UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q10-Q/A (Amendment No 1.)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: September 30, 2022 |
OR
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . |
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Commission File number: 0-10004 | | |
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NAPCO SECURITY TECHNOLOGIES, INC. |
(Exact name of Registrant as specified in its charter) |
Delaware | | 11-2277818 |
(State or other jurisdiction of | | (IRS Employer Identification |
incorporation of organization) | | Number) |
| |
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333 Bayview Avenue | |
|
Amityville, New York | | 11701 |
(Address of principal executive offices) | | (Zip Code) |
(631) 842-9400 |
(Registrant’s telephone number including area code) |
|
|
(Former name, former address and former fiscal year if |
changed from last report) |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
| Trading Symbol(s) |
| Name of each exchange on which registered |
Common Stock, par value $0.01 per share | | NSSC | | The Nasdaq Stock Market LLC |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes ⌧ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ⌧ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ⌧
Number of shares outstanding of each of the issuer’s classes of common stock, as of: November 4, 2022
COMMON STOCK, $.01 PAR VALUE PER SHARE 36,744,755
EXPLANATORY NOTE
Napco Security Technologies, Inc. (“Company”) is filing this Amendment No. 1 on Form 10-Q/A (the “Amendment”) to amend its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2022, originally filed with the U.S. Securities and Exchange Commission (the “SEC”) on November 7, 2022 (the “Original Report”). In filing this amendment, the Company is restating its previously issued unaudited financial statements for the periods contained therein to account for changes to the Company’s inventory valuation, which led to changes in, among other things, cost of goods sold, gross profit, operating income and net income as more fully described below. Those previously issued financial statements should no longer be relied upon. Except as described below, all other information in, and the exhibits to, the Original Report remain unchanged. Accordingly, this Amendment should be read in conjunction with the Original Report and with our filings with the SEC made after the Original Report. This Amendment speaks as of the date of the Original Report, and the Company has not updated the Original Report to reflect events occurring subsequent to the date of the Original Report.
Background and Effects of the Restatement
In the course of preparing the Company’s fiscal fourth quarter and year-end financial statements, management of the Company identified certain errors related to the Company’s calculation of cost of goods sold (“COGS”) and inventory for the period ended September 30, 2022. Specifically, the costs of several raw material components fluctuated significantly during fiscal 2023, and the Company’s costing procedures did not appropriately account for such fluctuations. As a result, inventories were overstated and COGS was understated, resulting in overstated gross profit, operating income, provision for income taxes and net income for the period. The effects of these changes on the financial statements for this period is shown in Note 1A to the Condended Consolidated Financial Statements.
Internal Control Over Financial Reporting
In connection with the restatement, management has assessed the effectiveness of the Company’s internal control over financial reporting. Based on this assessment, the Company identified a material weakness in its internal control over financial reporting resulting in the conclusion by the Company’s Chief Executive Officer and Chief Financial Officer that the internal control over financial reporting and disclosure controls and procedures were not effective as of September 30, 2022. Management is taking steps towards remediating the material weakness in the Company’s internal control over financial reporting. For additional information related to the material weakness in internal control over financial reporting and the related remedial measures, see “Part II – Item 9A. Controls and Procedures.”
Items Amended in this Filing
This Amendment sets forth the Original Form 10-Q, as modified and superseded where necessary to reflect the restatement and the related internal control considerations. Accordingly, the following items included in the Original Form 10-Q have been amended:
• Part I, Item 1, Condensed Consolidated Financial Statements
• Part I, Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations
• Part I, Item 4, Controls and Procedures
• Part II, Item 1A, Risk Factors
Additionally, in accordance with Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the Company is including with this Amendment currently dated certifications from its Chief Executive Officer and Chief Financial Officer. These certifications are filed or furnished, as applicable, as Exhibits 31.1, 31.2 and 32.1.
2
NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES
PART I: FINANCIAL INFORMATION Item 1. Financial Statements NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying notes to condensed consolidated financial statements.
NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
See accompanying notes to condensed consolidated financial statements.
NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS 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) September 30, 2022 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. Deterioration of the current economic conditions may also affect this trend. The monthly recurring revenue, which is less 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. Stock Split In December 2021, the Company's Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend of the Company's common stock, payable to stockholders of record on December 20, 2021. The additional shares were distributed on January 4, 2022. All share and per share amounts (except par value) have been retroactively adjusted to reflect the stock split. There was no net effect on stockholders’ equity as a result of the stock split. Upon distribution of the dividend, the total number of shares outstanding increased from 18,365,878 to 36,731,756. 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 doubtful accounts, overhead expenses applied to inventory, inventory reserves, valuation of intangible 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 September 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 $5,066,000 and $63,000 of short-term time deposits at September 30, 2022 and June 30, 2022, respectively. The Company classifies all highly liquid investments with original maturities of three months or less as cash equivalents. During the three months ended September 30, 2022, the Company purchased three certificate of deposits totaling $15,000,000. One certificate of deposit with Investments – other The Company classifies certificates of deposit with an original maturity greater than three months as investments - other. Certificate of deposits are recorded at the original cost plus accrued interest. As of September 30, 2022 and June 30, 2022, the Company included $10,008,000 and $0, respectively, of certificate of deposits within investments - other. 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 would record an impairment charge if 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 three months ended September 30, 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 doubtful accounts of $216,000 and $243,000 as of both September 30, 2022 and June 30, 2022. 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) method. The reported net value of inventory includes finished saleable products, work-in-process and raw materials that will be sold or used in future periods. Inventory costs include raw materials, direct labor and overhead. The Company’s overhead expenses are applied based, in part, upon estimates of the proportion of those expenses that are related to procuring and storing raw materials as compared to the manufacture and assembly of finished products. These proportions, the method of their application, and the resulting overhead included in ending inventory, are based in part on subjective estimates and actual results could differ from those estimates. In addition, the Company records an inventory obsolescence reserve, which represents any excess of the cost of the inventory over its estimated realizable value. 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 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. Changes in intangible assets are as follows (in thousands):
Amortization expense for intangible assets subject to amortization was approximately $90,000 and $98,000 for the three months ended September 30, 2022 and 2021, respectively. Amortization expense for each of the next five fiscal years is estimated to be as follows: 2023 - $361,000; 2024 - $336,000; 2025 - $315,000; 2026 - $297,000; and 2027 - $283,000. The weighted average remaining amortization period for intangible assets was 16.0 years and 16.2 years at September 30, 2022 and June 30, 2022, respectively. 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 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 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 the three months ended September 30, 2022 and 2021 was $754,000 and $1,086,000, respectively. Research and Development Costs Research and development (“R&D”) 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 R&D expense for the three months ended September 30, 2022 and 2021 was $2,428,000 and $1,931,000, 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. Net Income per Share (2022 amounts as restated) Basic net income per common share (Basic EPS) is computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per common share (Diluted EPS) is computed by dividing net income by the weighted average number of common shares and dilutive common share equivalents and convertible securities then outstanding. The following provides a reconciliation of information used in calculating the per share amounts for the three months ended September 30, 2022 and 2021 (in thousands, except share and per share data):
Options to purchase 62,500 and 0 shares of common stock were excluded for the three months ended September 30, 2022 and 2021, 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 period.
