This discussion contains forward-looking statements that involve risks and uncertainties that could cause actual results or events to differ materially from those expressed or implied by such forward-looking statements as a result of many important factors, including those set forth in Part I of this Annual Report on Form 10-K under the caption "Risk Factors." Please see "Cautionary Note Regarding Forward-Looking Statements" in Part I above. We do not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Annual Report. The following discussion should be read in conjunction with the consolidated financial statements, including the related notes, appearing in Item 8 of this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

Use of Estimates - We have 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 consolidated financial statements included in Item 8 of this Annual Report on Form 10-K in accordance with generally accepted accounting principles in the United States. These estimates have a significant impact on our valuation and reserve accounts relating to the allowance for sales returns and allowances, doubtful accounts, inventory reserves and deferred income taxes. Actual results could differ from these estimates.

Revenue Recognition - Revenue is recognized at the point at which control of the underlying products are transferred to the customer. Satisfaction of our performance obligations occur upon the transfer of control of products, either from our facilities or directly from suppliers to customers. We consider customer purchase orders to be the contracts with a customer. All revenue is generated from contracts with customers. Reserves for sales allowances and customer returns are established based upon historical experience and our estimates of future returns. Sales returns for the years ended December 31, 2022 and 2021 were $0 and $1,000, respectively. The allowance for sales returns and allowances and doubtful accounts at December 31, 2022 and 2021 aggregated $7,000. We review the actual sales returns and bad debts for our customers and establish an estimate of future returns and an allowance for doubtful accounts.

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 $3,900,000 and $5,261,000 at December 31, 2022 and 2021, respectively, which is presented net of valuation allowances of $5,069,000 and $4,892,000 at December 31, 2022 and 2021, respectively. We increased our reserves by $180,000 and $150,000 during the years ended December 31, 2022 and 2021, respectively, while also applying $3,000 and $17,000 of our existing reserves to the underlying inventory values during the years ended December 31, 2022 and 2021, 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.

Deferred Taxes - If determined that it is more likely than not that we will not realize all or part of our net deferred tax assets in the future, we record a valuation allowance against the deferred tax assets, which allowance will be charged to income tax expense in the period of such determination. We also consider the scheduled reversal of deferred tax liabilities, tax planning strategies and future taxable income in assessing if deferred tax assets could be realized. We also consider the weight of both positive and negative evidence in determining whether a valuation allowance is needed. However, we have fully reduced by $1,915,000 the entire valuation allowance against our net deferred tax assets during the year ended December 31, 2022 primarily as a result of our recent history of net income. In prior years, due to a period of consistent losses through December 31, 2016 coupled with the current uncertainty with COVID-19 and recent world events, we had fully reserved a $1,915,000 allowance against our net deferred tax assets at December 31, 2021.





Overview

We are primarily focused on supplying ODM products for our OEM customer's multi-year turn-key projects. We also distribute discrete semiconductors, commodity Integrated Circuits (ICs), optoelectronic devices and passive components to other electronic distributors, CEMs and OEMs, who incorporate them in their products.

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 2022, we recorded a $180,000 increase to our inventory reserves.


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In accordance with generally accepted accounting principles, we have classified inventory as a current asset in our December 31, 2022, consolidated financial statements representing approximately 32.6% of current assets and 22.8% 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

The Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021

Net sales were $8,423,000 and $8,643,000 in 2022 and 2021, respectively, representing a decrease of $220,000 or 2.5%. The decrease was primarily in ODM Projects and owing to lower demand. Key customers of our ODM Projects have variable life cycles and production demands. As some projects are accelerating and others approach end of life, the timing of new production creates a fluctuation in sales. In 2023, we expect sales to decline, due to some of our customers building inventory during the pandemic which has reduced demand.

Gross profit was $4,393,000 and $4,121,000 in 2022 and 2021, respectively, which represented 52.2% and 47.7% of net sales for those periods. During 2022, we remained impacted by tariff costs on certain products imported from China, which went into effect as of July 6, 2018. However, we continue to pass along a portion of these costs to our customers to mitigate these costs.

Selling, general and administrative expenses were $2,158,000 and $2,029,000 in 2022 and 2021, respectively, which represented 25.6% and 23.5% of net sales for those periods. The year-over-year increase of $129,000 was primarily due to personnel costs.

Operating income was $2,235,000 and $2,092,000 in 2022 and 2021, respectively, which represented 26.5% and 24.2% of net sales for those periods.

Net interest income, primarily earned from certificates of deposits in banks was $40,000 and $19,000 in 2022 and 2021, respectively.

Income tax benefit(provision) was $1,382,000 and ($388,000) in 2022 and 2021, respectively. The decrease was primarily due fully reducing by $1,915,000 the entire valuation allowance against our net deferred tax assets.

As result of the foregoing, we recognized net income of $3,208,000 and $2,010,000 in 2022 and 2021, respectively, which represented 38.1% and 23.3% of net sales for those periods.

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. A summary of our cash flows resulting from our operating, investing and financing activities for the years ended December 31, 2022 and 2021 were as follows:





                         Twelve Months Ended December 31,
                             2022                  2021

Operating activities   $       1,691,000       $   1,741,000
Investing activities   $        (968,000 )     $  (1,523,000 )
Financing activities   $      (1,495,000 )     $    (889,000 )

Cash provided by operating activities decreased to $1,691,000 during 2022, as compared to $1,741,000 in the prior year. The $50,000 decrease was primarily due to changes in inventory, accounts receivable, deferred income taxes, accounts payable and net income.





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Cash used for investing activities was $968,000 during 2022, as compared to $1,523,000 in the prior year. The decrease was from purchase of short-term investments (see also Item 8 - Note 1 - Short-term Investments).

Cash used in financing activities was $1,495,000 during 2022, as compared to $889,000 in the prior year. In 2022, we made dividend payments of $1,703,000 and received proceeds from the exercise of stock options of $208,000. In 2021, we made dividend payments of $965,000 and received proceeds from the exercise of stock options of $76,000.

We believe that funds generated from operations, existing cash balances and short-term investments 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 December 31, 2022, inventory represented approximately 32.6% of current assets and 22.8% 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 a one (1) year time frame. Hence, inventory would not be as readily marketable or liquid as other items included in current assets, such as cash.

Recent Accounting Pronouncements

Refer to Note 1 of our consolidated financial statements for recent accounting pronouncements.

Off-Balance Sheet Arrangements

We had no material off-balance sheet arrangements that have, or are likely to have, a current or future material effect on our operations.

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