Item 2. Management's Discussions and Analysis of Financial Condition and Results of Operations.
Forward-looking Statements
Statements made in this Quarterly Report which are not purely historical are forward-looking statements with respect to the goals, plan objectives, intentions, expectations, financial condition, results of operations, future performance and our business, including, without limitation, (i) our ability to raise capital, and (ii) statements preceded by, followed by or that include the words "may," "would," "could," "should," "expects," "projects," "anticipates," "believes," "estimates," "plans," "intends," "targets" or similar expressions.
Forward-looking statements involve inherent risks and uncertainties, and important factors (many of which are beyond our control) that could cause actual results to differ materially from those set forth in the forward-looking statements, including the following, general economic or industry conditions, nationally and/or in the communities in which we may conduct business, changes in the interest rate environment, legislation or regulatory requirements, conditions of the securities markets, our ability to raise capital, changes in accounting principles, policies or guidelines, financial or political instability, acts of war or terrorism, other economic, competitive, governmental, regulatory and technical factors affecting our current or potential business and related matters.
Accordingly, results actually achieved may differ materially from expected results in these statements. Forward-looking statements speak only as of the date they are made. We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect events or circumstances occurring after the date of such statements.
Business Operations
Meganet is focused on the development of data security solutions for enterprise, large organizations and corporations around the globe, including the U.S. Department of Defense, Military Intelligence and the Federal Government. The Company has developed and does develop products that it believes are attractive and important to these markets.
Working with government in a business capacity can be a long and arduous process. Governments and their agencies have constant budget restraints and lengthy product procurement processes. In many if not in most cases, a bidding process is required before an order for goods can be placed with a private supplier. Before products can be sold to the U.S. Government or to any of its agencies, the product and/or its supplier must be certified by the U.S. Government, which certification is not easy to obtain. From the time a product is developed until the time it is actually shipped to an agency in return for payment can be months if not years.
The financial statements that form part of this annual report have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Our independent accountants that audited the financial statements observed that the Company requires capital for its contemplated operational and marketing activities and that the Company's ability to raise additional capital through the future issuances of common stock is unknown and that the obtainment of additional financing, the successful development of the Company's contemplated plan of operations, and its transition to the attainment of profitable operations are necessary for the Company to continue operations. The independent accountants concluded that the ability to successfully resolve these factors raise substantial doubt about the Company's ability to continue as a going concern.
Our management has been with Meganet from its inception and has in the past shepherded all software products from the development stage through the government procurement process to final delivery and payment. Management believes that despite the Company's current illiquid position, the Company is in a position to receive significant income in the upcoming 18 to 24 months from the sale of products in the so-called product pipeline. Being in the pipeline does not mean that product has necessarily been bought, sold or ordered. It does mean that products are somewhere in the bidding and/or procurement process and in management's opinion have a reasonable chance of becoming orders, having a portion of those orders delivered and thereby producing collected revenues for the Company in material amounts within the next 18 to 24 months. Management reasonably expects 50% of the potential product sales in its pipeline to produce revenue.
Liquidity
At September 30, 2016, the Company had cash in the amount of $1,575 compared to $2,043,548 in current liabilities. On a monthly basis the Company has fixed expenditures including without limitation rent and salary in the approximate amount of $20,000. This $20,000 includes the $10,000 monthly salary of our CEO which he does not take but rather accrues if money is not available for payment of the salary. Taking this into consideration, the Company needs $10,000 per month which equals $120,000 for 12 months to sustain operations and estimates it will need $180,000 in additional capital to sustain business operations over the next twelve months. Our CEO will lend the full $180,000 to Meganet, if cash is not otherwise available within the Company. Two thirds or 67% of this amount will pay rent, approximately 13% will pay property taxes, approximately 5% will pay utilities, 10% will pay salary and the remaining 5% will pay for maintenance and miscellaneous office expenses such as mail and shipping expense and office supplies. During the six months ended September 30, 2016, our CEO advanced to the Company $31,342 and was repaid $9,904 to meet the financial needs of the Company.
