assess whether the contract is, or contains, a lease. The assessment is based on (1) whether the contract involves the use of a distinct identified asset, (2) whether the Company obtains the right to substantially all the economic benefit from the use of the asset throughout the period, and (3) whether the Company has the right to direct the use of the asset.

All significant lease arrangements are generally recognized at lease commencement. Operating lease right-of-use (“ROU”) assets and lease liabilities are recognized at commencement. An ROU asset and corresponding lease liability are not recorded for leases with an initial term of 12 months or less (short term leases) and we recognize lease expense for these leases as incurred over the lease term.

ROU assets represent our right to use an underlying asset during the reasonably certain lease term and lease liabilities represent our obligation to make lease payments arising from the lease. We primarily use our incremental borrowing rate based on information available at the lease commencement date, in determining the present value of lease payments. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option.

Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Lease payments may be fixed or variable, however, only fixed payments or in-substance fixed payments are included in determining the lease liability. See Note 11 – Commitments for additional accounting policies and transition disclosures.

Revenue Recognition

The Company recognizes revenue when its customers obtain control of its products or services, in an amount that reflects the consideration that the Company expects to receive in exchange for those goods and services. See Note 2 – Revenue Recognition for additional accounting policies and transition disclosures.

Advertising and Promotional Costs

Advertising and promotional costs are included in "Selling, General and Administrative" expenses in the consolidated statements of income and are expensed as incurred. Advertising expense for the three months ended December 31, 2019 and 2018 was $627,000 and $435,000, respectively. Advertising expense for the six months ended December 31, 2019 and 2018 was $1,141,000 and $1,085,000, respectively.

Research and Development Costs

Research and development costs incurred by the Company are charged to expense as incurred and are included in operating expenses in the consolidated statements of income. Company-sponsored research and development expense for the three months ended December 31, 2019 and 2018 was $1,823,000 and $1,762,000, respectively. Company-sponsored research and development expense for the three months ended December 31, 2019 and 2018 was $3,572,000 and $3,507,000, respectively.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company measures and recognizes the tax implications of positions taken or expected to be taken in its tax returns on an ongoing basis.

Net Income per Share

Basic net income per common share (“Basic EPS”) is computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per common share (“Diluted EPS”) is computed by dividing net income by the weighted average number of common shares and dilutive common share equivalents and convertible securities then outstanding.

The following provides a reconciliation of information used in calculating the per share amounts for the three months ended December 31 (in thousands, except per share data):

	Net Income				Weighted Average Shares				Net Income per Share
	2019		2018		2019		2018		2019		2018
Basic EPS	$	3,572	$	2,869		18,478		18,603	$	0.19	$	0.15
Effect of Dilutive Securities:
Stock Options		--		--		60		46		--		--
Diluted EPS	$	3,572	$	2,869		18,538		18,649	$	0.19	$	0.15

Options to purchase 36,000 and 11,826 shares of common stock were excluded for the three months ended December 31, 2019 and 2018, respectively were not included in the computation of Diluted EPS because their inclusion would be anti-dilutive. These options were still outstanding at the end of the respective periods.

The following provides a reconciliation of information used in calculating the per share amounts for the six months ended December 31 (in thousands, except per share data):

	Net Income				Weighted Average Shares				Net Income per Share
	2019		2018		2019		2018		2019		2018
Basic EPS	$	6,805	$	4,373		18,478		18,665	$	0.37	$	0.23
Effect of Dilutive Securities:
Stock Options		--		--		59		48		--		--
Diluted EPS	$	6,805	$	4,373		18,537		18,713	$	0.37	$	0.23

Options to purchase 18,000 and 5,913 shares of common stock were excluded for the six months ended December 31, 2019 and 2018, respectively were not included in the computation of Diluted EPS because their inclusion would be anti-dilutive. These options were still outstanding at the end of the respective periods.

Stock-Based Compensation

The Company has established three share incentive programs as discussed in Note 8.

Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the vesting period. Determining the fair value of share-based awards at the grant date requires assumptions and judgments about expected volatility and forfeiture rates, among other factors.

Stock-based compensation costs of $308,000 and $147,000 were recognized for the three months ended December 31, 2019 and 2018, respectively. Stock-based compensation costs of $325,000 and $152,000 were recognized for the six months ended December 31, 2019 and 2018, respectively.

Foreign Currency

The Company has determined the functional currency of all foreign subsidiaries is the U.S Dollar. All foreign operations are considered a direct and integral part or extension of the Company's operations. The day-to-day operations of all foreign subsidiaries are dependent on the economic environment of the U.S Dollar. Therefore, no realized or unrealized gains and losses associated with foreign currency translation are recorded for the six months ended December 31, 2019 or 2018.

Comprehensive Income

For the six months ended December 31, 2019 and 2018, the Company's operations did not give rise to material items includable in comprehensive income, which were not already included in net income. Accordingly, the Company's comprehensive income approximates its net income for all periods presented.

Segment Reporting

The Company’s reportable operating segments are determined based on the Company's management approach. The management approach is based on the way that the chief operating decision maker organizes the segments within an enterprise for making operating decisions and assessing performance. The Company's results of operations are reviewed by the chief operating decision maker on a consolidated basis and the Company operates in only one segment. The Company has presented required geographical data in Note 12.

Shipping and Handling Revenues and Costs

The Company records the amount billed to customers for shipping and handling in net sales ($108,000 and $103,000 in the three months ended December 31, 2019 and 2018, respectively and $220,000 and $204,000 in the six months ended December 31, 2019 and 2018, respectively) and classifies the costs associated with these revenues in cost of sales ($271,000 and $265,000 in the three months ended December 31, 2019 and 2018, respectively and $531,000 and $547,000 in the six months ended December 31, 2019 and 2018, respectively).

