See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTSSTATEMENT OF INCOMESTOCKHOLDERS EQUITY (unaudited)

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

See accompanying notes to condensed consolidated financial statements.

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

MARCH 31,SEPTEMBER 30, 2019

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

Nature of Business:

Napco Security Technologies, Inc. and Subsidiaries (the "Company" or “Napco”) is a diversified manufacturer of security products, encompassing access control systems, door securitydoor-locking 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. 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 Napco'sthe 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. Deterioration of the current economic conditions may also affect this trend.

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, 20182019 and the notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on September 13, 2018.2019. 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, concentration of credit risk,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 March 31,September 30, 2019 and June 30, 20182019 due to their short-term maturities.

Cash and Cash Equivalents

Cash and cash equivalents include approximately $460,000 of short-term time deposits at March 31,September 30, 2019 and June 30, 2018.2019. 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 FDICFederal Deposit Insurance Corporation (“FDIC”) and other international agencies as of March 31,September 30, 2019 and June 30, 2018.2019. 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 reserves for doubtful accounts of $117,000 and $195,000$88,000 as of March 31,September 30, 2019 and June 30, 2018, respectively.2019. Our reserves for doubtful accounts 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.

Inventories

Inventories are valued at the lower of cost or net realizable value, with cost being determined on the first-in, first-out (FIFO)(“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 marketrealizable 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. Infinite-livedIndefinite-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):

Amortization expense for intangible assets subject to amortization was approximately $78,000$66,000 and $93,000$78,000 for the three months endedMarch 31, 2019and 2018, respectively. Amortization expense for intangible assets subject to amortization was approximately $235,000 and $278,000 for the nine months endedMarch 31,September 30, 2019and 2018, respectively. Amortization expense for each of the next five fiscal years is estimated to be as follows: 2019 - $313,000; 2020 -$264,000; 2021 - $223,000; 2022 - $188,000; and 2023 - $159,000.$159,000 and 2024 - $134,000. The remaining weighted average amortization period for intangible assets was 9.48.9 years and 10.49.9 years atMarch 31,September 30, 2019and 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.

Revenue RecognitionLeases

The Company recognizes revenue

Effective July 1, 2019, in accordance with Accounting Standards Codification (“ASC”), Topic 606,842,Revenue from Contracts with CustomersLeases, which 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 adopted effective July 1, 2018. Accordingly,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 March 31,September 30, 2019 and 2018 was $190,000$514,000 and $171,000, respectively. Advertising expense for the nine months ended March 31, 2019 and 2018 was $1,275,000 and $1,274,000,$650,000, 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 operations.income. Company-sponsored research and development expense for the three months ended March 31,September 30, 2019 and 2018 was $1,851,000$1,749,000 and $1,669,000,$1,745,000, respectively. Company-sponsored research and development expense for the nine months ended March 31, 2019 and 2018 was $5,358,000 and $4,915,000, respectively. These amounts, previously recorded in cost of sales have been reclassified to research and development to conform with the current period presentation.

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 Perper Share

Basic net income per common share (Basic EPS)(“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)(“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 March 31September 30 (in thousands, except per share data):

No options to purchase shares ofThere were no anti-dilutive common stock were excludedshare equivalents for the three months ended March 31,September 30, 2019 and 2018.

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

Options to purchase 3,942 and 290 shares of common stock were excluded for the nine months ended March 31, 2019 and 2018, respectively, and 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 $0$17,000 and $5,000 were recognized for the three months ended March 31, 2019 and 2018, respectively. Stock-based compensation costs of $152,000 and $141,000 were recognized for the nine months ended March 31,September 30, 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 andor unrealized gains and losses associated with foreign currency translation isare recorded for the three and nine months ended March 31,September 30, 2019 or 2018.

Comprehensive Income

For the three and nine months ended March 31,September 30, 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 ($109,000112,000 and $105,000$101,000 in the three months ended March 31,September 30, 2019 and 2018, respectively and $313,000 and $352,000 in the nine months ended March 31, 2019 and 2018, respectively); and classifies the costs associated with these revenues in cost of sales ($280,000260,000 and $247,000$282,000 in the three months ended March 31, 2019 and 2018, respectively and $827,000 and $706,000 in the nine months ended March 31,September 30, 2019 and 2018, respectively).

