What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-08-09 compared with 2023-05-10 · 147 added, 148 removed, 124 unchanged (70% of the section changed)

19 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 six months ended March 31, 2023 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

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.

Management believes there have been no significant changes for the nine months ended June 30, 2023 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.

Recent Trends affecting our Financial Performance

COVID-19 has adversely affected the distribution channel leading to 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 and continues to experience shortages with their vendors as well.

However, as time passes lead times have significantly improved.

The TS segment has many vendors it transacts with and supply shortages only remain with a few of our vendors.

The HPP segment has and continues to experience shortages with some 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.

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.

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 March 31, 2023, 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 June 30, 2023, 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.

It is not possible at this time to predict the size of the impact or consequences of the conflict on the Company and our customers and suppliers.

Results of Operations

Overview of the three months ended March 31, 2023

Our sales increased by approximately $1.3 million, or 11%, to $13.3 million for the three months ended March 31, 2023 compared to $12.0 million for the three months ended March 31, 2022.

Our gross margin percentage increased to 38% of sales for the three months ended March 31, 2023 compared to 35% for the three months ended March 31, 2022.

For the three months ended March 31, 2023 there was an operating income of $237 thousand compared to a $24 thousand operating loss for the three months ended March 31, 2022.

Other income, (expense) remained at $0.2 million for the three months ended March 31, 2023 and 2022.

An income tax expense of $71 thousand was recorded for the three months ended March 31, 2023 compared to an income tax expense of $5 thousand in the same period in the prior year.

The following table details our results of operations in dollars and as a percentage of sales for the three months ended March 31, 2023 and 2022:

March 31, 2023

March 31, 2022

Overview of the three months ended June 30, 2023

Our sales increased by approximately $4.4 million, or 33%, to $17.7 million for the three months ended June 30, 2023 compared to $13.3 million for the three months ended June 30, 2022.

Our gross margin percentage decreased to 33% of sales for the three months ended June 30, 2023 compared to 37% for the three months ended June 30, 2022.

For the three months ended June 30, 2023 there was operating income of $575 thousand compared to operating income of $19 thousand for the three months ended June 30, 2022.

Other income, net decreased $0.5 million to $0.2 million for the three months ended June 30, 2023 compared to $0.7 million for the same prior year period An income tax benefit of $1.7 million was recorded for the three months ended June 30, 2023 compared to an income tax expense of $11 thousand in the same period in the prior year.

The following table details our results of operations in dollars and as a percentage of sales for the three months ended June 30, 2023 and 2022:

June 30, 2023

June 30, 2022

(Dollar amounts in thousands)

4 unchanged sentences

Total costs and expenses

Operating income (loss)

Other income (expense), net

Operating income

Other income, net

Income before income taxes

Income tax expense

Our sales increased by approximately $1.3 million to $13.3 million for the three months ended March 31, 2023 compared to $12.0 million for the same prior year period.

Income tax (benefit) expense

Our sales increased by approximately $4.4 million, or 33%, to $17.7 million for the three months ended June 30, 2023 compared to $13.3 million for the same prior year period.

The increase in sales is the result of an increase of $3.8 million in our TS segment combined with a $0.6 million increase in our HPP segment.

TS segment sales change was as follows for the three months ended March 31, 2023 and 2022:

TS segment sales change was as follows for the three months ended June 30, 2023 and 2022:

Increase (decrease)

(Dollar amounts in thousands)

1 unchanged sentence

division due to increased sales to several major customers.

Service sales for the three months ended March 31, 2023 increased $0.2 million from the same prior year period, which was attributable to the U.S.

The increase in service sales included increased managed services sales of $0.3 million and increased third party maintenance sales of $0.1 million, partially offset by decreased internal and third party service sales of $0.2 million.

HPP segment sales change was as follows for the three months ended March 31, 2023 and 2022:

Service sales for the three months ended June 30, 2023 decreased $0.1 million from the same prior year period, which was attributable to the U.S.

