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Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: DECEMBER 31, 2020

OR

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

Commission File number:                0-10004                     

NAPCO SECURITY TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

Delaware

11-2277818

(State or other jurisdiction of

(IRS Employer Identification

incorporation of organization)

Number)

 

 

333 Bayview Avenue

 

Amityville, New York

11701

(Address of principal executive offices)

(Zip Code)

(631) 842-9400

(Registrant’s telephone number including area code)

 

 

(Former name, former address and former fiscal year if

changed from last report)

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

Title of each class

    

Trading Symbol(s)

    

Name of each exchange on which registered

Common Stock, par value $0.01 per share

NSSC

Nasdaq Stock Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:            Yes            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

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: February 8, 2021

COMMON STOCK, $.01 PAR VALUE PER SHARE     18,347,351

Table of Contents

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

Page

PART I:  FINANCIAL INFORMATION

ITEM 1.

Financial Statements

3

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES INDEX –DECEMBER 31, 2020

Condensed Consolidated Balance Sheets December 31, 2020 (unaudited) and June 30, 2020

3

Condensed Consolidated Statements of Income for the Three Months ended December 31, 2020 and 2019 (unaudited)

4

Condensed Consolidated Statements of Income for the Six Months ended December 31, 2020 and 2019 (unaudited)

5

Condensed Consolidated Statements of Stockholders Equity for the Six Months ended December 31, 2020 and 2019 (unaudited)

6

Condensed Consolidated Statements of Cash Flows for the Six Months ended December 31, 2020 and 2019 (unaudited)

7

Notes to Condensed Consolidated Financial Statements (unaudited)

8

ITEM 2.

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

25

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

28

ITEM 4.

Controls and Procedures

28

PART II:  OTHER INFORMATION

ITEM 1A.

Risk Factors

29

ITEM 6.

Exhibits

30

SIGNATURE PAGE

31

2

Table of Contents

PART I:           FINANCIAL INFORMATION

Item 1.  Financial Statements

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

December 31, 2020

    

(unaudited)

    

June 30, 2020

(in thousands, except share data)

CURRENT ASSETS

  

 

  

Cash and cash equivalents

$

26,796

$

18,248

Accounts receivable, net of allowance for doubtful accounts of $196 and $326 at December 31, 2020 and June 30, 2020, respectively, and other reserves

 

21,223

 

22,932

Inventories, net

 

29,383

 

35,231

Prepaid expenses and other current assets

 

1,860

 

2,049

Total Current Assets

 

79,262

 

78,460

Inventories - non-current, net

 

8,653

 

6,524

Property, plant and equipment, net

 

7,842

 

8,088

Intangible assets, net

 

4,903

 

5,116

Operating lease asset

7,384

7,395

Other assets

 

249

 

255

TOTAL ASSETS

$

108,293

$

105,838

CURRENT LIABILITIES

  

 

  

Accounts payable

$

4,402

$

6,547

Accrued expenses

 

5,273

 

5,744

Accrued salaries and wages

 

2,114

 

2,181

Current portion of long-term debt

1,084

1,794

Accrued income taxes

 

606

 

1,148

Total Current Liabilities

 

13,479

 

17,414

Long term debt, net of current portion

2,820

2,110

Deferred income taxes

 

30

 

112

Accrued income taxes

 

1,257

 

1,188

Long term operating lease liabilities

7,102

7,113

Total Liabilities

 

24,688

 

27,937

COMMITMENTS AND CONTINGENCIES

 

  

 

  

STOCKHOLDERS’ EQUITY

Common Stock, par value $0.01 per share; 40,000,000 shares authorized; 21,241,066 shares issued; and 18,347,351 shares outstanding

 

212

 

212

Additional paid-in capital

 

17,954

 

17,766

Retained earnings

 

84,960

 

79,444

Less: Treasury Stock, at cost (2,893,715 shares)

 

(19,521)

 

(19,521)

TOTAL STOCKHOLDERS’ EQUITY

 

83,605

 

77,901

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

$

108,293

$

105,838

See accompanying notes to condensed consolidated financial statements.

