Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
The discussion below contains certain forward-looking statements including, but not limited to, among others, statements concerning future revenues and future business plans. Forward-looking statements include statements in which we use words such as “expect”, “believe”, “anticipate”, “intend”, “project”, “estimate”, “should”, “could”, “may”, “plan”, “potential”, “predict”, “project”, “will”, “would” and similar expressions. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, the forward-looking statements are subject to significant risks and uncertainties, and thus we cannot assure you that these expectations will prove to have been correct, and actual results may vary from those contained in such forward-looking statements. We discuss many of these risks and uncertainties in Item 1A under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, and in this Form 10-Q, included under Item 1A “Risk Factors.” Factors that may cause such variances include, but are not limited to, our dependence on a small number of customers for a significant portion of our revenue, our high dependence on contracts with the U.S. federal government, our reliance in certain circumstances on single sources for supply of key product components, intense competition in the market segments in which we operate, changes in the U.S. Tax laws, continued disruptions in the supply chain and inflationary pressures, the impact of the Ukraine-Russian military conflict on global trade and financial markets, and the impact of the novel coronavirus (COVID-19) on our business, results of operations and financial condition. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our estimates and assumptions only as of the date of this document. Except as required by law, we do not undertake any obligation to publicly update or revise any
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forward-looking statements contained in this report, whether as a result of new information, future events or otherwise. This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our financial statements and the related notes included elsewhere in this filing and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates, including those related to uncollectible receivables, inventory valuation, impairment assessment of intangibles, income taxes, deferred compensation and retirement plans, as well as estimated selling prices used for revenue recognition and contingencies. We base our estimates on historical performance and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A description of our critical accounting policies is contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021 in the “Critical Accounting Policies” section contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Management believes there have been no significant changes for the six months ended March 31, 2022 to the items that we disclosed as our critical accounting estimates in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the fiscal year ended September 30, 2021.
Observations on effects of novel coronavirus and Russia/Ukraine Conflict
On March 11, 2020, the World Health Organization characterized the novel coronavirus outbreak as a pandemic. The outbreak has and continues to adversely affect the economies of the U.S., U.K., and other international markets and economies in which we operate. As a result of the World Health Organization characterizing the COVID-19 outbreak as a pandemic, national, state, and local governments have and continue to take actions such as declaring a state of emergency, implementing social distancing and other guidelines, and shutting down and/or limiting the opening or operation of certain businesses which are not considered essential.
In these times of pandemic, our top priorities are to protect the health, well-being, and safety of our employees and partners, while still focusing on the key drivers of our business. To that end, and to insure we continue to operate safely and cautiously while also meeting our public health responsibilities, the Company has adopted flexible business practices including allowing most employees to work remotely in all locations.
COVID-19 has adversely affected the distribution channel leading to significantly longer lead times when ordering product. Manufacturers are not producing as much product as prior to the pandemic due to disruptions, resulting in supply shortages. Additionally, recent global shipping delays have exacerbated this problem. The TS segment has many vendors it transacts with and supply shortages are pervasive with many of them. The HPP segment has also experienced shortages with their vendors as well. The HPP segment secured a $1.8 million contract for real-time networking monitoring for cyber attack detection in the first quarter of fiscal year 2022, but due to the delays by manufacturers the sale is anticipated to be recognized in revenue over the next two years when we can obtain the product from the manufacturers. Related to the supply shortage and potentially inflation, we have experienced price increases for our products, which we try to pass on to the customer.
We recognize the pandemic has created a dynamic and uncertain situation in the national economy, and we continue to closely monitor the latest information to make timely, informed business decisions and public disclosures regarding the potential impact of the pandemic on our operations. Despite reduced infection rates and ever-increasing vaccination rates in the United States, many nations and certain pockets within the United States are still battling various strains/variants of the novel coronavirus, creating ongoing uncertainties as to when economies will return to business as usual and what that will look like, what regulatory measures or voluntary actions will be further implemented to limit the spread of COVID-19 and its variants and the duration of any such measures. The extent, severity and impact of any further
24
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spread of COVID-19 variants or resurgence of COVID-19 in a given geographic region after it has hit its “peak,” and the extent to which herd immunity will be achieved through the vaccination process is still uncertain. In summary, the scope of this pandemic and its effects are unprecedented, and we cannot at this time make a reasonable estimate on the extent or duration of the impacts on our business.