The decrease in service sales included decreased internal and third party service sales of $0.5 million and decreased third party maintenance sales of $0.1 million, partially offset by increased managed services sales of $0.5 million.

HPP segment sales change was as follows for the three months ended June 30, 2023 and 2022:

(Dollar amounts in thousands)

The HPP product sales remained relatively flat for the three months ended March 31, 2023 compared to the same prior year period as a result of no significant changes in any product line’s revenue.

The HPP services sales increased $0.3 million for the three months ended March 31, 2023 compared to the same prior year period as a result of increased repair revenue of $0.2 million and increased royalties on high-speed processing boards related to the E2D program 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 three months ended March 31, 2023 and 2022:

The HPP product sales increased $0.6 million for the three months ended June 30, 2023 compared to the same prior year period as a result of increased sales to one major customer of $0.8 million, partially offset by a $0.2 million decrease to several customers of Myricom product.

The HPP service sales remained relatively flat at $0.3 million for the three months ended June 30, 2023 compared to the same prior year period as a result of decreased royalties on high-speed processing boards related to the E2D program of $0.1 million offset with increased ARIA revenue 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 three months ended June 30, 2023 and 2022:

Increase (decrease)

2 unchanged sentences

division of $3.7 million combined with an increase in the HPP segment of $0.6 million.

The $0.1 million decrease in sales to Europe was primarily the result of decreased sales by our HPP segment.

The sales to Asia increased by $0.2 million primarily due to an increase in the HPP segment.

The $0.1 million increase in sales to Europe was primarily the result of increased sales by our TS segment’s U.S.

The sales to Asia remained relatively flat for the three months ended June 30, 2023 compared to the same prior year period without any significant changes in any division.

Gross Margins

Our gross margin ("GM") increased $0.8 million for the three months ended March 31, 2023 as compared to the same prior year period.

The GM as a percentage of sales increased to 38% for the three months ended March 31, 2023 compared to the same prior year period of 35%.

Our gross margin ("GM") increased $1.0 million for the three months ended June 30, 2023 as compared to the same prior year period.

The GM as a percentage of sales decreased to 33% for the three months ended June 30, 2023 compared to the same prior year period of 37%.

Increase (decrease)

(Dollar amounts in thousands)

The impact of product mix within our TS segment on gross margin for the three months ended March 31, 2023 and 2022 was as follows:

The impact of product mix within our TS segment on gross margin for the three months ended June 30, 2023 and 2022 was as follows:

Increase (decrease)

(Dollar amounts in thousands)

The overall TS segment GM as a percentage of sales remained relatively flat at 34% for the three month period ended March 31, 2023 compared to 34% for the same prior year period.

Both the U.S.

division did not have a variance in either product or service GM as a percentage of revenue.

Many different types of products are sold by the TS division and the product GM as a percentage of revenue had no change from the same prior year period.

The service GM as a percentage of revenue remained flat due to no significant changes in the types of service revenue and a small increase in volume.

The impact of product mix within our HPP segment on gross margin for the three months ended March 31, 2023 and 2022 was as follows:

The overall TS segment GM as a percentage of sales decreased to 31% for the three month period ended June 30, 2023 compared to 37% for the same prior year period.

Product GM as a percentage of revenue decreased 3% due to a few large sales with lower margins.

The service GM as a percentage of revenue remained flat due to no significant changes in the margins for any type of service revenue.

The impact of product mix within our HPP segment on gross margin for the three months ended June 30, 2023 and 2022 was as follows:

Increase (decrease)

(Dollar amounts in thousands)

The overall HPP segment GM as a percentage of sales increased to 67% for the three months ended March 31, 2023 from 45% for the three months ended March 31, 2022.

The 25% increase in product GM as a percentage of product revenue for the three months ended March 31, 2023 compared to the same prior year period is due to higher margin Myricom products being sold than the same prior year period as the Myricom products have a wide range of GM as a percentage of revenue.