Stock-Based Compensation The Company has established four 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 $477,000 and $89,000 were recognized for the three months ended September 30, 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 three months ended September 30, 2022 or 2021. Comprehensive Income For the three months ended September 30, 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 13. Shipping and Handling Sales and Costs The Company records the amount billed to customers for shipping and handling in net sales ($112,000 and $106,000 in the three months ended September 30, 2022 and 2021, respectively); and classifies the costs associated with these sales in cost of sales ($394,000 and $333,000 in the three months ended September 30, 2022 and 2021, respectively). Leases The Company records lease assets and 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 is 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. In January 2021, the FASB issued authoritative guidance that makes amendments to the new rules on accounting for reference rate reform. The amendments clarify that for all derivative instruments affected by the changes to interest rates used for discounting, margining or contract price alignment, regardless of whether they reference LIBOR or another rate expected to be discontinued as a result of reference rate reform, an entity may apply certain practical expedients in ASC Topic 848. Effective for the Company – This guidance can be applied for a limited time through December 31, 2022. The guidance will no longer be available to apply after December 31, 2022. Impact on consolidated financial statements – 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. Financial Instruments – Credit Losses (Topic 326) In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326),” which requires financial assets measured at amortized cost, such as our trade receivables, to be presented net of expected credit losses, which may be estimated based on relevant information such as historical experience, current conditions, and future expectations for each pool of similar financial assets. ASU 2016-13 becomes effective for the Company beginning in the quarter ended September 30, 2023. The Company is currently evaluating the impact of adoption on its consolidated financial statements. NOTE 1A – Restatement of Previously Issued Financial Statements During the preparation of the Company’s consolidated financial statements for the fiscal year ended June 30, 2023, management of the Company identified certain errors related to the Company’s calculation of cost of goods sold (“COGS”) and inventory for each of the first three quarters of fiscal 2023. Specifically, the costs of several raw materials fluctuated significantly during fiscal 2023, the Company’s costing procedures did not appropriately account for such fluctuations. As a result, inventories were overstated and COGS was understated, resulting in overstated gross profit, operating income and net income for each period. The effects of the restatement resulted in a decrease to overall inventory (current and non-current inventory) and increase to cost of sales of $3,601,000, a decrease to the provision for income taxes of $283,000 and a decrease to net income and retained earnings of $3,318,000. Net cash provided by operating activities remained the same. The table below sets forth the consolidated balance sheets information, including the balances originally reported and the restated balances as of September 30, 2022 (in thousands):
13 The table below sets forth the consolidated statements of income information, including the balances originally reported and the restated balances for the quarter ended September 30, 2022:
The table below sets forth the consolidated statements of cash flows information, including the balances originally reported and the restated balances for the quarter ended September 30, 2022:
In addition to the restated consolidated financial statements, the information contained in notes 1, 5, 7 and 13 have been restated. 14 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. All of these products and services are used for commercial, residential, institutional, industrial and governmental applications, and are sold primarily to independent distributors, dealers and installers of security equipment. Sales to unaffiliated customers are primarily shipped from the United States. As of September 30, 2022 and June 30, 2022, the Company included refund liabilities of approximately $4,242,000 and $5,863,000, respectively, in current liabilities. As of September 30, 2022 and June 30, 2022, the Company included return-related assets of approximately $987,000 and $974,000, respectively, in other current assets. As a percentage of gross sales, returns, rebates and allowances were 5% and 8% for the three months ended September 30, 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 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 of 15% and 16% as of September 30, 2022 and June 30, NOTE 4 – Marketable Securities The Company’s marketable securities include investments in fixed income mutual funds, which invest primarily in various government and corporate obligations, stocks and money market funds, and are reported at their fair values. The disaggregated net gains and losses 15 on the marketable securities recognized within the accompanying condensed consolidated statements of income for the three ended September 30, 2022 and 2021 are as follows (in thousands):
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:
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 at September 30, 2022 and June 30, 2022, respectively (in thousands):
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.
