NSSC · Read the filing

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

Napco Security Technologies, Inc (“NAPCO”, “the Company”, “we”) is one of the leading manufacturers and designers of high-tech electronic security devices, wireless communication services for intrusion and fire alarm systems as well as a leading provider of school safety solutions. We offer a diversified array of security products, encompassing access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products. 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. We have experienced significant growth in recent years, primarily driven by fast growing recurring service revenues generated from wireless communication services for intrusion and fire alarm systems, as well as our school security products that are designed to meet the increasing needs to enhance school security as a result of on-campus shooting and violence in the U.S..

Since 1969, NAPCO has established a heritage and proven record in the professional security community for reliably delivering both advanced technology and high-quality security solutions, building many of the industry’s widely recognized brands, such as NAPCO Security Systems, Alarm Lock, Continental Access, Marks USA, and other popular product lines: including Gemini and F64-Series hardwire/wireless intrusion systems and iSee Video internet video solutions. We are also dedicated to developing innovative technology and producing the next generation of reliable security solutions that utilize remote communications and wireless networks, including our StarLink, iBridge, and more recently the iSecure product lines. Today, millions of businesses, institutions, homes, and people around the globe are protected by products from the NAPCO Group of Companies.

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Our net sales were $170.0 million, $143.6 million and $114.0 million for the fiscal years ended June 30, 2023, 2022 and 2021, respectively. The change in our net sales was driven primarily by increased sales of our recurring services ($14.0 million) and sales of equipment ($12.5 million) as compared to the same period a year ago. The increase in equipment sales was due primarily to the increased demand for the Company’s door-locking products. Our net income was $27.1 million, $19.6 million and $15.4 million for the fiscal years ended June 30, 2022, 2021 and 2020, respectively. The increases in net income during this period were due primarily to the growth of our cellular products and the associated recurring revenue business.

Economic and Other Factors

We are subject to the effects of general economic and market conditions. If 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

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 2023 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.

Revenue Recognition

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 over the course of the month 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 or in 30 days for customers with an open account.

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 equipment 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

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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 7%, 10% and 10% for the fiscal years ended June 30, 2023, 2022 and 2021, respectively.

Reserve for Credit Losses

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. The Company had one customer with an accounts receivable balance that comprised 19%, 22% and 19% of the Company’s accounts receivable at June 30, 2023, 2022 and 2021, respectively. Sales to this customer did not exceed 10% of net sales during fiscal years ended June 30, 2023, 2022 and 2021. The Company had another customer with an accounts receivable balance that comprised 14% and 11% of the Company’s accounts receivable at June 30, 2023 and 2021, respectively. The customer accounts receivable balance did not exceed 10% at June 30, 2022. Sales to this customer did not exceed 10% of net sales in any of the fiscal years ended June 30, 2023, 2022 and 2021, respectively. The Company had a third customer with an accounts receivable balance that comprised 16% and 12% of the Company’s accounts receivable at June 30, 2022 and 2021. The customer accounts receivable balance did not exceed 10% at June 30, 2023. Sales to this customer did not exceed 10% of net sales in any of the fiscal years ended June 30, 2023, 2022 and 2021.

In the ordinary course of business, we have established a reserve for credit losses and customer deductions in the amount of $131,000 and $243,000 as of June 30, 2023 and 2022, respectively. Our reserve for credit losses is a subjective critical estimate that has a direct impact on reported net earnings. This reserve is based upon the evaluation of accounts receivable agings, specific exposures and historical or anticipated events.

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.

The Company records an inventory obsolescence reserve, which represents the difference between the cost of the inventory and its estimated realizable value. This reserve is calculated using an estimated obsolescence percentage applied to the inventory based on age, historical trends, product life cycle, 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. There is inherent professional judgment and subjectivity made by both production and engineering members of management in determining the estimated obsolescence percentage. In addition, and as necessary, the Company may establish specific reserves for future known or anticipated events. 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.

Long-Lived and Intangible Assets

Long-lived assets are amortized over their useful lives and 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. Intangible assets determined to have indefinite lives were not amortized but were tested for impairment at least annually.

Income Taxes

The Company has identified the United States and New York State as its major tax jurisdictions. Fiscal year 2018 and forward years are still open for examination. In December 2022, the Company received a letter from the Internal Revenue Service (“IRS”) notifying the Company that the IRS has closed its examination of the Company’s income tax return for fiscal year ended June 30,

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2020. There has been no changes proposed in relation to this examination. In addition, the Company has a wholly-owned subsidiary which operates in a Free Zone in the Dominican Republic (“DR”) and is exempt from DR income tax.

For the year ended June 30, 2023, the Company recognized a net income tax expense of $4,101,000. During the year ending June 30, 2023, the Company increased its reserve for uncertain income tax positions by $22,000. 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 June 30, 2023, the Company had accrued interest totaling $139,000 and $700,000 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 research and development (“R&D”) tax credits on eligible research and development expenditures. The R&D tax credits are recognized as a reduction to income tax expense.

Leases

The Company records lease assets and corresponding lease liabilities for the operating lease on our Consolidated Balance Sheets, excluding short-term leases (leases with terms of 12 months or less). Lease payments are discounted using a third-party secured incremental borrowing rate based on information available at lease commencement. The Company analyzes whether or not amendments to existing leases classify as a Lease Modification or a full or partial termination of the existing lease. See Note 13 – Commitments and Contingencies; Leases for additional accounting policies and disclosures.

Liquidity and Capital Resources

During the year ended June 30, 2023, the Company utilized a portion of its cash as of June 30, 2022 ($30,598,000 of $41,730,000) to purchase property, plant and equipment ($2,963,000), marketable securities ($148,000) and other investments ($25,190,000) and to pay a cash dividend ($2,298,000). 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.

As of June 30, 2023 and 2022, debt consisted of a revolving line of credit of $11,000,000 (“Revolver Agreement”), with no amounts outstanding, which expires in June 2024. As of June 30, 2021, the Company had term loans from the U.S. Small Business Administration totaling $3,904,000 through its Payroll Protection Program (“PPP”). The PPP Loans were entirely forgiven during first quarter of the fiscal year ending June 30, 2022. The revolving credit facility contains various restrictions and covenants including, among others, restrictions on borrowings and compliance with certain financial ratios, as defined in the agreement. The Company’s debt is described more fully in Note 8 to the condensed consolidated financial statements.

