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 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 nine months ended June 30, 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.
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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 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 June 30, 2022, the Russian/Ukrainian military conflict has not had a direct 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 June 30, 2022
Our sales decreased by approximately $0.4 million, or 3%, to $13.3 million for the three months ended June 30, 2022 as compared to $13.7 million for the three months ended June 30, 2021. The decrease in sales is the result of a decrease of $0.2 million in our TS segment combined with a $0.2 million decrease in our HPP segment. Our gross margin percentage increased to 37% of sales for the three months ended June 30, 2022 as compared to 31% for the three months ended June 30, 2021. For the three months ended June 30, 2022 there was an operating income of $19 thousand compared to an operating loss of $357 thousand for the three months ended June 30, 2021. Other income, (expense) net increased $0.7 million for the three months ended to June 30, 2022 as compared to the three months ended June 30, 2021. This is primarily due to a net increase in foreign exchange gain of $0.7 million from the prior year. The income tax expense of $11 thousand for the three months ended June 30, 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 $35 thousand for the three months ended June 30, 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.
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The following table details our results of operations in dollars and as a percentage of sales for the three months ended June 30, 2022 and 2021:
%
%
June 30, 2022
of sales
June 30, 2021
of sales
(Dollar amounts in thousands)
Sales
$
13,326
100
%
$
13,721
100
%
Costs and expenses:
Cost of sales
8,352
63
%
9,492
69
%
Engineering and development
884
7
%
700
6
%
Selling, general and administrative
4,071
31
%
3,886
28
%
Total costs and expenses
13,307
100
%
14,078
103
%
Operating income (loss)
19
—
%
(357)
(3)
%
Other income, (expense) net
676
5
%
(31)
—
%
Income (loss) before income taxes
695
5
%
(388)
(3)
%
Income tax expense
11
—
%
35
—
%
Net income (loss)
$
684
5
%
$
(423)
(3)
%
Sales
Our sales decreased by approximately $0.4 million to $13.3 million for the three months ended June 30, 2022 as compared to $13.7 million for the prior year period. The decrease in sales is the result of a decrease of $0.2 million in our TS segment combined with a $0.2 million decrease in our HPP segment.
TS segment sales change was as follows for the three months ended June 30, 2022 and 2021:
June 30,
Increase (decrease)
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
8,011
$
9,540
$
(1,529)
(16)
%
Services
4,577
3,223
1,354
42
%
Total
$
12,588
$
12,763
$
(175)
(1)
%
The decrease in TS segment product sales of $1.5 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 June 30, 2022 increased $1.4 million from the prior year period, which is attributable to the U.S. division. The increase in service sales included increased internal and third party service sales of $0.6 million, increased managed services sales of $0.4 million, and increased third party maintenance sales of $0.4 million.
HPP segment sales change was as follows for the three months ended June 30, 2022 and 2021:
June 30,
Decrease
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
427
$
602
$
(175)
(29)
%
Services
311
356
(45)
(13)
%
Total
$
738
$
958
$
(220)
(23)
%
The HPP product sales decreased by $0.2 million for the three months ended June 30, 2022 as compared to the prior year period as a result of a decrease in Myricom sales. The HPP services sales remained relatively flat for the three months ended June 30, 2022 compared to the prior year period as a result of ARIA revenue increasing $0.1 million, offset with a decrease of $0.1 million in royalties on high-speed processing boards related to the E2D program.
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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 June 30, 2022 and 2021:
June 30,
Increase (decrease)
2022
%
2021
%
$
%
(Dollar amounts in thousands)
Americas
$
13,020
98
%
$
12,764
93
%
$
256
2
%
Europe
189
1
%
747
5
%
(558)
(75)
%
Asia
117
1
%
210
2
%
(93)
(44)
%
Totals
$
13,326
100
%
$
13,721
100
%
$
(395)
(3)
%
The $0.3 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, partially offset by decreased sales by our HPP segment of $0.1 million. The $0.6 million decrease in sales to Europe was primarily the result of decreased sales by our TS segment’s U.S. division of $0.4 million combined with a decrease in the HPP division of $0.2 million. The sales to Asia decreased by $0.1 million primarily due to a decrease in the TS segment’s U.S. division.