Recently Issued and Adopted Accounting Standards

On July 1, 2019, we adopted Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), as amended, which supersedes the lease accounting guidance under Topic 840, and generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We adopted the new guidance using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application and not restating comparative periods. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases. For information regarding the impact of Topic 842 adoption, see Significant Accounting Policies - Leases and Note 11- Leases.

NOTE 2 – Revenue Recognition and Contracts with Customers

On July 1, 2018, the Company adopted new guidance on revenue from contracts with customers using the modified retrospective method applied to contracts that were not completed as of July 1, 2018. Results for reporting periods beginning after July 1, 2018 are presented under the new guidance, while prior period amounts are not adjusted and continue to be reported in accordance with previous guidance.

The Company recorded a net decrease to opening retained earnings of approximately $719,000 (net of tax benefit of $191,000) as of July 1, 2018, for the cumulative impact of adopting the new guidance. The impact primarily related to the change in the recognition and measurement of certain types of variable consideration, which resulted in the increase in sales allowance reserves (i.e. refund liabilities) by a net of $1,627,000 and increased other assets (i.e. return related assets) by approximately $716,000. As of December 31, 2019, the Company included return-related assets of approximately $893,000 in other current assets.

Also, due to the adoption of the new standard, the Company classified certain reserves in respect of refund liabilities that were previously presented as a reduction from receivables, to current liabilities amounting to approximately $3,459,000 as of December 31, 2019. Further, amounts related to promotion payments to customers are now classified as a reduction of sales.

Net Sales

The Company is engaged in one major line of business: the development, manufacture, and distribution of security products, encompassing access control systems, door security products, intrusion and fire alarm systems, alarm communication services, and video surveillance products for commercial and residential use. The Company also provides wireless communication service for intrusion and fire alarm systems on a monthly basis. These products are used for commercial, residential, institutional, industrial and governmental applications, and are sold worldwide principally to independent distributors, dealers and installers of security equipment. Sales to unaffiliated customers are primarily shipped from the United States. The Company has customers worldwide with major concentrations in North America.

Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services.

For product sales the Company typically transfers control at a point in time upon shipment or delivery of the product. For monthly communication services the Company satisfies its performance obligation as the services are rendered and therefore recognizes revenue over the monthly period.

Typically timing of revenue recognition coincides with the timing of invoicing to the customers, at which time the Company has an unconditional right to consideration. As such, the Company typically records a receivable when revenue is recognized.

The contract with the customer states the final terms of the sale, including the description, quantity, and price of each product purchased. Payment for product sales is typically due within 30 and 180 days of the delivery date. Payment for monthly communication services is billed on a monthly basis and is typically due at the beginning of the month of service.

The Company provides limited standard warranty for defective products, usually for a period of 24 to 36 months. The Company accepts returns for such defective products as well as for other limited circumstances. The Company also provides rebates to customers for meeting specified purchasing targets and other coupons or credits in limited circumstances. The Company establishes reserves for the estimated returns, rebates and credits and measures such variable consideration based on the expected value method using an analysis of historical data. Changes to the estimated variable consideration in subsequent periods are not material.

The Company analyzes sales returns and is able to make reasonable and reliable estimates of product returns based on the Company’s past history. Estimates for sales returns are based on several factors including actual returns and based on expected return data communicated to it by its customers. Accordingly, the Company believes that its historical returns analysis is an accurate basis for its allowance for sales returns. Actual results could differ from those estimates. As a percentage of gross sales, sales returns, rebates and allowances were 9% and 5% for the three months ended December 31, 2019 and 2018, respectively. As a percentage of gross sales, sales returns, rebates and allowances were 11% and 7% for the six months ended December 31, 2019 and 2018, respectively.

In accordance with ASC 606-10-50, the Company disaggregates revenue from contracts with customers into major product lines. The Company determines that disaggregating revenue into these categories achieves the disclosure objective to depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. As noted in the accounting policy footnote, the Company’s business consists of one operating segment. Following is the disaggregation of revenues based on major product lines (in thousands):

	Three months ended December 31,				Six months ended December 31,
	2019		2018		2019		2018
Major Product Lines:
Intrusion and Access alarm products	$	7,772	$	7,724	$	15,786	$	14,815
Door locking devices		12,273		12,961		25,180		25,460
Services		5,784		4,144		11,148		7,930
Total Revenues	$	25,829	$	24,829	$	52,114	$	48,205

NOTE 3 - Business and Credit Concentrations

An entity is more vulnerable to concentrations of credit risk if it is exposed to risk of loss greater than it would have had if it mitigated its risk through diversification of customers. Such risks of loss manifest themselves differently, depending on the nature of the concentration, and vary in significance. The Company had one customer with an accounts receivable balance that comprised 21% and 19% of the Company’s accounts receivable at December 31, 2019 and June 30, 2019, respectively. Sales to this customer comprised 8% and 10% of net sales in the three and six months ended December 31, 2019, respectively. Sales to this customer comprised 12% and 11% of net sales in the three and six months ended December 31, 2018, respectively. The Company had another customer with an accounts receivable balance that comprised 12% and 11% of the Company’s accounts receivable at December 31, 2019 and June 30, 2019, respectively. Sales to this customer did not exceed 10% of net sales in either of the three or six months ended December 31, 2019 or 2018.

NOTE 4 - Inventories

Inventories, net of reserves are valued at lower of cost (first-in, first-out method) or net realizable value. The Company regularly reviews parts and finished goods inventories on hand and, when necessary, records a provision for excess or obsolete inventories. The Company also regularly reviews the period over which its inventories will be converted to sales. Any inventories expected to convert to sales beyond 12 months from the balance sheet date are classified as non-current.