It is common for companies to resolve illiquid positions by attempting to raise additional working capital through the sale of equity capital or short term borrowing from third parties. However, our management does not believe this will be necessary. Rather management believes there will be sales sufficient to cover the next 18 to 24 months of cash operating expenses; however, there can be no surety that anticipated sales will materialize. Also, in the event that sales anticipated during the next 18 to 24 months are funded in the later end of the 18 to 24 month period, it will be necessary for the Company to procure additional operating capital during the early months of the next 18 to 24 month period. In order to provide for this potential situation, our CEO has agreed to contribute additional amounts to capital as needed to cover operating expenses.
Background to Understanding the Financial Results for the Past Three Years
To understand Meganet's financial results for the past three years, it is necessary to understand its sales cycle which is different from traditional companies that may have sales on a daily, weekly and/or monthly basis. Meganet's sales cycle is highly sporadic as a result of its product lines and its customer mix.
Product Lines
Meganet is a technology company supplying world markets with products primarily instrumental in military defense, personal protection, data protection, home land security and other intelligence and counter-intelligence uses. Examples of products for these uses are bomb jammers and cell phone interceptors.
This product base lends itself to sporadic sales cycles for the following reasons. In times of war which can come upon a country quickly, a country will have immediate need of products for military defense uses such as bomb jammers. In times of peace, bomb jammers may not be needed for many years. To the contrary, as a country develops and implements a long term homeland security strategy, it may put out bids for certain types of intelligence and counter-intelligence products that it may leave out to bid for one to two years. To participate in such a bidding process, Meganet must maintain protectable state of the art technologies over a lengthy bidding process that it can deliver in quick fashion in the event it is awarded the bid for a particular product.
Customer Mix
Meganet's focus is on government and military markets which has advantages and disadvantages. Advantages include the fact that governments have deep pockets and when they really need a product they can procure it and pay for it. Also, when a company such as Meganet has a technology that a government really needs, the product can sustain a large margin in the sales price. In addition, technology is often scalable. Once developed, products based upon a technology can bring close to a 100% return.
Disadvantages in selling to governments and militaries include the fact that there is fierce competition for these lucrative markets and large suppliers are notorious for using underhanded methods. Also, governments are subject to budgetary issues and budgetary crises and ever changing priorities for fixed budgeted funds. Governments have bidding requirements. This can be good and bad. Bidding does allow for companies such as Meganet to bid against the large suppliers. However, it makes for lengthy and unwieldy sales cycles that make it difficult to predict and sustain cash flow.
Examples Illustrative of Meganet's Sales Cycle
A good way to understand Meganet's sales cycle is to see examples of past sales. Meganet obtained its product base and its business plan from a company called Meganet Corporation, a California corporation ("Meganet California"). In 2002, Meganet California made a sale to the U.S. Department of Labor. After soliciting the U.S. Department of Labor for over a year, Meganet California received a software order for $4,200,000. Development costs of the software had been expensed as they were incurred and since it was software it had no production cost. Therefore the sale was virtually 100% profit to the company at the time it was realized. However, in the 12 months leading to this sale, total sales were only $100,000.
Another example is Meganet California's sale to the U.S. Department of Transportation (the "DOT") in 2005. After pursuing a sale for only three months which would typically be just the beginning of a solicitation cycle, an internal security breach at the DOT heightened security concerns and it issued Meganet California a $10,000,000 contract immediately. In the 12 months prior to the sale, Meganet California had sales of under $1,000,000 dollars total.
A third example is a sale to the U.S. Department of Veteran Affairs (the "DVA") in 2007. Meganet California had been soliciting the DVA's business for three years trying to sell a biometric USB storage device without success. One day without prior notice, Meganet California was selected as the sole source provider of biometric USB storage devices nationwide to over 5,000 facilities. Like before, sales for the prior 12 months had been under $1,000,000.
For the past two years, Meganet has been working hard toward securing some large sales which it believes will materialize in the near future. However, the financial statements included in this annual report show sales minimal sales. However, this pattern of sporadic sales is typical for this Company.
Our sporadic sales cycle is not the only reason for the lack of sales in the prior two years. The global economic crisis has made many of our customers put purchases on hold. The U.S. government in particular has had many departments put projects on hold, cancel some existing projects and in many cases simply run out of budget for new products. Also in the private sector, the economic downturn has made the purchase of products like ours not a possibility at this time.
Meganet is a company that goes from one large sale to the next with low or quite periods in between.