The 4% decrease in service GM as a percentage of services revenue from the same prior year period was due to increased repair revenue in proportion to increased royalties because repair revenue has lower margins than royalties, which are nearly all gross margin.

The overall HPP segment GM as a percentage of sales increased to 65% for the three months ended June 30, 2023 from 49% for the three months ended June 30, 2022.

The 37% increase in product GM as a percentage of product revenue for the three months ended June 30, 2023 compared to the same prior year period is due to higher margin Myricom products being sold than the same prior year period as the Myricom products have a wide range of GM as a percentage of revenue.

The 23% decrease in service GM as a percentage of services revenue from the same prior year period was due to decreased royalties, which are nearly all gross margin.

Engineering and Development Expenses

The engineering and development expenses incurred by our HPP segment increased $141 thousand for the three months ended March 31, 2023 to $0.9 million compared to the same 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.

The engineering and development expenses incurred by our HPP segment decreased $0.1 million for the three months ended June 30, 2023 to $0.7 million compared to the same prior year period due to decreased labor expenses.

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 March 31, 2023 and 2022:

Three months ended March 31,

The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the three months ended June 30, 2023 and 2022:

Three months ended June 30,

(Dollar amounts in thousands)

By Operating Segment:

SG&A expenses of $3.9 million for the three months ended March 31, 2023 increased $0.4 million compared to the same prior year period.

SG&A expenses of $4.6 million for the three months ended June 30, 2023 increased $0.5 million compared to the same prior year period.

The TS segment SG&A expenses increased by approximately $0.4 million due to increased variable compensation from higher sales and increased payroll.

The HPP segment SG&A expenses decreased approximately $0.1 million for the three months ended March 31, 2023 as compared to the prior year period due to decreased labor and fringe benefit expenses.

The HPP segment SG&A expenses increased approximately $0.1 million for the three months ended June 30, 2023 as compared to the prior year period due to increased variable compensation.

Other Income/Expenses

The following table details other income (expense) for the three months ended March 31, 2023 and 2022:

The following table details other income, net for the three months ended June 30, 2023 and 2022:

Three months ended

March 31, 2023

March 31, 2022

June 30, 2023

June 30, 2022

(Amounts in thousands)

3 unchanged sentences

Other income (expense), net

Total other income (expense), net

Total other income (expense), net for the three months ended March 31, 2023 remained relatively flat at $0.2 million compared to the three months ended March 31, 2022.

The $0.3 million increased foreign exchange loss for the three months ended March 31, 2023 was due to the U.S.

Dollar and Euro weakening relative to British Pound compared to the same prior year period.

Total other income, net

Total other income (expense), net for the three months ended June 30, 2023 decreased $0.4 million compared to the three months ended June 30, 2022.

The $0.7 million increased foreign exchange loss for the three months ended June 30, 2023 was due to the U.S.

Dollar and Euro weakening relative to the British Pound compared to the same prior year period.

In consolidation, U.S.

3 unchanged sentences

Dollar and Euro bank accounts in our TS U.K.

There were three changes that partially offset the foreign exchange loss.

Interest income increased $199 thousand for the three months ended March 31, 2023 compared to the same prior year period primarily due 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) entered into during fiscal year 2022, which were partially offset with lower interest income recognized from prior agreements as interest income decreases as time elapses due to principal payments being received.

Interest income increased $243 thousand for the three months ended June 30, 2023 compared to the same prior year period primarily due 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) entered into subsequent to the fiscal third quarter of 2022, which were partially offset with lower interest income recognized from prior agreements as interest income decreases as time elapses due to principal payments being received.

All of these agreements are in the TS-US division.

Additionally, interest rates have significantly increased from the same prior year period, which has resulted in increased interest income from money market accounts from both the U.S.

The interest expense decrease of $39 thousand for the three months ended March 31, 2023 compared to the same prior year period was related to the TS U.S.

Additionally, interest rates have significantly increased from the same prior year period, which has resulted in increased interest income from money market accounts and investments from both the U.S.

