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EX-32.1 - EXHIBIT 32.1 - CSP INC /MA/cspi-2017331xex321.htm
EX-31.2 - EXHIBIT 31.2 - CSP INC /MA/cspi-2017331xex312.htm
EX-31.1 - EXHIBIT 31.1 - CSP INC /MA/cspi-2017331xex311.htm
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 
FORM 10-Q 
 

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended
March 31, 2017
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             .

Commission File Number 0-10843
 
CSP Inc.
(Exact name of Registrant as specified in its Charter)
 
Massachusetts
04-2441294
(State of incorporation)
(I.R.S. Employer Identification No.)
175 Cabot Street - Suite 210
Lowell, Massachusetts 01854
(978) 954-5038
(Address and telephone number of principal executive offices)
 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  o.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
x
 
 
 
 
Emerging growth company
o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of May 5, 2017, the registrant had 3,921,083 shares of common stock issued and outstanding.

1


INDEX

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CSP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except par value) 
 
March 31,
2017
 
September 30,
2016
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
11,038

 
$
13,103

Accounts receivable, net of allowances of $270 and $240
23,364

 
18,997

Unbilled accounts receivable
954

 
567

Inventories, net
6,489

 
5,580

Deferred costs
1,718

 
635

Deferred income taxes
1,331

 
1,331

Other current assets
1,435

 
1,586

Total current assets
46,329

 
41,799

Property, equipment and improvements, net
1,553

 
1,680

 
 
 
 
Other assets:
 

 
 

Intangibles, net
227

 
287

Deferred costs
26

 
18

Deferred income taxes
1,668

 
1,723

Cash surrender value of life insurance
3,216

 
3,015

Other assets
178

 
185

Total other assets
5,315

 
5,228

Total assets
$
53,197

 
$
48,707

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
14,548

 
$
11,932

Deferred revenue
7,277

 
4,704

Pension and retirement plans
518

 
581

Income taxes payable
53

 
166

Total current liabilities
22,396

 
17,383

Pension and retirement plans
12,977

 
13,441

Other long term liabilities
225

 
228

Total liabilities
35,598

 
31,052

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Shareholders’ equity:
 
 
 
Common stock, $.01 par value per share; authorized, 7,500 shares; issued and outstanding 3,918 and 3,821 shares, respectively
40

 
39

Additional paid-in capital
13,278

 
12,924

Retained earnings
16,150

 
16,623

Accumulated other comprehensive loss
(11,869
)
 
(11,931
)
Total shareholders’ equity
17,599

 
17,655

Total liabilities and shareholders’ equity
$
53,197

 
$
48,707


See accompanying notes to unaudited consolidated financial statements.

3


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except for per share data)

 
For the three months ended
 
For the six months ended
 
March 31,
2017
 
March 31,
2016
 
March 31,
2017
 
March 31,
2016
Sales:
 
 
 
 
 
 
 
Product
$
18,684

 
$
20,972

 
$
33,322

 
$
37,975

Services
6,632

 
6,167

 
11,910

 
12,840

Total sales
25,316

 
27,139

 
45,232

 
50,815

 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Product
15,878

 
17,054

 
28,103

 
31,290

Services
3,743

 
3,752

 
6,982

 
8,002

Total cost of sales
19,621

 
20,806

 
35,085

 
39,292

 
 
 
 
 
 
 
 
Gross profit
5,695

 
6,333

 
10,147

 
11,523

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Engineering and development
573

 
790

 
1,169

 
1,589

Selling, general and administrative
4,500

 
4,665

 
8,458

 
8,713

Total operating expenses
5,073

 
5,455

 
9,627

 
10,302

 
 
 
 
 
 
 
 
Operating income
622

 
878

 
520

 
1,221

 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
Foreign exchange gain (loss)
28

 
(103
)
 
82

 
(63
)
Other expense, net
(11
)
 
(14
)
 
(21
)
 
(26
)
Total other income (expense)
17

 
(117
)
 
61

 
(89
)
Income before income taxes
639

 
761

 
581

 
1,132

Income tax expense
211

 
258

 
196

 
346

Net income
$
428

 
$
503

 
$
385

 
$
786

Net income attributable to common stockholders
$
410

 
$
480

 
$
357

 
$
756

Net income per share – basic
$
0.11

 
$
0.13

 
$
0.10

 
$
0.21

Weighted average shares outstanding – basic
3,724

 
3,609

 
3,697

 
3,589

Net income per share – diluted
$
0.11

 
$
0.13

 
$
0.09

 
$
0.20

Weighted average shares outstanding – diluted
3,847

 
3,730

 
3,807

 
3,728

 
See accompanying notes to unaudited consolidated financial statements.

4


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)

 
 
For the three months ended
 
For the six months ended
 
 
March 31,
2017
 
March 31,
2016
 
March 31,
2017
 
March 31,
2016
 
 
 
 
 
 
 
 
 
Net income
 
$
428

 
$
503

 
$
385

 
$
786

Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation gain adjustments
 
(76
)
 
125

 
62

 
123

Other comprehensive income (loss)
 
(76
)
 
125

 
62

 
123

Total comprehensive income
 
$
352

 
$
628

 
$
447

 
$
909


See accompanying notes to unaudited consolidated financial statements.


