Forward Looking Statements
This Quarterly Report on Form 10-Q, including, without limitation, the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Such forward-looking statements are generally accompanied by words such as "estimate," "expect," "believe," "should," "would," "could," "anticipate," "may" or other words that convey uncertainty of future events or outcomes. These statements relate to future events or to our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations, which we describe in more detail elsewhere in this Quarterly Report on Form 10-Q, as well as in our 2019 Annual Report on Form 10-K, filedMarch 27, 2020 , in Item 1A "Risk Factors" include, but are not limited to: ? the uncertain ramifications related to the coronavirus outbreak;
? our ability to successfully create, market, sell and distribute our new Shield
product to a new and distinct customer base
? our ability to produce and promote our new commercial product, Intrusion
Shield, and market it through new sales channels to a new set of prospective
customers;
? insufficient cash to operate our business and inability to meet our liquidity
requirements; ? loss of revenues due to the failure of our newer products, Shield in particular, to achieve market acceptance;
? our need to increase current revenue levels in order to achieve sustainable
profitability; ? our unavailability to make future borrowings under the CEO Note;
? our ability to replace all or a portion of the borrowing capacity available to
the Company under the CEO Note and whether any such terms would be available
on terms acceptable to the Company, if at all; ? our ability to raise funds through debt or equity offerings related to launching a commercial product;
? concentration of our revenues from
customers and the possibility of loss of one of these customers and the unique
risks associated with government customers; ? our dependence on sales made through indirect channels; and
? the influence that our management and larger stockholders have over actions
taken by the Company. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. These forward-looking statements and other statements made elsewhere in this report are made in reliance on the Private Securities Litigation Reform Act of 1995. Any forward-looking statement you read in this Quarterly Report on Form 10-Q or our Annual Report on Form 10-K reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. The section below entitled "Factors That May Affect Future Results of Operations" sets forth and incorporates by reference certain factors that could cause actual future results of the Company to differ materially from these statements. 13
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Results of Operations
The following table sets forth, for the periods indicated, certain financial data as a percentage of net revenues. The period-to-period comparison of financial results is not necessarily indicative of future results.
Three Months Ended Six Months Ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 Total revenue 100.0 % 100.0 % 100.0 % 100.0 % Total cost of revenue 39.3 39.6 40.5 39.9 Gross profit 60.7 60.4 59.5 60.1 Operating expenses: Sales and marketing 29.3 1.0 28.8 6.3 Research and development 54.8 7.4 48.1 6.7 General and administrative 19.7 8.0 16.9 9.0 Operating income (loss) (43.1 ) 43.9 (34.3 ) 38.1 Interest income 0.1 - 0.2 - Interest expense (0.2 ) (0.2 ) (0.1 ) (0.6 ) Income (loss) before income tax provision (43.2 ) 43.7 (34.2 ) 37.5 Income tax provision - - - - Net income (loss) (43.2 )% 43.7 % (34.2 )% 37.5 % Preferred stock dividends accrued (2.0 ) (0.8 ) (1.9 ) (0.9 ) Net income (loss) attributable to common stockholders (45.2 )% 42.9 % (36.1 )% 36.6 % Three Months Ended Six Months Ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 Domestic revenues 100.0 % 100.0 % 100.0 % 100.0 % Export revenues - - - - Net revenues 100.0 % 100.0 % 100.0 % 100.0 % Net Revenues. Net revenues for the quarter and six months endedJune 30, 2020 were$1.7 million and$3.5 million , respectively, compared to$4.0 million and$7.2 million for the same periods in 2019. Product revenues decreased$2.3 million for the quarter endedJune 30, 2020 , and$3.7 million for the six months endedJune 30, 2020 compared to the same periods in 2019. Decreased product revenues were primarily due to a decrease in sales of our TraceCop product line. TraceCop sales for the quarters endedJune 30, 2020 and 2019 were$1.6 million and$4.0 million , respectively. Savant sales were$106 thousand for the quarter endedJune 30, 2020 and were$29 thousand for the quarter endedJune 30, 2019 . Concentration of Revenues. Revenues from sales to variousU.S. government entities totaled$1.5 million , or 91.0% of revenues, for the quarter endedJune 30, 2020 compared to$3.9 million , or 91.3% of revenues, for the same period in 2019. Revenues from sales to variousU.S. government entities totaled$2.8 million , or 80.8% of revenues, for the six months endedJune 30, 2020 compared to$6.4 million , or 89.2% of revenues, for the same period in 2019. Sales to commercial customers totaled 9.0% of total