The interest expense decrease of $2 thousand for the three months ended June 30, 2023 compared to the same prior year period was related to the TS U.S.

division making principal payments on multi-year vendor contracts that started in the second quarter of fiscal year 2021 related to sales agreements that have payment terms in excess of one year as the Company incurs less interest expense over time as principal payments are made.

This was partially offset with interest expense incurred during the three months ended June 30, 2023 for a new multi-year vendor contract with payment terms in excess of one year.

This is the only new multi-year vendor agreement since the third quarter of fiscal year 2022.

See Note 10 in Item 1 to this Quarterly Report on Form 10-Q for details.

There have been no subsequent multi-year vendor agreements from the second quarter of fiscal year 2022.

Other income (expense), net did not have a significant change from the prior year.

An income tax expense of $71 thousand was recorded for the three months ended March 31, 2023 compared to an income tax expense of $5 thousand in the same period in the prior year.

The income tax expense for the three months ended March 31, 2023 was primarily driven by minimum state tax expenses and the required capitalization of R&D expenses under IRC Section 174, partially offset by the use of federal NOL and R&D credits.

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

The income tax expense for the three months ended March 31, 2022 was primarily driven by minimum state tax expenses due to the full valuation allowance in place during the period.

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 March 31, 2023 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 six months ended March 31, 2023

Our sales increased by approximately $7.3 million, or 30%, to $31.6 million for the six months ended March 31, 2023 as compared to $24.4 million for the six months ended March 31, 2022.

The increase in sales is the result of an increase of $5.5 million in our TS segment and an increase of $1.8 million in our HPP segment.

Our gross margin percentage increased to 34% of sales for the six months ended March 31, 2023 compared to 32% for the six months ended March 31, 2022.

For the six months ended March 31, 2023 there was an operating income of $1.6 million compared to an operating loss of $0.4 million for the six months ended March 31, 2022.

Other income, (expense) net decreased $0.3 million for the six months ended March 31, 2023 to a loss of $0.1 million compared to income of $0.2 million for the six months ended March 31, 2022.

An income tax expense of $204 thousand was recorded for the six months ended March 31, 2023 compared to an income tax expense of $17 thousand in the same period in the prior year.

The following table details our results of operations in dollars and as a percentage of sales for the six months ended March 31, 2023 and 2022:

March 31, 2023

March 31, 2022

An income tax benefit of $1.7 million was recorded for the three months ended June 30, 2023 compared to an income tax expense of $11 thousand in the same prior year period.

The income tax benefit for the three months ended June 30, 2023 was primarily driven by the release of the full valuation allowance against the Company’s deferred tax assets that was established in fiscal year 2021.

Since that time, the COVID-19 pandemic has ended, and the Company’s Technology Solutions business has grown in fiscal years 2022 and 2023, which provided strong financial results including growth in product and software sales, third party maintenance sales, and recurring managed services and cloud software sales.

The backlog continues to be strong as of June 30, 2023.

The income tax provision for each quarter is generally determined based upon the expected effective income tax rate for the full year and the tax rate applicable to certain discrete transactions in the interim period.

To determine the annual effective income tax rate, we must estimate both the total income (loss) before income tax for the full year and the jurisdictions in which that income (loss) is subject to tax.

The actual effective income tax rate for the full year may differ from these estimates if income (loss) before income tax is greater than or less than what was estimated or if the allocation of income (loss) to jurisdictions in which it is taxed is different from the estimated allocations.

While the Company had maintained a full valuation allowance, we had been using the discrete effective tax rate method to calculate income taxes for the purposes of quarterly reporting.

Now that the valuation allowance has been reduced, the Company has resumed using the annualized effective tax rate method to calculate income taxes as prescribed under ASC 740 for the three months ended June 30, 2023.

Overview of the nine months ended June 30, 2023

Our sales increased by $11.6 million, or 31%, to $49.3 million for the nine months ended June 30, 2023 as compared to $37.7 million for the nine months ended June 30, 2022.