Inventories, net of reserves consist of the following (in thousands):

	December 31, 2019		June 30, 2019
Component parts	$	25,914	$	21,543
Work-in-process		6,468		5,377
Finished products		9,524		7,918
	$	41,906	$	34,838

Classification of inventories, net of reserves (in thousands):

Current	$	34,740	$	29,576
Non-current		7,166		5,262
	$	41,906	$	34,838

NOTE 5 – Property, Plant and Equipment

Property, plant and equipment consist of the following (in thousands):

	December 31, 2019			June 30, 2019			Useful Life in Years

Land	$	904		$	904		--
Buildings		8,911			8,911		30 to 40
Molds and dies		7,337			7,333		3 to 5
Furniture and fixtures		2,695			2,691		5 to 10
Machinery and equipment		24,489			23,915		7 to 10
Leasehold improvements		2,106			1,625		Shorter of the lease term or life of asset
		46,442			45,379
Less: accumulated depreciation and amortization		(38,291	)		(37,685	)
	$	8,151		$	7,694

Depreciation and amortization expense on property, plant, and equipment was approximately $311,000 and $259,000 for the three months ended December 31, 2019 and 2018, respectively. Depreciation and amortization expense on property, plant, and equipment was approximately $606,000 and $506,000 for the six months ended December 31, 2019 and 2018, respectively.

NOTE 6 - Income Taxes

The provision for income taxes represents Federal, foreign, and state and local income taxes. The effective rate differs from statutory rates due to the effect of state and local income taxes, tax rates in foreign jurisdictions, global intangible low-taxed income (“GILTI”), tax benefit of R&D credits and certain nondeductible expenses. Our effective tax rate will change from quarter to quarter based on recurring and non-recurring factors including, but not limited to, the geographical mix of earnings, enacted tax legislation, and state and local income taxes. In addition, changes in judgment from the evaluation of new information resulting in the recognition de-recognition or re-measurement of a tax position taken in a prior annual period is recognized separately in the quarter of the change.

On December 22, 2017, the U.S. government passed the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act is comprehensive tax legislation effective January 1, 2018 that implements complex changes to the U.S. tax code including, but not limited to, the reduction of the corporate tax rate from 35% to 21% and includes provisions to tax GILTI. We were subject to the GILTI provisions effective for the fiscal year ended June 30, 2019. The Tax Act also imposed a one-time transition tax on its unremitted foreign earnings. ASC 740 requires filers to record the effects of tax law changes in the period enacted. However, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”), that permits filers to record provisional amounts during a measurement period ending no later than one year from the date of the Act’s enactment. As of March 31, 2019, the Company finalized its accounting for the income tax effects of the Tax Act and no additional expense was recorded since the final transition tax expense was equal to the $381,000 provisional expense reported in the fiscal year ended June 30, 2018. The net section 965 tax liability was $442,000 which is payable over 8 years.

For the six months ended December 31, 2019, the Company recognized a net income tax expense of $800,000. During the six months ended December 31, 2019, the Company increased its reserve for uncertain income tax positions by $45,000. The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense and accrued income taxes. As of December 31, 2019, the Company had accrued interest totaling $0 as well as $171,000 of unrecognized net tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in any future period. The Company claims R&D tax credits on eligible development R&D expenditures. The R&D tax credits are recognized as a reduction to income tax expense.

The Company does not expect that our unrecognized tax benefits will significantly change within the next twelve months. We file a consolidated U.S. income tax return and tax returns in certain state and local and foreign jurisdictions. As of December 31, 2019, we remain subject to examination in all tax jurisdictions for all relevant jurisdictional statutes for fiscal years 2016 and thereafter.

In January 2020, the Company received a letter from the IRS (“IRS”) notifying it that the IRS would be examining the Company’s income tax return for fiscal year ended June 30, 2017. Management believes that its provision for income taxes for this period is adequate. However, the outcome cannot be predicted with certainty.

In July 2019, the Company received a Form 4549-A, Income Tax Examination Changes (“IRS Notice”) from the IRS proposing an adjustment to income for the fiscal 2016 tax year regarding deemed dividends based on its interpretation under Internal Revenue Code (“IRC”) Section 956 arising from the intercompany balances on the books of the Company. The incremental tax liability associated with the income adjustment proposed in the IRS Notice would be approximately $1.8 million, excluding any interest and penalties. The Company filed a protest with the IRS in August 2019. The Company believes that the position of the IRS with regard to this matter is inconsistent with the provisions of the IRC Section 956 and management believes that the Company will prevail, and that the tax originally paid in fiscal 2016 is correct, as such no additional reserve for this tax uncertainty has been recognized. However, there can be no assurance that this matter will ultimately be resolved in the Company's favor.

The Company has identified its U.S. Federal income tax return and its State return in New York as its major tax jurisdictions.

NOTE 7 - Long-Term Debt

As of December 31, 2019, long-term debt consisted of a revolving line of credit of $11,000,000 (“Agreement”), which expires in June 2021. There were no outstanding borrowings under the revolving line of credit at December 31, 2019 or June 30, 2019.

The Agreement also provides for an interest rate option of London Interbank Offered Rate (“LIBOR”) plus 1.15% to 2.00%, depending on the ratio of outstanding debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”), which is to be measured and adjusted quarterly, a prime rate-based option of the prime rate plus 0.25% and other terms and conditions as more fully described in the Agreement. In addition, the Agreement provides for availability to be limited to the lesser of $11,000,000 or the result of a borrowing base formula based upon the Company’s Accounts Receivables and Inventory values net of certain deductions. The Company’s obligations under the Agreement continue to be secured by all of its assets, including but not limited to, deposit accounts, accounts receivable, inventory, and the Company’s corporate headquarters in Amityville, NY, equipment and fixtures and intangible assets. In addition, the Company’s wholly-owned subsidiaries, with the exception of the Company’s foreign subsidiaries, have issued guarantees and pledges of all of their assets to secure the Company’s obligations under the Agreement. All of the outstanding common stock of the Company’s domestic subsidiaries and 65% of the common stock of the Company’s foreign subsidiaries has been pledged to secure the Company’s obligations under the Agreement.

