What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-02-09 compared with 2022-08-10 · 77 added, 177 removed, 85 unchanged (75% of the section changed)

4 unchanged sentences

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.

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, 2022.

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.

11 unchanged sentences

A description of our critical accounting policies is contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022 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.

Management believes there have been no significant changes for the three months ended December 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, 2022.

Observations on effects of novel coronavirus and Russia/Ukraine Conflict

8 unchanged sentences

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.

The HPP segment has and continues to experience shortages with their vendors as well.

If we are unable to successfully resolve these disruptions and shortages, the timing and amount of our future results may be materially impacted.

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 was recognized fully in revenue in the first quarter of fiscal year 2023 when we obtained 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.

3 unchanged sentences

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.

As of December 31, 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.

1 unchanged sentence

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.

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

June 30, 2021

Overview of the three months ended December 31, 2022

Our sales increased by approximately $5.9 million, or 48%, to $18.3 million for the three months ended December 31, 2022 as compared to $12.4 million for the three months ended December 31, 2021.

The increase in sales is the result of an increase of $4.5 million in our TS segment combined with a $1.4 million increase in our HPP segment.

Our gross margin percentage increased to 32% of sales for the three months ended December 31, 2022 as compared to 29% for the three months ended December 31, 2021.

For the three months ended December 31, 2022 there was an operating income

of $1.4 million compared to an operating loss of $0.4 million for the three months ended December 31, 2021.

Other income, (expense) net decreased $0.3 million for the three months ended to December 31, 2022 as compared to the three months ended December 31, 2021.

An income tax expense of $133 thousand was recorded for the three months ended December 31, 2022 compared to an income tax expense of $12 thousand in the same period of fiscal year 2022.

The following table details our results of operations in dollars and as a percentage of sales for the three months ended December 31, 2022 and 2021:

December 31, 2022

December 31, 2021

(Dollar amounts in thousands)

9 unchanged sentences

Net income (loss)

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:

Increase (decrease)

Our sales increased by approximately $5.9 million to $18.3 million for the three months ended December 31, 2022 as compared to $12.4 million for the prior year period.

The increase in sales is the result of an increase of $4.5 million in our TS segment combined with a $1.4 million increase in our HPP segment.

TS segment sales change was as follows for the three months ended December 31, 2022 and 2021:

(Dollar amounts in thousands)

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.

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:

The increase in TS segment product sales of $4.1 million during the period is primarily attributable to an increase in the U.S.

division due to increased sales to several major customers.

Service sales for the three months ended December 31, 2022 increased $0.5 million from the prior year period, which is attributable to the U.S.

The increase in service sales included increased third party maintenance sales of $0.4 million, increased managed services sales of $0.3 million, partially offset with decreased internal and third party service sales of $0.2 million.

HPP segment sales change was as follows for the three months ended December 31, 2022 and 2021:

Increase (decrease)

(Dollar amounts in thousands)

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.

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:

The HPP product sales increased by $1.4 million for the three months ended December 31, 2022 as compared to the prior year period primarily as a result of one large Myricom product order placed in the first quarter of fiscal year 2022,

but due to supply chain delays was not fully fulfilled until the first quarter of fiscal year 2023.

The HPP services sales remained relatively flat for the three months ended December 31, 2022 compared to the prior year period as a result of ARIA revenue increasing $0.1 million, which was offset with a decrease of $0.1 million in royalties on high-speed processing boards related to the E2D program.

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 December 31, 2022 and 2021:

Increase (decrease)

1 unchanged sentence

The $6.3 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.

division of $4.8 million combined with sales by our HPP segment of $1.5 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 the HPP division of $0.1 million.

The sales to Asia decreased by $0.1 million primarily due to a decrease in the TS segment’s U.S.

The sales to Asia remained relatively flat compared to prior year without any significant changes in any divisions.

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%.

Increase (decrease)

Our gross margin ("GM") increased $2.2 million for the three months ended December 31, 2022 as compared to the prior year period.

The GM as a percentage of sales increased to 32% for the three months ended December 31, 2022 as compared to the prior year period of 29%.

(Dollar amounts in thousands)

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:

Increase (decrease)

The impact of product mix within our TS segment on gross margin for the three months ended December 31, 2022 and 2021 was as follows:

(Dollar amounts in thousands)

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.

The overall TS segment GM as a percentage of sales remained flat at 26% for the three month period ended December 31, 2022 compared to the prior year period.

This was primarily due to prior year’s services GM being a larger percentage of total GM relative to product GM, which was offset in the current year by improved product GM as a percentage of product sales.

Product GM as a percentage of product sales increased to 17% for the three months ended December 31, 2022 from 14% 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.

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:

Service GM as a percentage of service sales remained flat at 56% for the three months ended December 31, 2022 compared to the prior year period due to no significant changes in any types of service revenue margin as a percentage of its respective revenue.

The impact of product mix within our HPP segment on gross margin for the three months ended December 31, 2022 and 2021 was as follows:

Increase (decrease)

(Dollar amounts in thousands)

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.

The overall HPP segment GM as a percentage of sales increased to 66% for the three months ended December 31, 2022 from 58% for the three months ended December 31, 2021.

The 24% increase in product GM as a percentage of product revenue for the three months ended December 31, 2022 compared to the same prior year period is primarily due to one major order that did not occur in the prior year period.

The 23% decrease in service GM as a percentage of services revenue from prior year was due to decreased royalty sales, which are nearly all margin.

