Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the condensed consolidated financial statements, including the related notes, appearing in Item 1 of Part 1 of this quarterly report on Form 10-Q, as well as our most recent annual report on Form 10-K for the year ended December 31, 2019.
This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) with respect to the financial condition, results of operations and business of the Company. Forward-looking statements usually are denoted by words or phrases such as “believes,” “expects,” “projects,” “estimates,” “anticipates,” “will likely result” or similar expressions. We wish to caution readers that all forward-looking statements are necessarily speculative and not to place undue reliance on forward-looking statements, which speak only as of the date made, and to advise readers that actual results could vary due to a variety of risks and uncertainties, including the risks described in our Annual Report on Form 10-K for the year ended December 31, 2019 and other reports we file with the Securities and Exchange Commission. Except as required by law, we undertake no obligation to update forward-looking statements.
References to “Taitron,” the “Company,” “we,” “our” and “us” refer to Taitron Components Incorporated and its wholly owned and majority-owned subsidiaries, unless the context otherwise requires.
Critical Accounting Policies and Estimates
Use of Estimates - Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States. These estimates have a significant impact on our valuation and reserve accounts relating to the allowance for sales returns, doubtful accounts, inventory reserves and deferred income taxes. Actual results could differ from these estimates.
Revenue Recognition – Revenue is recognized upon shipment of the products, which is when legal transfer of title occurs and control of the product is transferred to the customer. Reserves for sales allowances and customer returns are established based upon historical experience and our estimates of future returns. Sales returns for both the three months ended September 30, 2020 and 2019 were $0 and for the nine months ended September 30, 2020 and 2019 were $5,000 and $4,000, respectively. The allowance for sales returns and doubtful accounts at September 30, 2020 and December 31, 2019 aggregated $7,000 and $19,000, respectively.
Inventory – Inventory, consisting principally of products held for resale, is recorded at the lower of cost (determined using the first in-first out method) and net realizable value. We had inventory balances in the amount of $3,384,000 and $3,588,000 at September 30, 2020 and December 31, 2019, respectively, which is presented net of valuation allowances of $6,144,000 and $5,893,000, respectively. We evaluate inventories to identify excess, high-cost, slow-moving or other factors rendering inventories as unmarketable at normal profit margins. Due to the large number of transactions and the complexity of managing and maintaining a large inventory of product offerings, estimates are made regarding adjustments to the cost of inventories. If our assumptions about future demand change, or market conditions are less favorable than those projected, additional write-downs of inventories may be required. In any case, actual amounts could be different from those estimated.
Overview
We are primarily focused on supplying ODM products (custom made small devices) for our OEM and CEM customer’s multi-year turn-key projects. We also distribute ODM components (private labeled electronic components) and name brand electronic components.
Our core strategy has shifted to primarily focus on higher margin ODM Projects that require custom products designed for specific applications to OEM customers, and away from actively marketing our superstore strategy of maintaining a vast quantity of electronic components to fill customer orders immediately from available stock held in inventory. As a result, we expect our components inventory will be more passively marketed and distributed online for clearance through our internet sales portal, however at potentially lower rates due to the pricing pressures normally attributed with online shopping.
In accordance with generally accepted accounting principles, we have classified inventory as a current asset in our September 30, 2020, condensed consolidated financial statements representing approximately 32% of current assets and 24% of total assets. However, if all or a substantial portion of the inventory was required to be immediately liquidated, the inventory would not be as readily marketable or liquid as other items included or classified as a current asset, such as cash. We cannot assure you that demand in the discrete semiconductor market will increase and that market conditions will improve. Therefore, it is possible that further declines in our carrying values of inventory may result.
Our gross profit margins are subject to a number of factors, including product demand, the relative strength of the U.S. dollar, provisions for inventory reserves, our ability to purchase inventory at favorable prices and our sales product mix.
Results of Operations
Significant Risks and Uncertainties
On January 30, 2020, the World Health Organization declared the novel coronavirus 2019 (“COVID-19”) outbreak to constitute a “Public Health Emergency of International Concern.” The COVID-19 outbreak is disrupting supply chains and affecting production and sales across a range of industries. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and on March 13, 2020, the United States declared a national emergency with respect to COVID-19. The outbreak of COVID-19 has severely impacted global economic activity and caused significant volatility and negative pressure in financial markets. The global impact of the outbreak has been rapidly evolving and many countries, including the United States, have reacted by instituting quarantines, mandating business and school closures and restricting travel. The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, impact on our customers, employees and vendors all of which are uncertain and cannot be predicted. At this point, the extent to which COVID-19 may impact our financial condition or results of operations is uncertain.
During the third quarter of fiscal 2020, we continued to experience increased costs associated with our logistics operations, and shipping delays. Our suppliers and customers were also negatively impacted, including delays in the production and export of products. The impact to our customers may also result in an increase in past due accounts receivable. To mitigate the impact of COVID-19, we have taken measures to promote the safety and security of our employees while complying with various government mandates, including work-from-home arrangements and social-distancing initiatives to reduce the transmission of COVID-19.