The Agreement contains various restrictions and covenants including, among others, restrictions on payment of dividends, restrictions on borrowings and compliance with certain financial ratios, as defined in the Agreement.

NOTE 8 - Stock Options

The Company follows ASC Topic 718, “Compensation-Stock Compensation”, which requires that all share based payments to employees, including stock options, be recognized as compensation expense in the consolidated financial statements based on their fair values and over the requisite service period. The Company recorded non-cash compensation expense relating to stock-based compensation of $308,000 and $147,000 for the three months ended December 31, 2019 and 2018, respectively ($.02 and $0.00 per basic and diluted share for each period, respectively) and $325,000 and $152,000 for the six months ended December 31, 2019 and 2018, respectively ($.02 and $0.00 per basic and diluted share for each period, respectively).

2012 Employee Stock Option Plan

In December 2012, the stockholders approved the 2012 Employee Stock Option Plan (“2012 Employee Plan”). The 2012 Employee Plan authorizes the granting of awards, the exercise of which would allow up to an aggregate of 950,000 shares of the Company's common stock to be acquired by the holders of such awards. Under this plan, the Company may grant stock options, which are intended to qualify as incentive stock options (“ISOs”), to valued employees. Any plan participant who is granted ISOs and possesses more than 10% of the voting rights of the Company's outstanding common stock must be granted an option with a price of at least 110% of the fair market value on the date of grant.

Under the 2012 Employee Plan, stock options may be granted to valued employees with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable, in whole or in part, at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a “change in control” as defined in the plan. At December 31, 2019, 100,500 stock options were outstanding, 48,400 stock options were exercisable and 764,900 stock options were available for grant under this plan.

The fair value of each option granted during the six months ended December 31 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	2019		2018
Risk-free interest rates		1.80% - 2.10%		3.10%
Expected lives		10 years		10 years
Expected volatility		45% - 46%		52%
Expected dividend yields		0%		0%

The following table reflects activity under the 2012 Employee Plan for the six months ended December 31,:

	2019				2018
	Options		Weighted average exercise price		Options			Weighted average exercise price
Outstanding, beginning of year		72,500	$	11.01		57,200		$	7.09
Granted		28,000		30.13		24,000			15.28
Exercised		--		--		(9,500	)		5.97
Outstanding, end of period		100,500	$	16.34		71,700		$	9.98
Exercisable, end of period		48,400	$	11.10		36,500		$	7.84
Weighted average fair value at grant date of options granted	$	16.57			$	8.76
Total intrinsic value of options exercised	$	--			$	104,000
Total intrinsic value of options outstanding	$	1,359,000			$	417,000
Total intrinsic value of options exercisable	$	895,000			$	290,000

0 and 9,500 stock options were exercised during the six months ended December 31, 2019 and 2018, respectively. $0 and $24,000 of cash was received from option exercises during the six months ended December 31, 2019 and 2018, respectively, and the actual tax benefit realized for the tax deductions from option exercises was $0 and $13,000, respectively.

The following table summarizes information about stock options outstanding under the 2012 Employee Plan at December 31, 2019:

	Options outstanding						Options exercisable
Range of exercise prices	Number outstanding		Weighted average remaining contractual life		Weighted average exercise price		Number exercisable		Weighted average exercise price
$4.37-$33.59		100,500		7.8	$	16.34		48,400	$	11.10
		100,500		7.8	$	16.34		48,400	$	11.10

As of December 31, 2019, there was $564,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2012 Employee Plan. 28,000 and 24,000 options were granted during the six months ended December 31, 2019 and 2018, respectively. 13,000 and 12,800 options vested during the three months ended December 31, 2019 and 2018, respectively. 14,600 and 800 options vested during the six months ended December 31, 2019 and 2018, respectively. The total fair value of the options vesting during the three months ended December 31, 2019 and 2018 under this plan was $133,000 and $26,000, respectively. The total fair value of the options vesting during the six months ended December 31, 2019 and 2018 under this plan was $150,000 and $39,000, respectively.

2012 Non-Employee Stock Option Plan

In December 2012, the stockholders approved the 2012 Non-Employee Stock Option Plan (the “2012 Non-Employee Plan”). This plan authorizes the granting of awards, the exercise of which would allow up to an aggregate of 50,000 shares of the Company's common stock to be acquired by the holders of such awards. Under this plan, the Company may grant stock options to non-employee directors and consultants to the Company and its subsidiaries.

Under the 2012 Non-Employee Plan, stock options may be granted with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable in whole or in part at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a “change in control” as defined in the plan. At December 31, 2019, 10,200 stock options were outstanding, 5,400 stock options were exercisable and no further stock options were available for grant under this plan.

The following table reflects activity under the 2012 Non-Employee Plan for the six months ended December 31,:

	2019				2018
	Options		Weighted average exercise price		Options		Weighted average exercise price
Outstanding, beginning of year		10,200	$	7.99		27,800	$	6.85
Exercised		--		--		11,000		5.36
Outstanding, end of period		10,200	$	7.99		16,800	$	7.83
Exercisable, end of period		5,400	$	7.35		7,800	$	6.83
Weighted average fair value at grant date of options granted		n/a				n/a
Total intrinsic value of options exercised		n/a			$	120,000
Total intrinsic value of options outstanding	$	218,000			$	133,000
Total intrinsic value of options exercisable	$	119,000			$	70,000

0 and 11,000 stock options were exercised during the six months ended December 31, 2019 and 2018, respectively. No cash was received from option exercises during either of the six months ended December 31, 2019 or 2018 and the actual tax benefit realized for the tax deductions from option exercises was $0 and $28,000, respectively.

