The results of operations for the three and nine months ended September 30, 2022 are not necessarily indicative of the results to be expected for the full year ending December 31, 2022.

See Note 9 for a discussion of a change in accounting principle which occurred in the second quarter of 2022. TransAct changed its method of inventory valuation from standard costing which approximates first-in first-out (“FIFO”) to the average costing methodology. All prior periods presented have been retrospectively adjusted to apply the new method of accounting.

Certain prior period amounts have been adjusted to conform with the current year presentation.

Impact of the COVID-19 pandemic and Global Supply Chain Disruptions

Since early 2020, the COVID-19 pandemic has continued to cause uncertainty and disruption in the global economy and financial markets, such as increased shipping and logistics costs and supply chain disruptions.  We have also been impacted by global supply chain issues and inflationary pressures, which have increased our costs and, in some instances, slowed our ability to deliver products to customers.  During 2021, our inventory levels decreased significantly as a result of these supply chain disruptions and we experienced significantly lower sales levels because of the global economic slowdown.  However, during the first nine months of 2022, we have been able to increase our inventory levels and minimize the impact to our customers by successfully modifying our products that were affected by supply chain disruptions as well as sourcing component parts from alternate suppliers.  This strategy allowed us to meet expanding customer demands and significantly grow our sales after the first quarter of 2022 as the pandemic eased.  Although we have been able to increase inventory levels during the first nine months of 2022, there can be no assurance that new supply chain disruptions will not affect our products or that we will be able to make timely modifications to address any future supply chain issues that arise.  Further, while we have offset most of our cost increases by increasing prices of our products, there can be no guarantee that we will be able to offset any future cost increases should they arise.  After a slowdown in the first quarter of 2022 resulting from the Omicron and other variants of COVID-19, we have continued to experience demand recovery in the second and third quarters of 2022. We expect this recovery to continue during the remainder of 2022.

Balance Sheet, Cash Flow and Liquidity. We have taken the following actions to increase liquidity and strengthen our financial position in an effort to mitigate the negative impacts from the COVID-19 pandemic, supply chain disruptions and inflationary pressures:

After reviewing whether conditions and/or events raise substantial doubt about our ability to meet future financial obligations over the 12 months following the issuance date of the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q (this “Form 10-Q”), including consideration of the actions taken to manage expenses and liquidity, we believe that our net cash to be provided by operations combined with our cash and cash equivalents and borrowing availability under our revolving credit facility will provide sufficient liquidity to fund our current obligations, capital spending, and working capital requirements and to comply with the financial covenants of our credit facility over at least 12 months following such issuance date.

For a discussion of our significant accounting policies, see Note 2, Summary of Significant Accounting Policies within Part II, Item 8, “Financial Statements and Supplementary Data” in the Annual Report on Form 10-K for the year ended December 31, 2021.  Other than as described in Note 9 of this Form 10Q, there have been no changes to our significant accounting policies since our Annual Report on Form 10K for the year ended December 31, 2021.

We account for revenue in accordance with ASC Topic 606: Revenue from Contracts with Customers.

Disaggregation of revenue

Contract balances

Contract assets consist of unbilled receivables.  Pursuant to the over-time revenue recognition model, revenue may be recognized prior to the customer being invoiced.  An unbilled receivable is recorded to reflect revenue that is recognized when such revenue exceeds the amount invoiced to the customer. Unbilled receivables are separated into current and non-current assets and included within “Accounts receivable, net” and “Other assets” in non-current assets in the Condensed Consolidated Balance Sheets.

Contract liabilities consist of customer pre-payments and deferred revenue.  Customer prepayments are reported as “Accrued liabilities” in current liabilities in the Condensed Consolidated Balance Sheets and represent customer payments made in advance of performance obligations in instances where credit has not been extended and are recognized as revenue when the performance obligation is complete.  Deferred revenue is reported separately in current liabilities and non-current liabilities and consists of our extended warranty contracts, technical support for our food service technology terminals, EPICENTRAL® maintenance contracts and prepaid software subscriptions for our BOHA! software applications and is recognized as revenue as (or when) we perform under the contract.  For the nine months ended September 30, 2022, we recognized revenue of $0.8 million related to our contract liabilities at December 31, 2021. Total net contract liabilities consisted of the following:

Remaining performance obligations

Remaining performance obligations represent the transaction price of firm orders for which a good or service has not been delivered to our customer.  As of September 30, 2022, the aggregate amount of transaction prices allocated to remaining performance obligations was $19.0 million.  The Company expects to recognize revenue of $18.5 million of its remaining performance obligations within the next 12 months following September 30, 2022, $0.4 million within the next 24 months following September 30, 2022 and the balance of these remaining performance obligations within the next 36 months following September 30, 2022.

We generally provide hardware warranties on our products for up to 24 months and record the estimated cost of such product warranties at the time the sale is recorded.  Estimated warranty costs are based upon actual past experience of product repairs and the related estimated cost of labor and material to make the necessary repairs.