5


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
For the Six Months Ended March 31, 2017:
(Amounts in thousands, except per share data)
 
 
Shares
 
Amount
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
other
comprehensive
loss
 
Total
Shareholders’
Equity
Balance as of September 30, 2016
3,821

 
$
39

 
$
12,924

 
$
16,623

 
$
(11,931
)
 
$
17,655

Net income

 

 

 
385

 

 
385

Other comprehensive income

 

 

 

 
62

 
62

Exercise of stock options
5

 

 
15

 

 

 
15

Stock-based compensation

 

 
249

 

 

 
249

Restricted stock cancellation
(8
)
 

 

 

 

 

Restricted stock issuance
89

 
1

 

 

 

 
1

Issuance of shares under employee stock purchase plan
11

 

 
90

 

 

 
90

Cash dividends on common stock ($0.22 per share)

 

 

 
(858
)
 

 
(858
)
Balance as of March 31, 2017
3,918

 
$
40

 
$
13,278

 
$
16,150

 
$
(11,869
)
 
$
17,599

 
See accompanying notes to unaudited consolidated financial statements.

6


CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
 
For the six months ended
 
March 31,
2017
 
March 31,
2016
Cash flows (used in) provided by operating activities:
 
 
 
Net income
$
385

 
$
786

Adjustments to reconcile net income to net cash used in operating activities:
 

 
 

Depreciation and amortization
268

 
286

Amortization of intangibles
61

 
65

Loss on sale of fixed assets, net
5

 

Foreign exchange gain (loss)
(82
)
 
63

Non-cash changes in accounts receivable
69

 
136

Non-cash changes in inventory
81

 
226

Stock-based compensation expense on stock options and restricted stock awards
249

 
181

Deferred income taxes
(4
)
 
23

Increase in cash surrender value of life insurance
(50
)
 
(50
)
Changes in operating assets and liabilities:
 

 
 

Increase in accounts receivable
(5,207
)
 
(3,008
)
Decrease in life insurance receivable
413

 

(Increase) decrease in inventories
(1,028
)
 
444

(Increase) decrease in deferred costs
(1,131
)
 
493

(Increase) decrease in refundable income taxes
(3
)
 
44

Increase in other current assets
(278
)
 
(548
)
Decrease in other assets

 
25

Increase in accounts payable and accrued expenses
2,821

 
1,530

Increase (decrease) in deferred revenue
2,786

 
(715
)
Decrease in pension and retirement plans liability
(23
)
 
(164
)
Increase (decrease) in income taxes payable
(104
)
 
268

Increase in other long term liabilities
4

 
4

Net cash (used in) provided by operating activities
(768
)
 
89

Cash flows used in investing activities:
 

 
 

Life insurance premiums paid
(150
)
 
(161
)
Purchases of property, equipment and improvements
(178
)
 
(345
)
Net cash used in investing activities
(328
)
 
(506
)
Cash flows used in financing activities:
 

 
 

Dividends paid
(858
)
 
(833
)
Proceeds from issuance of shares under equity compensation plans
106

 
73

Net cash used in financing activities
(752
)
 
(760
)
Effects of exchange rate on cash
(217
)
 
16

Net decrease in cash and cash equivalents
(2,065
)
 
(1,161
)
Cash and cash equivalents, beginning of period
13,103

 
11,181

Cash and cash equivalents, end of period
$
11,038

 
$
10,020

Supplementary cash flow information:
 

 
 

Cash paid for income taxes
$
272

 
$
28

Cash paid for interest
$
75

 
$
85


 See accompanying notes to unaudited consolidated financial statements.

7


CSP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED MARCH 31, 2017 AND 2016

 
Organization and Business
 
CSP Inc. was founded in 1968 and is based in Lowell, Massachusetts. To meet the diverse requirements of its industrial, commercial and defense customers worldwide, CSP Inc. and its subsidiaries (collectively “we”, “us”, “our”,
“CSPI” or the “Company”) develop and market IT integration solutions and high-performance cluster computer systems. The Company operates in two segments, its High Performance Products (“HPP”) segment (formerly the “High Performance Products and Solutions” segment) and its Technology Solutions (“TS”) segment (formerly the "Information Technology Solutions" segment).
 
1.    Basis of Presentation
 
The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of the interim periods presented. All adjustments were of a normal recurring nature. Certain information and footnote disclosures normally included in the annual consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States, have been omitted.

Accordingly, the Company believes that although the disclosures are adequate to make the information presented not misleading, the unaudited consolidated financial statements should be read in conjunction with the footnotes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2016.

Reclassifications

Certain reclassifications have been made to prior year financial statements to conform to current period financial statement presentation with no effect on previously reported financial positions, results of operations or cash flows. The reclassification was to break out deferred costs separately from inventory on the balance sheet.
  