The COVID-19 pandemic has had a negative impact on our results of operations and financial performance for the third quarter of 2020, and we expect it will continue to have a negative impact on our revenue, earnings and cash flows in the fourth quarter of 2020 and possibly into 2021. Accordingly, current results and financial condition discussed herein may not be indicative of future operating results and trends. See the Risk Factors included in our Annual report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission as well as the additional Risk Factor included in Part II—Item 1A of this quarterly report regarding the impacts of the COVID-19 outbreak.
Third quarter of 2020 versus 2019.
Net sales in the third quarter of 2020 totaled $1,991,000 versus $1,658,000 in the comparable period for 2019, an increase of $333,000 or 20.1% over the same period last year. The increase was primarily driven by an increase of ODM project sales volume.
Gross profit for the third quarter of 2020 was $967,000 versus $888,000 in the comparable period for 2019, and gross margin percentage of net sales was 48.6% in the third quarter of 2020 versus 53.6% in the comparable period for 2019.
Selling, general and administrative expenses in the third quarter of 2020 totaled $542,000 versus $566,000 in the comparable period for 2019. The $24,000 decrease was primarily driven by lower salaries and personnel related costs.
Other income, net of other expense, in the third quarter of 2020 was $12,000 versus $188,000 in the comparable period for 2019 and primarily derived from rental income of excess office space at our headquarters in Valencia, California and our Shanghai, China. The $188,000 increase was primarily derived from the derived from the gain on sale of our Mexico property of $160,000 during the three months ended September 30, 2019.
Income tax provision was $1,000 for the third quarter of 2020 versus $2,000 in the comparable period for 2019, as we do not expect significant taxable income for the year ending December 31, 2020.
Net income was $443,000 for the third quarter of 2020 versus $515,000 in the comparable period for 2019, a decrease of $72,000 resulting from the reasons discussed above.
Nine Months Ended September 30, 2020 versus Nine Months Ended September 30, 2019.
Net sales in the nine months ended September 30, 2020 was $4,766,000 versus $4,814,000 in the comparable period for 2019, a decrease of $48,000 or 1.0% over the same period last year. The decrease was driven by a decrease of ODM project sales volume.
Gross profit for the nine months ended September 30, 2020 was $2,257,000 versus $2,406,000 in the comparable period for 2019, and gross margin percentage of net sales was approximately 47.4% for the nine months ended September 30, 2020 and 50.0% for 2019, respectively.
Selling, general and administrative expenses in the nine months ended September 30, 2020 totaled $1,659,000 versus $1,712,000 in the comparable period for 2019, a decrease of $53,000 over the same period last year. The $53,000 decrease was primarily driven by lower salaries and personnel related costs.
Other income, net of other expenses, in the nine months ended September 30, 2020 was $29,000 versus $244,000 in the comparable period for 2019. Other income was primarily from rental income of excess office space at our headquarters in Valencia, California and our Shanghai, China office. The $215,000 increase was primarily derived from the gain on sale of our Mexico property of $160,000 during the three months ended September 30, 2019.
Income tax provision was $3,000 for the nine months ended September 30, 2020 versus $4,000 in the comparable period for 2019, as we do not expect significant taxable income for the year ending December 31, 2020.
Net income was $652,000 for the nine months ended September 30, 2020 versus $955,000 in the comparable period for 2019, a decrease of $303,000 resulting from the reasons discussed above.
Liquidity and Capital Resources
We historically have satisfied our liquidity requirements through cash generated from operations, short-term commercial loans, subordinated related party promissory notes and issuance of equity securities.
Cash flows provided by operating activities were $1,467,000 versus $858,000 in the nine months ended September 30, 2020 and 2019, respectively. The increase of $609,000 in cash flows provided by operations compared with the prior period resulted from changes in operating assets and liabilities, primarily from accounts receivable, inventories and accounts payable compared to the prior period.
Cash flows used for investing activities were $13,000 versus $2,000 provided by for the nine months ended September 30, 2020 and 2019, respectively. The decrease of $15,000 compared with the prior period was primarily due to our $186,000 investment in convertible securities (see Note 3) offset by proceeds of $200,000 from the sale of our building in Mexico.
Cash flows used for financing activities were $385,000 and $390,000 for the nine months ended September 30, 2020 and 2019, respectively. The decrease of $5,000 compared with the prior period was primarily due to the loan proceeds (see Note 4) and stock options exercised, offset by increased cash dividend payments of $91,000. The increase to our cash dividends was based upon our November 1, 2019 announcement that our quarterly cash dividends increased by 16.7% from $0.03 per share to $0.035 per share.
We believe that funds generated from operations, existing cash balances and, if necessary, related party short-term loans, are likely to be sufficient to finance our working capital and capital expenditure requirements for the foreseeable future. If these funds are not sufficient, we may secure new sources of asset-based lending on accounts receivables or issue debt or equity securities. Otherwise, we may need to liquidate assets to generate the necessary working capital.
Inventory is included and classified as a current asset. As of September 30, 2020, inventory represented approximately 32% of current assets and 24% of total assets. However, it is likely to take over one (1) year for the inventory to turn and therefore is likely not saleable within this time frame. Hence, inventory would not be as readily marketable or liquid as other items included in current assets, such as cash.
Off-Balance Sheet Arrangements
As of September 30, 2020, we had no off-balance sheet arrangements.