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):
16 NOTE 6 – 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 $367,000 and $340,000 for the three months ended September 30, 2022 and 2021, respectively. NOTE 7 - Income Taxes (2022 amounts as restated) 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. For the three months ended September 30, 2022 and September
The Company does not expect that In January 2022, the Company received a letter from the IRS (“IRS”) notifying it that the IRS would be examining the Company’s income tax return for fiscal year ended June 30, 2020. Management believes that its provision for income taxes for this period is adequate. However, the outcome cannot be predicted with certainty. 17 NOTE 8 - Long-Term Debt As of September 30, 2022 and June 30, 2022, the Company had a revolving line of credit of $11,000,000 Outstanding balances and interest rates as of September 30, 2022 and June 30, 2022 are as follows (dollars in thousands):
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 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 quarter ended September 30, 2021 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 Option 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 three months ended September 30, 2022 and 2021, the Company recorded non-cash compensation expense of 18 $477,000 ($0.01 per basic and diluted share) and $89,000 ($0.00 per basic and diluted share), respectively, relating to stock-based compensation. 2022 Employee Stock Option Plan
Under the 2022 Employee 2012 Employee Stock Option Plan In December 2012, the stockholders approved the 2012 Employee Stock Option Plan (the 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 September 30, 2022, 555,380 stock options were outstanding, 183,852 stock options were exercisable and 1,101,420 stock options were available for grant under this plan. No options may be granted under this plan after December 2022. 37,500 Options were granted during the three months ended September 30, 2022. There were no options granted during the three months ended September 30, 2021. 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:
The following table reflects activity under the 2012 Employee Plan for the three months ended September 30:
5,200 and 5,000 stock options were exercised during the three months ended September 31, 2022 and 2021, respectively. $45,000 and $16,000 cash was received from the option exercises during the three months ended September 30, 2022 and 2021, respectively. The actual tax benefit realized for the tax deductions from option exercises during the three months ended September 30, 2022 and 2021 was $0 for each period. The following table summarizes information about stock options outstanding under the 2012 Employee Plan at September 30, 2022:
As of September 30, 2022, there was $2,651,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2012 Employee Plan. 37,500 and 0 options were granted during the three months ended September 30, 2022 and 2021, respectively. 12,300 and 4,800 options vested during the three months ended September 30, 2022 and 2021, respectively. The total grant date fair value of the options vesting during the three months ended September 30, 2022 and 2021 under this plan was $129,000 and $29,000, 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. 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 September 30, 2022, 20,400 stock options were outstanding, 11,280 stock options were exercisable and no further stock options were available for grant under this plan.
There were no options granted during the three months ended September 30, 2022 and 2021. No options may be granted under this plan after December 2022. 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:
The following table reflects activity under the 2012 Non-Employee Plan for the three months ended September 30:
No stock options were exercised during the three months ended September 30, 2022 or 2021. No cash was received from option exercises during either of the three months ended September 30, 2022 or 2021 and the actual tax benefit realized for the tax deductions from option exercises was $0 for both periods. The following table summarizes information about stock options outstanding under the 2012 Non-Employee Plan at September 30, 2022:
As of September 30, 2022, there was $64,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2012 Non-Employee Plan. No options were granted during the three months ended September 30, 2022 and 2021. No options vested during the three months ended September 30, 2022 and 2021. 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 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. 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 September 30, 2022, 82,700 stock options were outstanding, 38,740 stock options were exercisable and no further stock options were available for grant under this plan. There were no options granted during the three months ended September 30, 2022 and 2021. No options may be granted under this plan after December 2028. 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:
The following table reflects activity under the 2018 Non-Employee Plan for the three months ended September 30:
6,300 and 0 options were exercised during the three months ended September 30, 2022 and 2021, respectively. The 6,300 options that were exercised during the three months ended September 30, 2022 were settled by exchanging 3,020 shares of the Company’s common stock which were retired and returned to unissued status upon receipt. No cash was received from option exercises during The following table summarizes information about stock options outstanding under the 2018 Non-Employee Plan at September 30 2022:
As of September 30, 2022, there was $228,000 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 September 30, 2022 and 2021. No options vested during the three months ended September 30, 2022. 2020 Non-Employee Stock Option Plan In May 2020, the stockholders approved the 2020 Non-Employee Stock Option Plan (the “2020 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. Under the 2020 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 September 30, 2022, 51,900 stock options were outstanding, 14,380 stock options were exercisable and 48,100 stock options were available for grant under this plan. 25,000
The following table reflects activity under the 2020 Non-Employee Plan for the three months ended September 30:
No stock options were exercised during the three months ended September 30, 2022 or 2021. No cash was received from option exercises during either of the three months ended September 30, 2022 or 2021 and the actual tax benefit realized for the tax deductions from option exercises was $0 for both periods. The following table summarizes information about stock options outstanding under the 2020 Non-Employee Plan at September 30, 2022:
As of September 30, 2022, there was $374,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2020 Non-Employee Plan. 25,000 and 0 options were granted during the three months ended September 30, 2022 and 2021, respectively. 7,000 and 2,000 options vested during the three months ended September 30, 2022 and 2021, respectively. The total grant date fair value of the options vesting during the three months ended September 30, 2022 and 2021 under this plan was $79,000 and $12,000, respectively.