2.    Use of Estimates
 
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period, including estimates and assumptions related to reserves for bad debt, reserves for inventory obsolescence, the impairment assessment of intangible assets, the calculation of estimated selling price and post-delivery support obligations used for revenue recognition, the calculation of liabilities related to deferred compensation and retirement plans and the calculation of income tax liabilities. Actual results may differ from those estimates under different assumptions or conditions.
 
3.    Earnings Per Share of Common Stock
 
Basic net income per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per common share reflects the maximum dilution that would have resulted from the assumed exercise and share repurchase related to dilutive stock options and is computed by dividing net income by the assumed weighted average number of common shares outstanding.
 
We are required to present earnings per share, or EPS, utilizing the two class method because we had outstanding, non-vested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, which are considered participating securities.

 

8


Basic and diluted earnings per share computations for the Company’s reported net income attributable to common stockholders are as follows:

 
For the three months ended
 
For the six months ended
 
March 31, 2017
 
March 31, 2016
 
March 31, 2017
 
March 31, 2016
 
(Amounts in thousands except per share data)
Net income
$
428

 
$
503

 
$
385

 
$
786

Less: net income attributable to nonvested common stock
18

 
23

 
28

 
30

Net income attributable to common stockholders
$
410

 
$
480

 
$
357

 
$
756

 
 
 
 
 
 
 
 
Weighted average total shares outstanding – basic
3,888

 
3,782

 
3,986

 
3,732

Less: weighted average non-vested shares outstanding
164

 
173

 
289

 
143

Weighted average number of common shares outstanding – basic
3,724

 
3,609

 
3,697

 
3,589

Potential common shares from non-vested stock awards and the assumed exercise of stock options
123

 
121

 
110

 
139

Weighted average common shares outstanding – diluted
3,847

 
3,730

 
3,807

 
3,728

 
 
 
 
 
 
 
 
Net income per share – basic
$
0.11

 
$
0.13

 
$
0.10

 
$
0.21

Net income per share – diluted
$
0.11

 
$
0.13

 
$
0.09

 
$
0.20

 

All anti-dilutive securities, including certain stock options, are excluded from the diluted income per share computation. For the three and six months ended March 31, 2017, there were no shares subject to stock options excluded from the diluted income per share calculation because their inclusion would have been anti-dilutive as their exercise price exceeded fair value. For the three and six months ended March 31, 2016, 30,000 and 33,000 shares subject to stock options, respectively, were excluded from the diluted income per share calculation because their inclusion would have been anti-dilutive as their exercise price exceeded fair value.


4.    Inventories

Inventories consist of the following:
 
March 31, 2017
 
September 30, 2016
 
(Amounts in thousands)
Raw materials
$
1,552

 
$
1,658

Work-in-process
819

 
814

Finished goods
4,118

 
3,108

Total
$
6,489

 
$
5,580

 
Finished goods includes inventory that has been shipped, but for which all revenue recognition criteria has not been met, of approximately $0.1 million and $0.1 million as of March 31, 2017 and September 30, 2016, respectively.
 
Total inventory balances in the table above are shown net of reserves for obsolescence of approximately $3.1 million and $3.0 million as of March 31, 2017 and September 30, 2016, respectively.
 

9

Draft 5                        Preliminary & Tentative        For Discussion Purposes Only

5.    Deferred Costs

Deferred costs represent costs of labor, third party maintenance and support contracts, and outside consultants related to transactions where the revenue recognition criteria has not been met.


6.    Accumulated Other Comprehensive Loss
 
The components of accumulated other comprehensive loss are as follows:
 
 
March 31, 2017
 
September 30, 2016
 
 
(Amounts in thousands)
Cumulative effect of foreign currency translation
 
$
(2,745
)
 
$
(2,807
)
Cumulative unrealized loss on pension liability
 
(9,124
)
 
(9,124
)
Accumulated other comprehensive loss
 
$
(11,869
)
 
$
(11,931
)


7.    Pension and Retirement Plans
 
The Company has defined benefit and defined contribution plans in the United Kingdom, Germany and the U.S. In the United Kingdom and Germany, the Company provides defined benefit pension plans and defined contribution plans for some of its employees. In the U.S., the Company provides benefits through supplemental retirement plans to certain former employees. The domestic supplemental retirement plans have life insurance policies which are not plan assets but were purchased by the Company as a vehicle to fund the costs of the plan. Domestically, the Company also provides for officer death benefits through post-retirement plans to certain officers.  All of the Company’s defined benefit plans are closed to newly hired employees and have been since September 2009.

The Company funds its pension plans in amounts sufficient to meet the requirements set forth in applicable employee benefits laws and local tax laws. Liabilities for amounts in excess of these funding levels are accrued and reported in the consolidated balance sheets.
 
The Company's pension plan in the United Kingdom is the only plan with plan assets. The plan assets consist of an investment in a commingled fund which in turn comprises a diversified mix of assets including corporate equity securities, government securities and corporate debt securities.
 