The following table summarizes information about stock options outstanding under the 2012 Non-Employee Plan at December 31, 2019:

	Options outstanding						Options exercisable
Range of exercise prices	Number outstanding		Weighted average remaining contractual life		Weighted average exercise price		Number exercisable		Weighted average exercise price
$4.37 - $8.70		10,200		7.3	$	7.99		5,400	$	7.35
		10,200		7.3	$	7.99		5,400	$	7.35

As of December 31, 2019, there was $23,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2012 Non-Employee Plan. No options were granted during either of the six months ended December 31, 2019 or 2018. 2,400 and 5,000 options vested during the three and six months ended December 31, 2019 and 2018, respectively. The total fair value of the options vesting during the three and six months ended December 31, 2019 and 2018 under this plan was $13,000 and $22,000, respectively.

2018 Non-Employee Stock Option Plan

In December 2018, the stockholders approved the 2018 Non-Employee Stock Option Plan (the “2018 Non-Employee Plan”). This plan authorizes the granting of awards, the exercise of which would allow up to an aggregate of 50,000 shares of the Company's common stock to be acquired by the holders of such awards. Under this plan, the Company may grant stock options to non-employee directors and consultants to the Company and its subsidiaries.

Under the 2018 Non-Employee Plan, stock options may be granted with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable in whole or in part at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a “change in control” as defined in the plan. At December 31, 2019, 31,200 stock options were outstanding, 6,400 stock options were exercisable and 14,000 stock options were available for grant under this plan.

	2019		2018
Risk-free interest rates		1.80%		2.9%
Expected lives		10 years		10 years
Expected volatility		45%		50%
Expected dividend yields		0%		0%

The following table reflects activity under the 2018 Non-Employee Plan for the six months ended December 31,:

	2019				2018
	Options		Weighted average exercise price		Options		Weighted average exercise price
Outstanding, beginning of year		15,200	$	16.20		--	$	--
Granted		16,000		30.54		20,000		16.20
Outstanding, end of period		31,200	$	23.55		20,000	$	16.20
Exercisable, end of period		8,800	$	21.41		4,000	$	16.20
Weighted average fair value at grant date of options granted	$	17.40			$	10.24
Total intrinsic value of options exercised		n/a				n/a
Total intrinsic value of options outstanding	$	200,000			$	--
Total intrinsic value of options exercisable	$	74,000			$	--

No stock options were exercised during the six months ended December 31, 2019 or 2018. No cash was received from option exercises during either of the six months ended December 31, 2019, 2019 or 2018 and the actual tax benefit realized for the tax deductions from option exercises was $0 for each of these periods.

The following table summarizes information about stock options outstanding under the 2018 Non-Employee Plan at December 31, 2019:

	Options outstanding						Options exercisable
Range of exercise prices	Number outstanding		Weighted average remaining contractual life		Weighted average exercise price		Number exercisable		Weighted average exercise price
$16.20-$30.54		31,200		9.4	$	23.55		8,800	$	21.41
		31,200		9.4	$	23.55		8,800	$	21.41

As of December 31, 2019, there was $299,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2018 Non-Employee Plan. 16,000 and 20,000 options were granted during the six months ended December 31, 2019 and 2018, respectively. 6,400 and 4,000 options vested during the three and six months ended December 31, 2019 and 2018, respectively. The total fair value of the options vested during the three and six months ended December 31, 2019 and 2018 under this plan was $88,000 and $41,000, respectively.

NOTE 9 – Stockholders’ Equity Transactions

On September 16, 2014, the Company’s board of directors authorized the repurchase of up to 1 million of the approximately 19.4 million shares of the Company’s common stock outstanding. On December 21, 2018, the Company’s board of directors authorized the repurchase of up to an additional 500,000 shares. As of December 31, 2019, there was an aggregate 434,725 shares that may yet be purchased under the two repurchase plans. The repurchase will be made from time to time in the open market or in privately negotiated transactions subject to market conditions and the market price of the common stock. The Company did not repurchase any of its outstanding common stock during the six months ended December 31, 2019. Shares repurchased under the two plans from inception through June 30, 2019 are included in the Company’s Treasury Stock as of December 31, 2019.

NOTE 10 - 401(k) Plan

The Company maintains a 401(k) plan (“the Plan”) that covers all U.S. non-union employees with one or more years of service and is qualified under Sections 401(a) and 401(k) of the Internal Revenue Code. Company contributions to this plan are discretionary and totaled $34,000 and $31,000 for the three months ended December 31, 2019 and 2018, respectively, and $64,000 and $65,000 for the six months ended December 31, 2019 and 2018, respectively.

NOTE 11 - Commitments and Contingencies

Leases

Effective July 1, 2019, the Company adopted the new lease accounting standard using the modified retrospective transition option of applying the new standard at the adoption date. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to not reassess (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) initial direct costs for any existing leases. Adoption of the new standard resulted in the recording of an operating ROU asset and lease liabilities of approximately $7.7 million. Given the length of the lease term, the right-of-use asset and corresponding liability assume a weighted discount rate as disclosed below. A change in the rate utilized could have a material effect on the amounts reported. Financial positions for reporting periods beginning on or after July 1, 2019 are presented under new guidance, while prior period amounts are not adjusted and continue to be reported in accordance with previous guidance.