The increase in sales is the result of an increase of $9.3 million in our TS segment and an increase of approximately $2.3 million in our HPP segment.

Our gross margin percentage remained consistent at 34% of sales for the nine months ended June 30, 2023 compared to 34% for the nine months ended June 30, 2022.

For the nine months ended June 30, 2023 there was operating income of $2.2 million compared to operating loss of $0.4 million for the nine months ended June 30, 2022.

Other income, net decreased $0.8 million for the nine months ended June 30, 2023 to income of $0.1 million compared to income of $0.9 million for the nine months ended June 30, 2022.

An income tax benefit of $1.5 million was recorded for the nine months ended June 30, 2023 compared to an income tax expense of $28 thousand in the same prior year period.

The following table details our results of operations in dollars and as a percentage of sales for the nine months ended June 30, 2023 and 2022:

June 30, 2023

June 30, 2022

(Dollar amounts in thousands)

5 unchanged sentences

Operating income (loss)

Other (expense) income, net

Income (loss) before income taxes

Income tax expense

Net income (loss)

Our sales increased by approximately $7.3 million, or 30%, to $31.6 million for the six months ended March 31, 2023 as compared to $24.4 million for the six months ended March 31, 2022.

The increase in sales is the result of an increase of $5.5 million in our TS segment and an increase of $1.8 million in our HPP segment.

TS segment sales change was as follows for the six months ended March 31, 2023 and 2022:

Other income, net

Income before income taxes

Income tax (benefit) expense

Our sales increased by approximately $11.6 million, or 31%, to $49.3 million for the nine months ended June 30, 2023 as compared to $37.7 million for the nine months ended June 30, 2022.

The increase in sales is the result of an increase of $9.3 million in our TS segment and an increase of approximately $2.3 million in our HPP segment.

TS segment sales change was as follows for the nine months ended June 30, 2023 and 2022:

(Dollar amounts in thousands)

2 unchanged sentences

division of $0.1 million due to one large order with a major customer.

Service sales for the

six months ended March 31, 2023 increased $0.7 million from the prior year period, which is attributable to the U.S.

The changes in service sales included increased managed services sales of $0.6 million, increased third party maintenance sales of $0.5 million, and decreased internal and third party service sales of $0.4 million.

HPP segment sales change was as follows for the six months ended March 31, 2023 and 2022:

Service sales for the nine months ended June 30, 2023 increased $0.5 million from the prior year period, which is attributable to the U.S.

The changes in service sales included increased managed services sales of $0.9 million and increased third party maintenance sales of $0.4 million, partially offset by decreased internal and third party service sales of $0.8 million.

HPP segment sales change was as follows for the nine months ended June 30, 2023 and 2022:

(Dollar amounts in thousands)

The HPP product sales increased by $1.5 million for the six months ended March 31, 2023 as compared to the prior year period, primarily as a result of one large Myricom product order of $1.8 million 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.

This sale was partially offset with $0.3 million of decreased Myricom product revenue to several major customers.

The HPP services sales increased $0.3 million for the six months ended March 31, 2023 compared to the prior year period from increased ARIA revenue of $0.2 million and increased repair revenue of $0.2 million, partially offset with decreased royalties on high-speed processing boards related to the E2D program 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, 2023 and 2022:

The HPP product sales increased by $2.0 million for the nine months ended June 30, 2023 as compared to the prior year period, primarily as a result of one large Myricom product order of $1.8 million 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.

Additionally, increased volume to a major customer of $0.8 million occurred during the nine months ended June 30, 2023, which was offset with a $0.6 million decrease in Myricom product from other customers.

The HPP service sales increased $0.3 million for the nine months ended June 30, 2023 compared to the prior year period from increased ARIA revenue of

$0.3 million and increased repair revenue of $0.1 million, partially offset with decreased royalties on high-speed processing boards related to the E2D program 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 nine months ended June 30, 2023 and 2022:

Increase (decrease)

3 unchanged sentences

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 due to a large volume by one customer in the same prior year period which did not reoccur in the current period combined with a decrease in the HPP segment of $0.1 million.