Recently Issued and Adopted Accounting Standards

In May 2014, the Financial Accounting Standards Board (FASB) issued

On July 1, 2019, we adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers2016-02, Leases (Topic 606)842) (ASU 2014-09)2016-02), as amended, which amendedsupersedes the lease accounting standards for revenue recognition. This standard superseded all prior revenue recognition standardsguidance under Topic 840, and generally requires entitieslessees to recognize revenueoperating and financing lease liabilities and corresponding right-of-use assets on the balance sheet and to depictprovide enhanced disclosures surrounding the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

The Companyleasing arrangements. We adopted this ASU effective July 1, 2018. See Note 2, Revenue Recognition for additional accounting policy and transition disclosures.

In February 2016, the FASB issued authoritativenew guidance that requires lessees to account for most leases on their balance sheets withusing the liability being equal to the present value of the lease payments.  The right-of-use asset will be based on the lease liability adjusted for certain costs such as direct costs.  Lease expense will be recognized similar to current accounting guidance with operating leases resulting in a straight-line expense and financing leases resulting in a front-loaded expense similar to the current accounting for capital leases.  This guidance becomes effective for the Company’s fiscal 2020 first quarter, with early adoption permitted.  This guidance must be adopted using a 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 leases that exist or are entered into afteroperating leases. For information regarding the beginningimpact of the earliest comparative period in the financial statements,Topic 842 adoption, see Significant Accounting Policies - Leases and provides for certain practical expedients.  The Company is currently evaluating the timing, impact and method of applying this guidance on its consolidated financial statements.Note 11- Leases.

NOTE 2 – Revenue Recognition and Contracts with Customers

Adoption

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 $720,000$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 September 30, 2019, the Company included return-related assets of approximately $737,000 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 $3,203,000$3,181,000 as of March 31,September 30, 2019. Further, amounts related to promotion payments to customers are now classified as a reduction of sales.

The impact of applying this ASU for the three and nine months ended March 31, 2019 resulted in an immaterial change in product 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 8% and 7%9% for the three months ended March 31, 2019 and 2018, respectively. As a percentage of gross sales, sales returns, rebates and allowances were 7% and 8% for the nine months ended March 31,September 30, 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):

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 26%24% and 22%19% of the Company’s accounts receivable at March 31,September 30, 2019 and June 30, 2018,2019, respectively. Sales to this customer comprised 14%13% and 12%10% of net sales in the three and nine months ended March 31,September 30, 2019 and 2018, respectively. The Company had another customer with an accounts receivable balance that comprised 11% of the Company’s accounts receivable at September 30, 2019 and June 30, 2019. Sales to this customer did not exceed 10% of net sales in either of the three or nine months ended March 31, 2018. The Company had another customer with an accounts receivable balance that comprised 12% and 11% of the Company’s accounts receivable at March 31, 2019 and JuneSeptember 30, 2018, respectively. Sales to this customer did not exceed 10% of net sales in either of the three or nine months ended March 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):

NOTE 5 –- Property, Plant and Equipment

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

Depreciation and amortization expense on property, plant, and equipment was approximately $281,000$295,000 and $259,000$246,000 for the three months ended March 31,September 30, 2019 and 2018, respectively. Depreciation and amortization expense on property, plant, and equipment was approximately $787,000 and $743,000 for the nine months ended March 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 arewere 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 ninethree months ended March 31,September 30, 2019, the Company recognized a net income tax expense of $1,187,000.$369,000. During the ninethree months ended March 31,September 30, 2019, the Company increased its reserve for uncertain income tax positions by $35,000.$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 March 31,September 30, 2019, the Company had accrued interest totaling $0 and $256,000$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 March 31,September 30, 2019, we remain subject to examination in all tax jurisdictions for all relevant jurisdictional statutes for fiscal years 2016 and thereafter.

In November 2018,July 2019, the Company received a Notice of Proposed Adjustment ("NOPA"Form 4549-A, Income Tax Examination Changes (“IRS Notice”) from the Internal Revenue Service (“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 NOPAIRS Notice would be approximately $1.8 million, excluding any interest and penalties. The Company stronglyfiled 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 March 31,September 30, 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 March 31,September 30, 2019 or June 30, 2018.2019.

The Agreement also provides for a LIBOR-basedan interest rate option of LIBORLondon Interbank Offered Rate (“LIBOR”) plus 1.15% to 2.00%, depending on the ratio of outstanding debt to EBITDA,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, “Share-Based Payment”“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 $0$17,000 and $5,000 for the three months ended March 31,September 30, 2019 and 2018, respectively ($0.00 per basic and diluted share for each period) and $152,000 and $141,000 for the nine months ended March 31, 2019 and 2018, respectively ($0.01 per basic and diluted share each period).

2012 Employee Stock Option Plan

In December 2012, the stockholders approved the 2012 Employee Stock Option Plan (the “2012(“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 March 31,September 30, 2019, 68,00080,500 stock options were outstanding, 33,30035,400 stock options were exercisable and 797,900784,900 stock options were available for grant under this plan

plan.

