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, 2024. 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, intense competition in the market segments in which we operate, changes in the U.S. Tax laws, the impact of the Ukrainian-Russian military and Israeli-Hamas conflict on global trade and financial markets, and the impact of pandemics 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, 2024.
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 ongoing basis, we evaluate our estimates, including those related to the allowance for credit losses for accounts receivable and financing 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, 2024 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 three months ended December 31, 2024 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, 2024.
Recent trends affecting our financial performance
As of December 31, 2024, the Russian/Ukrainian military conflict and the Israeli-Hamas conflict have not had a direct significant impact on revenue as we do not have any significant recurring customers in either region. However, we do have customers and suppliers in surrounding regions which may be affected and further escalation of both conflicts and geopolitical tensions related to such conflicts could adversely affect our business, financial condition and results of operations, by among other things, cyberattacks, 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 conflicts on the Company and our customers or suppliers.
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Results of Operations.
Overview of the three months ended December 31, 2024
Our sales increased by $0.3 million, or 2%, to $15.7 million for the three months ended December 31, 2024 as compared to $15.4 million for the three months ended December 31, 2023. The increase in sales is the result of an increase of $0.6 million in our TS segment, partially offset with a $0.3 million decrease in our HPP segment. Our gross margin percentage as a percentage of sales increased to 29% for the three months ended December 31, 2024 as compared to 27% for the three months ended December 31, 2023. For the three months ended December 31, 2024 there was an operating loss of $(0.4) million compared to an operating loss of $(0.3) million for the three months ended December 31, 2023. Other income, net was $0.7 million for the three months ended to December 31, 2024 as compared to $0.3 million for the three months ended December 31, 2023. An income tax benefit of $(115) thousand was recorded for the three months ended December 31, 2024 compared to an income tax expense of $13 thousand in the same period of fiscal year 2024. Net income for the three months ended December 31, 2024 was $472 thousand as compared to a net loss of $(73) thousands for the same prior year period.
The following table details our results of operations in dollars and as a percentage of sales for the three months ended December 31, 2024 and 2023:
%
%
December 31, 2024
of sales
December 31, 2023
of sales
(Dollar amounts in thousands)
Sales
$
15,670
100
%
$
15,375
100
%
Costs and expenses:
Cost of sales
11,106
71
%
11,280
73
%
Engineering and development
786
5
%
700
5
%
Selling, general and administrative
4,132
26
%
3,738
24
%
Total costs and expenses
16,024
102
%
15,718
102
%
Operating loss
(354)
(2)
%
(343)
(2)
%
Other income, net
711
4
%
283
2
%
Income (loss) before income taxes
357
2
%
(60)
—
%
Income tax (benefit) expense
(115)
(1)
%
13
—
%
Net income (loss)
$
472
3
%
$
(73)
—
%
Sales
Our sales increased by approximately $0.3 million to $15.7 million for the three months ended December 31, 2024 as compared to $15.4 million for the same prior year period.
TS segment sales change was as follows for the three months ended December 31, 2024 and 2023:
December 31,
Increase (decrease)
2024
2023
$
%
(Dollar amounts in thousands)
Products
$
10,933
$
10,935
$
(2)
—
%
Services
4,307
3,728
579
16
%
Total
$
15,240
$
14,663
$
577
4
%
TS segment product sales remained flat for the three months ended December 31, 2024 when compared to the same period in prior year. The U.S. division product sales increased by $0.2 million, but was offset with the U.K. division decreased sales of $0.2 million. Service sales for the three months ended December 31, 2024 increased $0.6 million from the prior year period, which is attributable to the U.S. division. The increase in service sales was due to increased third party maintenance sales of $0.6 million.
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HPP segment sales change was as follows for the three months ended December 31, 2024 and 2023:
December 31,
Increase (decrease)
2024
2023
$
%
(Dollar amounts in thousands)
Products
$
82
$
472
$
(390)
(83)
%
Services
348
240
108
45
%
Total
$
430
$
712
$
(282)
(40)
%
The HPP product sales decreased by $0.4 million for the three months ended December 31, 2024 as compared to the same prior year period primarily as a result of a $0.5 million decrease in Myricom product sales, partially offset with increased ARIA Zero Trust Protect (AZT PROTECT TM ) sales of $0.1 million. The AZT PROTECT TM software license is recognized at a point in time and recorded in product revenue. The software license is the large majority of the revenue in an AZT PROTECT TM sale with the other portion of revenue coming from the post-contract customer support, which is recorded over time in the services revenue financial statement line item. The HPP services sales increased $0.1 million for the three months ended December 31, 2024 compared to the prior year period as a result of increased ARIA sales, which includes our ARIA ADR cybersecurity solution and post-contract customer support (PCS) for our AZT PROTECT TM software. These items are both recognized ratably over the contract term.