Gross Margins
Our gross margin ("GM") increased $0.7 million for the three months ended June 30, 2022 as compared to the prior year period. The GM as a percentage of sales increased to 37% for the three months ended June 30, 2022 as compared to the prior year period of 31%.
June 30,
2022
2021
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
TS
$
4,612
37
%
$
3,664
29
%
$
948
8
%
HPP
362
49
%
565
59
%
(203)
(10)
%
Total
$
4,974
37
%
$
4,229
31
%
$
745
6
%
The impact of product mix within our TS segment on gross margin for the three months ended June 30, 2022 and 2021 was as follows:
June 30,
2022
2021
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
1,745
22
%
$
1,748
18
%
$
(3)
4
%
Services
2,867
63
%
1,916
59
%
951
4
%
Total
$
4,612
37
%
$
3,664
29
%
$
948
8
%
The overall TS segment GM as a percentage of sales increased to 37% for the three month period ended June 30, 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 June 30, 2022 from 18% for the prior year period. This was primarily due to higher margin products being sold to several major customers. Service GM as a percentage of service sales increased to 63% for the three months ended June 30, 2022 from 59% for the prior year period due to increased third party maintenance sales and increased selling prices for internal services in proportion to cost of sales.
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The impact of product mix within our HPP segment on gross margin for the three months ended June 30, 2022 and 2021 was as follows:
June 30,
2022
2021
Decrease
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
144
34
%
$
219
36
%
$
(75)
(2)
%
Services
218
70
%
346
97
%
(128)
(27)
%
Total
$
362
49
%
$
565
59
%
$
(203)
(10)
%
The overall HPP segment GM as a percentage of sales decreased to 49% for the three months ended June 30, 2022 from 59% for the three months ended June 30, 2021. The 2% decrease in product GM as a percentage of product revenue for the three months ended June 30, 2022 compared to the same prior year period is due to product mix. The 27% decrease in service GM as a percentage of services revenue from prior year was due to decreased royalty sales, which are nearly all margin along with increased manufacturing overhead expenses including payroll.
Engineering and Development Expenses
The engineering and development expenses incurred by our HPP segment increased $184 thousand for the three months ended June 30, 2022 to $0.9 million when compared to the prior year period due to increased consulting expenses. The current period expenses were primarily for product engineering expenses incurred in connection with the continued development of the ARIA Zero Trust Gateway 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 June 30, 2022 and 2021:
Three months ended June 30
$
%
% of
% of
Increase
Increase
2022
Total
2021
Total
(Decrease)
(Decrease)
(Dollar amounts in thousands)
By Operating Segment:
TS segment
$
3,223
79
%
$
2,649
68
%
$
574
22
%
HPP segment
848
21
%
1,237
32
%
(389)
(31)
%
Total
$
4,071
100
%
$
3,886
100
%
$
185
5
%
SG&A expenses of $4.1 million for the three months ended June 30, 2022 increased $0.2 million as compared to the prior year period. The TS segment G&A expenses increased by approximately $0.6 million due to increased variable compensation. The HPP segment SG&A expenses decreased approximately $0.4 million for the three months ended June 30, 2022 as compared to the prior year period due to decreased headcount related payroll expenses and stock compensation.
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Other Income/Expenses
The following table details other income (expense) for the three months ended June 30, 2022 and 2021:
Three months ended
Increase
June 30, 2022
June 30, 2021
(Decrease)
(Amounts in thousands)
Foreign exchange gain (loss)
$
618
$
(110)
$
728
Interest expense
(80)
(131)
51
Interest income
158
175
(17)
Other income (expense), net
(20)
35
(55)
Total other income (expense), net
$
676
$
(31)
$
707
The $0.7 million increase in total other income (expense), net for the three months ended June 30, 2022 as compared to the prior year period is primarily due to a net increase in foreign exchange gain of $0.7 million.