The Company believes its current working capital, anticipated cash flows from operations and its Revolving Credit Agreement will be sufficient to fund the Company’s operations through at least the next twelve months.

The Company takes into consideration several factors in measuring its liquidity, including the ratios set forth below:

As of June 30,

Sales to Receivables 6.5 to 1 4.9 to 1 4.1 to 1

Total debt to equity 0.0 to 1 0.0 to 1 0.0 to 1

As of June 30, 2022, the Company had no material commitments for capital expenditures or inventory purchases other than purchase orders issued in the normal course of business. On April 26, 1993, the Company's foreign subsidiary entered into a 99-year land lease

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of approximately 4 acres of land in the Dominican Republic, on which the Company’s principle manufacturing facility is located, at an annual base rent of approximately $235,000 and $105,000 in annual service charges. The service charges increase 2% annually over the remaining life of the lease.

Working Capital. Working capital increased by $18,531,000 to $111,673,000 at June 30, 2023 from $93,142,000 at June 30, 2022. Working Capital increased by $17,751,000 to $93,142,000 at June 30, 2022 from $75,391,000 at June 30, 2021.Working capital is calculated by deducting Current Liabilities from Current Assets.

Accounts Receivable. Accounts Receivable decreased by $3,149,000 to $26,069,000 at June 30, 2023 as compared to $29,218,000 at June 30, 2022. The decrease in Accounts Receivable was due primarily to a decrease in net sales of hardware for the quarter ended June 30, 2023 as compared to the same period a year ago. Accounts Receivable increased by $1,137,000 to $29,218,000 at June 30, 2022 as compared to $28,081,000 at June 30, 2021. The increase in Accounts Receivable was due primarily to an increase in net sales for the quarter ended June 30, 2022 as compared to the same period a year ago.

Inventories. Inventories, which include both current and non-current portions, decreased by $1,437,000 to $48,349,000 at June 30, 2023 as compared to $49,786,000 at June 30, 2022. The decrease was due primarily to lower costs of certain component part as well as lower freight costs in fiscal 2023, both of which had increased in price due to the supply chain shortages in fiscal 2022. Inventories increased by $18,086,000 to $49,786,000 at June 30, 2022 as compared to $31,700,000 at June 30, 2021. The increase was due primarily to higher costs of component parts and freight-in. The increase was also due to the ongoing shortages of certain component parts and the Company purchasing large quantities of these hard to source component parts when they become available.

Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses, not including income taxes payable, decreased by $4,939,000 to $19,686,000 as of June 30, 2023 as compared to $24,625,000 at June 30, 2022. This decrease was primarily due to decreased purchases of component parts during the quarter ended June 30, 2023 as compared to the same period a year ago. Accounts payable and accrued expenses, not including income taxes payable, increased by $8,470,000 to $24,625,000 as of June 30, 2022 as compared to $16,155,000 at June 30, 2021. This increase was primarily due to increased purchases of component parts during the quarter ended June 30, 2022 as compared to the same period a year ago as well as an increase in the Company’s accrued refund liability, which is explained in Note 2 to the Notes to the Company’s Consolidated Financial Statements.

Off-Balance Sheet Arrangements

The Company does not maintain any off-balance sheet arrangements.

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Results of Operations

Fiscal 2023 Compared to Fiscal 2022

Fiscal year ended June 30, (dollars in thousands)

% Increase/

Gross profit as a % of net sales 43.1 % 41.2 % 4.6 %

Selling, general and administrative as a % of net sales 19.8 % 22.9 % (13.5) %

Interest Income (expense), net 822 (16) (5,237.5) %

Other Income (expense), net 81 (266) (130.8) %

Gain on extinguishment of debt — 3,904 100.0 %

Net sales in fiscal 2023 increased by $26,404,000 to $169,997,000 as compared to $143,593,000 in fiscal 2022. The increase in net sales was primarily due to increased sales of the Company’s recurring alarm communication services ($13,954,000), Alarm Lock brand door-locking products ($12,067,000), Marks brand door-locking products ($2,644,000) and Continental brand access control products ($916,000) as partially offset by a decrease in sales of Napco brand intrusion products ($3,178,000). The Company’s increase in equipment sales was primarily due to increased demand for door locking and access control products in the new construction and retrofit building markets. In addition, fiscal 2022 net sales of the Company’s cellular radio products benefited from dealers needing to replace their existing 3G radios with 4G or 5G models as the major cellular providers sunset their 3G networks. Fiscal 2023 returned to more normal sales levels.

The Company's gross profit increased by $14,077,000 to $73,233,000 or 43.1% of net sales in fiscal 2023 as compared to $59,156,000 or 41.2% of net sales in fiscal 2022. Gross profit on equipment sales was $19,865,000 or 18.0% of net equipment sales in fiscal 2023 and $19,141,000 or 19.6% of net equipment sales, in fiscal 2022. Gross profit on service revenues was $53,368,000 or 89.0% of net service revenues in fiscal 2023 and $40,015,000 or 87.0% of net service revenues, in fiscal 2022. The increase in Gross profit on equipment sales was primarily the result of the higher equipment sales, which increased overhead absorption, as partially offset by increased labor costs in both the U.S. and Dominican Republic as well as higher prices of certain component parts. The Company purchased these higher-priced components at a significant premium during the supply chain interruptions during the latter part of fiscal 2022 in order to continue to supply the Company’s communication devices that led to the creation of recurring service revenues for the Company. The prices of these components began decreasing during fiscal 2023.

Research and Development expenses increased by $1,304,000 to $9,328,000 in fiscal 2023 as compared to $8,024,000 in fiscal 2022. This increase was due primarily to salary increases and additional staff.