Results of Operations
For the Three Months Ended September 30, 2016 Compared to the Three Months Ended September 30, 2015
Revenues for the three months ended September 30, 2016 and 2015 were $0 and $1,051, respectively, and we incurred no costs of revenues for either period. Operating expenses for the three months ended September 30, 2016 and 2015 were $78,611 and $111,064, respectively, and yielded a net loss from operations of $78,611 and $111,013 respectively. For the three months ended September 30, 2016, operating expenses consisted of general and administrative expenses of $15,039, depreciation expense was $3,572 and compensation and rent expense were both $30,000. During the three months ended September 30, 2015, operating expenses consisted of general and administrative expenses of $39,887, depreciation expense was $11,072, compensation expense was $30,105 and rent expense was $30,000. The $32,453 decrease in operating expenses is mainly due to a $24,848 reduction in general and administrative expenses as a result of decreased legal and audit fees, as well as a $7,500 decrease in depreciation expense during the three months ended September 30, 2016 compared to the same period in the prior year.
Other expenses for the three months ended September 30, 2016 and 2015 were $19,446 and $11,688, respectively. Other income and expenses consisted of Bitcoin mining income of $0 and $5,482, respectively, offset by Bitcoin mining expense of $0 and $608, respectively. Interest expense was $19,446 and $16,562 for the three months ended September 30, 2016 and 2015, respectively.
Net loss was $98,057 and $121,701 for the three months ended September 30, 2016 and 2015, respectively.
For the Six Months Ended September 30, 2016 Compared to the Six Months Ended September 30, 2015
Revenues for the six months ended September 30, 2016 and 2015 were $120 and $82,134, respectively, and we incurred no costs of revenues for either period. Operating expenses for the six months ended September 30, 2016 and 2015 were $151,444 and $209,209, respectively, and yielded a net loss from operations of $151,324 and $127,075, respectively. For the six months ended September 30, 2016, operating expenses consisted of general and administrative expenses of $23,656, depreciation expense was $7,776, compensation expense was $60,012 and rent expense was $60,000. During the six months ended September 30, 2015, operating expenses consisted of general and administrative expenses of $58,895, depreciation expense was $21,970, compensation expense was $68,213 and rent expense was $60,131. The $82,014 decrease in revenue is mainly the result of one sale for $80,000 during the six months ended September 30, 2015. The $57,765 decrease in operating expenses is mainly due to a $35,239 reduction in general and administrative expenses as a result of decreased legal and audit fees, as well as a $14,194 decrease in depreciation expense and $8,201 decrease in compensation expense during the three months ended September 30, 2016 compared to the same period in the prior year.
Other expenses for the six months ended September 30, 2016 and 2015 were $38,451 and $25,142, respectively. Other income and expenses consisted of Bitcoin mining income of $0 and $7,867, respectively, offset by Bitcoin mining expense of $0 and $608, respectively. Interest expense was $38,451 and $32,401 for the six months ended September 30, 2016 and 2015, respectively.
Net loss was $189,775 and $152,217 for the six months ended September 30, 2016 and 2015, respectively.
Liquidity
Current assets at September 30, 2016 totaled $1,575 in cash, as compared to $1,627 in cash at March 31, 2016.
During the six months ended September 30, 2016, our operating activities used net cash of $21,490, compared to $83,668 in the comparable 2015 period. Investing activities used cash of $3,975 for the purchase of fixed assets during the period ended September 30, 2015, there were no such purchases in 2016. Financing activities provided $21,438 in cash during the six months ended September 30, 2016 from officer advances, compared to $88,735 in the comparable 2015 period.
At September 30, 2016, the Company had a working capital deficit of $2,041,973, as compared to $1,898,425 at March 31, 2016.
Contractual Obligations
The Company has no long-term debt obligations, capital lease obligations, purchase obligations or other long-term liabilities. The Company incurs rent of $10,000 per month for its office and shop space on a month to month basis.
Off-balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
No Undisclosed Material Trends or Events
There are no trends, events or developments that occurred during the fiscal quarter ended September 30, 2016, or from September 30, 2016 through the date of this quarterly report that would indicate or would be a material departure from the financial information set forth in this quarterly report. Furthermore, there are no other undisclosed events or events likely to occur, of which management is aware, that would materially affect the business and/or financial information set forth in this quarterly report.