Our lease obligation consists of a 99 year lease which commenced on April 26, 1993 with one of the Company’s foreign subsidiaries, expiring in 2092, for approximately four acres of land in the Dominican Republic at an annual cost of $288,000, on which the Company’s principal production facility is located.

Operating leases are included in operating lease right-of-use assets, accrued expenses and operating lease liabilities, non-current on our condensed consolidated balance sheets

For the three and six months ended December 31, 2019 cash payments against operating lease liabilities totaled $72,000 and $168,000, respectively.

Supplemental balance sheet information related to operating leases was as follows:

Weighted-average remaining lease term	72 years
Weighted-average discount rate	3.55%

The following is a schedule, by years, of maturities of lease liabilities as of December 31, 2019 (in thousands):

Year Ending June 30,	Amount
2020	$	143
2021		277
2022		268
2023		258
2024		256
Thereafter		6,211
Total	$	7,406

As previously disclosed in our 2019 Annual Report on Form 10-K and under the previous lease accounting standard, undiscounted future minimum lease payments for operating leases having initial or remaining non-cancellable lease terms in excess of one year are as follows (in thousands):

Year Ending June 30,	Amount
2020	$	315
2021		314
2022		311
2023		297
2024		288
Thereafter		19,536
Total	$	21,061

Operating lease expense totaled approximately $79,000 and $84,000, for the three months ended December 31, 2019 and 2018, respectively. Operating lease expense totaled approximately $158,000 and $167,000, for the six months ended December 31, 2019 and 2018, respectively.

Litigation

In the normal course of business, the Company is a party to claims and/or litigation. Management believes that the settlement of such claims and/or litigation, considered in the aggregate, will not have a material adverse effect on the Company's financial position and results of operations.

Employment and Severance Agreements

As of December 31, 2019, the Company was obligated under three employment agreements and one severance agreement. The employment agreements are with the Company’s CEO, Senior Vice President of Sales and Marketing (“the SVP of Sales”) and the Senior Vice President of Engineering (“the SVP of Engineering”). The employment agreement with the CEO provides for an annual salary of $806,000, as adjusted for inflation; incentive compensation as may be approved by the Board of Directors from time to time and a termination payment in an amount up to 299% of the average of the prior five calendar year's compensation, subject to certain limitations, as defined in the agreement. The employment agreement renews annually in August unless either party gives the other notice of non-renewal at least six months prior to the end of the applicable term. The employment agreement with the SVP of Sales expires in October 2022 and provides for an annual salary of $358,000 and provides for payment equal to nine months of salary and six months of health insurance in the event of a non-voluntary termination of employment without cause or for any reason within three months of a change in control of the Company. The employment agreement with the SVP of Engineering expires in August 2022 and provides for an annual salary of $334,000 and provides for payment equal to nine months of salary and six months of health insurance in the event of a non-voluntary termination of employment without cause or for any reason within three months of a change in control of the Company. The severance agreement is with the Senior Vice President of Operations and Finance and provides for, if terminated by the Company without cause or within three months of a change in corporate control of the Registrant, severance of nine month’s salary, continued company-sponsored health insurance for six months from the date of termination and certain non-compete and other restrictive provisions.

Note 12 – Geographical Data

The Company is engaged in one major line of business: the development, manufacture, and distribution of security products, encompassing access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products for commercial and residential use. The Company also provides wireless communication service for intrusion and fire alarm systems. These products are used for commercial, residential, institutional, industrial and governmental applications, and are sold worldwide principally to independent distributors, dealers and installers of security equipment. Sales to unaffiliated customers are primarily shipped from the United States. The Company has customers worldwide with major concentrations in North America.

Financial Information Relating to Domestic and Foreign Operations (in thousands)

	Three months ended December 31,				Six months ended December 31,
	2019		2018		2019		2018
Sales to external customers(1):
Domestic	$	25,236	$	24,013	$	51,055	$	46,886
Foreign		593		816		1,059		1,319

Total Net Sales	$	25,829	$	24,829	$	52,114	$	48,205

Identifiable assets:	December 31, 2019		June 30, 2019
United States	$	62,918	$	59,683
Dominican Republic (2)		38,442		26,225
Total Identifiable Assets	$	101,360	$	85,908

(1) All of the Company's sales originate in the United States and are shipped primarily from the Company's facilities in the United States. There were no sales into any one foreign country in excess of 10% of total Net Sales.

(2) Consists primarily of inventories (December 31, 2019 = $27,198, June 30, 2019 = $22,549) and long-lived assets (December 31, 2019 = $11,000, June 30, 2019 = $3,443) located at the Company's principal manufacturing facility in the Dominican Republic.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q and the information incorporated by reference may include "Forward-Looking Statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. The Company intends the Forward-Looking Statements to be covered by the Safe Harbor Provisions for Forward-Looking Statements. All statements regarding the Company's expected financial position and operating results, its business strategy, its financing plans and the outcome of any contingencies are Forward-Looking Statements. The Forward-Looking Statements are based on current estimates and projections about our industry and our business. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," or variations of such words and similar expressions are intended to identify such Forward-Looking Statements. The Forward-Looking Statements are subject to risks and uncertainties that could cause actual results to differ materially from those set forth or implied by any Forward-Looking Statements. For example, the Company is highly dependent on its Chief Executive Officer for strategic planning. If he is unable to perform his services for any significant period of time, the Company's ability to grow could be adversely affected. In addition, factors that could cause actual results to differ materially from the Forward-Looking Statements include, but are not limited to, uncertain economic, military and political conditions in the world, our ability to maintain and develop competitive products, adverse tax consequences of offshore operations, the ability to maintain adequate financing and significant fluctuations in the exchange rate between the Dominican Peso and the U.S. Dollar. The Company’s Risk Factors are discussed in more detail in Item 1A in the Company’s 2019 Annual Report on Form 10-K.