Selling, general and administrative expenses for fiscal 2023 increased by $673,000 to $33,580,000 as compared to $32,907,000 in fiscal 2022. Selling, general and administrative expenses as a percentage of net sales increased to 19.8% in fiscal 2023 from 22.9% in fiscal 2022. The increases in dollars resulted primarily from costs associated with the Company’s Form S-3 filing as well as increased credit card processing fees, as partially offset by lower legal and employee compensation costs.

Interest and other income/(expense), net for fiscal 2023 increased by $1,186,000 to income of $903,000 as compared to an expense of $283,000 for the same period a year ago. This increase was due primarily to the Company investing more of its cash into short term investments as described more fully in Note 1 and Note 4 to the consolidated financial statements.

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Gain on extinguishment of debt resulted from a one-time gain in fiscal 2022 which resulted from the forgiveness of the Company’s PPP loans as described in the Liquidity and Capital Resources section and Note 8 to the condensed consolidated financial statements.

The Company’s provision for income taxes for fiscal 2023 increased by $1,854,000 to $4,101,000 as compared to $2,247,000 for the same period a year ago. The Company’s effective tax rate for fiscal 2023 increased to 13% as compared to 10% for fiscal 2022. The increase in the Company’s fiscal 2023 effective tax rate is primarily due to the $3,904,000 in non-taxable income from a one-time extinguishment of debt included in fiscal 2022.

Net income for fiscal 2023 increased by $7,528,000 to $27,127,000 as compared to $19,599,000 in fiscal 2022. This resulted primarily from the items discussed above.

Results of Operations

Fiscal 2022 Compared to Fiscal 2021

Fiscal year ended June 30, (dollars in thousands)

% Increase/

Gross profit as a % of net sales 41.2 % 44.5 % (7.4) %

Selling, general and administrative as a % of net sales 22.9 % 22.1 % 3.7 %

Interest expense, net (16) (18) (11.1) %

Other Income (expense), net (266) 13 (2,146.2) %

Gain on extinguishment of debt 3,904 — — %

Net sales in fiscal 2022 increased by $29,558,000 to $143,593,000 as compared to $114,035,000 in fiscal 2021. The increase in net sales was primarily due to increased sales of the Company’s recurring alarm communication services ($12,077,000), Napco brand intrusion products ($11,699,000), Alarm Lock brand door-locking products ($3,136,000), Marks brand door-locking products ($1,533,000) and Continental brand access control products ($1,113,000). The Company’s increase in equipment sales was primarily due to customer demand returning after the decline during the COVID-19 pandemic and the related closures throughout the United States. In addition, fiscal 2022 net sales increased due, in part, to an increase in sales of the Company’s cellular radio products as the major cellular providers sunset their 3G networks.

The Company's gross profit increased by $8,408,000 to $59,156,000 or 41.2% of net sales in fiscal 2022 as compared to $50,748,000 or 44.5% of net sales in fiscal 2021. Gross profit on equipment sales was $19,141,000 or 19.6% of net equipment sales in fiscal 2022 and $21,730,000 or 27.1% of net equipment sales, in fiscal 2021. Gross profit on service revenues was $40,015,000 or 87.0% of net service revenues in fiscal 2022 and $29,018,000 or 85.6% of net service revenues, in fiscal 2021. Gross profit on equipment sales was primarily affected by increased costs of component parts and freight as well as the shift in sales to the Company’s Starlink radio products, which typically have lower margins but result in recurring service revenues.

Research and Development expenses increased by $404,000 to $8,024,000 in fiscal 2022 as compared to $7,620,000 in fiscal 2021. This increase was due primarily to salary increases and additional staff.

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Selling, general and administrative expenses for fiscal 2022 increased by $7,711,000 to $32,907,000 as compared to $25,196,000 in fiscal 2021. Selling, general and administrative expenses as a percentage of net sales increased to 22.9% in fiscal 2022 from 22.1% in fiscal 2021. The increases in dollars and as a percentage of net sales resulted primarily from increases in sales commissions, tradeshow, stock option and legal expenses.

Interest and other expense, net for fiscal 2022 remained relatively constant at $16,000 as compared to $5,000 for the same period a year ago.

The Company’s provision for income taxes for fiscal 2022 decreased by $267,000 to $2,247,000 as compared to $2,514,000 for the same period a year ago. The Company’s effective tax rate decreased to 10% for fiscal 2022 as compared to 14% for fiscal 2021. The decrease in the Company’s fiscal 2022 effective tax rate is primarily due to the $3,904,000 in non-taxable income from extinguishment of debt.

Net income for fiscal 2022 increased by $4,186,000 to $19,599,000 as compared to $15,413,000 in fiscal 2021. This resulted primarily from the items discussed above.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and the documents we incorporate by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All statements, other than statements of historical fact, included or incorporated in this prospectus regarding our strategy, future operations, clinical trials, collaborations, intellectual property, cash resources, financial position, future revenues, projected costs, prospects, plans, and objectives of management are forward-looking statements. The words “believes,” “anticipates,” “estimates,” “plans,” “expects,” “intends,” “may,” “could,” “should,” “potential,” “likely,” “projects,” “continue,” “will,” “schedule,” “would,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We cannot guarantee that we actually will achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties, and other factors, which may be beyond our control, and which may cause our actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those indicated or implied by forward-looking statements. See “Risk Factors” in our Annual Report on Form 10-K for the year ended June 30, 2022 for more information. These factors and the other cautionary statements made in this prospectus and the documents we incorporate by reference should be read as being applicable to all related forward-looking statements whenever they appear in this prospectus and the documents we incorporate by reference. In addition, any forward-looking statements represent our estimates only as of the date that this prospectus is filed with the SEC and should not be relied upon as representing our estimates as of any subsequent date. We do not assume any obligation to update any forward-looking statements. We disclaim any intention or obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as may be required by law.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's principal financial instrument is long-term debt (consisting of a revolving credit facility) that provides for interest based on the prime rate or LIBOR as described in the agreement. The Company is affected by market risk exposure primarily through the effect of changes in interest rates on amounts payable by the Company under these credit facilities.

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 $892,000.