As of March 31, 2022, the Russian/Ukrainian military conflict has not had a significant impact on revenue as we do not have any recurring customers in either country. However, we do have customers and suppliers in surrounding regions which may be affected and further escalation of the Russian-Ukraine military conflict and geopolitical tensions related to such military conflict could adversely affect our business, financial condition and results of operations, by among other things, cyber attacks, supply disruptions, lower consumer demand, and changes to foreign exchange rates and financial markets. It is not possible at this time to predict the size of the impact or consequences of the conflict to the Company and our customers and suppliers.
Results of Operations
Overview of the three months ended March 31, 2022
Our sales decreased by approximately $2.1 million, or 15%, to $12.0 million for the three months ended March 31, 2022 as compared to $14.1 million for the three months ended March 31, 2021. The decrease in sales is the result of a decrease of $2.4 million in our TS segment, partially offset by a $0.3 million increase in our HPP segment. Our gross margin percentage increased to 35% of sales for the three months ended March 31, 2022 as compared to 31% for the three months ended March 31, 2021. For the three months ended March 31, 2022 there was an operating loss of $24 thousand compared to an operating loss of $0.1 million for the three months ended March 31, 2021, primarily as a result of increased services revenue, which has much larger margins than product revenue, despite total decreased revenue. Other income, (expense) net increased $0.2 million for the three months ended to March 31, 2022 as compared to the three months ended March 31, 2021. This is primarily due to a net increase in foreign exchange gain of $0.3 million from the prior year, partially offset by a decrease in other income (expense), net of $0.1 million which was related to a one-time gain from an overpayment of a rebate received in the prior year. The income tax expense of $5 thousand for the three months ended March 31, 2022 is primarily driven by minimum state tax expenses, as the Company continues to maintain a full valuation allowance on their operations. The income tax expense of $723 thousand for the three months ended March 31, 2021 was primarily driven by an increase in the valuation allowance against deferred tax assets in the period offset by a benefit recorded for the change in tax law, allowing for the immediate deduction of covered expense incurred through the Paycheck Protection Program.
The following table details our results of operations in dollars and as a percentage of sales for the three months ended March 31, 2022 and 2021:
%
%
March 31, 2022
of sales
March 31, 2021
of sales
(Dollar amounts in thousands)
Sales
$
11,981
100
%
$
14,088
100
%
Costs and expenses:
Cost of sales
7,781
65
%
9,720
70
%
Engineering and development
717
6
%
762
5
%
Selling, general and administrative
3,507
29
%
3,727
26
%
Total costs and expenses
12,005
100
%
14,209
101
%
Operating loss
(24)
—
%
(121)
(1)
%
Other income, (expense) net
185
2
%
(3)
—
%
Income (loss) before income taxes
161
1
%
(124)
(1)
%
Income tax expense
5
—
%
723
5
%
Net income (loss)
$
156
1
%
$
(847)
(6)
%
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Sales
Our sales decreased by approximately $2.1 million to $12.0 million for the three months ended March 31, 2022 as compared to $14.1 million for the prior year period. The decrease in sales was the result of a decrease of $2.4 million in our TS segment, partially offset by a $0.3 million increase in our HPP segment.
TS segment sales change was as follows for the three months ended March 31, 2022 and 2021:
March 31,
Increase (decrease)
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
7,255
$
10,260
$
(3,005)
(29)
%
Services
3,583
2,940
643
22
%
Total
$
10,838
$
13,200
$
(2,362)
(18)
%
The decrease in TS segment product sales of $3.0 million during the period is attributable to a decrease in the U.S. division due to decreased sales to several major customers and delays in obtaining product due to supply chain shortages. Service sales for the three months ended March 31, 2022 increased $0.6 million from the prior year period, which is attributable to the U.S. division. The changes in service sales included increased managed services sales of $0.5 million and increased internal and third party service sales of $0.4 million, partially offset by a $0.3 million decrease in third party maintenance.
HPP segment sales change was as follows for the three months ended March 31, 2022 and 2021:
March 31,
Increase
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
962
$
716
$
246
34
%
Services
181
172
9
5
%
Total
$
1,143
$
888
$
255
29
%
The HPP product sales increased by $0.2 million for the three months ended March 31, 2022 as compared to the prior year period, primarily as a result of a $0.3 million increased Myricom sales, partially offset by decreased parts sales of $0.1 million. The HPP services sales remained relatively flat for the three months ended March 31, 2022 compared to the prior year period as royalties on high-speed processing boards related to the E2D program and repairs remained flat.