The sales to Asia increased by $0.2 million due to an increase in the HPP segment.

division of $0.2 million due to a large volume from one customer in the same prior year period which did not reoccur in the current period combined with a decrease in the HPP segment of $0.2 million, partially offset by an increase in the TS UK division of $0.1 million.

The sales to Asia increased by $0.1 million due to an increase in the HPP segment of $0.2 million, partially offset by the TS U.S.

division of $0.1 million.

Gross Margins

Our gross margin ("GM") increased $3.0 million for the six months ended March 31, 2023 as compared to the same prior year period.

The GM as a percentage of total sales increased to 34% for the six months ended March 31, 2023 as compared to the same prior year period of 32%.

Our gross margin ("GM") increased $3.9 million for the nine months ended June 30, 2023 as compared to the same prior year period.

The GM as a percentage of total sales remained relatively flat at 34% for the nine months ended June 30, 2023 as compared to the same prior year period of 34%.

Increase (decrease)

(Dollar amounts in thousands)

The impact of product mix within our TS segment on gross margin for the six months ended March 31, 2023 and 2022 was as follows:

The impact of product mix within our TS segment on gross margin for the nine months ended June 30, 2023 and 2022 was as follows:

Increase (decrease)

(Dollar amounts in thousands)

The overall TS segment GM as a percentage of total sales remained flat at 30% for the six month period ended March 31, 2023 compared to 30% from the prior year period.

Product GM as a percentage of product revenue increased slightly due to the mix of products sold during the six months ended March 31, 2023 compared to the same period of the prior year.

Service GM as a percentage of service revenue increased slightly due to increased revenue without having to add more variable expenses to obtain this revenue during the six months ended March 31, 2023 compared to the same period of the prior year.

The impact of product mix within our HPP segment on gross margin for the six months ended March 31, 2023 and 2022 was as follows:

The overall TS segment GM as a percentage of total sales decreased to 30% for the nine month period ended June 30, 2023 compared to 32% from the prior year period.

This is due to a disproportionate increase in GM from products when compared to services since services GM as a percentage of revenue is significantly higher than products.

However, product and service GM as a percentage of each type of revenue remained relatively flat from the prior year.

The impact of product mix within our HPP segment on gross margin for the nine months ended June 30, 2023 and 2022 was as follows:

Increase (decrease)

(Dollar amounts in thousands)

The overall HPP segment GM as a percentage of sales increased to 67% for the six months ended March 31, 2023 from 52% for the six months ended March 31, 2022.

The 25% increase in product GM as a percentage of product revenue was primarily attributed to the higher margin Myricom products we sold for the six months ended March 31, 2023 compared to the same prior year period.

The overall HPP segment GM as a percentage of sales increased to 66% for the nine months ended June 30, 2023 from 51% for the nine months ended June 30, 2022.

The 28% increase in product GM as a percentage of product revenue was primarily attributed to the higher margin Myricom products we sold for the nine months ended June 30, 2023 compared to the same prior year period.

The Myricom products have a wide range of gross margin percentage.

The 17% decrease in service GM as a percentage of service revenue for the six months ended March 31, 2023 compared to the same prior year period was due to decreased royalty sales, which are nearly all margin along with increased repair revenue that has lower margins than the royalty sales.

The 17% decrease in service GM as a percentage of service revenue for the nine months ended June 30, 2023 compared to the same prior year period was due to decreased royalty sales, which are nearly all margin, partially offset with increased repair GM that has lower margins than the royalty sales.

Engineering and Development Expenses

The engineering and development expenses incurred by our HPP segment increased to $1.7 million for the six months ended March 31, 2023 when compared to the same prior year period of $1.3 million due to higher consulting expenses.

The engineering and development expenses incurred by our HPP segment increased to $2.4 million for the nine months ended June 30, 2023 when compared to the same prior year period of $2.2 million due to higher consulting expenses of $0.4 million, partially offset by decreased labor expenses of $0.2 million.