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, 2024 and 2023:
December 31,
Increase (decrease)
2024
%
2023
%
$
%
(Dollar amounts in thousands)
Americas
$
15,484
99
%
$
14,552
95
%
$
932
6
%
Europe
181
1
%
451
3
%
(270)
(60)
%
Asia-Pacific
5
—
%
372
2
%
(367)
(99)
%
Totals
$
15,670
100
%
$
15,375
100
%
$
295
2
%
The $0.9 million increase in sales to the Americas was primarily the result of an increase in the TS segment’s U.S. division of $1.2 million, partially offset with a decrease in the HPP segment of $0.3 million. The $0.3 million decrease in sales to Europe was primarily the result of decreased sales by our TS segment’s U.K. division. The sales to Asia-Pacific decreased $0.4 million due to a decrease of sales in the TS segment’s U.S. division.
Gross Margins
Our gross margin ("GM") increased $0.5 million for the three months ended December 31, 2024 as compared to the same prior year period. The GM as a percentage of sales increased to 29% for the three months ended December 31, 2024 as compared to the same prior year period of 27%.
December 31,
2024
2023
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
TS
$
4,349
29
%
$
3,757
26
%
$
592
3
%
HPP
215
50
%
338
47
%
(123)
3
%
Total
$
4,564
29
%
$
4,095
27
%
$
469
2
%
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The impact of product mix within our TS segment on gross margin for the three months ended December 31, 2024 and 2023 was as follows:
December 31,
2024
2023
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
1,836
17
%
$
1,897
17
%
$
(61)
—
%
Services
2,513
58
%
1,860
50
%
653
8
%
Total
$
4,349
29
%
$
3,757
26
%
$
592
3
%
The overall TS segment GM as a percentage of sales increased to 29% for the three month period ended December 31, 2024 compared to the prior year period of 26%. Product GM as a percentage of product sales remained flat at 17% for the three months ended December 31, 2024 compared to the prior year period. There were not any significant changes in GM for any individual products sold. Service GM as a percentage of service sales increased to 58% for the three months ended December 31, 2024 compared to the prior year period of 50% due to increased third party maintenance sales in which the sale is recorded “net” meaning gross profit is recorded in the services sales financial statement line item. This “net” recording increases GM as a percentage of sales.
The impact of product mix within our HPP segment on gross margin for the three months ended December 31, 2024 and 2023 was as follows:
December 31,
2024
2023
Increase (decrease)
GM$
GM%
GM$
GM%
GM$
GM%
(Dollar amounts in thousands)
Products
$
60
73
%
$
282
60
%
$
(222)
13
%
Services
155
45
%
56
23
%
99
22
%
Total
$
215
50
%
$
338
47
%
$
(123)
3
%
The overall HPP segment GM as a percentage of sales increased to 50% for the three months ended December 31, 2024 from 47% for the three months ended December 31, 2023. The 13% increase in product GM as a percentage of product revenue for the three months ended December 31, 2024 compared to the same prior year period is primarily due to recognition of the software license of AZT PROTECT TM , which is nearly all profit. The 22% increase in service GM as a percentage of services revenue from the prior year was due to increased ARIA ADR revenue and PCS for AZT PROTECT TM , which have fixed costs meaning more revenue will result in increased GM as a percentage of sales.
Engineering and Development Expenses
The engineering and development expenses incurred by our HPP segment increased $0.1 million for the three months ended December 31, 2024 to $0.8 million when compared to the prior year period due to increased consulting and stock compensation expense. The current period expenses were primarily for 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 three months ended December 31, 2024 and 2023:
Three months ended December 31,
% of
% of
$
%
2024
Total
2023
Total
Increase
Increase
(Dollar amounts in thousands)
By Operating Segment:
TS segment
$
3,030
73
%
$
2,755
74
%
$
275
10
%
HPP segment
1,102
27
%
983
26
%
119
12
%
Total
$
4,132
100
%
$
3,738
100
%
$
394
11
%
SG&A expenses of $4.1 million for the three months ended December 31, 2024 increased $0.4 million as compared to the prior year period. The TS segment G&A expenses increased by $0.3 million primarily due to increased commissions as a result of higher gross margin and stock compensation expense when compared to the prior year period. The HPP segment SG&A expenses increased $0.1 million for the three months ended December 31, 2024 as compared to the prior year period primarily due to trade show attendance and related time and travel as well as increased stock compensation expense.
Other Income/Expenses
The following table details Total other income (expense), net for the three months ended December 31, 2024 and 2023:
Three months ended
December 31, 2024
December 31, 2023
$ Change
(Amounts in thousands)
Foreign exchange gain (loss)
$
295
$
(174)
$
469
Interest expense
(77)
(49)
(28)
Interest income
489
496
(7)
Other income, net
4
10
(6)
Total other income, net
$
711
$
283
$
428
The $0.4 million increase in Total other income, net for the three months ended December 31, 2024 as compared to the same prior year period is primarily due to a net increase in Foreign exchange gain.