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 gain 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 June 30, 2022 causing a foreign exchange gain combined with the Euro strengthening relative to the British Pound for the same period.
The interest income decrease of $17 thousand for the three months ended June 30, 2022 as compared to the prior year period is primarily due to more principal payments and the receivables accruing less interest from prior year periods, 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 in the current year.
The interest expense decrease of $51 thousand for the three months ended June 30, 2022 as compared to the prior year period is related to the TS U.S. division entering into two large multi-year contracts in the second quarter of fiscal year 2021, which incurred less interest expense in fiscal year 2022 due to principal payments. 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 $11 thousand for the three months ended June 30, 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 $35 thousand for the three months ended June 30, 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 in general 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 June 30, 2022 because we 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 nine months ended June 30, 2022
Our sales decreased by approximately $1.5 million, or 4%, to $37.7 million for the nine months ended June 30, 2022 as compared to $39.2 million for the nine months ended June 30, 2021. The decrease in sales is the result of a decrease of $1.1 million in our TS segment and a decrease of approximately $0.4 million in our HPP segment. Our gross margin percentage increased to 34% of sales for the nine months ended June 30, 2022 as compared to 31% for the nine months
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ended June 30, 2021. For the nine months ended June 30, 2022 there was an operating loss of $0.4 million compared to an operating loss of $1.0 million for the nine months ended June 30, 2021. Other income, (expense) net decreased $0.9 million for the nine months ended to June 30, 2022 as compared to the nine months ended June 30, 2021. The two largest items contributing to this change is 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 $1.5 million from the prior year. The income tax expense of $28 thousand for the nine months ended June 30, 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 $868 thousand for the nine months ended June 30, 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 nine months ended June 30, 2022 and 2021:
%
%
June 30, 2022
of sales
June 30, 2021
of sales
(Dollar amounts in thousands)
Sales
$
37,676
100
%
$
39,197
100
%
Costs and expenses:
Cost of sales
24,888
66
%
27,222
69
%
Engineering and development
2,228
6
%
2,191
6
%
Selling, general and administrative
10,961
29
%
10,799
28
%
Total costs and expenses
38,077
101
%
40,212
103
%
Operating loss
(401)
(1)
%
(1,015)
(3)
%
Other income, (expense) net
903
2
%
1,764
5
%
Income before income taxes
502
1
%
749
2
%
Income tax expense
28
—
%
868
2
%
Net income (loss)
$
474
1
%
$
(119)
—
%
Sales
Our sales decreased by approximately $1.5 million to $37.7 million for the nine months ended June 30, 2022 as compared to $39.2 million for the prior year period. The decrease in sales is the result of a decrease of $1.1 million in our TS segment and a decrease of approximately $0.4 million in our HPP segment.
TS segment sales change was as follows for the nine months ended June 30, 2022 and 2021:
June 30,
Increase (decrease)
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
23,266
$
27,032
$
(3,766)
(14)
%
Services
11,465
8,763
2,702
31
%
Total
$
34,731
$
35,795
$
(1,064)
(3)
%
The decrease in TS segment product sales of $3.8 million during the period as compared to the prior year period is attributable to a decrease in the U.S. division of $2.4 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 $1.4 million due to one customer not repeating a high volume of sales in the current period. Service sales for the nine months ended June 30, 2022 increased $2.7 million from the prior year period, which is attributable to the U.S. division. The changes in service sales included increased internal and third party service sales of $1.3 million, increased managed services sales of $1.2 million, and increased third party maintenance sales of $0.2 million.