NOTE 10 – Stockholders’ Equity Transactions On September 16, 2014, the Company’s board of directors authorized the repurchase of up to 2 million of the approximately 38.8 million shares of the Company’s common stock then outstanding. Such repurchases may 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 On December 6, 2021, the In December 2021, the Company's Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend of the Company’s common stock payable to stockholders of record on December 20, 2021. The additional shares were distributed on January 4, 2022. All share and per share amounts (except par value) have been retroactively adjusted to reflect the stock split. There was no net effect on total stockholders' equity as a result of the stock split. During the three months ended September 30, 2022, certain employees and During fiscal 2022, certain employees and NOTE 11 - 401(k) Plan The Company maintains a 401(k) plan (“the Plan”) that NOTE 12 - Commitments and Contingencies Leases Our lease obligation consists of a 99-year lease, entered into by one of the Company’s foreign subsidiaries, for approximately four acres of land in the Dominican Republic on which the Company’s principal production facility is located. The lease, which commenced on April 26, 1993 and expires in 2092, initially had an annual base rent of approximately $235,000 plus $53,000 in annual service charges. On September 14, 2022, a lease modification was executed which provides for an annual base rent of $235,000 plus $105,000 in annual
service charges. The service charges increase 2% annually over the remaining life of the lease. The modification resulted in a remeasurement of the operating lease asset and liability, and the effect was a reduction to the asset and liability of $1.3 million. 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 September 30, 2022 and 2021, cash payments against operating lease liabilities totaled $72,000 for each period. 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, 2022 (in thousands):
Operating lease expense totaled approximately $80,000 for each the three months ended September 30, 2022 and 2021, 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 Agreements As of September 30, 2022, the Company was obligated under two employment agreements and one severance agreement. The employment agreements are with the Company’s CEO The employment agreement with the CEO provides for an annual salary of $872,000, 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 Engineering expires in August 2024 and provides for an annual salary of $361,000, and, if terminated by the Company without cause, severance of nine month’s salary and continued company-sponsored health insurance for six months from the date of termination. The severance agreement is with the Executive Vice President of Operations and Chief Financial Officer and provides for, if terminated by the Company without cause or within three months of a change in corporate control of the Company, severance of nine
NOTE 13 – Geographical Data The Company is engaged in one major line of business: the development, manufacture, and distribution of security products, encompassing access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products for commercial and residential use. The Company also provides wireless communication service for intrusion and fire alarm systems. These products are used for commercial, residential, institutional, industrial and governmental applications, and are sold worldwide principally to independent distributors, dealers and installers of security equipment. Sales to unaffiliated customers are primarily shipped from the United States. The Company has customers worldwide with major concentrations in North America. Financial Information Relating to Domestic and Foreign Operations (in thousands):
NOTE 14 - Subsequent Events The Company has evaluated subsequent events occurring after the date of the condensed consolidated financial statements for events requiring recording or disclosure in the condensed consolidated financial statements. The Company’s Board of Directors approved a new Employee Stock Option Plan (“2022 Plan”) in August 2022. The 2022 Plan is subject to shareholder approval at the Company’s annual shareholder’s meeting in December 2022. The plan would authorize 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. The terms of the 2022 Plan are substantially the same as those of the 2012 Employee Stock Option Plan. The 2022 Plan is intended to replace the 2012 Employee Stock Option Plan, which expires in 2022.