3

Table of Contents

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)

Three Months ended December 31, 

2020

    

2019

Net sales:

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

Equipment revenues

$

19,016

 

$

20,045

Service revenues

 

8,189

 

5,784

 

27,205

 

25,829

Cost of sales:

 

  

 

  

Equipment related expenses

 

14,599

 

12,602

Service related expenses

 

1,203

 

1,100

 

15,802

 

13,702

Gross Profit

 

11,403

 

12,127

Research and development

 

1,884

 

1,823

Selling, general, and administrative expenses

 

5,850

 

6,310

 

7,734

 

8,133

Operating Income

 

3,669

 

3,994

Other expense (income):

 

  

 

  

Interest expense (income), net

 

3

 

(9)

Income before Provision for Income Taxes

 

3,666

 

4,003

Provision for Income Taxes

 

469

 

431

Net Income

$

3,197

$

3,572

Income per share:

 

  

 

  

Basic

$

0.17

$

0.19

Diluted

$

0.17

$

0.19

Weighted average number of shares outstanding:

 

  

 

  

Basic

 

18,347,000

 

18,478,000

Diluted

 

18,402,000

 

18,538,000

See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)

    

Six Months ended December 31, 

    

2020

    

2019

Net sales:

 

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

Equipment revenues

$

34,914

$

40,966

Service revenues

 

15,464

 

11,148

 

50,378

 

52,114

Cost of sales:

 

 

Equipment related expenses

 

25,906

 

26,240

Service related expenses

 

2,377

 

2,229

 

28,283

 

28,469

Gross Profit

 

22,095

 

23,645

Research and development

 

3,773

 

3,572

Selling, general, and administrative expenses

 

11,999

 

12,470

15,772

16,042

Operating Income

 

6,323

 

7,603

Other expense (income):

 

 

Interest expense (income), net

 

9

 

(2)

Income before Provision for Income Taxes

 

6,314

 

7,605

Provision for Income Taxes

 

798

 

800

Net Income

$

5,516

$

6,805

Income per share:

 

 

Basic

$

0.30

$

0.37

Diluted

$

0.30

$

0.37

Weighted average number of shares outstanding:

 

 

Basic

 

18,347,000

 

18,478,000

Diluted

 

18,397,000

 

18,537,000

See accompanying notes to condensed consolidated financial statements.

5

Table of Contents

NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (unaudited)

Six months ended December 31, 2020 (in thousands, except for share data)

Common Stock

Treasury Stock

    

Number of

    

    

Additional

    

    

    

    

 

Shares

 

Paid-in

 

Number of

 

Retained

 

Issued

Amount

 

Capital

Shares

Amount

Earnings

Total

Balances at June 30, 2020

 

21,241,066

$

212

$

17,766

 

(2,893,715)

$

(19,521)

$

79,444

$

77,901

Net income

 

 

 

 

 

 

2,319

 

2,319

Stock-based compensation expense

 

 

 

104

 

 

 

 

104

Balances at September 30, 2020

 

21,241,066

$

212

$

17,870

 

(2,893,715)

$

(19,521)

$

81,763

$

80,324

Net income

3,197

3,197

Stock-based compensation expense

84

84

Balances at December 31, 2020

21,241,066

$

212

$

17,954

(2,893,715)

$

(19,521)

$

84,960

$

83,605

    

Six months ended December 31, 2019 (in thousands, except share data)

    

Common Stock

  

Treasury Stock

  

  

    

Number of

    

    

Additional

    

    

    

    

 

Shares

 

Paid-in

 

Number of

 

Retained

 

Issued

Amount

 

Capital

Shares

Amount

Earnings

Total

Balances at June 30, 2019

 

21,227,094

$

212

$

17,103

 

(2,749,310)

$

(17,067)

$

70,924

$

71,172

Net income

 

 

 

 

 

 

3,233

 

3,233

Stock-based compensation expense

 

 

 

17

 

 

 

 

17

Balances at September 30, 2019

 

21,227,094

$

212

$

17,120

 

(2,749,310)

$

(17,067)

$

74,157

$

74,422

Net income

 

 

 

 

 

 

3,572

 

3,572

Stock-based compensation expense

 

 

 

308

 

 

 

 

308

Balances at December 31, 2019

21,227,094

$

212

$

17,428

(2,749,310)

$

(17,067)

$

77,729

$

78,302

See accompanying notes to condensed consolidated financial statements.