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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

a. Financial Statements: Financial statements required pursuant to this Item are presented on pages FS-1 through FS-27 of this report as follows:

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

Page

Management Report on Internal Control FS-1

Report of Independent Registered Public Accounting Firm (PCAOB ID 23) FS-2

Consolidated Financial Statements:

Consolidated Balance Sheets as of June 30, 2023 and 2022 FS-6

Notes to Consolidated Financial Statements FS-10

Management Report on Internal Control

Management has prepared and is responsible for our consolidated financial statements and related notes. Management is also responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Napco Technologies, Inc. (the “Company”) internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with the authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements prepared for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management conducted an assessment of the effectiveness of internal control over financial reporting based on the framework in Internal Control – Integrated Framework (2013) as issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management determined that as of June 30, 2023, the Company identified three material weaknesses in internal control.

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ITEM 4: Controls and Procedures

One material weakness in internal control related to ineffective information technology general controls (ITGCs) in the area of user access and lack of effective program change-management over certain information technology (IT) systems that support the Company’s financial reporting processes. Our business process controls (automated and manual) that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted. We believe that these control deficiencies were a result of: IT control processes lacking sufficient documentation and risk-assessment procedures to assess changes in the IT environment and program change management of personnel that could impact internal controls over financial reporting.

The second material weakness in internal control related to the reserve for excess and slow-moving inventory. This control deficiency was a result of a lack of effective review and reconciliation controls over the forecasted sales and usage data.

In addition to the foregoing, during the Company’s closing of its books for the period ended June 30, 2023, management identified a third material weakness related to the Company’s Cost of Goods Sold (“COGS”) and Inventory during the first three quarters of fiscal 2023. COGS reflected in the Company’s Original Form 10-Q was based on inventory costing as of June 30, 2022. However, in the period following June 30, 2022, substantial fluctuations occurred in certain material costs. Our inventory costing process did not identify these fluctuations in a timely manner resulting in Inventory being overstated and COGS being understated and resulting in an overstated gross profit, operating income, income before the provision for income taxes and net income for the first three quarters of fiscal 2023. While the Company has begun the process to take measures which it believes will remediate the underlying causes of this material weakness, there can be no assurance as to when the remediation plan will be fully developed and implemented and whether such measures will be effective. Until the Company’s remediation plan is fully implemented and effective, the Company will continue to devote time, attention and financial resources to these efforts.

Based on these material weaknesses, the Company’s management has concluded that at June 30, 2023 the Company’s internal controls over financial reporting were not effective.

Management is currently designing and implementing additional controls and procedures to remediate these items and expects to complete these actions during fiscal 2024. While the Company has begun the process to take measures which it believes will remediate the underlying causes of these material weaknesses, there can be no assurance as to when the remediation plans will be fully developed and implemented and whether such measures will be effective. Until the Company’s remediation plans are fully implemented and effective, the Company will continue to devote time, attention and financial resources to these efforts.

During the three months ended June 30, 2023, 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 except as described above.

The effectiveness of our internal control over financial reporting as of June 30, 2023 has been audited by Baker Tilly US, LLP, an independent registered public accounting firm, as stated in their report included herein.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders and the board of directors of Napco Security Technologies, Inc. and Subsidiaries:

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Napco Security Technologies, Inc. and Subsidiaries (the "Company") as of June 30, 2023 and 2022, the related consolidated statements of income, stockholders’ equity, and cash flows, for each of the three years in the period ended June 30, 2023, and the related notes (collectively referred to as the "consolidated financial statements"). We also have audited the Company’s internal control over financial reporting as of June 30, 2023, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2023, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, because of the

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effect of the material weaknesses identified below on the achievement of the objectives of the control criteria, the Company did not maintain, in all material respects, effective internal control over financial reporting as of June 30, 2023, based on criteria established in Internal Control – Integrated Framework (2013) issued by COSO.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing on page FS-1 and under Item 9A:

There were ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Company’s financial reporting processes. As a result, business process automated and manual controls that were dependent on the affected ITGCs were ineffective because they could have been adversely impacted. This control deficiency was a result of IT control processes that lacked sufficient documentation and risk-assessment processes inadequate to identify and assess changes in IT environments and personnel that could impact internal control over financial reporting.

There were ineffectively designed control activities over the reserve for excess and slow-moving inventory, including the lack of effective review and reconciliation controls over forecasted sales and usage data.

There were ineffectively designed control activities over the proper costing of inventory at interim dates to ensure that inventory is presented on a first-in first-out (FIFO) basis and at net realizable value.

The material weaknesses referred to above are described in Management's Report on Internal Control Over Financial Reporting. We considered the material weaknesses in determining the nature, timing, and extent of audit tests applied in our audit of the 2023 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting

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principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.

Excess and Slow-Moving Inventory Reserve

Critical Audit Matter Description

As described in Notes 1 and 5 to the consolidated financial statements, management establishes its reserve for excess and slow-moving inventory equal to the difference between the cost of the inventory and the estimated net realizable value of the inventory. The estimated reserve percentages consider future inventory requirements to support forecasted sales based on historical usage, known trends, market conditions, and the ability to find alternate applications of its raw materials into finished goods to better match customer demand.

We identified the reserve for excess and slow-moving inventory as a critical audit matter because of the significant estimates and assumptions management makes to determine the reserve, specifically the future inventory requirements and related forecasted sales and usage. Performing audit procedures to evaluate the reasonableness of these estimates, including the estimated reserve percentages, and assumptions is subjective and requires a high degree of auditor judgment.

How We Addressed the Matter in Our Audit

The primary procedures we performed to address this critical audit matter included:

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Impact on Financial Statements of Material Weakness in Internal Control Over Financial Reporting – Refer to Management’s Report on Internal Control Over Financial Reporting appearing on page FS-1 and under Item 9A.

Critical Audit Matter Description

As discussed above and in Management’s Report on Internal Control Over Financial Reporting, the Company identified a material weakness in their internal control over financial reporting associated with user access and program change-management over certain information technology (IT) systems that support the Company’s financial reporting processes, and related material weakness in the components of Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). This material weakness impacts the Company’s controls over IT systems and business processes and affects substantially all financial statement account balances and disclosures.