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 six months ended March 31, 2023 and 2022:

Six months ended March 31,

The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the nine months ended June 30, 2023 and 2022:

Nine months ended June 30,

(Dollar amounts in thousands)

By Operating Segment:

SG&A expenses increased $0.6 million for the six months ended March 31, 2023 compared to the same prior year period.

SG&A expenses increased $1.2 million for the nine months ended June 30, 2023 compared to the same prior year period.

The $1.2 million increase in TS segment SG&A expenses compared to the same prior year period is primarily the result of approximately $0.5 million increased variable compensation, $0.4 million increased salaries and benefits, $0.2 million increased travel expenses, and $0.1 million of decreased provision for losses on accounts receivable.

The HPP segment SG&A expenses decreased $0.2 million for the six months ended March 31, 2023 as compared to the prior year period due to decreased labor and fringe expenses.

The HPP segment SG&A expenses remained relatively flat at approximately $2.7 million for the nine months ended June 30, 2023 as compared to the prior year period with variable compensation increasing by $0.3 million and labor decreasing by $0.3 million.

Other Income/Expenses

The following table details other income (expense) for the six months ended March 31, 2023 and 2022:

Six months ended

March 31, 2023

March 31, 2022

The following table details other income, net for the nine months ended June 30, 2023 and 2022:

Nine months ended

June 30, 2023

June 30, 2022

(Amounts in thousands)

3 unchanged sentences

Other income (expense), net

Total other (expense) income, net

Total other income (expense), net for the six months ended March 31, 2023 decreased $0.3 million to an expense of $0.1 million compared to income of $0.2 million the prior year.

The $0.8 million increased foreign exchange loss for the six months ended March 31, 2023 was due to the U.S.

Dollar and Euro weakening relative to British Pound compared to the same prior year period.

Total other income, net

Total other income (expense), net for the nine months ended June 30, 2023 decreased $0.8 million to income of $0.1 million compared to income of $0.9 million in the same prior year period.

The $1.5 million increased foreign exchange loss for the nine months ended June 30, 2023 was due to the U.S.

Dollar and Euro weakening relative to the British Pound compared to the same prior year period.

In consolidation, U.S.

3 unchanged sentences

Dollar and Euro bank accounts in our TS U.K.

There were three changes that partially offset the foreign exchange loss.

Interest income increased $315 thousand for the six months ended March 31, 2023 compared to the same prior year period primarily due 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) entered into during fiscal year 2022, which were partially offset with lower interest income recognized from prior agreements as interest income decreases as time elapses due to principal payments being received.

Interest income increased $558 thousand for the nine months ended June 30, 2023 compared to the same prior year period primarily due 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) entered into subsequent to the fiscal third quarter of 2022, which were partially offset with lower interest income recognized from prior agreements as interest income decreases as time elapses due to principal payments being received.

All of these agreements are in the TS-US division.

Additionally, interest rates have significantly increased from the same prior year period, which has resulted in increased interest income from money market accounts from both the U.S.

The interest expense decrease of $80 thousand for the six months ended March 31, 2023 compared to the same prior year period was related to the TS U.S.

The interest expense decrease of $78 thousand for the nine months ended June 30, 2023 compared to the same prior year period was related to the TS U.S.

This decrease was partially offset with an increase from one subsequent multi-year vendor agreement in the third quarter of fiscal year 2023.

This is the only new agreement from the third quarter of fiscal year 2022.

See Note 10 in Item 1 to this Quarterly Report on Form 10-Q for details.

There have been no subsequent multi-year vendor agreements from the second quarter of fiscal year 2022.

Other income (expense), net did not have a significant change from the prior year.

An income tax expense of $204 thousand was recorded for the six months ended March 31, 2023 compared to an income tax expense of $17 thousand in the same period in the prior year.