The fair value of each option granted during the ninethree months ended March 31, 2019September 30 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

The following table reflects activity under the 2012 Employee Plan for the ninethree months ended March 31,September 30,:

3,7000 and 18,1002,500 stock options were exercised during the three months ended March 31,September 30, 2019 and 2018, respectively. $3,000$0 and $45,000$16,000 of cash was received from option exercises during the three months ended March 31,September 30, 2019 and 2018, respectively, and the actual tax benefit realized for the tax deductions from option exercises was $3,000 and $0 respectively. 13,200 and 20,600 stock options were exercised during the nine months ended March 31, 2019 and 2018, respectively. $27,000 and $61,000for each of cash was received from option exercises during the nine months ended March 31, 2019 and 2018, respectively, and the actual tax benefit realized for the tax deductions from option exercises was $7,000 and $0, respectively.these periods.

The following table summarizes information about stock options outstanding under the 2012 Employee Plan at March 31,September 30, 2019:

As of March 31,September 30, 2019, there was $253,000$402,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2012 Employee Plan. 08,000 and 5,0004,000 options were granted during the three months ended March 31,September 30, 2019 and 2018, respectively. 24,000 and 25,000 options were granted during the nine months ended March 31, 2019 and 2018, respectively. 01,600 and 1,000 options vested during the three months ended March 31,September 30, 2019 and 2018, respectively. The total fair value of the options vesting during the ninethree months ended March 31,September 30, 2019 and 2018 under this plan was $86,000$17,000 and $84,000,$13,000, respectively.

2012 Non-Employee Stock Option Plan

In December 2012, the stockholders approved the 2012 Non-Employee Stock Option Plan (the “20122012 Non-Employee Plan”)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 March 31,September 30 2019, 13,20010,200 stock options were outstanding, 4,2003,000 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 ninethree months ended March 31,September 30,:

3,600 and 0No stock options were exercised during either of the three months ended March 31,September 30, 2019 and 2018, respectively.or 2018. No cash was received from option exercises during either of the three months ended March 31,September 30, 2019 or 2018 and the actual tax benefit realized for the tax deductions from option exercises was $10,000 and $0 respectively. 14,600 and 0 stock options were exercised during the nine months ended March 31, 2019 and 2018, respectively. No cash was received from option exercises during eitherfor each of the nine months ended March 31, 2019 or 2018 and the actual tax benefit realized for the tax deductions from option exercises was $35,000 and $0, respectively.

these periods.

The following table summarizes information about stock options outstanding under the 2012 Non-Employee Plan at March 31,September 30, 2019:

As of March 31,September 30, 2019, there was $50,000$40,000 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 three months ended March 31,September 30, 2019 or 2018. 0 and 15,000 options were granted during the nine months ended March 31, 2019 and 2018, respectively. No options vested during either of the three months ended March 31, 2019 or 2018. No options vested during either of the nine months ended March 31,September 30, 2019 or 2018.

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 March 31,September 30, 2019, 20,00015,200 stock options were outstanding, 4,0002,400 stock options were exercisable and 30,000 stock options were available for grant under this plan.

The fair value of each option granted during the nine months ended March 31, 2019 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

The following table reflects activity under the 2018 Non-Employee Plan for the ninethree months ended March 31,September 30,:

No stock options were exercised during the three months ended March 31, 2019 or 2018. No stock options were exercised during the nine months ended March 31,September 30, 2019 or 2018. No cash was received from option exercises during either of the three or nine months ended March 31,September 30, 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 March 31,September 30, 2019:

As of March 31,September 30, 2019, there was $164,000$131,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2018 Non-Employee Plan. No options were granted during the three months ended March 31,September 30, 2019 or 2018. 20,000 and 0 options were granted during the nine months ended March 31, 2019 and 2018, respectively. No options vested during either of the three months ended March 31,September 30, 2019 or 2018. The total fair value of the options vesting during the nine months ended March 31, 2019 and 2018 under this plan was $41,000 and $0, respectively.

2002 Employee Stock Option Plan

In December 2002, the stockholders approved the 2002 Employee Stock Option Plan (the “2002 Employee Plan”). This plan expired in October 2012. This plan authorized the granting of awards, the exercise of which would allow up to an aggregate of 1,836,000 shares of the Company's common stock to be acquired by the holders of such awards. Under this plan, the Company may have granted stock options, which were intended to qualify as incentive stock options (ISOs), to key employees. Any plan participant who was granted ISOs and possessed more than 10% of the voting rights of the Company's outstanding common stock must have been granted an option with a price of at least 110% of the fair market value on the date of grant.