Our sales by geographic area, which is based on the customer location to which the products were shipped or services rendered, were as follows for the three months ended March 31, 2022 and 2021:
March 31,
Decrease
2022
%
2021
%
$
%
(Dollar amounts in thousands)
Americas
$
11,420
95
%
$
13,033
92
%
$
(1,613)
(12)
%
Europe
500
4
%
779
6
%
(279)
(36)
%
Asia
61
1
%
276
2
%
(215)
(78)
%
Totals
$
11,981
100
%
$
14,088
100
%
$
(2,107)
(15)
%
The $1.6 million decrease in sales to the Americas was primarily the result of a decrease in the TS segment’s U.S. division of $2.2 million, partially offset by increased sales by our HPP segment of $0.6 million. The $0.3 million decrease in sales to Europe was primarily the result of decreased sales by our TS Segment’s U.S. division of $0.2 million combined with a decrease in our HPP segment of $0.1 million. The sales to Asia decreased by $0.2 million primarily due to a decrease in the HPP segment.
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Gross Margins
Our gross margin ("GM") decreased $0.2 million for the three months ended March 31, 2022 as compared to the prior year period. The GM as a percentage of sales increased to 35% for the three months ended March 31, 2022 as compared to the prior year period of 31%. This is primarily due to increased service revenue and decreased product revenue as service revenue has significantly higher GM as a percentage of sales.
March 31,
2022
2021
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
TS
$
3,680
34
%
$
3,885
29
%
$
(205)
5
%
HPP
520
45
%
483
54
%
37
(9)
%
Total
$
4,200
35
%
$
4,368
31
%
$
(168)
4
%
The impact of product mix within our TS segment on gross margin for the three months ended March 31, 2022 and 2021 was as follows:
March 31,
2022
2021
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
1,570
22
%
$
2,095
20
%
$
(525)
2
%
Services
2,110
59
%
1,790
61
%
320
(2)
%
Total
$
3,680
34
%
$
3,885
29
%
$
(205)
5
%
The overall TS segment GM as a percentage of sales increased to 34% for the three month period ended March 31, 2022 compared to 29% for the prior year period. This was primarily due to increased GM from services revenue, which is relatively higher margin, compared to product revenue from the prior year. Product GM as a percentage of product sales increased to 22% for the three months ended March 31, 2022 from 20% for the prior year period. This was primarily due higher margin products being sold to several customers. Service GM as a percentage of service sales decreased to 59% for the three months ended March 31, 2022 from 61% for the prior year period due to both the U.S. division having wage increases and additional hires to sustain the growth of managed services.
The impact of product mix within our HPP segment on gross margin for the three months ended March 31, 2022 and 2021 was as follows:
March 31,
2022
2021
Increase (Decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
383
40
%
$
326
46
%
$
57
(6)
%
Services
137
76
%
157
91
%
(20)
(15)
%
Total
$
520
45
%
$
483
54
%
$
37
(9)
%
The overall HPP segment GM as a percentage of sales decreased to 45% for the three months ended March 31, 2022 from 54% for the three months ended March 31, 2021. The 6% decrease in product GM as a percentage of product revenue for the three months ended March 31, 2022 compared to the same prior year period is due to product mix. The 15% decrease in service GM as a percentage of services revenue from prior year was due to increased manufacturing overhead expenses including payroll.
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Engineering and Development Expenses
The engineering and development expenses incurred by our HPP segment decreased $45 thousand for the three months ended March 31, 2022 to $0.7 million when compared to the prior year period due to decreased headcount related expenses, partially offset with increased consulting expenses. The current period expenses were primarily for product engineering expenses incurred in connection with the continued development of the ARIA SDS cyber security products.
Selling, General and Administrative Expenses
The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the three months ended March 31, 2022 and 2021:
Three months ended March 31,
$
%
% of
% of
2022
Total
2021
Total
Decrease
Decrease
(Dollar amounts in thousands)
By Operating Segment:
TS segment
$
2,602
74
%
$
2,667
72
%
$
(65)
(2)
%
HPP segment
905
26
%
1,060
28
%
(155)
(15)
%
Total
$
3,507
100
%
$
3,727
100
%
$
(220)
(6)
%
SG&A expenses of $3.5 million for the three months ended March 31, 2022 decreased $0.2 million as compared to the prior year period. The TS segment G&A expenses decreased by approximately $0.1 million due to a reversal of previous bad debt expense as the account receivable expensed was recovered. The HPP segment SG&A expenses decreased approximately $0.1 million for the three months ended March 31, 2022 as compared to the prior year period due to a gain on a life insurance policy of $0.1 million. The individual the life insurance policy covered was not a current employee at time of expiration.