The income tax expense for the for the six months ended March 31, 2023 was primarily driven by minimum state tax expenses and the required capitalization of R&D expenses under IRC Section 174, partially offset by the use of federal NOL and R&D credits.

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

The income tax expense for the six months ended March 31, 2022 was primarily driven by minimum state tax expenses due to the full valuation allowance in place during the period.

An income tax benefit of $1.5 million was recorded for the nine months ended June 30, 2023 compared to an income tax expense of $28 thousand in the same prior year period.

Since that time, the COVID-19 pandemic has ended, the Company’s Technology Solutions business has grown in fiscal years 2022 and 2023, which provided strong financial results including growth in product and software sales, third party maintenance sales, and recurring managed services and cloud software sales.

The backlog continues to be strong as of June 30, 2023.

The actual effective income tax rate for the full year may

differ from these estimates if income (loss) before income tax is greater than or less than what was estimated or if the allocation of income (loss) to jurisdictions in which it is taxed is different from the estimated allocations.

While the Company had maintained a full valuation allowance, we had been using the discrete effective tax rate method to calculate income taxes for the purposes of quarterly reporting.

Liquidity and Capital Resources

Our primary source of liquidity is our cash and cash equivalents, which decreased by $10.7 million to $13.3 million as of March 31, 2023 from $24.0 million as of September 30, 2022.

Our significant sources of cash for the six months ended March 31, 2023 included a decrease in other assets of $2.3 million and a decrease in accounts receivable and long-term receivable of $1.6 million.

Our primary source of liquidity is our cash and cash equivalents, which decreased by approximately $10.2 million to $13.8 million as of June 30, 2023 from $24.0 million as of September 30, 2022.

Our significant sources of cash for the nine months ended June 30, 2023 included a decrease in other assets of $2.6 million and a decrease in refundable income taxes of $0.5 million.

Within Accounts receivable there is $8.2 million due reflecting sales whose payment terms exceed one year.

We will receive payments of $0.6 million and $6.2 million in the third and fourth quarter of fiscal year 2023 from these agreements, respectively.

Our significant uses of cash for the six months ended March 31, 2023 were primarily related to a decrease in accounts payable and accrued expenses and other long-term liabilities of $8.6 million, purchases of held-to-maturity investments of $3.5 million, an increase in inventory of $2.0 million, and a net payment under the line-of-credit agreement of $1.8 million.

Our cash held by our foreign subsidiary in the United Kingdom totaled approximately $4.5 million as of March 31, 2023 and consisted of 0.3 million Euros, 0.2 million British Pounds, and 3.8 million U.S.

We are scheduled to receive payments of $5.9 million in the fourth quarter of fiscal year 2023 from these agreements.

Our significant uses of cash for the nine months ended June 30, 2023 were primarily related to a decrease in accounts payable and accrued expenses and other long-term liabilities of $8.4 million, net purchases of held-to-maturity investments of $2.4 million, net payments under the line-of-credit agreement of $1.8 million, and dividends paid to shareholders of $0.5 million.

Our cash held by our foreign subsidiary in the United Kingdom totaled approximately $4.8 million as of June 30, 2023 and consisted of 0.2 million Euros, 0.2 million British Pounds, and 4.2 million U.S.

This cash is included in our total cash and cash equivalents reported on the Condensed Consolidated Balance Sheets.

Approximately 3.5 million U.S.

Dollars was transferred during the first quarter of fiscal year 2023 from the foreign subsidiary in the U.K.

Dollars was transferred tax-free during the first quarter of fiscal year 2023 from the foreign subsidiary in the U.K.

(TS-UK) to Modcomp, Inc.

(TS-US) to use in operations.

As of March 31, 2023 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.

As of June 30, 2023 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 $13.7 million and $11.9 million were available as of March 31, 2023 and September 30, 2022, respectively.

As of March 31, 2023 and September 30, 2022 there were no cash withdrawals outstanding.

An amount of $13.7 million and $11.9 million were available as of June 30, 2023 and September 30, 2022, respectively.

As of June 30, 2023 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