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HPP segment sales change was as follows for the nine months ended June 30, 2022 and 2021:
June 30,
Decrease
2022
2021
$
%
(Dollar amounts in thousands)
Products
$
2,109
$
2,494
$
(385)
(15)
%
Services
836
908
(72)
(8)
%
Total
$
2,945
$
3,402
$
(457)
(13)
%
The HPP product sales decreased by $0.4 million for the nine months ended June 30, 2022 as compared to the prior year period, primarily as a result of an approximately $0.5 million decrease in E2D part sales, partially offset with an increase of Myricom sales of $0.1 million. The HPP services sales decreased $0.1 million for the nine months ended June 30, 2022 compared to the prior year period from decreased royalties on high-speed processing boards related to the E2D program of $0.1 million combined with decreased repairs of $0.1 million, partially offset with an increase of $0.1 million in ARIA revenue.
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 nine months ended June 30, 2022 and 2021:
June 30,
Increase (decrease)
2022
%
2021
%
$
%
(Dollar amounts in thousands)
Americas
$
36,187
96
%
$
35,547
91
%
$
640
2
%
Europe
1,202
3
%
3,067
8
%
(1,865)
(61)
%
Asia
287
1
%
583
1
%
(296)
(51)
%
Totals
$
37,676
100
%
$
39,197
100
%
$
(1,521)
(4)
%
The $0.6 million increase in sales to the Americas was primarily the result of an increase in the TS segment’s U.S. division of $0.8 million, partially offset with a decrease in the TS U.K. division of $0.2 million. The $1.9 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 TS U.S. division of $0.3 million and a decrease in the HPP segment of $0.3 million. The sales to Asia decreased by $0.3 million due to a decrease in the HPP segment of $0.2 million combined with a decrease in the TS segment’s U.S. division of $0.1 million.
Gross Margins
Our gross margin ("GM") increased $0.8 million for the nine months ended June 30, 2022 as compared to the prior year period. The GM as a percentage of total sales increased to 34% for the nine months ended June 30, 2022 as compared to the prior year period of 31%. The GM as a percentage of total sales increased in the TS segment, but this was partially offset by a decrease in the HPP segment.
June 30,
2022
2021
Increase (decrease)
(Dollar amounts in thousands)
GM$
GM%
GM$
GM%
GM$
GM%
TS
$
11,284
32
%
$
9,985
28
%
$
1,299
4
%
HPP
1,504
51
%
1,990
58
%
(486)
(7)
%
Total
$
12,788
34
%
$
11,975
31
%
$
813
3
%
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The impact of product mix within our TS segment on gross margin for the nine months ended June 30, 2022 and 2021 was as follows:
June 30,
2022
2021
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
4,459
19
%
$
4,728
17
%
$
(269)
2
%
Services
6,825
60
%
5,257
60
%
1,568
—
%
Total
$
11,284
32
%
$
9,985
28
%
$
1,299
4
%
The TS segment GM as a percentage of total sales increased to 32% for the nine month period ended June 30, 2022 compared to 28% from the prior year period. This was primarily due to significantly increased GM from services compared to the prior year period combined with increased product GM as a percentage of revenue to 19% for the nine month period ended June 30, 2022 compared to 17% for the prior year period. The product GM as a percentage of product revenue 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 remained relatively flat at 60% for the nine months ended June 30, 2022 compared to the prior year period due to increased sales offset with 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 nine months ended June 30, 2022 and 2021 was as follows:
June 30,
2022
2021
Decrease
(Dollar amounts in thousands)
GM$
GM%
GM$
GM%
GM$
GM%
Products
$
826
39
%
$
1,120
45
%
$
(294)
(6)
%
Services
678
81
%
870
96
%
(192)
(15)
%
Total
$
1,504
51
%
$
1,990
58
%
$
(486)
(7)
%
The overall HPP segment GM as a percentage of sales decreased to 51% for the nine months ended June 30, 2022 from 58% for the nine months ended June 30, 2021. The 6% decrease in product GM was primarily attributed to lower margin product sold for the nine months ended June 30, 2022 compared to the same prior year period. The 15% decrease in service GM as a percentage of services revenue from the prior year period was due to decreased royalty sales, which are nearly all margin along with increased manufacturing overhead expenses including payroll.