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 engineering and development expenses incurred by our HPP segment increased $0.2 million for the three months ended December 31, 2022 to $0.8 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

The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the three months ended December 31, 2022 and 2021:

Three months ended December 31,

(Dollar amounts in thousands)

By Operating Segment:

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.

SG&A expenses of $3.6 million for the three months ended December 31, 2022 increased $0.2 million as compared to the prior year period.

The TS segment G&A expenses increased by approximately $0.3 million due to increased variable compensation as there were higher sales in the first quarter of fiscal year 2023 when compared to the prior year period.

The HPP segment SG&A expenses decreased approximately $0.1 million for the three months ended December 31, 2022 as compared to the prior year period due to decreased labor expenses and consulting.

Other Income/Expenses

The following table details other income (expense) for the three months ended June 30, 2022 and 2021:

The following table details other income (expense) for the three months ended December 31, 2022 and 2021:

Three months ended

June 30, 2022

June 30, 2021

December 31, 2022

December 31, 2021

(Amounts in thousands)

Foreign exchange gain (loss)

Foreign exchange loss

Interest expense

2 unchanged sentences

Total other income (expense), net

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.

The $0.3 million decrease in total other income (expense), net for the three months ended December 31, 2022 as compared to the prior year period is primarily due to a net increase in foreign exchange loss of $0.5 million, partially offset by an increase in interest income of $0.1 million.

In consolidation, U.S.

2 unchanged sentences

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.

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

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

June 30, 2021

(Dollar amounts in thousands)

Costs and expenses:

Cost of sales

Engineering and development

Selling, general and administrative

Total costs and expenses

Operating loss

Other income, (expense) net

Income before income taxes

Income tax expense

Net income (loss)

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:

Increase (decrease)

(Dollar amounts in thousands)

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.

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.

HPP segment sales change was as follows for the nine months ended June 30, 2022 and 2021:

(Dollar amounts in thousands)

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:

Increase (decrease)

(Dollar amounts in thousands)

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.

Increase (decrease)

(Dollar amounts in thousands)

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:

Increase (decrease)

(Dollar amounts in thousands)

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:

(Dollar amounts in thousands)

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.

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,

(Dollar amounts in thousands)

By Operating Segment:

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

June 30, 2022

June 30, 2021

(Amounts in thousands)

Foreign exchange gain (loss)

Interest expense

Interest income

Gain on debt forgiveness

Other income, net

Total other income (expense), net

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.

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.

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.

The US dollar weakened relative to the British Pound for the three months ended December 31, 2022 causing a foreign exchange loss, partially offset with the Euro strengthening relative to the British Pound for the same period.

The interest income increase of $116 thousand for the three months ended December 31, 2022 as compared to the prior year period is primarily due to new 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) entered into subsequent to the first quarter of fiscal year 2022 in the TS-US division combined with higher interest income from our cash and cash equivalents due to increased interest rates in the first quarter of fiscal year 2023.

This was partially offset by less interest income from agreements that have payments in excess of one year that were entered into in the first quarter of fiscal year 2022 or prior due to more principal payments resulting in the receivables accruing less interest income.

The interest expense decrease of $41 thousand for the three months ended December 31, 2022 as compared to the prior year period is related to the TS U.S.

division entering into multi-year contracts in prior years, which incur less interest expense as time elapses due to principal payments being made.

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.

An income tax expense of $133 thousand was recorded for the three months ended December 31, 2022 compared to an income tax expense of $12 thousand in the same period of fiscal year 2022.

The income tax expense for three months ended December 31, 2022 is primarily driven by minimum state tax expenses and the required capitalization of R&D expenses under IRC Section 174, offset by the use of federal NOL and R&D credits.

The Company continues to maintain a full valuation allowance on its operations but will continue to evaluate this need going forward.

The income tax expense for the three months ended December 31, 2021 was driven by an increase in the valuation allowance against deferred tax assets in the period, offset by a benefit recorded for a change in tax law, allowing for the immediate deduction of covered expenses incurred through the Paycheck Protection Program (PPP).

However, we used a discrete effective tax rate method to calculate income taxes for the three months ended December 31, 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.

Our primary source of liquidity is our cash and cash equivalents, which decreased by $4.4 million to $19.6 million as of December 31, 2022 from $24.0 million as of September 30, 2022.

Our significant sources of cash for the three months ended December 31, 2022 included a decrease in accounts receivable and long-term receivable of $1.2 million, an increase of $0.3 million in net amount received under the line-of-credit agreement, a decrease in other assets of $0.3 million, and a decrease in inventories of $0.2 million.

Our significant uses of cash for the three months ended December 31, 2022 were primarily related to a decrease in accounts payable and accrued expenses and other long-term liabilities of $7.4 million and repayments on notes payable of $0.4 million.

Our cash held by our foreign subsidiary in the United Kingdom totaled approximately $5.0 million as of December 31, 2022 and consisted of 0.4 million Euros, 0.2 million British Pounds, and 4.4 million U.S.

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.

Approximately 3.5 million U.S.

Dollars was transferred from the foreign subsidiary in the U.K.

to Modcomp, Inc.

(TS-US) to use in operations during the first quarter of fiscal year 2023.

As of December 31, 2022 and September 30, 2022, 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.

An amount of $11.5 million and $11.9 million were available as of December 31, 2022 and September 30, 2022, respectively.

As of December 31, 2022 and September 30, 2022 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 .”

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What changed 10-Q

Item 2. Management’s Discussion and Analysis