Under the 2002 Employee Plan, stock options have been granted to key employees with a term of 10 years at an exercise price equal to the fair market value on the date of grant and are exercisable in whole or in part at 20% per year from the date of grant. At March 31, 2019, no stock options were outstanding or exercisable and no further stock options were available for grant under this plan after the plan expired in October 2012.

No options were exercised during either of the three months ended March 31, 2019 or 2018. 0 and 5,000 stock options were exercised during the nine months ended March 31, 2019 and 2018, respectively. The 5,000 exercises were settled in cashless exercises by exchanging 2,815 shares of the Company’s common stock which were retired and returned to unissued status. No cash was received from option exercises during either of the three or nine months ended March 31, 2019 and 2018 and the actual tax benefit realized for the tax deductions from option exercises was $0 for each of these periods.

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 then outstanding. On December 21, 2018, the Company’s board of directors authorized the repurchase of up to an additional 500,000 shares. As of March 31,September 30, 2019, there was an aggregate 434,725 shares that may yet be purchased under the two repurchase plans. The repurchasesrepurchase 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. Relative to the loan agreement described in Note 6, the Company’s lender gave its consent to this stock repurchase plan. The Company did not repurchase any of its outstanding common stock during the three months ended September 30, 2019. The Company repurchased 274,06539,163 shares at a weighted average price of $14.59$14.02 under these plansthis plan during the ninethree months ended March 31, 2019.September 30, 2018. Shares repurchased through March 31, 2019September 30, 2018 are included in the Company’s Treasury Stock as of March 31, 2019.

September 30, 2018.

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$30,000 and $35,000$34,000 for the three months ended March 31, 2019 and 2018, respectively, and $99,000 and $99,000 for the nine months ended March 31,September 30, 2019 and 2018, respectively.

NOTE 11 - Commitments and Contingencies

Leases

The

Effective July 1, 2019, the Company is committedadopted 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 variousthe 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 obligations consist of operating leases not including the landfor office equipment and a 99 year lease discussed below, which do not extend beyond fiscal 2023.

Rent expense, with the exception of the land lease referred to below, totaled approximately $12,000 and $11,000 for the three months ended March 31, 2019 and 2018, respectively and $34,000 and $24,000 for the nine months ended March 31, 2019 and 2018, respectively.

Land Lease

Oncommenced on April 26, 1993 with one of the Company'sCompany’s foreign subsidiaries, entered into a 99 year lease, expiring in 2092, for approximately four acres of land in the Dominican Republic at an annual cost of $288,000, on which the Company'sCompany’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 months ended September 30, 2019 cash payments against operating lease liabilities totaled $96,000.

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

The following is a schedule, by years, of maturities of lease liabilities as of September 30, 2019 (in thousands):

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):

Operating lease expense totaled approximately $79,000 and $83,000, for the three months ended September 30, 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 March 31,September 30, 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 $752,000,$775,000, 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 2020 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 bonus arrangement for fiscal 2019 and, if terminated by the Companynon-voluntary termination of employment without cause severanceor for any reason within three months of nine months’ salary and continued company-sponsored health insurance for six months froma change in control of the date of termination.Company. The employment agreement with the SVP of Engineering expires in August 2020 and provides for an annual salary of $302,000 and provides for payment equal to nine months of salary and six months of health insurance in the event of a bonus arrangement for fiscal 2019 and, if terminated by the Companynon-voluntary termination of employment without cause severanceor for any reason within three months of nine month’s salary and continued company-sponsored health insurance for six months froma change in control of the date of termination.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 securitydoor-locking 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. 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) 

(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 (March 31,(September 30, 2019 = $22,630,$24,232, June 30, 20182019 = $16,592)$22,549) and long-lived assets (March 31,(September 30, 2019 = $3,411,$11,064, June 30, 20182019 = $3,462)$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 20182019 Annual Report on Form 10-K.

Overview

The Company is a diversified manufacturer of security products, encompassing access control systems, door securitydoor-locking 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. 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 months ended March 31,September 30, 2019 and 2018 and 2% and 3% for the nine months ended March 31, 2019 and 2018, respectively.

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 typically devotes 6-8% of revenues to research and development (“R&D”)(R&D) on an annual basis. The Company does not expect products resulting from our R&D investments in a given fiscal 2019year to contribute materially to revenue during that same fiscal 2019,year, but mayshould 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 beingbecoming 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 the Company’sNapco'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. DeteriorationThe 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 20182019 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