revenue for the second quarter of 2020 compared to 8.7% of total revenue for the second quarter of 2019. During the second quarter of 2020 and 2019, no individual commercial customer had revenues over 10.0% of total revenue. Although we expect our concentration of revenues to vary among customers in future periods depending upon the timing of certain sales, we anticipate that sales to government customers will continue to account for a significant portion of our revenues in future periods. Sales to the government present risks in addition to those involved in sales to commercial customers which could adversely affect our revenues, including, without limitation, potential disruption to appropriation and spending patterns and the government's reservation of the right to cancel contracts and purchase orders for its convenience. Although we do not anticipate that any of our revenues with government customers will be renegotiated, a large number of cancelled or renegotiated government orders could have a material adverse effect on our financial results. Currently, we are not aware of any proposed cancellation or renegotiation of any of our existing arrangements with government entities and, historically, government entities have not cancelled or renegotiated orders which had a material adverse effect on our business. 14 -------------------------------------------------------------------------------- Gross Profit. Gross profit was$1.0 million or 60.7% of net revenues for the quarter endedJune 30, 2020 , compared to$2.4 million or 60.4% of net revenues for the quarter endedJune 30, 2019 . Gross profit was$2.1 million or 59.5% of net revenues for the six months endedJune 30, 2020 compared to$4.3 million or 60.1% of net revenues for the six months endedJune 30, 2019 . Gross profit on product revenues trended from 59.5% of net revenues for the six months endedJune 30, 2020 to 60.1% of net revenues for the six months endedJune 30, 2019 , mainly due to TraceCop/Savant product mix. Gross profit as a percentage of net revenues is impacted by several factors, including shifts in product mix, changes in channels of distribution, revenue volume, pricing strategies, and fluctuations in revenues of integrated third-party products. Sales and Marketing. Sales and marketing expenses increased to$0.5 million for the quarter endedJune 30, 2020 compared to$46 thousand for the same period in 2019. Sales and marketing expenses increased to$1.0 million for the six months endedJune 30, 2020 compared to$0.5 million for the same period in 2019. Sales and marketing expenses may vary in the future. Sales and marketing expenses increased compared to the comparable periods last year due to increases in labor and expenses and the Company was able to collect payment of$200 thousand from a customer related expense in 2018 that reduced expense in 2019. We believe that these costs will increase through the end of 2020 due to increased marketing expense related to the Shield launch. Research and Development. Research and development expenses increased to$0.9 million for the quarter endedJune 30, 2020 compared to$0.3 million for the same period in 2019. Research and development expenses increased to$1.7 million for the six months endedJune 30, 2020 compared to$0.5 million for the same period in 2019. The increase in research and development expense was due partly to increased costs related to the development of our Intrusion Shield product as well as an increase in labor expense due to less direct labor required on existing projects. Research and development costs are expensed in the period in which they are incurred. Research and development expenses may vary in the future; mainly dependent on levels of research and development labor expense charged to projects. General and Administrative. General and administrative expenses remained constant at$0.3 million for the quarters endedJune 30, 2020 and 2019. General and administrative expenses decreased to$0.6 million for the six months endedJune 30, 2020 compared to$0.7 million for the same period in 2019. It is expected that general and administrative expenses will remain relatively constant throughout the remainder of 2020, although expenses may be increased due to increased expenses related to a new product launch. Interest. Interest expense decreased to$2 thousand for the quarter endedJune 30, 2020 compared to$9 thousand for the same period in 2019. Interest expense decreased to$2 thousand for the six months endedJune 30, 2020 compared to$44 thousand for the same period in 2019. Interest expense decreased due to decreased amount of Loan Payable to Officer culminating in our repayment of the balance inMay 2019 . Interest expense will vary in the future based on our cash flow and borrowing needs. Interest income increased to$1 thousand for the quarter endedJune 30, 2020 compared to none for the same period in 2019. Interest income increased to$7 thousand for the six months endedJune 30, 2020 compared to none for the same period in 2019. This is attributable to investing extra cash in money market accounts and getting better interest rates.