Engineering and Development Expenses
The engineering and development expenses incurred by our HPP segment remained relatively flat at $2.2 million for the nine months ended June 30, 2022 when compared to the prior year period due to decreased headcount related expenses 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 Zero Trust Gateway cyber security products.
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Selling, General and Administrative Expenses
The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the nine months ended June 30, 2022 and 2021:
Nine months ended June 30,
$
%
% of
% of
Increase
Increase
2022
Total
2021
Total
(Decrease)
(Decrease)
(Dollar amounts in thousands)
By Operating Segment:
TS segment
$
8,208
75
%
$
7,435
69
%
$
773
10
%
HPP segment
2,753
25
%
3,364
31
%
(611)
(18)
%
Total
$
10,961
100
%
$
10,799
100
%
$
162
2
%
SG&A expenses decreased $0.2 million for the nine months ended June 30, 2022 compared to the prior year period. The $0.8 million increase in TS segment SG&A expenses compared to the same prior year period is primarily the result of approximately $0.7 million increased variable compensation and $0.1 million increased marketing, travel, and other expenses. The HPP segment SG&A expenses decreased approximately $0.6 million for the nine months ended June 30, 2022 as compared to the prior year period due to a decrease in headcount as well as a decrease in expenses including variable and stock compensation.
Other Income/Expenses
The following table details other income (expense) for the nine months ended June 30, 2022 and 2021:
Nine months ended
Increase
June 30, 2022
June 30, 2021
(Decrease)
(Amounts in thousands)
Foreign exchange gain (loss)
$
777
$
(731)
$
1,508
Interest expense
(286)
(244)
(42)
Interest income
429
406
23
Gain on debt forgiveness
—
2,196
(2,196)
Other income, net
(17)
137
(154)
Total other income (expense), net
$
903
$
1,764
$
(861)
The $0.9 million decrease in total other income (expense), net for the nine months ended June 30, 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 $1.5 million in the current period. Additionally, other income (expense), net decreased by $0.2 million primarily due to a one-time gain from an overpayment of a rebate received in the prior year, which did not reoccur in the current year period. 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 gain is primarily from a U.S. Dollar bank account, partially offset with a foreign exchange loss from a Euro bank account. The US dollar significantly strengthened relative to the British Pound for the nine months ended June 30, 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 $23 thousand for the nine months ended June 30, 2022 as compared to the prior year period is primarily related to additional interest income from 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) during fiscal year 2022, which were partially offset with lower interest income recognized from prior agreements as time elapses due to principal payments being received in the TS-US segment from agreements in the prior year periods.
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The interest expense increase of $42 thousand for the nine months ended June 30, 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 nine 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 $28 thousand for the nine months ended June 30, 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 $868 thousand for the nine months ended June 30, 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 in general 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 June 30, 2022 because we 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 $1.4 million to $21.4 million as of June 30, 2022 from $20.0 million as of September 30, 2021.
Our significant sources of cash for the nine months ended June 30, 2022 included an increase in deferred revenue of $2.9 million, an increase of $2.1 million in net amount received under the line-of-credit agreement, and a decrease in accounts receivable and long-term receivable of $2.1 million.
Our significant uses of cash for the nine months ended June 30, 2022 were primarily related to a decrease in accounts payable and accrued expenses and other long-term liabilities of $2.1 million, an increase in inventory of $1.6 million, repayment of life insurance policy loans of $0.9 million, repayments on debt of $0.7 million, and purchases of property, equipment, and improvements of $0.2 million.
Our cash held by our foreign subsidiary in the United Kingdom totaled approximately $8.9 million as of June 30, 2022 and consisted of 0.4 million Euros, 0.3 million British Pounds, and 8.3 million U.S. Dollars. This cash is included in our total cash and cash equivalents reported within our financial statements.
As of June 30, 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 $12.0 million and $14.1 million were available as of June 30, 2022 and September 30, 2021, respectively. As of June 30, 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.
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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.