As of September 30, 2022, $57 thousand of the accrued product warranty liability was classified as current in “Accrued liabilities” in the Condensed Consolidated Balance Sheet and the remaining $20 thousand was classified as non-current in “Other liabilities”.

Credit Facility

On March 13, 2020, we entered into a credit facility (the “Siena Credit Facility”) with the Lender and terminated our credit facility with TD Bank, N.A.  The Siena Credit Facility provides for a revolving credit line of up to $10.0 million and was originally scheduled to expire on March 13, 2023.  Borrowings under the Siena Credit Facility bear a floating rate of interest equal to the greatest of (i) the prime rate plus 1.75%, (ii) the federal funds rate plus 2.25%, and (iii) 6.50%. The total deferred financing costs related to expenses incurred to complete the Siena Credit Facility was $245 thousand, which were reported as “Other current assets” in current assets and “Other assets” in non-current assets in the Condensed Consolidated Balance Sheets.  We also pay a fee of 0.50% on unused borrowings under the Siena Credit Facility.  Borrowings under the Siena Credit Facility are secured by a lien on substantially all the assets of the Company.

The Siena Credit Facility imposes a financial covenant on the Company and borrowings are subject to a borrowing base based on (i) 85% of eligible accounts receivable plus the lesser of (a) $5.0 million and (b) 50% of eligible raw material and 60% of finished goods inventory and restricts, among other things, our ability to incur additional indebtedness and create other liens.  The three-month period from April 1, 2020 to June 30, 2020 was the first period we were subject to the original financial covenant, which required the Company to maintain a minimum EBITDA and continued through the 12-month period from April 1, 2020 to March 31, 2021.  On July 21, 2021, the Company entered into an amendment (“Siena Credit Facility Amendment No. 1”) to the Siena Credit Facility.  Siena Credit Facility Amendment No. 1 changed the financial covenant under the Siena Credit Facility from a minimum EBITDA covenant to an excess availability covenant requiring that the Company maintain excess availability of at least $750 thousand under the Siena Credit Facility, tested as of the end of each calendar month, beginning with the calendar month ending July 31, 2021.  From July 31, 2021 to September 30, 2022, we remained in compliance with our excess availability covenant. As of September 30, 2022, we had $2.3 million of outstanding borrowings under the Siena Credit Facility and $2.5 million of net borrowing capacity available under the Siena Credit Facility.

On July 19, 2022, the Company and the Lender entered into Amendment No. 2 (“Siena Credit Facility Amendment No. 2”) to the Siena Credit Facility, as amended by Siena Credit Facility Amendment No. 1.  Also on July 19, 2022, the Company and the Lender entered into an Amended and Restated Fee Letter (the “Amended Fee Letter”) in connection with the Siena Credit Facility Amendment No. 2. The Siena Credit Facility Amendment No. 2 did not modify the aggregate amount of the revolving commitment or the interest rate applicable to the loans.

The changes to the Siena Credit Facility provided for in Siena Credit Facility Amendment No. 2 include, among other things, the following:

(i) The extension of the maturity date from March 13, 2023 to March 13, 2025; and

(ii) The termination of the existing blocked account control agreement and entry into a new “springing” deposit account control agreement, permitting the Company to direct the use of funds in its deposit account until such time as (a) the sum of excess availability under Siena Credit Facility (as amended) and unrestricted cash is less than $5 million for 3 consecutive business days or (b) an event of default occurs and is continuing.

In addition, the Amended Fee Letter requires the Company, while it retains the ability to direct the use of funds in the deposit account, to maintain outstanding borrowings of at least $2,250,000 in principal amount. If the Company does not have the ability to direct the use of funds in the deposit account, then the Amended Fee Letter requires the Company to pay interest on at least $2,250,000 principal amount of loans, whether or not such amount of loans is actually outstanding.

PPP Loan

On May 1, 2020, the Company was granted the PPP Loan from Berkshire Bank in the aggregate amount of $2.2 million, pursuant to the PPP.  Under the terms of the PPP, the PPP Loan would be forgiven to the extent that funds from the PPP Loan were used for payroll costs and costs to continue group health care benefits, as well as for interest on mortgage obligations incurred before February 15, 2020, rent under lease agreements in effect before February 15, 2020, utilities for which service began before February 15, 2020, and interest on debt obligations incurred before February 15, 2020, subject to conditions and limitations provided in the CARES Act.  At least 60% (under the PPP terms, as amended) of the proceeds from the PPP Loan were required to be used for eligible payroll costs for the PPP Loan to be forgiven.

On July 8, 2021, the Company received notifications from Berkshire Bank and the SBA that the PPP Loan (including all interest accrued thereon) of $2.2 million had been fully forgiven by the SBA and that the forgiveness payment date was July 1, 2021.  The forgiveness of the PPP Loan was reported as “Gain on forgiveness of long-term debt” in the Consolidated Statement of Operations during the year ended December 31, 2021.