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NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

 

Six Months ended December 31, 

    

2020

    

2019

(in thousands)

CASH FLOWS FROM OPERATING ACTIVITIES

  

 

  

Net income

$

5,516

$

6,805

Adjustments to reconcile net income to net cash provided by operating activities:

 

  

 

Depreciation and amortization

 

855

 

744

(Recovery of) provision for doubtful accounts

 

(130)

 

39

Deferred income taxes

 

(82)

 

491

Stock based compensation expense

 

188

 

325

Changes in operating assets and liabilities:

 

  

 

  

Accounts receivable

 

1,839

 

2,833

Inventories

 

3,719

 

(7,068)

Prepaid expenses and other current assets

 

189

 

218

Accounts payable, accrued expenses, accrued salaries and wages, accrued income taxes

 

(3,157)

 

426

Net Cash Provided by Operating Activities

 

8,937

 

4,813

CASH FLOWS FROM INVESTING ACTIVITIES

 

  

 

  

Purchases of property, plant, and equipment

 

(389)

 

(1,063)

Net Cash Used in Investing Activities

 

(389)

 

(1,063)

Net Change in Cash and Cash Equivalents

 

8,548

 

3,750

CASH AND CASH EQUIVALENTS - Beginning

 

18,248

 

8,028

CASH AND CASH EQUIVALENTS - Ending

$

26,796

$

11,778

SUPPLEMENTAL CASH FLOW INFORMATION

 

  

 

  

Interest paid

$

10

$

18

Income taxes paid

$

1,351

$

734

See accompanying notes to condensed consolidated financial statements.

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NAPCO SECURITY TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

DECEMBER 31, 2020

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, wireless communication services for intrusion and fire alarm systems as well as a leading provider of school safety solutions. We offer a diversified array of security products, encompassing access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products. These products are used for commercial, residential, institutional, industrial and governmental applications, and are sold worldwide principally to independent distributors, dealers and installers of security equipment. We have experienced significant growth in recent years, primarily driven by fast growing recurring service revenues generated from wireless communication services for intrusion and fire alarm systems, as well as our school security products that are designed to meet the increasing needs to enhance school security as a result of on-campus shooting and violence in the U.S. While recurring service revenues have continued to increase during the COVID-19 pandemic, equipment sales were negatively impacted by the economic slowdown associated with this pandemic.

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

Our fourth quarter of fiscal 2020 and the first and second quarters of fiscal 2021 reflected the challenging business environment resulting from the COVID-19 pandemic. The COVID-19 pandemic has caused difficulties for security equipment professionals getting access to both commercial and residential installation sites. We sell our products primarily through distribution to dealers and we are now seeing strong sell-through statistics from several of our largest distributors.  

Significant Accounting Policies:

Principles of Consolidation

The 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 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, inventory reserves, valuation of intangible assets and income taxes.  Actual results could differ from those estimates.

Fair Value of Financial Instruments

The methods and assumptions used to estimate the fair value of the following classes of financial instruments were: Current Assets and Current Liabilities - The carrying amount of cash and cash equivalents, certificates of deposits, current receivables and payables and certain other short-term financial instruments approximate their fair value as of December 31, 2020 and June 30, 2020 due to their short-term maturities. Long-term debt and lease liabilities approximate fair value based on prevailing market rates.