    

10


The components of net periodic benefit costs related to the U.S. and international plans are as follows:
 
 
For the Three Months Ended March 31,
 
2017
 
2016
 
Foreign
 
U.S.
 
Total
 
Foreign
 
U.S.
 
Total
 
(Amounts in thousands)
Pension:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
10

 
$

 
$
10

 
$
9

 
$

 
$
9

Interest cost
93

 
11

 
104

 
146

 
11

 
157

Expected return on plan assets
(65
)
 

 
(65
)
 
(92
)
 

 
(92
)
Amortization of:
 

 
 

 
 

 
 

 
 

 
 

Prior service gain

 

 

 

 

 

Amortization of net gain (loss)
91

 
(1
)
 
90

 
44

 
(1
)
 
43

Net periodic benefit cost
$
129

 
$
10

 
$
139

 
$
107

 
$
10

 
$
117

 
 
 
 
 
 
 
 
 
 
 
 
Post Retirement:
 

 
 

 
 

 
 

 
 

 
 

Service cost
$

 
$
10

 
$
10

 
$

 
$
7

 
$
7

Interest cost

 
10

 
10

 

 
11

 
11

Amortization of net gain (loss)

 
4

 
4

 

 
(20
)
 
(20
)
Net periodic cost (benefit)
$

 
$
24

 
$
24

 
$

 
$
(2
)
 
$
(2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended March 31,
 
2017
 
2016
 
Foreign
 
U.S.
 
Total
 
Foreign
 
U.S.
 
Total
 
(Amounts in thousands)
Pension:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
19

 
$

 
$
19

 
$
18

 
$

 
$
18

Interest cost
188

 
22

 
210

 
297

 
22

 
319

Expected return on plan assets
(131
)
 

 
(131
)
 
(190
)
 

 
(190
)
Amortization of:
 
 
 
 
 

 
 
 
 
 
 

Prior service gain

 

 

 

 

 

Amortization of net gain (loss)
182

 
(2
)
 
180

 
89

 
(2
)
 
87

Net periodic benefit cost
$
258

 
$
20

 
$
278

 
$
214

 
$
20

 
$
234

 
 
 
 
 
 
 
 
 
 
 
 
Post Retirement:
 

 
 

 
 

 
 

 
 

 
 

Service cost
$

 
$
19

 
$
19

 
$

 
$
14

 
$
14

Interest cost

 
22

 
22

 

 
21

 
21

Amortization of net gain (loss)

 
8

 
8

 

 
(40
)
 
(40
)
Net periodic cost (benefit)
$

 
$
49

 
$
49

 
$

 
$
(5
)
 
$
(5
)


    
    

11


The fair value of the assets held by the U.K. pension plan by asset category are as follows:
 
Fair Values as of
 
March 31, 2017
 
September 30, 2016
 
Fair Value Measurements Using Inputs Considered as
 
Fair Value Measurements Using Inputs Considered as
Asset Category
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(Amounts in thousands)
Cash on deposit
$
73

 
$
73

 
$

 
$

 
$
86

 
$
86

 
$

 
$

Pooled funds
7,445

 

 
7,445

 

 
7,543

 

 
7,543

 

Total plan assets
$
7,518

 
$
73

 
$
7,445

 
$

 
$
7,629

 
$
86

 
$
7,543

 
$

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 




12


8.    Segment Information

The following table presents certain operating segment information.

 
 
 
 
Technology Solutions Segment
 
 
For the three months ended March 31,
 
High Performance Products Segment
 
Germany
 
United
Kingdom
 
U.S.
 
Total
 
Consolidated
Total
 
 
(Amounts in thousands)
2017
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
1,993

 
$
2,319

 
$
2,162

 
$
12,210

 
$
16,691

 
$
18,684

Service
 
1,427

 
4,069

 
209

 
927

 
5,205

 
6,632

Total sales
 
3,420

 
6,388

 
2,371

 
13,137

 
21,896

 
25,316

Income (loss) from operations
 
368

 
261

 
(35
)
 
28

 
254

 
622

Assets
 
16,667

 
17,513

 
2,864

 
16,153

 
36,530

 
53,197

Capital expenditures
 
41

 
43

 

 
22

 
65

 
106

Depreciation and amortization
 
55

 
53

 
2

 
62

 
117

 
172

 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
2,861

 
$
1,389

 
$
1,352

 
$
15,370

 
$
18,111

 
$
20,972

Service
 
597

 
4,027

 
262

 
1,281

 
5,570

 
6,167

Total sales
 
3,458

 
5,416

 
1,614

 
16,651

 
23,681

 
27,139

Income (loss) from operations
 
(501
)
 
718

 
(1
)
 
662

 
1,379

 
878

Assets
 
15,353

 
12,311

 
2,791

 
17,793

 
32,895

 
48,248

Capital expenditures
 
17

 
52

 
31

 
55

 
138

 
155

Depreciation and amortization
 
60

 
42

 
33

 
56

 
131

 
191

 
 
 
 
 
 
 
 
 
 
 
 
 

13


 
 
 
 
Technology Solutions Segment
 
 
For the six months ended March 31,
 
High Performance Products Segment
 
Germany
 
United
Kingdom
 
U.S.
 