The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock options and restricted stock units, when the average market price of the common stock is lower than the exercise price of the related stock award during the period, as the inclusion of these stock awards in the computation of diluted earnings would be anti-dilutive.  For the three months ended September 30, 2022 and 2021, there were 0.3 million and 0.3 million, respectively, of potentially dilutive shares consisting of stock awards that were excluded from the calculation of earnings per diluted share.  For the nine months ended September 30, 2022 and 2021, there were 1.6 million and 0.4 million, respectively, of potentially dilutive shares consisting of stock awards that were excluded from the calculation of earnings per diluted share.  In periods for which a net loss is reported, such as the nine months ended September 30, 2022 and 2021, basic and diluted net loss per common share are calculated using the same method.

For the three months ended September 30, 2022, the dilutive effect of outstanding options and restricted stock units, as determined by the treasury stock method, was less than one thousand shares and thus did not impact the rounded shares presented above.

We account for leases in accordance with ASC Topic 842: Leases.

We enter into lease agreements for the use of real estate space and certain equipment under operating leases and we have no financing leases. Our leases are included in “Right-of-use-assets” and “Lease liabilities” in our Condensed Consolidated Balance Sheets.  Our leases have remaining lease terms of two to four years, some of which include options to extend. Lease expense is recognized on a straight-line basis over the lease term.

On April 30, 2021, we entered into an amendment to modify the expiration date of our lease on our Hamden, Connecticut facility.  The lease, which was last amended on January 3, 2017, was scheduled to expire on April 30, 2027.  The lease amendment modified the expiration date to October 31, 2023 with an option to extend the lease for an additional two-year period, extending the expiration date to October 31, 2025.  The modification resulted in reducing the right-of-use-asset and lease liability by $0.3 million.

On April 26, 2022, we entered into an amendment to modify the expiration date of our lease on our Las Vegas, Nevada facility.  The lease was set to expire on November 1, 2022 and the amendment extended the lease term to November 30, 2025. The lease amendment resulted in an increase to the right-of-use-asset and lease liability of $0.8 million. The lease amendment modified the base rent and extended the lease term from October 31, 2022 to November 30, 2025.

Operating lease expense for the three months ended September 30, 2022 and 2021 was $261 thousand and $235 thousand, respectively, and is reported as “Cost of sales”, “Engineering, design and product development expense”, “Selling and marketing expense”, and “General and administrative expense” in the Condensed Consolidated Statements of Operations.  Operating lease expense for the nine months ended September 30, 2022 and 2021 was $748 thousand and $717 thousand, respectively. Operating lease expenses include short-term lease costs, which were immaterial during the periods presented.

We recorded an income tax benefit for the third quarter of 2022 of $62 thousand at an effective tax rate of (13.3%), compared to an income tax benefit for the third quarter of 2021 of $442 thousand at an effective tax rate of (96.3%).  For the nine months ended September 30, 2022,  we recorded an income tax benefit of $2.3 million at an effective tax rate of (27.0%), compared to an income tax benefit for the nine months ended September 30, 2021 of $1.6 million at an effective tax rate of (33.6%).

We are subject to U.S. federal income tax, as well as income tax in certain U.S. states and foreign jurisdictions.  We have substantially concluded all U.S. federal, state and local income tax, and foreign tax regulatory examination matters through 2018.  However, our federal tax returns from 2019 through 2021 remain open to examination. Various state and foreign tax jurisdiction tax years remain open to examination as well, though we believe that any additional assessment would be immaterial to the Condensed Consolidated Financial Statements.

As of September 30, 2022, we had $116 thousand of total gross unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods.  For the third quarter of 2022, we recognized $28 thousand of previously unrecognized tax benefits as the statute of limitations on the use of our 2018 research and development credit expired during the third quarter of 2022.

We recognize interest and penalties related to uncertain tax positions in the income tax provision.  As of September 30, 2022, we had $20 thousand of accrued interest and penalties related to uncertain tax positions.

Management evaluates all jurisdictions based on historical pre-tax earnings and taxable income to determine the need for valuation allowances on a quarterly basis.  The three months ended September 30, 2022 benefitted from the remeasurement of our deferred tax asset valuation allowance associated with our operations in the United Kingdom.  Based on this analysis, we currently have no valuation allowances recorded for any jurisdiction.

Effective April 1, 2022, TransAct changed its method of inventory valuation from standard costing which approximates FIFO to the average costing methodology.  We believe this methodology is preferable because it reflects a better estimate of inventory cost as we do not typically perform intensive manufacturing of our finished products, which are therefore better measured under average cost.  In addition, our business is projected to include an increasing sales volume of software going forward, which better aligns with average costing.  Comparative financial statements of prior periods have been adjusted to apply the new method retrospectively.  Tax effects are calculated at the Company’s marginal tax rate, or the tax impact of incremental income changes rather than the average tax rate applied to our total net loss before income taxes.  The following financial statement line items for the periods presented were impacted by the change in accounting principle.