Due to the ineffective ITGCs, the information in system generated reports produced by those financial reporting systems could not be relied upon without further testing. We determined it necessary to perform incremental audit procedures over the completeness and accuracy of financial information utilizing the impacted IT systems as a critical audit matter. Significant auditor judgment was required to design and execute the incremental audit procedures and to assess the sufficiency of the procedures performed and evidence obtained due to ineffective controls and the complexity of the Company’s IT environment.

How We Addressed the Matter in Our Audit

As a result of the material weakness, in performing our audit procedures we lowered the threshold for investigating differences between recorded amounts and independent expectations developed by us that we would have otherwise used, and increased the number of tested transactions we would have otherwise made if the Company’s controls were designed and operating effectively. In addition, we utilized original source documents for audit evidence, rather than system reports or other information generated by the Company’s IT systems. For any reports obtained from the IT system, the engagement team designed specific audit procedures to audit the completeness and accuracy of such reports.

We have served as the Company's auditor since 2008.

/s/BAKER TILLY US, LLP

Uniondale, New York

September 8, 2023

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NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

CURRENT ASSETS

Investments - other 25,660 —

Marketable securities 5,136 5,068

Income tax receivable 75 —

Prepaid expenses and other current assets 3,402 2,838

Inventories - non-current, net 13,287 9,005

Property, plant and equipment, net 9,308 7,939

Deferred income taxes 2,652 —

Operating lease asset 5,797 7,350

CURRENT LIABILITIES

Accrued salaries and wages 3,546 4,064

Accrued income taxes — 1,868

Deferred income taxes — 166

Long term operating lease liabilities 5,689 7,068

COMMITMENTS AND CONTINGENCIES (Note 13)

STOCKHOLDERS’ EQUITY

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 166,654 $ 148,576

See accompanying notes to consolidated financial statements.

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NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Year Ended June 30,

(in thousands, except for share and per share data)

Net sales:

Cost of sales:

Operating expenses:

Other income (expense):

Interest and other income (expense), net 903 (283) (5)

Gain on extinguishment of debt — 3,904 —

Income per share:

Weighted average number of shares outstanding:

See accompanying notes to consolidated financial statements.

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NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(in thousands except for share data)

Common Stock Treasury Stock

Number of Additional

Shares Paid-in Number of Retained

Issued Amount Capital Shares Amount Earnings Total

Stock options exercised 7,466 — — — — — —

Stock-based compensation expense — — 435 — — — 435

Net income — — — — — 15,413 15,413

Stock options exercised 32,314 — 155 — — — 155

Stock-based compensation expense — — 1,649 — — — 1,649

Stock options exercised 35,615 1 84 — — — 85

Stock-based compensation expense — — 1,464 — — — 1,464

Cash dividend — — — — — (2,298) (2,298)

See accompanying notes to consolidated financial statements.

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NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Fiscal Year ended June 30,

(in thousands)

CASH FLOWS FROM OPERATING ACTIVITIES

Gain on disposal of fixed asset (15) — —

Interest income on other investments (470) — —

Unrealized loss (gain) on marketable securities 80 426 9

(Recovery) reserve of credit losses (112) 17 (100)

Change to inventory reserve (445) 1,187 (79)

Gain on extinguishment of debt — (3,904) —

Changes in operating assets and liabilities:

Prepaid expenses and other current assets (564) (430) (359)

Income tax receivable (75) — —

Other assets 35 (103) —

CASH FLOWS FROM INVESTING ACTIVITIES

Purchases of property, plant, and equipment (2,962) (1,482) (1,007)

Proceeds from disposal of fixed asset 38 — —

Purchases of marketable securities (148) (81) (5,422)

Purchases of other investments (35,281) — —

Redemption of other investments 10,091 — —

Net Cash Used in Investing Activities (28,262) (1,563) (6,429)

CASH FLOWS FROM FINANCING ACTIVITIES

Proceeds from stock option exercises 85 155 —

Cash paid for dividend (2,298) — —

Net Cash (Used in) Provided by Financing Activities (2,213) 155 —

Net (decrease) increase in Cash and Cash Equivalents (5,775) 6,924 16,558

SUPPLEMENTAL CASH FLOW INFORMATION

Interest paid $ 16 $ 16 $ 18

See accompanying notes to consolidated financial statements.

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NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Nature of Business:

Napco Security Technologies, Inc (“NAPCO”, “the Company”, “we”) is one of the leading manufacturers and designers of high-tech electronic security devices, cellular communication services for intrusion and fire alarm systems as well as a leading provider of school safety solutions. We offer a diversified array of security products, encompassing access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products. 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. We have experienced significant growth in recent years, primarily driven by fast growing recurring service revenues generated from wireless communication services for intrusion and fire alarm systems, as well as our school security products that are designed to meet the increasing needs to enhance school security as a result of on-campus shooting and violence in the U.S.

The Company's fiscal year begins on July 1 and ends on June 30. Historically, the end users of the Company’s hardware products want to install these products prior to the summer; therefore, sales of these 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 for all of our products may be affected by the housing and construction markets. Significant future deterioration of the current economic conditions may also affect this trend. The monthly recurring revenue, which is less susceptible to these fluctuations, allows us to generate a more consistent and predictable stream of income and mitigates the risk of fluctuation in market demand for our equipment products.

Significant Accounting Policies:

Principles of Consolidation

The consolidated financial statements include the accounts of Napco Security Technologies, Inc. and 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 Generally Accepted Accounting Principles (“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 credit losses, overhead expenses applied to inventory, inventory reserves, valuation ofintangible assets, share based compensation 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 June 30, 2022 and 2021 due to their short-term maturities.Long-term debt and lease liabilities reflect fair value based on prevailing market rates.

Cash and Cash Equivalents

Cash and cash equivalents include approximately $15,242,000 of short-term time deposits, consisting of several certificates of deposit totaling $15,179,000 and $63,000 in a money market fund as of June 30, 2023. Cash and cash equivalents include approximately $63,000 of short-term time deposits, consisting of $63,000 in a money market fund as of June 30, 2022. The Company classifies these highly liquid investments with original maturities of three months or less as cash equivalents. Certificates of deposit with an original maturity greater than three months are classified as Investments – other.