Total
 
Consolidated
Total
 
 
(Amounts in thousands)
2017
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
3,520

 
$
4,399

 
$
2,863

 
$
22,540

 
$
29,802

 
$
33,322

Service
 
2,651

 
7,128

 
313

 
1,818

 
9,259

 
11,910

Total sales
 
6,171

 
11,527

 
3,176

 
24,358

 
39,061

 
45,232

Income (loss) from operations
 
414

 
158

 
(241
)
 
189

 
106

 
520

Assets
 
16,667

 
17,513

 
2,864

 
16,153

 
36,530

 
53,197

Capital expenditures
 
58

 
87

 

 
33

 
120

 
178

Depreciation and amortization
 
110

 
91

 
5

 
123

 
219

 
329

 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
4,811

 
$
3,291

 
$
3,345

 
$
26,528

 
$
33,164

 
$
37,975

Service
 
1,464

 
8,799

 
452

 
2,125

 
11,376

 
12,840

Total sales
 
6,275

 
12,090

 
3,797

 
28,653

 
44,540

 
50,815

Income (loss) from operations
 
(924
)
 
1,181

 
(48
)
 
1,012

 
2,145

 
1,221

Assets
 
15,353

 
12,311

 
2,791

 
17,793

 
32,895

 
48,248

Capital expenditures
 
165

 
119

 
33

 
28

 
180

 
345

Depreciation and amortization
 
117

 
82

 
38

 
114

 
234

 
351


Income (loss) from operations consists of sales less cost of sales, engineering and development expenses, and selling, general and administrative expenses but is not affected by either other income/expense or by income taxes expense/benefit. Non-operating charges/income consists principally of investment income and interest expense.  All intercompany transactions have been eliminated.
    
The following table lists customers from which the Company derived revenues in excess of 10% of total revenues for the six months ended March 31, 2017, and 2016.

 
 
For the three months ended March 31,
 
For the six months ended March 31,
 
 
2017
 
2016
 
2017
 
2016
 
 
Customer Revenues
 
% of Total
Revenues
 
Customer Revenues
 
% of Total
Revenues
 
Customer Revenues
 
% of Total
Revenues
 
Customer Revenues
 
% of Total
Revenues
 
 
 
(dollars in millions)
Customer A
 
$
3.7

 
15
%
 
$
5.6

 
20
%
 
$
6.6

 
14
%
 
$
8.4

 
17
%
Customer B
 
$
3.8

 
15
%
 
$
3.8

 
14
%
 
$
6.0

 
13
%
 
$
7.6

 
15
%

In addition, accounts receivable from Customer A totaled approximately $1.7 million, or 7%, and approximately $3.0 million, or 15%, of total consolidated accounts receivable as of March 31, 2017 and September 30, 2016, respectively. Accounts receivable from Customer B totaled approximately $8.7 million, or 36%, and approximately $2.5 million, or 13%, of total consolidated accounts receivable as of March 31, 2017 and September 30, 2016, respectively. We believe that the Company is not exposed to any significant credit risk with respect to the accounts receivable with these customers as of March 31, 2017. No other customers accounted for 10% or more of total consolidated accounts receivable as of March 31, 2017 or September 30, 2016.


14

Draft 5                        Preliminary & Tentative        For Discussion Purposes Only


9.    Dividends
        
On January 12, 2017, the Company's board of directors declared a cash dividend of $0.11 per share which was paid on February 8, 2017 to shareholders of record as of January 27, 2017, the record date.

On February 23, 2017, the Company's board of directors declared a cash dividend of $0.11 per share which was paid on March 17, 2017 to shareholders of record as of March 3, 2017, the record date.




10.    Recent Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update, or ASU, No. 2014 ‑09, Revenue from Contracts with Customers, which outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers.  This ASU clarifies the principles for recognizing revenue by, among other things, removing inconsistencies in revenue requirements, improving comparability of revenue recognition practices across entities and industries and providing improved disclosure requirements. In August 2015, the FASB approved a one year deferral of the effective date for this ASU to interim and annual reporting periods beginning after December 15, 2017; however, early adoption at the original effective date is still permitted.  While the Company has begun its assessment of the new standard, it has not yet selected a transition method nor has it determined the effect the standard will have on its ongoing financial reporting.
 