Other Income/Expenses
The following table details other income (expense) for the three months ended March 31, 2022 and 2021:
Three months ended
Increase
March 31, 2022
March 31, 2021
(Decrease)
(Amounts in thousands)
Foreign exchange gain (loss)
$
176
$
(154)
$
330
Interest expense
(101)
(75)
(26)
Interest income
126
133
(7)
Other income (expense), net
(16)
93
(109)
Total other income (expense), net
$
185
$
(3)
$
188
The $0.2 million increase in total other income (expense), net for the three months ended March 31, 2022 as compared to the prior year period is primarily due to a net increase in foreign exchange gain of $0.3 million, partially offset by an decrease in other income (expense), net of $0.1 million, which was related to a one-time gain from an overpayment of a rebate received in the prior year. The rebate was several years old, which is the reason it was recorded in other income (expense), net.
In consolidation, U.S. dollars and Euros are remeasured into the functional currency, British Pounds, of our U.K. subsidiary. This non-cash remeasurement is included in foreign exchange gain or loss on the income statement and the foreign exchange loss is primarily from a Euro and U.S. Dollar bank account. The US dollar strengthened relative to the British Pound for the three months ended March 31, 2022 causing a foreign exchange gain, which was partially offset with the Euro weakening relative to the British Pound for the same period.
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The interest income decrease of $7 thousand for the three months ended March 31, 2022 as compared to the prior year period is primarily due to more principal payments and the receivables accruing less interest, partially offset with additional agreements that have payment terms in excess of one year (see Note 6 in Item 1 to this Quarterly Report on Form 10-Q for details) from the TS-US segment from the prior year period.
The interest expense increase of $26 thousand for the three months ended March 31, 2022 as compared to the prior year period is related to the TS U.S. division entering into multiple multi-year contracts starting in the second quarter of fiscal year 2021, which only incurred interest expense for one month in the second fiscal quarter of the prior year. Additionally agreements were entered into subsequent to the first quarter of the prior year causing more interest expense to be recognized. Payments on these agreements contain both principal and interest expense. See Note 10 in Item 1 to this Quarterly Report on Form 10-Q for details.
Income Taxes
The income tax expense of $5 thousand for the three months ended March 31, 2022 is primarily driven by minimum state tax expenses, as the Company continues to maintain a full valuation allowance on their operations. The income tax expense of $723 thousand for the three months ended March 31, 2021 was primarily driven by an increase in the valuation allowance against deferred tax assets in the period offset by a benefit recorded for the change in tax law, allowing for the immediate deduction of covered expense incurred through the Paycheck Protection Program.
We have historically calculated the provision for income taxes during interim reporting periods by applying an estimate of the annual effective tax rate for the full calendar year to ordinary income or loss for the reporting period. However, we used a discrete effective tax rate method to calculate income taxes for the quarter ended March 31, 2022 because we have determined that our ordinary income or loss cannot be reliably estimated and small changes in estimated ordinary income would result in significant changes in the estimated annual effective tax rates.
Overview of the six months ended March 31, 2022
Our sales decreased by approximately $1.1 million, or 4%, to $24.4 million for the six months ended March 31, 2022 as compared to $25.5 million for the six months ended March 31, 2021. The decrease in sales is the result of a decrease of $0.9 million in our TS segment and a decrease of $0.2 million in our HPP segment. Our gross margin percentage increased to 32% of sales for the six months ended March 31, 2022 as compared to 30% for the six months ended March 31, 2021. For the six months ended March 31, 2022 there was an operating loss of $0.4 million compared to an operating loss of $0.7 million for the six months ended March 31, 2021, primarily as a result of improved margins in the TS segment. Other income, (expense) net decreased $1.6 million for the six months ended to March 31, 2022 as compared to the six months ended March 31, 2021. The largest items contributing to this change are the forgiveness of the Payroll Protection Program loans in the prior year in the amount of $2.2 million causing a gain which did not occur in the current period, partially offset with a net increase in foreign exchange gain of $0.8 million from the prior year. The income tax expense of $17 thousand for the six months ended March 31, 2022 is primarily driven by minimum state tax expenses, as the Company continues to maintain a full valuation allowance on their operations. The income tax expense of $833 thousand for the six months ended March 31, 2021 was primarily driven by an increase in the valuation allowance against deferred tax assets in the period, offset by a benefit recorded for the change in tax law, allowing for the immediate deduction of covered expense incurred through the Paycheck Protection Program.