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Cash and cash equivalents consists of the following as of (in thousands):

Money Market Fund 63 63

Certificates of Deposit 15,179 —

Investments-other consists of the following as of (in thousands):

Certificates of Deposit $ 25,660 $ —

Certificates of deposit are recorded at the original cost plus accrued interest. The Company’s Certificates of Deposit consist of the following as of (in thousands):

Balance Sheet Classification Interest Rate Maturity Date Cost Carrying Value

The Company has cash balances in banks in excess of the maximum amount insured by the FDIC and other international agencies as of June 30, 2023 and 2022. The Company has not historically experienced any credit losses with balances in excess of FDIC limits.

Marketable Securities

The Company’s marketable securities include investments in mutual funds, which invest primarily in various government and corporate obligations, stocks and money market funds. The Company’s marketable securities are reported at fair value with the related unrealized and realized gains and losses included in other expense (income). Realized gains or losses on mutual funds are determined on a specific identification basis. The Company evaluates its investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value had been below cost basis, the financial condition of the issuer and the Company’s ability and intent to hold the investment for a period of time, which may be sufficient for anticipated recovery of market value. The Company records an impairment charge to the extent that the cost of the available-for-sale securities exceeds the estimated fair value of the securities and the decline in value is determined to be other-than-temporary. During the years ended June 30, 2023 and 2022, the Company did not record an impairment charge regarding its investment in marketable securities because management believes, based on its evaluation of the circumstances, that the decline in fair value below the cost of certain of the Company’s marketable securities is temporary.

Accounts Receivable

Accounts receivable is stated net of the reserves for credit losses of $131,000 and $243,000 as of June 30, 2023 and 2022, respectively. Our reserves for credit losses are subjective critical estimates that have a direct impact on reported net earnings. These reserves are based upon the evaluation of our accounts receivable aging, specific exposures, sales levels and historical trends.

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Inventories

The Company records an inventory obsolescence reserve, which represents any excess of the cost of the inventory over its estimated realizable value. This reserve is calculated using an estimated obsolescence percentage applied to the inventory based on age, historical trends, product life cycle, 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.

Long-Lived and Intangible Assets

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

Amortization expense for intangible assets subject to amortization was approximately $361,000, $391,000 and $425,000 for the fiscal years ended June 30, 2023, 2022 and 2021, respectively. Amortization expense for each of the next five fiscal years is estimated to be as follows: 2024 - $336,000; 2025 - $315,000; 2026 - $297,000; 2027 - $283,000; and 2028 - $269,000. The weighted average remaining amortization period for intangible assets was 15.5 years and 16.2 years at June 30, 2023 and 2022, respectively.

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Revenue Recognition

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 over the course of the month and therefore recognizes revenue over the monthly period.

The Company analyzes product 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.

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 fiscal years ended June 30, 2023, 2022 and 2021 was $2,931,000, $2,889,000 and $1,306,000, 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 fiscal years ended June 30, 2023, 2022 and 2021 was $9,328,000, $8,024,000 and $7,620,000, 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. The Company records uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.

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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 fiscal years ended June 30 (in thousands, except per share data):

Weighted Average Net Income per

Net Income Shares Share

Effect of Dilutive Securities:

Options to purchase 7,534, 214,109 and 40,000 shares of common stock for the fiscal years ended June 30, 2023, 2022 and 2021, 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 five share incentive programs as discussed in Note 9.

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 $1,464,000, $1,649,000 and $435,000 were recognized for the fiscal years ended June 30, 2023, 2022 and 2021, 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 and unrealized gains and losses associated with foreign currency translation are recorded for the fiscal years ended June 30, 2023, 2022 or 2021.

Comprehensive Income

For the fiscal years ended June 30, 2023, 2022 and 2021, 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 14.

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Shipping and Handling Sales and Costs

The Company records the amount billed to customers for shipping and handling in net sales ($450,000, $428,000 and $395,000 in the fiscal years ended June 30, 2023, 2022 and 2021, respectively) and classifies the costs associated with these sales in cost of sales ($1,697,000, $1,425,000 and $1,058,000 in the fiscal years ended June 30, 2023, 2022 and 2021, respectively).

Leases

The Company records lease assets and corresponding lease liabilities for the operating lease on our Consolidated Balance Sheets, excluding short-term leases (leases with terms of 12 months or less) as described under ASU No. 2016-02, Leases (Topic 842). Lease payments are discounted using a third-party secured incremental borrowing rate based on information available at lease commencement. The Company analyzes whether or not amendments to existing leases classify as a Lease Modification or a full or partial termination of the existing lease. See Note 13 – Commitments and Contingencies; Leases for additional accounting policies and disclosures. Recently

Recently Issued Accounting Standards

Reference Rate Reform (ASC Topic 848)

In March 2020, the FASB issued authoritative guidance to provide optional relief for companies preparing for the discontinuation of interest rates such as the London Interbank Offered Rate (“LIBOR”), which was expected to be phased out at the end of calendar 2021, and applies to lease contracts, hedging instruments, held-to-maturity debt securities and debt arrangements that have LIBOR as the benchmark rate.

The Company’s bank has notified the Company that its LIBOR option will continue to be available to it through June 30, 2023, at which time the option will shift to the Benchmark Replacement as defined in the agreement with the bank (see Note 8). The Company does not believe that this transition will have a material impact on its financial condition.

NOTE 2 – Revenue Recognition and Contracts with Customers

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.

As of June 30, 2023 and 2022, the Company included refund liabilities of approximately $5,521,000 and $5,863,000, respectively, in current liabilities. As of June 30, 2023 and 2022, the Company included return-related assets of approximately $1,338,000 and $974,000, respectively, in other current assets.

As a percentage of gross sales, sales returns, rebates and allowances were 7%, 10% and 10% for the fiscal years ended June 30, 2023, 2022 and 2021, respectively.