In May 2015, the FASB issued ASU No. 2015-07, Disclosures for Investments in Certain Entities That Calculate Net
Asset Value per Share (or Its Equivalent), which excludes investments measured at net asset value, as a practical expedient for
fair value, from the fair value hierarchy. This ASU is effective for interim and annual reporting periods beginning after
December 15, 2015, and required retrospective application, with early adoption permitted. The implementation of this ASU has not had a material impact on our consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-12, Plan Accounting: Defined Contribution Pension Plans (Topic 962),
Health and Welfare Benefits Plans (Topic 965), which requires fully benefit-responsive investment contracts to be measured at
contract value. Those Topics also require an adjustment to reconcile contract value to fair value, when these measures differ,
on the face of the plan financial statements. Fair value is measured using the requirements in Topic 820, Fair Value
Measurement. This ASU was effective for fiscal years beginning after December 15, 2015, and required retrospective application, with early adoption permitted. The implementation of this ASU has not had a material impact on our consolidated
financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330) Simplifying the Measurement of Inventory, which requires entities to measure inventory at the lower of cost or net realizable value, except for inventory measured using last-in, first-out (LIFO) or the retail inventory method. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017 and requires prospective application, with early adoption permitted as of the beginning of an interim or annual reporting period. The Company has not yet assessed the potential impact of implementing this ASU on our consolidated financial statements.
 
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740) Balance Sheet Classification of Deferred Taxes, which require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Topic apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this Topic. The amendments in this Topic are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The implementation of this guidance is not expected to have a material impact to the disclosures on our consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This updated Topic 842 affects any entity that enters into a lease (as that term is defined in this Update), with some specified scope exemptions. The guidance in this Update supersedes Topic 840, Leases. The amendments in this Topic are effective for financial statements issued for annual periods beginning after December 15, 2018, and interim periods

15


within those annual periods. The Company has not yet assessed the potential impact of implementing this ASU on our consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-08 (Topic 606), Principal versus Agent Considerations (Reporting Revenue Gross versus Net) to clarify the implementation guidance on principal versus agent considerations. The amendments in this update provides additional guidance on indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customer and does not change the core principle of previously issued guidance. The amendments in this Topic are effective for financial statements issued for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The Company does not expect the implementation of this ASU to have a material impact on our consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09 (Topic 718), Compensation - Stock Compensation, Improvements to Employee Share-Based Payment Accounting to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Additionally, the amendments eliminate the guidance in Topic 718 that was indefinitely deferred shortly after the issuance of FASB Statement No. 123 (revised 2004), Share-Based Payment. This should not result in a change in practice because the guidance that is being superseded was never effective. The amendments in this Topic are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company does not expect the implementation of this ASU to have a material impact on our consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04 (Topic 350), Intangibles - Goodwill and Other (Simplifying the Test for Goodwill Impairment) to simplify the subsequent measurement of goodwill. The amendments in this update provides for the elimination of Step 2, which requires an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) including those procedures that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. The amendments in this update defines an impairment loss as the excess of the carrying amount of the intangible assets to the fair value of a reporting unit. The amendments in this Topic are effective for financial statements issued for annual periods beginning after December 15, 2019, and early adoption is permitted for interim or annual goodwill impairment tests performed on testing after January 1, 2017. The Company does not expect the implementation of this ASU to have a material impact on our consolidated financial statements.



16


Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
The discussion below contains certain forward-looking statements related but not limited to, among others, statements concerning future revenues and future business plans. Forward-looking statements include statements in which we use words such as “expect”, “believe”, “anticipate”, “intend”, “project”, “estimate”, “should”, “could”, “may”, “plan”, “potential”, “predict”, “project”, “will”, “would” and similar expressions. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, the forward-looking statements are subject to significant risks and uncertainties, and thus we cannot assure you that these expectations will prove to have been correct, and actual results may vary from those contained in such forward-looking statements. We discuss many of these risks and uncertainties in Item 1A under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2016. Factors that may cause such variances include, but are not limited to, our dependence on a small number of customers for a significant portion of our revenue, our high dependence on contracts with the U.S. federal government, our reliance in certain circumstances on single sources for supply of key product components, and intense competition in the market segments in which we operate. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our estimates and assumptions only as of the date of this document. Except as required by law, we do not undertake any obligation to publicly update or revise any forward-looking statements contained in this report, whether as a result of new information, future events or otherwise. This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with our financial statements and the related notes included elsewhere in this filing and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2016.
  
Critical Accounting Policies
 
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates, including those related to uncollectible receivables, inventory valuation, impairment assessment of intangibles, income taxes, deferred compensation and retirement plans, as well as estimated selling prices used for revenue recognition and contingencies. We base our estimates on historical performance and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A description of our critical accounting policies is contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2016 in the “Critical Accounting Policies” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.




Results of Operations

Overview of the three months ended March 31, 2017

     Our revenues decreased by approximately $1.8 million, or 7%, to $25.3 million for the three months ended March 31, 2017 as compared to $27.1 million for the three months ended March 31, 2016. The decrease in revenue is the result of a decrease of $1.8 million in our TS segment. Our gross margin percentage decreased overall, from 23% of revenues for the three months ended March 31, 2016, to 22% for the three months ended March 31, 2017. Operating income decreased by $0.3 million to $0.6 million for the three month period ended March 31, 2017 as compared to $0.9 million for the three month period ended March 31, 2016 as a result of a $0.6 million decrease in gross profit combined with a change to the product mix, which was partially offset by $0.4 million of lower operating expenses.