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Table of Contents

Cash and Cash Equivalents

Cash and cash equivalents include approximately $460,000 of short-term time deposits at December 31, 2020 and June 30, 2020. 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 FDIC and other international agencies as of December 31, 2020 and June 30, 2020. 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 $196,000 as of December 31, 2020 and $326,000 as of June 30, 2020. 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, 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 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 with definite lives are amortized over their useful lives and are reviewed for impairment whenever there is an indication that the carrying amount may not be recovered.

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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. At the acquisition, the Marks trade name was deemed to have an indefinite life. At the conclusion of fiscal 2020, the Company determined that the trade-name was impaired. Accordingly, the Company recorded an impairment charge of $1,852,000 and reclassified the remaining balance of the underlying asset from indefinite-lived to a long-lived asset with a remaining useful life of 20 years as of June 30, 2020.

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

December 31, 2020

June 30, 2020

    

Carrying

    

Accumulated

    

Net book

    

Carrying

    

Accumulated

    

Net book

value

amortization

value

value

amortization

value

Customer relationships

$

9,800

$

(8,844)

$

956

$

9,800

$

(8,732)

$

1,068

Trade name

4,048

 

(101)

 

3,947

 

4,048

 

 

4,048

$

13,848

$

(8,945)

$

4,903

$

13,848

$

(8,732)

$

5,116

Amortization expense for intangible assets subject to amortization was approximately $107,000 and $66,000 for the three months ended December 31, 2020 and 2019, respectively. Amortization expense for intangible assets subject to amortization was approximately $213,000 and $132,000 for the six months ended December 31, 2020 and 2019, respectively. Amortization expense for each of the next five fiscal years is estimated to be as follows:2021 - $425,000; 2022 - $390,000; 2023 - $362,000; 2024 - $336,000; and 2025 - $315,000. The weighted average remaining amortization period for intangible assets was 17.2 years and 17.5 years at December 31, 2020 and June 30, 2020, 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 Recognition

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

Advertising and Promotional Costs

Advertising and promotional costs are included in "Selling, General and Administrative" expenses in the consolidated statements of income and are expensed as incurred. Advertising expense for the three months ended December 31, 2020 and 2019 was $347,000 and $627,000, respectively. Advertising expense for the six months ended December 31, 2020 and 2019 was $690,000 and $1,141,000, 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. Research and development expense for the three months ended December 31, 2020 and 2019 was $1,884,000 and $1,823,000, respectively. Research and development expense for the six months ended December 31, 2020 and 2019 was $3,773,000 and $3,572,000, respectively.

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Income Taxes

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

Net Income per Share

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

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

Net Income

Weighted Average Shares

Net Income per Share

    

2020

    

2019

    

2020

    

2019

    

2020

    

2019

Basic EPS

$

3,197

$

3,572

18,347

18,478

$

0.17

$

0.19

Effect of Dilutive Securities:

Stock Options

 

 

55

60

 

 

Diluted EPS

$

3,197

$

3,572

18,402

18,538

$

0.17

$

0.19

Options to purchase 32,000 and 36,000 shares of common stock were excluded for the three months ended December 31, 2020 and 2019, 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.

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

Weighted Average

Net Income per

Net Income

Shares

 Share

    

2020

    

2019

    

2020

    

2019

    

2020

    

2019

Basic EPS

$

5,516

$

6,805

18,347

18,478

$

0.30

$

0.37

Effect of Dilutive Securities:

  

 

  

 

 

 

  

 

  

Stock Options

 

 

50

 

59

 

 

Diluted EPS

$

5,516

$

6,805

 

18,397

 

18,537

$

0.30

$

0.37

Options to purchase 36,000 and 18,000 shares of common stock were excluded for the six months ended December 31, 2020 and 2019, 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 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.

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Stock-based compensation costs of $84,000 and $308,000 were recognized for the three months ended December 31, 2020 and 2019, respectively. Stock-based compensation costs of $188,000 and $325,000 were recognized for the six months ended December 31, 2020 and 2019, 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 or six months ended December 31, 2020 or 2019.