Overview

The Company is a diversified manufacturer of security products, encompassing access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products for commercial and residential use. The Company also provides wireless communication service for intrusion and fire alarm systems. These products are used for commercial, residential, institutional, industrial and governmental applications, and are sold worldwide principally to independent distributors, dealers and installers of security equipment. International sales accounted for approximately 2% of our revenues for each of the three and six months ended December 31, 2019 and 3% of our revenues for each of the three and six months ended December 31, 2018.

The Company owns and operates manufacturing facilities in Amityville, New York and the Dominican Republic. A significant portion of our operating costs are fixed, and do not fluctuate with changes in production levels or utilization of our manufacturing capacity. As production levels rise and factory utilization increases, the fixed costs are spread over increased output, which may contribute to increasing profit margins. Conversely, when production levels decline our fixed costs are spread over reduced levels, which may contribute to decreasing margins.

The security products market is characterized by constant incremental innovation in product design and manufacturing technologies. Generally, the Company devotes 6-8% of revenues to research and development (R&D) on an annual basis. The Company does not expect products resulting from our R&D investments in a given fiscal year to contribute materially to revenue during that same fiscal year, but should benefit the Company over future years. In general, the new products introduced by the Company are initially shipped in limited quantities, and increase over time. Prices and manufacturing costs tend to decline over time as products and technologies mature.

Economic and Other Factors

We are subject to the effects of general economic and market conditions. In the event that the U.S. or international economic conditions deteriorate, our revenue, profit and cash-flow levels could be materially adversely affected in future periods. In the event of such deterioration, many of our current or potential future customers may experience serious cash flow problems and as a result may, modify, delay or cancel purchases of our products. Additionally, customers may not be able to pay, or may delay payment of, accounts receivable that are owed to us. If such events do occur, they may result in our fixed and semi-variable expenses becoming too high in relation to our revenues and cash flows.

Seasonality

The Company's fiscal year begins on July 1 and ends on June 30. Historically, the end users of Napco's products want to install its products prior to the summer; therefore sales of its products historically peak in the period April 1 through June 30, the Company's fiscal fourth quarter, and are reduced in the period July 1 through September 30, the Company's fiscal first quarter. In addition, demand is affected by the housing and construction markets. The timing of any significant deterioration of the current economic conditions may also affect this trend.

Critical Accounting Policies and Estimates

The Company's significant accounting policies are fully described in Note 1 to the Company's consolidated financial statements included in its 2019 Annual Report on Form 10-K. Management believes these critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Results of Operations

	Three months ended December 31, (dollars in thousands)									Six months ended December 31, (dollars in thousands)
	2019			2018			% Increase/ (decrease)			2019			2018			% Increase/ (decrease)
Net sales	$	25,829		$	24,829			4.0	%	$	52,114		$	48,205			8.1	%
Gross profit		12,127			10,671			13.6	%		23,645			20,230			16.9	%
Gross profit as a % of net sales		47.0	%		43.0	%		9.3	%		45.4	%		42.0	%		8.1	%
Research and development		1,823			1,762			3.5	%		3,572			3,507			1.9	%
Selling, general and administrative		6,310			5,615			12.4	%		12,470			11,670			6.9	%
Selling, general and administrative as a percentage of net sales		24.4	%		22.6	%		8.0	%		23.9	%		24.2	%		(1.2	)%
Operating income		3,994			3,294			21.3	%		7,603			5,053			50.5	%
Interest (income) expense, net		(9	)		6			(250.0	)%		(2	)		13			(115.4	)%
Provision for income taxes		431			419			2.9	%		800			667			19.9	%
Net income		3,572			2,869			24.5	%		6,805			4,373			55.6	%

Sales for the three months ended December 31, 2019 increased by $1,000,000 to $25,829,000 as compared to $24,829,000 for the same period a year ago. Sales for the six months ended December 31, 2019 increased by $3,909,000 to $52,114,000 as compared to $48,205,000 for the same period a year ago. The increase in sales for the three months ended December 31, 2019 was due primarily to increased communication service revenues ($1,640,000) and sales of intrusion and access products ($49,000) as partially offset by a decrease in sales of door-locking products ($689,000). The increase in sales for the six months ended December 31, 2019 was due primarily to increased communication service revenues ($3,218,000) and sales of intrusion and access products ($971,000) as partially offset by a decrease in sales of door-locking products ($280,000).

Gross profit for the three months ended December 31, 2019 increased to $12,127,000 or 47.0% of sales as compared to $10,671,000 or 43.0% of sales for the same period a year ago. Gross profit for the six months ended December 31, 2019 increased to $23,645,000 or 45.4% of sales as compared to $20,230,000 or 42.0% of sales for the same period a year ago. The increase in gross profit and gross profit as a percentage of sales for the three and six months was primarily due to the increase in service revenues as described above.

Research and development expenses for the three months ended December 31, 2019 remained relatively constant at $1,823,000 as compared to $1,762,000 for the same period a year ago. Research and development expenses for the six months ended December 31, 2019 remained relatively constant at $3,572,000 as compared to $3,507,000 for the same period a year ago.