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

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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):

Fiscal year ended June 30,

Major Product Lines:

The following table represents the allowance for credit losses accounts as of the respective years ending June 30 (in thousands):

For the Year Ended June 30, 2021:

Allowance for credit losses $ 326 $ 30 $ (130) $ 226

For the Year Ended June 30, 2022:

Allowance for credit losses $ 226 $ 17 $ — $ 243

For the Year Ended June 30, 2023:

Allowance for credit losses $ 243 $ 6 $ (118) $ 131

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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. The Company had one customer with an accounts receivable balance that comprised 19%, 22% and 19% of the Company’s overall accounts receivable at June 30, 2023, 2022 and 2021, respectively. Sales to this customer did not exceed 10% of the Company’s net sales during fiscal years ended June 30, 2023, 2022 and 2021. The Company had another customer with an accounts receivable balance that comprised 14% and 11% of the Company’s overall accounts receivable at June 30, 2023 and 2021, respectively. This customers’ accounts receivable balance did not exceed 10% of the Company’s overall accounts receivable at June 30, 2022. Sales to this customer did not exceed 10% of the Company’s net sales in any of the fiscal years ended June 30, 2023, 2022 and 2021. The Company had a third customer with an accounts receivable balance that comprised 16% and 12% of the Company’s overall accounts receivable at June 30, 2022 and 2021, respectively. This customers’ accounts receivable balance did not exceed 10% of the Company’s overall accounts receivable at June 30, 2023. Sales to this customer did not exceed 10% of the Company’s net sales in any of the fiscal years ended June 30, 2023, 2022 and 2021.

NOTE 4 – Marketable Securities

Marketable securities include investments in fixed income mutual funds, which are reported at their fair values. The disaggregated net gains and losses on the marketable securities recognize in the income statement for the years ended June 30, 2023, 2022 and 2021 are as follows (in thousands):

Year ended June 30,

The fair values of the Company’s marketable securities are determined as being the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the Company utilizes the three-tier value hierarchy, as prescribed by US GAAP, which prioritizes the inputs used in measuring fair value as follows:

• Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

• Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

• Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The Company’s marketable securities, which are considered available-for-sale securities, are re-measured to fair value on a recurring basis and are valued using Level 1 inputs using quoted prices (unadjusted) for identical assets in active markets.

The following tables summarize the Company’s investments (in thousands):

Unrealized Unrealized

Cost Fair Value Gain (Loss) Cost Fair Value Gain (Loss)

Investment income is recognized when earned and consists principally of interest income from fixed income mutual funds. Realized gains and losses on sales of investments are determined on a specific identification basis.

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For the years ended June 30, 2023 and 2022, there were no transfers between Levels 1 and 2 investments and no transfers in or out of Level 3.

NOTE 5 - Inventories

Inventories, net of reserves are valued at lower of cost (first-in, first-out method) or net realizable value. Inventories, net of reserves consist of the following (in thousands):

Classification of inventories, net of reserves:

The following table represents the inventory obsolescence and net realizable value inventory reserves as of the respective years ending June 30 (in thousands):

For the Year Ended June 30, 2021:

For the Year Ended June 30, 2022:

For the Year Ended June 30, 2023:

NOTE 6 - Property, Plant, and Equipment

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

Less: accumulated depreciation and amortization (43,063) (41,546)

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Depreciation and amortization expense on property, plant, and equipment was approximately $1,569,000, $1,380,000 and $1,260,000 in fiscal 2023, 2022 and 2021, respectively.

NOTE 7 - Income Taxes

The provision for income taxes is comprised of the following (in thousands):

For the Year ended June 30,

Current income taxes:

Deferred income taxes:

State (484) — —

A reconciliation of the U.S. Federal statutory income tax rate to our actual effective tax rate on earnings before income taxes is as follows for the years ended June 30, (dollars in thousands):

% of % of % of

Pre-tax Pre-tax Pre-tax

Amount Income Amount Income Amount Income

Increases (decreases) in taxes resulting from:

Foreign withholding tax — — % — — % 205 1 %

Non-taxable debt extinguishment — — % (820) (3.8) % — — %

IRS examination settlements — — % — — % — — %

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Deferred tax assets and deferred tax liabilities at June 30, 2023 and 2022 are as follows (in thousands):

Deferred Tax Assets (Liabilities)

Accounts receivable $ 22 $ 42

Accrued liabilities 857 454

Stock based compensation expense 250 179

Revenue reserves 333 466

Unrealized loss (gain) on marketable securities 124 90

Capitalized research and development cost 2,923 —

Other 4 —

Total Deferred Tax Assets $ 4,910 $ 1,644

Valuation allowance — —

Deferred income tax assets, net of valuation allowance $ 4,910 $ 1,644

Property, plant and equipment (729) (582)

Other deferred tax liabilities (613) (613)

Total Deferred Tax Liability $ (2,258) $ (1,810)

Net Deferred Tax Asset/(Liability) $ 2,652 $ (166)

The Company has identified the United States and New York State as its major tax jurisdictions. Fiscal year 2018 and forward years are still open for examination. In addition, the Company has a wholly-owned subsidiary which operates in a Free Zone in the Dominican Republic (“DR”) and is exempt from DR income tax.

The Company was audited by the IRS for the fiscal year 2017. The Company received Form 4549-A, Income Tax Examination Changes from the IRS proposing an adjustment to income for the fiscal 2017 tax year regarding deemed dividends based on its interpretation under IRC Section 956 arising from the intercompany balances on the books of the Company. During the third quarter of fiscal 2021, the Company settled the issue and paid the IRS $399,000. The Company reported the results of the IRS exam to all the jurisdictions in which it files and paid taxes and interest totaling $97,000. Subsequent to the quarter end, the Company paid the IRS $68,000 for interest. None of the payments were recorded to expense in 2021, since liabilities had previously been established.

In December 2022, the Company received a letter from the IRS (“IRS”) notifying it that the IRS has closed its examination of the Company’s income tax return for fiscal year ended June 30, 2020. There have been no changes proposed in relation to this examination.

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 tax rates in foreign jurisdictions, state and local income taxes, tax benefit of R&D credits, certain nondeductible expenses, uncertain tax positions and global intangible low-taxed income ("GILTI").