Comprehensive Income

For the three and six  months ended December 31, 2020 and 2019, 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 Sales and Costs

The Company records the amount billed to customers for shipping and handling in net sales ($93,000 and $108,000 in the three months ended December 31, 2020 and 2019, respectively and $199,000 and $220,000 in the six months ended December 31, 2020 and 2019, respectively); and classifies the costs associated with these revenues in cost of sales ($230,000 and $271,000 in the three months ended December 31, 2020 and 2019, respectively, and $451,000 and $531,000 in the six months ended December 31, 2020 and 2019, respectively).

Leases

Effective July 1, 2019, the Company adopted the new lease accounting standard using the modified retrospective transition option of applying the new standard at the adoption date. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to not reassess (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) initial direct costs for any existing leases. Adoption of the new standard resulted in the recording of an operating ROU asset and lease liabilities of approximately $7.7 million. Given the length of the lease term, the right-of-use asset and corresponding liability assume a weighted discount rate as disclosed below. A change in the rate utilized could have a material effect on the amounts reported. Financial positions for reporting periods beginning on or after July 1, 2019 are presented under new guidance. See Note 11 – Commitments and Contingencies; Leases for additional accounting policies and transition disclosures.

NOTE 2 – Revenue Recognition and Contracts with Customers

Net Sales

The Company is engaged in two major lines of business: (1) 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 and (2) the Company provides wireless communication service for intrusion and fire alarm systems on a monthly basis. These products and services 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.

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Table of Contents

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. As of December 31, 2020 and June 30, 2020, the Company included refund liabilities of approximately $3,798,000 and $3,331,000, respectively, in current liabilities. As of December 31, 2020 and June 30, 2020, the Company included return-related assets of approximately $792,000 and $701,000, respectively, in other current assets.

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 13% and 11% for the three months ended December 31, 2020 and 2019, respectively. As a percentage of gross sales, sales returns, rebates and allowances were 11% and 9% for the six months ended December 31, 2020 and 2019, 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):

Three months ended December 31, 

Six months ended December 31, 

    

2020

    

2019

    

2020

    

2019

Major Product Lines:

  

 

  

  

 

  

Intrusion and access alarm products

$

8,235

$

7,772

$

15,560

$

15,786

Door locking devices

 

10,781

 

12,273

 

19,354

 

25,180

Services

 

8,189

 

5,784

 

15,464

 

11,148

Total Revenues

$

27,205

$

25,829

$

50,378

$

52,114

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NOTE 3 - Business and Credit Concentrations

An entity is more vulnerable to concentrations of credit risk if it is exposed to risk of loss greater than it would have had if it mitigated its risk through diversification of customers. 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 18% and 24% of the Company’s accounts receivable at December 31, 2020 and June 30, 2020, respectively. Sales to this customer comprised 14% and 10% of net sales in the three and six months ended December 31, 2020, respectively. Sales to this customer comprised 10% of net sales in the six months ended December 31, 2019, respectively. The Company had another customer with an accounts receivable balance that comprised 12% of the Company’s accounts receivable at December 31, 2020. The customer's accounts receivable balance did not exceed 10% of accounts receivable at June 30, 2020. Sales to this customer did not exceed 10% of net sales in either of the six or three months ended December 31, 2020 and 2019. The Company had another customer with an accounts receivable balance that comprised 11% of the Company's accounts receivable at December 31, 2020.The customer’s accounts receivable balance did not exceed 10% of accounts receivable at June 30, 2020. Sales to this customer did not exceed 10% of net sales in either of the six or three months ended December 31, 2020 and 2019.