    

17


The following table details our results of operations in dollars and as a percentage of sales for the three months ended:
 
 
 
March 31, 2017
 
%
of sales
 
March 31, 2016
 
%
of sales
 
 
(Dollar amounts in thousands)
Total sales
 
$
25,316

 
100
%
 
$
27,139

 
100
 %
Costs and expenses:
 
 

 
 

 
 

 
 

Cost of sales
 
19,621

 
78
%
 
20,806

 
77
 %
Engineering and development
 
573

 
2
%
 
790

 
3
 %
Selling, general and administrative
 
4,500

 
18
%
 
4,665

 
17
 %
Total costs and expenses
 
24,694

 
98
%
 
26,261

 
97
 %
Operating income
 
622

 
2
%
 
878

 
3
 %
Other income (expense)
 
17

 
%
 
(117
)
 
 %
Income before income taxes
 
639

 
2
%
 
761

 
3
 %
Income tax expense
 
211

 
1
%
 
258

 
1
 %
Net income
 
$
428

 
1
%
 
$
503

 
2
 %


Revenues

     Our revenues decreased by approximately $1.8 million to $25.3 million for the three months ended March 31, 2017 as compared to $27.1 million of revenues for the three months ended March 31, 2016. The TS segment revenues decreased by $1.8 million and the HPP segment revenues were relatively unchanged.

HPP segment revenue change by product line was as follows for the three months ended March 31, 2017 and 2016:
 
 
 
 
 
 
Increase (decrease)
 
 
2017
 
2016
 
$
 
%
 
 
(Dollar amounts in thousands)
 
 
Products
 
$
1,993

 
$
2,861

 
$
(868
)
 
(30
)%
Services
 
1,427

 
597

 
830

 
139
 %
Total
 
$
3,420

 
$
3,458

 
$
(38
)
 
(1
)%

The decrease in HPP product revenues is primarily attributed to lower Myricom product line sales, partially due to a large shipment in 2016, for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016. The increase in HPP services revenues is primarily attributed to an increase in royalties on high-speed processing boards related to the E2D program shipped for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016.

TS segment revenue change by product line was as follows for the three months ended March 31, 2017 and 2016:
 
 
 
 
 
 
Decrease
 
 
2017
 
2016
 
$
 
%
 
 
(Dollar amounts in thousands)
 
 
Products
 
$
16,691

 
$
18,111

 
$
(1,420
)
 
(8
)%
Services
 
5,205

 
5,570

 
(365
)
 
(7
)%
Total
 
$
21,896

 
$
23,681

 
$
(1,785
)
 
(8
)%

The $1.8 million decrease in TS segment total revenues during the three months ended March 31, 2017 as compared to the three months ended March 31, 2016, was the result of decreases in revenues of $3.5 million in our U.S. division, partially offset by increases in our U.K. and Germany divisions of $0.7 million, and $1.0 million, respectively. Product revenues increased by approximately $0.8 million and $0.9 million in our U.K. and Germany divisions, respectively, and decreased by $3.2 million in our U.S. division, which includes a $1.9M decrease in revenue from a major customer that is attributed to the

18


timing of orders from our customer. The $0.4 million decrease in TS segment service revenues during the three months ended March 31, 2017 as compared to the three months ended March 31, 2016 was the result of a decrease in service revenues in our U.S. division.

      Our revenues by geographic area based on the customer location to which the products were shipped or services rendered was as follows for the three months ended March 31, 2017 and March 31, 2016:
 
 
 
 
Increase (decrease)
 
 
2017
 
%
 
2016
 
%
 
$
 
%
 
 
(Dollar amounts in thousands)
Americas
 
$
15,600

 
62
%
 
$
18,886

 
70
%
 
$
(3,286
)
 
(17
)%
Europe
 
8,910

 
35
%
 
6,509

 
24
%
 
2,401

 
37
 %
Asia
 
806

 
3
%
 
1,744

 
6
%
 
(938
)
 
(54
)%
Totals
 
$
25,316

 
100
%
 
$
27,139

 
100
%
 
$
(1,823
)
 
(7
)%

The $1.8 million decrease in revenues is primarily attributed to our TS segment. The $3.3 million decrease in revenue from the Americas is primarily the result of the timing of sales to a major customer and the $2.4 million increase in Europe is primarily the result of increased product sales by both our Germany and the U.K divisions.