On August 18, 2023, the Company’s Board of Directors declared a cash dividend of $.08 per share payable on September 22, 2023 to stockholders of record on September 1, 2023. On August 29, 2023, a purported class action was filed in the United States District Court for the Eastern District of New York against the Company, its Chairman and Chief Executive Officer, and its Chief Financial Officer, alleging violations of the Securities Exchange Act of 1934 in connection with statements made in the Company’s quarterly reports on Form 10-Q for the quarters ended September 30, 2022, December 31, 2022 and March 31, 2023 (the “10-Q’s”). The Company previously announced that it was going to restate the financial statements contained in the 10-Qs. The Company intends to vigorously defend against the action.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Restatement of Previously Issued Financial Statements This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” has been amended and restated to give effect to the restatement of our financial statements, as more fully described in Note 1A to our financial statements entitled “Restatement of Previously Issued Financial Statements”. For further detail regarding the restatement, see “Explanatory Note” and “Item 4. Controls and Procedures.” Management’s Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q 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 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. Overview 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. 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. 27 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 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. 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 2022 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
Net Sales for the three months ended September 30, 2022 increased by $8,442,000, or 27.2%, to $39,493,000 as compared to $31,051,000 for the same period a year ago. The increase in sales for the three months ended September 30, 2022 was due primarily to increased recurring communication service revenues ($3,582,000), Napco brand intrusion products, which include the Company’s cellular radio products ($3,332,000), Alarm Lock brand door-locking products ($1,126,000), and Continental brand access control products ($402,000). 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.
The Company's gross profit increased by Research and development expenses for the three months ended September 30, 2022 increased $497,000 to $2,428,000, or 6.2% of net sales, as compared to $1,931,000, or 6.2% of net sales, for the same period a year ago. The increase in dollars was due primarily to salary increases and additional staff. Selling, general and administrative expenses for the three months ended September 30, 2022 increased 15.6% to $8,490,000 from $7,346,000 for the same period a year ago. Selling, general and administrative expenses as a percentage of net sales decreased to 21.5% for the three months ended September 30, 2022 as compared to 23.7% for the same period a year ago. The increase in dollars resulted primarily from increases in sales commissions, stock option expense and legal expenses. The decrease as a percentage of net sales was due primarily to the increase in net sales as partially offset by the aforementioned increase in expense dollars. Interest and other (expense) income, net for the three months ended September 30, 2022 decreased by $120,000 to an expense of $103,000 as compared to income of $17,000 for the same period a year ago. Gain on extinguishment of debt resulted from a one-time gain in the three months ended September 30, 2021 which resulted from the forgiveness of the Company’s PPP loans as described in Note 8 to the condensed consolidated financial statements. The Company’s provision for income taxes for the three months ended September 30, 2022 increased by Net income for the three months ended September 30, 2022 decreased by
Liquidity and Capital Resources During the three months ended September 30, 2022, the Company utilized a portion of its cash balance at June 30, 2022 ($12,365,000 of $41,730,000) to fund operations ($1,965,000) and to purchase marketable securities and other investments ($10,028,000) and property, plant and equipment ($372,000). The Company believes its current working capital, cash flows from operations and its revolving credit agreement will be sufficient to fund the Company’s operations through the next twelve months. Accounts receivable at September 30, 2022 decreased by $7,876,000 to $21,342,000 as compared to $29,218,000 at June 30, 2022. This decrease Inventories, which include both current and non-current portions, increased by Accounts payable and accrued expenses, not including income taxes payable, decreased by $645,000 to $23,980,000 as of September 30, 2022 as compared to $24,625,000 as of June 30, 2022. This decrease As of September 30, 2022 and 2021, long-term debt consisted of a revolving line of credit of $11,000,000 (“Revolver Agreement”), with no amounts outstanding, which expires in June 2024. The revolving credit facility contains various restrictions and covenants including, among others, restrictions on borrowings and compliance with certain financial ratios, as defined in the agreement. The