NOTE 4 - Inventories

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

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

    

December 31, 

    

June 30, 

2020

2020

Component parts

$

20,839

$

22,877

Work-in-process

 

6,628

 

7,276

Finished product

 

10,569

 

11,602

$

38,036

$

41,755

Classification of inventories, net of reserves:

 

  

 

  

Current

$

29,383

$

35,231

Non-current

 

8,653

 

6,524

$

38,036

$

41,755

NOTE 5 – Property, Plant, and Equipment

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

    

December 31, 2020

    

June 30, 2020

Useful Life in Years

    

Land

$

904

$

904

Buildings

 

8,911

 

8,911

 

30 to 40

Molds and dies

 

7,352

 

7,337

 

3 to 5

Furniture and fixtures

 

2,792

 

2,792

 

5 to 10

Machinery and equipment

 

25,253

 

24,878

 

7 to 10

Building improvements

 

2,173

 

2,173

 

Shorter of the lease term or life of asset

 

47,385

 

46,995

 

  

Less: accumulated depreciation and amortization

 

(39,543)

 

(38,907)

 

  

$

7,842

$

8,088

 

  

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Table of Contents

Depreciation and amortization expense on property, plant, and equipment was approximately $319,000 and $311,000 for the three months ended December 31, 2020 and 2019, respectively. Depreciation and amortization expense on property, plant, and equipment was approximately $637,000 and $606,000 for the six months ended December 31, 2020 and 2019, 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.

For the six months ended December 31, 2020, the Company recognized net income tax expense of $798,000. During the six months ended December 31, 2020, the Company increased its reserve for uncertain income tax positions by $69,000. The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense and accrued income taxes. As of December 31, 2020, the Company had accrued interest totaling $100,000 as well as $918,000 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 R&D expenditures. The R&D tax credits are recognized as a reduction to income tax expense.

The Company does not expect that our unrecognized tax benefits will significantly change within the next twelve months. We file a consolidated U.S. income tax return and tax returns in certain state and local and foreign jurisdictions. As of December 31, 2020, we remain subject to examination in all tax jurisdictions for all relevant jurisdictional statutes for fiscal years 2017 and thereafter.

The Company was audited by the IRS for fiscal year 2016.  In July 2019, the Company received a Form 4549-A, Income Tax Examination Changes from the IRS proposing an adjustment to income for the fiscal 2016 tax year regarding deemed dividends based on its interpretation under Internal Revenue Code (“IRC”) Section 956 arising from the intercompany balances on the books of the Company. In August 2019, the Company filed a formal protest with the IRS requesting an opportunity to appeal the examination findings to the Appeals Office.  During fiscal year 2020, the Company settled the issue at Appeals and recorded a provision for the federal and state impact of $762,000 and $70,000 respectively. During the six months ended December 31, 2020, the Company recorded an additional provision of $15,000 for interest. As of December 31, 2020 all federal and state liabilities related to the fiscal year 2016 audit have been paid.  

The Company is currently under audit for the fiscal year 2017.  The IRS has raised the IRC Section 956 issue that was settled during the fiscal year 2016 audit.  The Company strongly believes that the position of the IRS with regard to this matter is inconsistent with the provisions of IRC Section 956 and that the Company is willing to litigate, if necessary to argue its position.  During fiscal year 2020, the Company’s provision for income taxes included a provision for the incremental tax liability of $657,000 and interest of $66,000 was recorded for the 2017 and 2018 fiscal years.  For the six months ended December 31, 2020, additional interest expense was accrued for in the amount of $12,000.

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

NOTE 7 - Long-Term Debt

As of December 31, 2020, long-term debt consisted of a revolving line of credit of $11,000,000 (“Revolver Agreement”) which expires in June 2024 and term loans from the U.S. Small Business Administration totaling $3,904,000 through its Payroll Protection Program.