The following table details our results of operations in dollars and as a percentage of sales for the six months ended March 31, 2022 and 2021:
%
%
March 31, 2022
of sales
March 31, 2021
of sales
(Dollar amounts in thousands)
Sales
$
24,350
100
%
$
25,476
100
%
Costs and expenses:
Cost of sales
16,536
68
%
17,730
70
%
Engineering and development
1,344
6
%
1,491
6
%
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Selling, general and administrative
6,890
28
%
6,913
27
%
Total costs and expenses
24,770
102
%
26,134
103
%
Operating loss
(420)
(2)
%
(658)
(3)
%
Other income, (expense) net
227
1
%
1,795
7
%
(Loss) income before income taxes
(193)
(1)
%
1,137
4
%
Income tax expense
17
—
%
833
3
%
Net (loss) income
$
(210)
(1)
%
$
304
1
%
Sales
Our sales decreased by approximately $1.1 million to $24.4 million for the six months ended March 31, 2022 as compared to $25.5 million for the prior year period. The decrease in sales is the result of a decrease of $0.9 million in our TS segment and a decrease of $0.2 million decrease in our HPP segment.
TS segment sales change was as follows for the six months ended March 31, 2022 and 2021:
March 31,
Increase (decrease)
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
15,255
$
17,492
$
(2,237)
(13)
%
Services
6,888
5,540
1,348
24
%
Total
$
22,143
$
23,032
$
(889)
(4)
%
The decrease in TS segment product sales of $2.2 million during the period is attributable to a decrease in the U.S. division of $0.9 million due to decreased sales to several major customers and delays in obtaining product due to supply chain shortages, combined with decreased sales in the U.K. division of $1.3 million due to one customer not repeating a high volume of sales in the current period. Service sales for the six months ended March 31, 2022 increased $1.3 million from the prior year period, which is attributable to the U.S. division. The changes in service sales included increased managed services sales of $0.8 million and increased internal and third party service sales of $0.7 million, partially offset with a decrease of $0.2 million in third party maintenance.
HPP segment sales change was as follows for the six months ended March 31, 2022 and 2021:
March 31,
Decrease
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
1,682
$
1,892
$
(210)
(11)
%
Services
525
552
(27)
(5)
%
Total
$
2,207
$
2,444
$
(237)
(10)
%
The HPP product sales decreased by $0.2 million for the six months ended March 31, 2022 as compared to the prior year period, primarily as a result of a $0.6 million decrease in E2D part sales, partially offset with an increase of Myricom sales of $0.4 million. The HPP services sales remained relatively flat for the six months ended March 31, 2022 compared to the prior year period with increased royalties on high-speed processing boards related to the E2D program of $0.1 million, offset by decreased repairs of $0.1 million.
Our sales by geographic area, which is based on the customer location to which the products were shipped or services rendered, were as follows for the six months ended March 31, 2022 and 2021:
March 31,
Increase (decrease)
2022
%
2021
%
$
%
(Dollar amounts in thousands)
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Americas
$
23,167
95
%
$
22,783
90
%
$
384
2
%
Europe
1,013
4
%
2,320
9
%
(1,307)
(56)
%
Asia
170
1
%
373
1
%
(203)
(54)
%
Totals
$
24,350
100
%
$
25,476
100
%
$
(1,126)
(4)
%
The $0.4 million increase in sales to the Americas was primarily the result of an increase in the TS segment’s U.S. division of $0.4 million and an increase in the HPP segment of $0.1 million, partially offset by decreased sales by our TS segment’s U.K. division of $0.1 million. The $1.3 million decrease in sales to Europe was primarily the result of decreased sales by our TS Segment’s U.K. division of $1.2 million due to a large volume by one customer in the prior year which did not reoccur in the current period combined with a decrease in the HPP segment of $0.1 million. The sales to Asia decreased by $0.2 million due to a decrease in the HPP segment of $0.3 million, partially offset by an increase in the TS segment’s U.S. division of $0.1 million.