Selling, general and administrative expenses for the three months ended December 31, 2019 increased by $695,000 to $6,310,000 as compared to $5,615,000 for the same period a year ago. Selling, general and administrative expenses as a percentage of net sales increased to 24.4% for the three months ended December 31, 2019 as compared to 22.6% for the same period a year ago. Selling, general and administrative expenses for the six months ended December 31, 2019 increased by $800,000 to $12,470,000 as compared to $11,670,000 for the same period a year ago. Selling, general and administrative expenses as a percentage of net sales decreased to 23.9% for the six months ended December 31, 2019 as compared to 24.2% for the same period a year ago. The increases for the three and six months were primarily due to increased media advertising, additional sales staff and salary increases, and increased stock option expense resulting from the significant increase in the Company’s common stock price which is used in the valuation of the options granted during the three months ended December 31, 2019. The increase as a percentage of sales for the three months were primarily due to selling, general and administrative expenses, as described above, increasing at a proportionately higher rate than net sales as compared to the same period a year ago. The decrease as a percentage of sales for the six months were primarily due to net sales increasing at a proportionately higher rate than these expenses during the Company’s first quarter of fiscal 2020 as compared to the same period a year ago .

Interest expense, net for the three months ended December 31, 2019 decreased to interest income of $9,000 as compared to $6,000 for the same period a year ago. Interest expense, net for the six months ended December 31, 2019 decreased to interest income of $2,000 as compared to $13,000 for the same period a year ago.

The Company’s provision for income taxes for the three months ended September 30, 2019 increased by $12,000 to $431,000 as compared to $419,000 for the same period a year ago. The Company’s provision for income taxes for the six months ended December 31, 2019 increased by $133,000 to $800,000 as compared to $667,000 for the same period a year ago. The increase in the provision for income taxes for the three months was caused primarily by an increase in Income before Provision for Income Taxes. As a result, the Company’s effective rate for income tax was 11% and 13% for the three months ended December 31, 2019 and 2018, respectively and 11% and 13% for the six months ended December 31, 2019 and 2018, respectively.

Net income for the three months ended December 31, 2019 increased by $703,000 to $3,572,000 or $0.19 per diluted share as compared to $2,869,000 or $0.15 per diluted share for the same period a year ago. Net income for the six months ended December 31, 2019 increased by $2,433,000 to $6,805,000 or $0.37 per diluted share as compared to $4,373,000 or $0.23 per diluted share for the same period a year ago. The change in net income for the three and six months ended December 31, 2019 was primarily due to the items described above.

Liquidity and Capital Resources

During the six months ended December 31, 2019 the Company utilized a portion of its cash generated from operations ($1,063,000 of $4,813,000) to purchase property, plant and equipment ($1,063,000). The Company believes its current working capital, cash flows from operations and its revolving credit agreement will be sufficient to fund the Company’s operations through the next twelve months.

Accounts receivable at December 31, 2019 decreased by $2,872,000 as compared to June 30, 2019. This decrease is primarily the result of the higher sales volume during the quarter ended June 30, 2019, which is typically the Company’s highest, as compared to the quarter ended December 31, 2019.

Inventories at December 31, 2019 increased by $7,068,000 as compared to June 30, 2019. This increase is primarily the result of the Company increasing inventory of certain new devices relating to its recurring communication service revenues as well as the Company’s level-loading its production output throughout the year, whereas the Company’s sales are typically highest in the fourth quarter.

Accounts payable and accrued expenses other than accrued income taxes increased by $1,133,000 as of December 31, 2019 as compared to June 30, 2019. This increase was due primarily to increased purchases of inventory as discussed above.

As of December 31, 2019, the Company maintained a revolving credit facility of $11,000,000 which expires in June 2021. As of December 31, 2019, the Company had no outstanding borrowings and $11,000,000 in availability under this facility. The Company’s long-term debt is described more fully in Note 7 to the condensed consolidated financial statements. The facility contains various restrictions and covenants including, among others, restrictions on borrowings and compliance with certain financial ratios, as defined in the restated agreement.

As of December 31, 2019 the Company had no material commitments for capital expenditures or inventory purchases other than purchase orders issued in the normal course of business.

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

All foreign sales transactions by the Company are denominated in U.S. dollars. As such, the Company has shifted foreign currency exposure onto its foreign customers. As a result, if exchange rates move against foreign customers, the Company could experience difficulty collecting unsecured accounts receivable, the cancellation of existing orders or the loss of future orders. The foregoing could materially adversely affect the Company's business, financial condition and results of operations. We are also exposed to foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"), the local currency of the Company's production facility in the Dominican Republic. The result of a 10% strengthening or weakening in the U.S. dollar to the RD$ would result in an annual increase or decrease in income from operations of approximately $700,000.

ITEM 4: Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management's control objectives.

At the conclusion of the period ended December 31, 2019, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at December 31, 2019.

During the six months ended December 31, 2019, there were no changes in the Company's internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.

PART II: OTHER INFORMATION

Item 1A. Risk Factors

Information regarding the Company’s Risk Factors are set forth in the Company’s Annual Report on Form 10-K for the year ended June 30, 2019. There has been no material change in the risk factors previously disclosed in the Company’s Form 10-K for the year ended June 30, 2019 during the six months ended December 31, 2019.

Item 6. Exhibits

31.1	Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Richard L. Soloway, Chairman of the Board and President
31.2	Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Kevin S. Buchel, Senior Vice President of Operations and Finance
32.1	Section 1350 Certifications
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

February 3, 2020

NAPCO SECURITY TECHNOLOGIES, INC.
(Registrant)

By:	/s/ RICHARD L. SOLOWAY
	Richard L. Soloway
	Chairman of the Board of Directors, President and Secretary
	(Chief Executive Officer)


By:	/s/ KEVIN S. BUCHEL
	Kevin S. Buchel
	Senior Vice President of Operations and Finance and Treasurer
	(Principal Financial and Accounting Officer)

NAPCO SECURITY TECHNOLOGIES, INC - FORM 10-Q - February 3, 2020

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NAPCO SECURITY TECHNOLOGIES, INC Reports