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Table of Contents

Outstanding balances and interest rates as of December 31, 2020 and June 30, 2020 are as follows (dollars in thousands):

December 31, 2020

June 30, 2020

 

    

Outstanding

    

Interest Rate

    

Outstanding

    

Interest Rate

 

Revolving line of credit

$

 

n/a

$

 

n/a

Term loans

 

3,904

 

1

%  

 

3,904

 

1

%

 

3,904

 

3,904

Less: current maturities

 

(1,084)

 

  

 

(1,794)

 

  

Long-term debt

$

2,820

 

  

$

2,110

 

  

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

Pursuant to the CARES Act, the loan may be forgiven by the SBA. The Company anticipates applying for forgiveness of these loans during fiscal 2021. The amount of loan forgiveness is determined by and is subject to the sole approval of the SBA. The amount of loan forgiveness is determined by calculating allowable expenses during a period of 24 weeks from the date of the receipt of the loan proceeds (the “Effective Period”) and may be reduced if loan proceeds are not used for qualified expenses. To receive loan forgiveness, the Company must apply for loan forgiveness and provide documentation as requested by the SBA. There will be no loan forgiveness without the Company’s submission of the proper application and documentation to Lender to include all SBA requirements. Not more than 25% of the amount forgiven can be attributable to non-payroll costs. While the Company believes it is eligible for forgiveness, no assurance can be provided that the Company will obtain forgiveness of the PPP Loan in whole or in part or, if forgiven, will not be disallowed by the SBA if audited.

The maturity dates of the PPP Loan are between April 17, 2022 and May 7, 2022, which is two years from the PPP Loan Agreement date. The interest accrues from the date of disbursement of the PPP Loan (the “Effective Date”). The PPP Loan bears interest at a fixed rate equal to one percent (1%) per annum and interest will accrue from the Effective Date. PPP Loan payments are deferred for ten months after the end of the effective period. Subject to  adjustment for any PPP Loan forgiveness granted by the CARES Act, the Company will subsequently pay 18 fully amortized monthly consecutive principal and interest payments for all principal and all accrued interest not yet paid, with the first PPP Loan payment due on the date that is ten months after the end of the effective period. The proceeds of the PPP Loan shall be used for the following purposes only: (i) payroll costs as defined by the CARES Act, (ii) costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums; (iii) mortgage interest payments, (iv) rent payments, (v) utility payments, (vi) interest payments on any other debt obligations incurred before February 15, 2020, and/or (vii) refinancing a SBA Economic Injury Disaster Loan made between January 31, 2020 and April 3, 2020.

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The PPP Loan and the related documentation contain customary events of default, including: (i) any representation or warranty made, or financial or other information provided, by the Company under the PPP Loan Agreement being false or misleading in any material respect; (ii) the failure by the Company to make required payments; (iii) the failure by the Company to perform or comply with certain agreements; and (iv) the dissolution or termination of the Company's existence as a going business, the insolvency of the Company, the appointment of a receiver for any part of the Company's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against the Company. Upon default, Lender may declare the entire unpaid principal balance under this Note and all accrued unpaid interest immediately due, and then the Company will pay that amount. Lender may hire or pay someone else to help collect this Note if the Company does not pay. The Company will pay Lender that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses, whether or not there is a lawsuit, including attorneys' fees, expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), and appeals. The Company also will pay any court costs, in addition to all other sums provided by law.

Should the Company default on the PPP Loan, SBA may be required to pay Lender under the SBA guarantee. SBA may then seek recovery of these funds from the Company and the Company may not claim or assert against SBA any immunities or defenses available under local law to defeat, modify or otherwise limit the Company's obligation to repay to SBA any funds advanced by Lender to the Company. If the Company defaults on the SBA-guaranteed loan and SBA suffers a loss, the names of the small business will be referred for listing in the Credit Alert Verification Reporting System (CAIVRS) database, which may affect their eligibility for further assistance.

The Company is accounting for the PPP Loan as debt in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 470, Debt and accrues interest in accordance with the interest method under FASB ASC 835-30.

The Company will not impute additional interest at a market rate (even though the stated interest rate may be below market) as transactions where interest rates are prescribed by governmental agencies are excluded from the scope of the FASB ASC 835-30 guidance on imputing interest.