Gross Margins
Our gross margin ("GM") increased $0.1 million for the six months ended March 31, 2022 as compared to the prior year period. The GM as a percentage of total sales increased to 32% for the six months ended March 31, 2022 as compared to the prior year period of 30%. The GM as a percentage of total sales increased in the TS segment, but was partially offset by a decrease in the HPP segment.
March 31,
2022
2021
Increase (decrease)
(Dollar amounts in thousands)
GM$
GM%
GM$
GM%
GM$
GM%
TS
$
6,672
30
%
$
6,321
27
%
$
351
3
%
HPP
1,142
52
%
1,425
58
%
(283)
(6)
%
Total
$
7,814
32
%
$
7,746
30
%
$
68
2
%
The impact of product mix within our TS segment on gross margin for the six months ended March 31, 2022 and 2021 was as follows:
March 31,
2022
2021
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
2,714
18
%
$
2,980
17
%
$
(266)
1
%
Services
3,958
57
%
3,341
60
%
617
(3)
%
Total
$
6,672
30
%
$
6,321
27
%
$
351
3
%
The TS segment GM as a percentage of total sales increased to 30% for the six month period ended March 31, 2022 compared to 27% for the prior year period. This was primarily due to significantly increased GM from services compared to the prior year period combined with product GM decreasing compared to the prior year period. Product GM as a percentage of product sales increased to 18% for the six months ended March 31, 2022 from 17% for the prior year period. This was primarily due higher margin products being sold to several customers including a new customer having significant volume with relatively high margins. Service GM as a percentage of service sales decreased to 57% for the six months ended March 31, 2022 from 60% for the prior year period due to the U.S. division having wage increases and additional hires to sustain the growth of managed services.
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The impact of product mix within our HPP segment on gross margin for the six months ended March 31, 2022 and 2021 was as follows:
March 31,
2022
2021
Decrease
(Dollar amounts in thousands)
GM$
GM%
GM$
GM%
GM$
GM%
Products
$
682
41
%
$
901
48
%
$
(219)
(7)
%
Services
460
88
%
524
95
%
(64)
(7)
%
Total
$
1,142
52
%
$
1,425
58
%
$
(283)
(6)
%
The overall HPP segment GM as a percentage of sales decreased to 52% for the six months ended March 31, 2022 from 58% for the six months ended March 31, 2021. The 7% decrease in product GM was primarily attributed to lower margin product sold for the six months ended March 31, 2022 compared to the same prior year period. The 7% decrease in service GM as a percentage of services revenue was due to increased manufacturing overhead expenses including payroll.
Operating Expenses
Engineering and Development Expenses
The engineering and development expenses incurred by our HPP segment decreased approximately $0.2 million for the six months ended March 31, 2022 to $1.3 million when compared to the prior year period due to decreased headcount related expenses, partially offset with higher consulting expenses. The current period expenses were primarily for product engineering expenses incurred in connection with the continued development of the ARIA SDS cyber security products.
Selling, General and Administrative Expenses
The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the six months ended March 31, 2022 and 2021:
Six months ended March 31,
$
%
% of
% of
Increase
Increase
2022
Total
2021
Total
(Decrease)
(Decrease)
(Dollar amounts in thousands)
By Operating Segment:
TS segment
$
4,985
72
%
$
4,786
69
%
$
199
4
%
HPP segment
1,905
28
%
2,127
31
%
(222)
(10)
%
Total
$
6,890
100
%
$
6,913
100
%
$
(23)
—
%
SG&A expenses of $6.9 million for the six months ended March 31, 2022 remained relatively flat compared to the prior year period. The $0.2 million increase in TS segment SG&A expenses compared to the same prior year period is primarily the result of increased payroll and recruiting expenses. The HPP segment SG&A expenses decreased approximately $0.2 million for the six months ended March 31, 2022 as compared to the prior year period due to decreased headcount related expenses of $0.1 million and a gain on a life insurance policy of $0.1 million. The individual the life insurance policy covered was not a current employee at time of expiration.
Other Income/Expenses
The following table details other income (expense) for the six months ended March 31, 2022 and 2021:
Six months ended
$ Increase
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March 31, 2022
March 31, 2021
(Decrease)
(Amounts in thousands)
Foreign exchange gain (loss)
$
159
$
(621)
$
780
Interest expense
(206)
(113)
(93)
Interest income
271
231
40
Gain on debt forgiveness
—
2,196
(2,196)
Other income, net
3
102
(99)
Total other income (expense), net
$
227
$
1,795
$
(1,568)
The $1.6 million decrease in total other income (expense), net for the six months ended March 31, 2022 as compared to the prior year period is primarily due to forgiveness of the Payroll Protection Program loans in the prior year for a gain of $2.2 million, partially offset with a net change of foreign exchange gain of approximately $0.8 million in the current period.