Gross Margins

     Our gross margin ("GM") decreased by $0.6 million to $5.7 million for the three months ended March 31, 2017 as compared to a gross margin of $6.3 million for the three months ended March 31, 2016. The GM as a percentage of revenue decreased from 23% for the three months ended March 31, 2016 to 22% for the three months ended March 31, 2017 as follows:
 
 
 
2017
 
2016
 
Increase (decrease)
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
 
 
(Dollar amounts in thousands)
HPP
 
$
2,172

64
%
 
$
1,898

55
%
 
$
274

 
9
 %
TS
 
3,523

16
%
 
4,435

19
%
 
(912
)
 
(3
)%
Total
 
$
5,695

22
%
 
$
6,333

23
%
 
$
(638
)
 
(1
)%
    
    
The impact of product mix within our HPP segment on gross margin for the three months ended March 31, 2017 and 2016 was as follows:
 
 
 
2017
 
2016
 
Increase (decrease)
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
 
 
(Dollar amounts in thousands)
Products
 
$
782

39
%
 
$
1,358

47
%
 
$
(576
)
 
(8
)%
Services
 
1,390

97
%
 
540

90
%
 
850

 
7
 %
Total
 
$
2,172

64
%
 
$
1,898

55
%
 
$
274

 
9
 %

The overall HPP segment gross margin as a percentage of sales increased to 64% for the three month period ended March 31, 2017 as compared to 55% for the three month period ended March 31, 2016. The 9% increase in gross margin as a percentage of sales in the HPP segment was primarily attributed to a favorable mix of high margin Multicomputer royalty revenues and a decreased level of inventory reserve adjustment during the three months ended March 31, 2017 as compared to the three months ended March 31, 2016.





19


The impact of product mix within our TS segment on gross margin for the three months ended March 31, 2017 and 2016 was as follows:
 
 
2017
 
2016
 
Decrease
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
 
 
(Dollar amounts in thousands)
Products
 
$
2,024

12
%
 
$
2,560

14
%
 
$
(536
)
 
(2
)%
Services
 
1,499

29
%
 
1,875

34
%
 
(376
)
 
(5
)%
Total
 
$
3,523

16
%
 
$
4,435

19
%
 
$
(912
)
 
(3
)%

     The overall TS segment gross margin as a percentage of sales decreased to 16% for the three month period ended March 31, 2017 as compared to 19% for the three month period ended March 31, 2016. The 3% decrease in gross margin as a percentage of TS Segment revenues is primarily attributed to having less service revenue in our German division and underutilization of engineering resources in our U.K. division during the three month period ended March 31, 2017 as compared the three month period ended March 31, 2016.

Operating Expenses

Engineering and Development Expenses
 
The engineering and development expenses incurred by our HPP segment were $0.6 million and $0.8 million for the three months ended March 31, 2017 and 2016, respectively. The current period expenses are primarily for Myricom product engineering expenses incurred in connection with the development of new Myricom products. The cost reduction for the three month period ended March 31, 2017 as compared to the three month period ended March 31, 2016 is primarily attributed to a reduction in outside consulting expenditures partially offset by increases in personnel costs.
 

Selling, General and Administrative Expenses
 
The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the three months ended March 31, 2017 and 2016:
 
 
For the three months ended March 31,
 
 
 
 
 
2017
 
% of
Total
 
2016
 
% of
Total
 
$ Increase (decrease)
 
% Increase (decrease)
 
(Dollar amounts in thousands)
By Operating Segment:
 
 
 
 
 
 
 
 
 
 
 
HPP segment
$
1,231

 
27
%
 
$
1,609

 
34
%
 
$
(378
)
 
(23
)%
TS segment
3,269

 
73
%
 
3,056

 
66
%
 
213

 
7
 %
Total
$
4,500

 
100
%
 
$
4,665

 
100
%
 
$
(165
)
 
(4
)%
 
SG&A expenses decreased by $0.2 million, or 4%, for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016. The decrease in HPP segment SG&A expenses is primarily attributed to decreases in variable compensation costs. The increase in the TS segment SG&A expenses is primarily attributed to increases in variable compensation and severance costs in Germany.


20


Other Income/Expenses
 
The following table details our other income (expense) for the three months ended March 31, 2017 and 2016:
 
For the three months ended,
 
 
 
March 31, 2017
 
March 31, 2016
 
Increase
 
(Amounts in thousands)
Interest expense
$
(18
)
 
$
(21
)
 
$
3

Interest income
1

 
1

 

Foreign exchange gain (loss)
28

 
(103
)
 
131

Other income, net
6

 
6

 

Total other income (expense), net
$
17

 
$
(117
)
 
$
134

 
The increase to other income (expenses) for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016 was primarily driven by the increase of approximately $0.1 million in the foreign exchange gain (loss) on foreign currency holdings in the current period as compared to the prior year period.


Income Taxes

For the three months ended March 31, 2017, the Company recognized an income tax expense of approximately $211 thousand. The U.S. tax expense is 62% of the income tax expense with Germany primarily accounting for remaining tax expense. The Company's effective tax rate was 33.1% for the quarter ended March 31, 2017 as compared to an effective tax rate of 33.9% for the quarter ended March 31, 2016.
 



Overview of the six months ended March 31, 2017

Our revenues decreased by approximately $5.6 million, or 11%, to $45.2 million for the six months ended March 31, 2017