For purposes of de-recognition or forgiveness of the liability, FASB ASC 470-50-15-4 refers to guidance in FASB ASC 405-20. Based on the guidance in FASB ASC 405-20-40-1, the proceeds from the loan would remain recorded as a liability until either (1) the loan is, in part or wholly, forgiven and the debtor has been “legally released” or (2) the debtor pays off the loan to the creditor. Once the loan is, in part or wholly, forgiven and legal release is received, the Company will reduce the liability by the amount forgiven and record a gain on extinguishment.

NOTE 8 - Stock Options

The Company follows ASC Topic 718, "Compensation-Stock Compensation", which requires that all share based payments to employees, including stock options, be recognized as compensation expense in the consolidated financial statements based on their fair values and over the requisite service period. The Company recorded non-cash compensation expense relating to stock-based compensation of $84,000 and $308,000 for the three months ended December 31, 2020 and 2019, respectively ($0.00 and $0.02 per basic and diluted share for each period, respectively) and $188,000 and $325,000 for the six months ended December 31, 2020 and 2019, respectively ($0.01 and $0.02 per basic and diluted share for each period, respectively).

2012 Employee Stock Option Plan

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

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Table of Contents

Under the 2012 Employee Plan, stock options may be granted to valued employees with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable, in whole or in part, at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a “change in control” as defined in the plan. At December 31, 2020, 117,840 stock options were outstanding, 47,800 stock options were exercisable and 731,960 stock options were available for grant under this plan.

No options were granted during the three or six months ended December 31, 2020. The fair value of each option granted during the six months ended December 31, 2019 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

    

2019

 

Risk-free interest rates

1.80% - 2.10

%

Expected lives

10 years

Expected volatility

45%-46

%

Expected dividend yields

0

%

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

2020

2019

Weighted average

Weighted average

    

Options

    

exercise price

    

Options

    

exercise price

Outstanding, beginning of year

117,840

$

18.84

72,500

$

11.01

Granted

28,000

30.13

Exercised

 

 

 

Outstanding, end of period

117,840

$

18.84

 

100,500

$

16.34

Exercisable, end of period

47,800

$

14.66

 

48,400

$

11.10

Weighted average fair value at grant date of options granted

n/a

 

$

16.57

 

Total intrinsic value of options exercised

n/a

n/a

 

Total intrinsic value of options outstanding

$

963,000

$

1,359,000

 

Total intrinsic value of options exercisable

$

590,000

$

895,000

 

No stock options were exercised during the six or three months ended December 31, 2020 or 2019. No cash was received from option exercises during either of the six or three months ended December 31, 2020 or 2019 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 Employee Plan at December 31, 2020:

Options outstanding

Options exercisable

    

    

Weighted average

    

    

    

Number

remaining

Weighted average

Number

Weighted average

Range of exercise prices

outstanding

contractual life

exercise price

exercisable

exercise price

$4.37‑$33.59

117,840

7.9

$

18.84

47,800

$

14.66

117,840

7.9

$

18.84

47,800

$

14.66

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Table of Contents

As of December 31, 2020, there was $748,000 of unearned stock-based compensation cost related to share-based compensation arrangements granted under the 2012 Employee Plan. 0 and 28,000 options were granted during the six months ended December 31, 2020 and 2019, respectively. 10,400 and 13,000 options vested during the three months ended December 31, 2020 and 2019, respectively. 12,800 and 14,600 options vested during the six months ended December 31, 2020 and 2019, respectively. The total fair value of the options vesting during the three months ended December 31, 2020 and 2019 under this plan was $106,000 and $133,000, respectively. The total fair value of the options vesting during the six months ended December 31, 2019 and 2018 under this plan was $135,000 and $150,000, respectively.

2012 Non-Employee Stock Option Plan

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

Under the 2012 Non-Employee Plan, stock options may be granted with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable in whole or in part at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a “change in control” as defined in the plan. At December 31 2020, 12,000 stock options were outstanding, 8,520 stock options were exercisable and no further stock options were available for grant under this plan.

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

2020

2019

    

    

Weighted average

    

    

Weighted average