Liquidity and Capital Resources
Our principal source of liquidity at
Net cash used in operations for the six months endedJune 30, 2020 was$1.0 million due primarily to a net loss of$1.2 million and the following uses of cash: a$352 thousand decrease in deferred revenue, a$234 thousand increase in prepaid expenses and other assets, and a$64 thousand decrease in accounts payable and accrued expenses. This was partially offset by the following provisions of cash and non-cash items: a$499 thousand decrease in accounts receivable,$124 thousand in noncash lease costs,$107 thousand in depreciation and amortization expense, and$74 thousand in stock-based compensation. Net cash provided by operations for the six months endedJune 30, 2019 was$2.3 million due primarily to a net income of$2.7 million and the following provisions of cash and non-cash items:$304 thousand in noncash lease costs, a$179 thousand increase in deferred revenue,$86 thousand in depreciation and amortization expense,$14 thousand in stock-based compensation, and$6 thousand in penalties and waived penalties on dividends. This was partially offset by a$738 thousand increase in accounts receivable, a$234 thousand increase in prepaid expenses and other assets, and a$66 thousand decrease in accounts payable and accrued expenses. Future fluctuations in accounts receivable and accounts payable will be dependent upon several factors, including, but not limited to, quarterly sales volumes and timing of invoicing, and the accuracy of our forecasts of product demand and component requirements. Net cash used in investing activities for the six months endedJune 30, 2020 , was$62 thousand for net purchases of property and equipment, compared to$168 thousand net cash used in investing activities for the six months endedJune 30, 2019 for net purchases of property and equipment. 15 -------------------------------------------------------------------------------- Net cash provided by financing activities in 2020 was$0.6 million generated primarily by proceeds from a PPP loan of$0.6 million and proceeds from exercise of stock options of$85 thousand . This was directly offset by the following uses of cash: payments for preferred stock dividends of$67 thousand , and payment on principal of finance right-of-use leases of$21 thousand . Net cash used in financing activities in 2019 was$2.3 million with payments on the loan from an officer of$1.8 million , payments for preferred stock dividends of$644 thousand , and payment on principal of finance right-of-use leases of$31 thousand . This was directly offset by the following provisions of cash: proceeds from exercise of stock options of$226 thousand .
At
During the six months endedJune 30, 2020 , the Company funded its operations through the use of cash and cash equivalents. As ofJune 30, 2020 , we had cash and cash equivalents of approximately$2,872,000 , down from approximately$3,334,000 as ofDecember 31, 2019 . We had a net loss of$715,000 for the quarter endedJune 30, 2020 compared to a net income of$1,758,000 for the quarter endedJune 30, 2019 . Based on projections of growth in revenue in the coming quarters, we believe that we will have sufficient cash resources to finance our operations and expected capital expenditures for the next twelve months. As ofOctober 24, 2019 , our funding available from the CEO Note terminated. Our management will be assessing whether to replace this borrowing capacity and assessing what terms may be available to the Company, including whether any such terms are available on terms acceptable to the Company, if at all (the "Potential Replacement Funding Facility"). We expect to fund our operations through anticipated Company profits, the Potential Replacement Funding Facility, and possible additional investments of equity and debt. Any equity or debt options, if available at all, may be on terms which are not favorable to us and, in the case of any potential equity financings, may result in dilution to our stockholders. If our operations do not generate positive cash flow in the future, or if we are not able to obtain additional debt or equity financing on terms and conditions acceptable to us, if at all, we may be unable to implement our business plan, fund our liquidity needs or even continue our operations.
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