Company’s long-term debt is described more fully in Note 8 to the condensed consolidated financial statements. As of September 30, 2022 the Company had no material commitments for capital expenditures or inventory purchases other than purchase orders issued in the normal course of business. ITEM 3: Quantitative and Qualitative Disclosures About Market Risk The Company's principal financial instrument is long-term debt (consisting of a revolving credit facility) that provides for interest based on the prime rate or LIBOR as described in the agreement. The Company is affected by market risk exposure primarily through the effect of changes in interest rates on amounts payable by the Company under these credit facilities. All foreign sales transactions by the Company are denominated in U.S. dollars. As such, the Company has shifted foreign currency exposure onto its foreign customers. As a result, if exchange rates move against foreign customers, the Company could experience difficulty collecting unsecured accounts receivable, the cancellation of existing orders or the loss of future orders. The foregoing could materially adversely affect the Company's business, financial condition and results of operations. We are also exposed to foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"), 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 $868,000. ITEM 4: Controls and Procedures (as Restated) We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives.
At the conclusion of the period ended September 30, 2022, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. As disclosed in our Annual Report on Form 10-K for the year ended June 30, 2022, management initially identified two material weaknesses in internal control. 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 material weakness did not result in any identified misstatements to the financial statements and there were no changes to the previously released financial 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. The material weakness did not result in a material misstatement to the financial Management is currently designing and implementing additional controls and procedures to remediate these items and expects to complete these actions during fiscal In addition to the foregoing, during the Company’s closing of its books for the period ended June 30, 2023, management identified an additional material weakness related to the Company’s Cost of Goods Sold (“COGS”) and Inventory during the quarter ended September 30, 2022. 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 material costs due to various macroeconomic factors. 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 and net income for the three months ended September 30, 2022. 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. During the three months ended September 30, 2022, 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 PART II: OTHER INFORMATION Item 1A. Risk Factors Information regarding the Company’s Risk Factors are set forth in the Company’s Annual Report on Form 10-K for the year ended June 30, 2022. There has been no material change in the risk factors previously disclosed in the Company’s Form 10-K for the three months ended September 30, The Company faces risks related to the restatement of its previously issued condensed financial statements with respect to the first three quarters of fiscal year ended June 30, 2023 (the “Affected Periods”). As discussed in the Explanatory Note and in Note 1A to the condensed financial statements in this Form 10-Q/A , we determined to restate certain information in our previously issued condensed financial statements for the Affected Periods. As a result, we have become subject to a number of additional risks and uncertainties, which may affect investor confidence in the accuracy of our financial disclosures, including the following: 31 •We will face litigation under the federal and state securities laws and other claims arising from the restatement. One such case has already been filed and we will likely face additional complaints. See Note 14-Subsequent Events. The cost of defending against those claims, the adequacy of our directors’ and officers’ liability insurance and the ultimate outcome of any such litigation cannot be predicted at this time •The processes undertaken to effect the restatement may not be adequate to identify and correct all errors in our historical financial statements, and, as a result, we may discover additional errors and our financial statements remain subject to the risk of future restatement. •The restatement has demonstrated an additional material weakness in our internal controls over financial reporting. The process of remediating that weakness and implementing new procedures and systems to correct the problems that led to the restatement will likely be time consuming and expensive and there can be no assurance how long that process will take or if the corrective measures will be successful. Furthermore, the implementation of those measures may result in an ongoing increase in administrative expenses which may adversely affect the Company’s profitability.
Item 6. Exhibits
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NAPCO SECURITY TECHNOLOGIES, INC. (Registrant)
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