During the year ending June 30, 2023, the Company increased its reserve for uncertain income tax positions by $22,000. 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 June 30, 2023, the Company had accrued interest totaling $139,000, penalties totaling $5,000, and $700,000 of unrecognized net tax benefits that, if recognized, would favorably affect the Company’s effective income tax rate in any future period. The Company does not expect that its unrecognized tax benefits will significantly change within the next twelve months. The Company claims R&D tax credits on eligible research and development expenditures. The R&D tax credits are recognized as a reduction to income tax expense.

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A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

NOTE 8 - Debt

As of June 30, 2023 and 2022, debt consisted of a revolving line of credit of $11,000,000 (“Revolver Agreement”), with no amounts outstanding, which expires in June 2024.

The Revolver Agreement also provides for a LIBOR-based interest rate option of LIBOR plus 1.15% to 2.00%, depending on the ratio of outstanding debt to 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 Revolver Agreement. The Company’s obligations under the Revolver Agreement continue to be secured by substantially all of its domestic assets, including but not limited to deposit accounts, accounts receivable, inventory, 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 Revolver 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 Revolver Agreement. The Revolver 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 Revolver Agreement. In September 2020, the Company and its lender amended the Revolver Agreement, which had an expiration date of June 2021, to expire in June 2024. The amended Revolver Agreement also removed certain requirements and restrictions on the Company as well as removing the mortgage on the Company’s Amityville facility.

During the fourth quarter of fiscal 2020, the Company received the proceeds of promissory notes dated between April 17, 2020 and May 7, 2020 (the "PPP Loan Agreement"), entered into between the Company and HSBC Bank USA N.A., as lender (the "Lender”). The Lender made the loans pursuant to the Paycheck Protection Program (the "PPP"), created by Section 1102 of the CARES Act and governed by the CARES Act, Section 7(a)(36) of the Small Business Act, any rules or guidance that has been issued by the Small Business Association (“SBA”) implementing the PPP and acting as guarantor, or any other applicable loan program requirements, as defined in 13 CFR § 120.10, as amended from time to time. Pursuant to the PPP Loan Agreement, the Lender made loans to the Company with an aggregate principal amount of $3,904,000 (the "PPP Loan"). The PPP Loan and related extinguishment was accounted for in accordance with ASC 470 “Debt”.

Pursuant to the CARES Act, the loans may be forgiven by the SBA. During the year ended June 30, 2022, the PPP Loans were forgiven, in their entirety, in accordance with guidelines set forth in the PPP loan documents. The Company recognized a gain on the extinguishment of debt during the fiscal year ended June 30, 2022 in the amount of $3,904,000 within the other (expense) income section in the accompanying condensed consolidated statements of income. The SBA reserves the right to audit PPP forgiveness applications for a period of six years from the date of forgiveness. It has indicated that it will audit all of those that are in excess of $2 million.

NOTE 9 - Stock Options

The Company follows ASC 718 (“Share-Based Payment”), 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. For the fiscal years ended June 30, 2023, 2022 and 2021, the Company recorded non-cash compensation expense of $1,464,000 ($.04 per basic and diluted share), $1,649,000 ($.04 per basic and diluted share) and $435,000 ($.01 per basic and diluted share), respectively, relating to stock-based compensation.

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2012 Employee Stock Option Plan

In December 2012, the stockholders approved the 2012 Employee Stock Option Plan (the “2012 Employee Plan”). The 2012 Employee Plan authorizes the granting of awards, the exercise of which would allow up to an aggregate of 1,900,000 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 June 30, 2023, 521,580 stock options were outstanding, 247,628 stock options were exercisable and no further stock options were available for grant under this plan. 37,500 options were granted under this plan during the year ended June 30, 2023.

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

Risk-free interest rates 3.03 % 1.64 % n/a

Expected lives 7.27 Years 6.18 Years n/a

Expected volatility 43 % 43 % n/a

Expected dividend yields 0 % 0 % n/a

The Company uses a weighted-average expected stock-price volatility assumption that is a combination of both current and historical implied volatilities of the underlying stock. The implied volatilities were obtained from publicly available data sources. For the weighted-average expected option life assumption, the Company considers the exercise behavior of past grants. The average risk-free interest rate is based on the U.S. Treasury Bond rate for the expected term of the options and the average dividend yield is based on historical experience.

The following table reflects activity under the 2012 Plan for the fiscal years ended June 30,:

Weighted average Weighted average Weighted average

Options exercise price Options exercise price Options exercise price

Forfeited/Lapsed — — — — (13,000) 6.91

37,500, 338,000 and 0 options were granted during the fiscal years ended June 30, 2023, 2022 and 2021, respectively. 39,000, 29,000 and 8,600 options were exercised during the fiscal years ended June 30, 2023, 2022 and 2021, respectively. 29,600 of the 39,000 stock options exercised during the fiscal year ended June 30, 2023, were settled by exchanging 10,150 shares of the Company’s common stock which were retired and returned to unissued status upon receipt. 1,000 of the 29,000 stock options exercised during the fiscal year ended June 30, 2022, were settled by exchanging 153 shares of the Company’s common stock which were retired and returned to

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unissued status upon receipt. 8,600 stock options exercised during the fiscal year ended June 30, 2021 were settled by exchanging 4,604 shares of the Company's common stock which were retired and returned to unissued status upon receipt. $84,000, $155,000 and $0 was received from the remaining option exercises for the fiscal years ended June 30, 2023, 2022 and 2021, respectively, 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 2012 Employee Plan at June 30, 2023:

Options outstanding Options exercisable

Weighted average

Number remaining Weighted average Number Weighted average

As of June 30, 2023 and 2022, there was $1,971,000 and $2,489,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2012 Employee Plan, respectively. 109,876, 107,576 and 44,776options vested during the years June 30, 2023, 2022 and 2021, respectively. The total grant datefair value of the options vesting during the fiscal years ended June 30, 2022, 2021 and 2020 under this plan was $981,000, $1,040,000 and $244,000, 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 100,000 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.

NSSC US Equity

NSSC · 10-K · period ended 2023-06-30

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

NSSC US Equity☆

NSSC · 10-K · period ended 2023-06-30

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

NSSC US Equity