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 (loss) on the income statement and the foreign exchange gain is primarily from the U.S. Dollar bank account. The US dollar strengthened relative to the British Pound for the three months ended December 31, 2024 causing a foreign exchange gain.
The interest income decrease of $7 thousand for the three months ended December 31, 2024 as compared to the prior year period is primarily due to higher interest income of $59 thousand from our Cash and cash equivalents from an increased average cash balance when compared to the prior year despite a decrease in interest rates, partially offset with a decrease of $52 thousand from interest income with financing sales in our TS U.S. division.
The Interest expense decrease of $28 thousand for the three months ended December 31, 2024 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 8 Accounts payable and accrued expenses, and Other noncurrent liabilities in Item 1 to this Quarterly Report on Form 10-Q for details.
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Income Taxes
An income tax benefit of $115 thousand was recorded for the three months ended December 31, 2024 compared to an income tax expense of $13 thousand in the same period of 2023. The difference between our effective income tax rate and the U.S. federal statutory rate are the impact of tax credits that we expect to be able to utilize against federal and state taxes and the change in valuation allowance maintained against certain state tax credits.
The income tax expense for the three months ended December 31, 2023 was primary driven by income earned in the United States.
Liquidity and Capital Resources
Our primary source of liquidity is our cash and cash equivalents and our line of credit.
Cash and cash equivalents increased by $0.1 million to $30.7 million as of December 31, 2024 from $30.6 million as of September 30, 2024.
The following is a summary of our cash flows for the three months ended December 31, 2024 and 2023:
Three months ended December 31,
(Dollar amounts in thousands)
2024
2023
(Dollar amounts in thousands)
Net cash provided by (used in):
Operating activities
$
1,741
$
1,673
Investing activities
(47)
(126)
Financing activities
(1,587)
(1,182)
Effect of exchange rate changes on cash
(38)
29
Increase in cash and cash equivalents
$
69
$
394
Operating Activities
Cash provided by operating activities remained flat at $1.7 million for the three months ended December 31, 2024 and 2023. The changes from the prior year are primarily related to increased collections from Financing receivables of $0.8 million, decreased Inventory of $4.8 million, partially offset with decreased Accounts payable and accrued expenses of $4.3 million, and a decrease in pension liabilities of $0.7 million. Accounts payable and accrued expenses fluctuations are dependent on when vendor invoices are received as well as the related timing of the payments. The remaining differences are primarily related to timing differences in operating assets and liabilities.
Investing Activities
Cash used in investing activities was $47 thousand for the three months ended December 31, 2024 compared to $126 thousand used in investing activities for the prior year. The decrease in cash used from the prior year is primarily related to a decrease in purchases of property, equipment, and improvements.
Financing Activities
Cash used in financing activities was $1.6 million for the three months ended December 31, 2024 compared to $1.2 million for the prior year. The primary difference was the timing in the net borrowing on the line-of-credit, which for the three months ended December 31, 2024 we had a net payment of $1.6 million compared to a net payment of $0.8 million in the prior year. There was also a repayment of a note of $0.4 million in the prior year, which was the final payment.
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Other Liquidity and Capital Resources Items
After foreign currency remeasurement and translation, our cash held by our foreign subsidiary in the United Kingdom totaled approximately $4.5 million as of December 31, 2024, which consisted of 0.2 million Euros, 0.3 million British Pounds, and 4.1 million U.S. Dollars. This cash is included in our total Cash and cash equivalents reported within our financial statements. Due to the pension obligation in the U.K., we maintain a large balance of cash in the U.K. However, we have entered a buy-in agreement for the U.K. pension.
As of December 31, 2024 and September 30, 2024, 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 the availability of a limited cash withdrawal of up to $1.0 million. Amounts of $12.4 million and $10.8 million were available as of December 31, 2024 and September 30, 2024, respectively. As of December 31, 2024 and September 30, 2024 there were no cash withdrawals outstanding. For further discussion of the Company’s line of credit, including its financial covenants, see Item 1, Note 9 Line of Credit.
We have multi-year agreements in which we sell certain customers goods and services with financing. This is on the Consolidated Balance Sheets as Financing receivables, net of allowances and Financing receivables due after one year, net of allowances. In the remainer of fiscal year 2025 we are scheduled to receive $2.4 million related to the financing receivables.
We also have multi-year agreements with vendors related to some of the financing agreements we have for customers, which are on the Consolidated Balance Sheets in Accounts payable and accrued expenses and Other noncurrent liabilities payables (long-term portion in other noncurrent liabilities). In the remainder of fiscal year 2025 we are scheduled to pay $2.6 million related to the payables. This number is higher than the amount to be received because the majority of vendor financing agreements include favorable negotiated terms in which the vendor payment terms extended beyond the customer receiable terms.
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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