In consolidation, U.S. dollars and Euros are remeasured into the functional currency, British Pounds, of our U.K. subsidiary. This non-cash remeasurement is included in foreign exchange gain or loss on the income statement and the foreign exchange loss is primarily from a Euro and U.S. Dollar bank account. The US dollar strengthened relative to the British Pound for the six months ended March 31, 2022 which caused the foreign exchange gain, partially offset by the Euro weakening relative to the British Pound for the same period.
The interest income increase of $40 thousand for the six months ended March 31, 2022 as compared to the prior year period is primarily related to additional agreements that have payment terms in excess of one year (see Note 6 in Item 1 to this Quarterly Report on Form 10-Q for details) in the TS-US segment subsequent to the prior year period.
The interest expense increase of $94 thousand for the six months ended March 31, 2022 as compared to the prior year period is related to the TS U.S. division entering into multiple multi-year contracts starting in the second quarter of fiscal year 2021 causing fiscal year 2022 to increase due to a full six months of interest expense incurred. Payments on these agreements contain both principal and interest expense. See Note 10 in Item 1 to this Quarterly Report on Form 10-Q for details.
Income Taxes
The income tax expense of $17 thousand for the six months ended March 31, 2022 is primarily driven by minimum state tax expenses, as the Company continues to maintain a full valuation allowance on its operations. The income tax expense of $833 thousand for the six months ended March 31, 2021 was primarily driven by an increase in the valuation allowance against deferred tax assets in the period, offset by a benefit recorded for the change in tax law, allowing for the immediate deduction of covered expense incurred through the Paycheck Protection Program.
We have historically calculated the provision for income taxes during interim reporting periods by applying an estimate of the annual effective tax rate for the full calendar year to ordinary income or loss for the reporting period. However, we used a discrete effective tax rate method to calculate income taxes for the quarter ended March 31, 2022 because we have determined that our ordinary income or loss cannot be reliably estimated and small changes in estimated ordinary income would result in significant changes in the estimated annual effective tax rates.
Liquidity and Capital Resources
Our primary source of liquidity is our cash and cash equivalents, which increased by $0.3 million to $20.3 million as of March 31, 2022 from $20.0 million as of September 30, 2021.
Our significant sources of cash for the six months ended March 31, 2022 included a decrease of $3.9 million in accounts receivable and long-term receivable, an increase in deferred revenue of $0.8 million, and a decrease in other assets of $1.0 million.
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Our significant uses of cash for the six months ended March 31, 2022 were primarily related to a decrease in accounts payable and accrued expenses of $3.7 million, research development expenses of approximately $0.7 million, repayments of debt of $0.6 million, and a decrease of other long-term liabilities of $0.4 million.
Our cash held by our foreign subsidiary in the United Kingdom totaled approximately $8.6 million as of March 31, 2022 and consisted of 0.3 million Euros, 0.3 million British Pounds, and 8.0 million U.S. Dollars. This cash is included in our total cash and cash equivalents reported within our financial statements.
As of March 31, 2022 and September 30, 2021, the Company maintained a line of credit with a capacity of up to $15.0 million for inventory accessible to both the HPP and TS segments. This line of credit also includes availability of a limited cash withdrawal of up to $1.0 million. An amount of $14.1 million and $14.1 million were available as of March 31, 2022 and September 30, 2021, respectively. As of March 31, 2022 and September 30, 2021 there were no cash withdrawals outstanding. For a further discussion of the Company’s line of credit, including its financial covenants, see Item 1, Note 10 “Notes Payable and Line of Credit .”
If cash generated from operations is insufficient to satisfy working capital requirements, we may need to access funds through bank loans or other means. If we are unable to secure additional financing, we may not be able to complete development or enhancement of products, take advantage of future opportunities, respond to competition, retain key employees, or continue to effectively operate our business.
Based on our current plans and business conditions, management believes that the Company’s available cash and cash equivalents, the cash generated from operations, and availability on our line of credit will be sufficient to provide for the Company’s working capital and capital expenditure requirements for at least 12 months from the date of this filing.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.