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EX-32.1 - EXHIBIT 32.1 - CSP INC /MA/cspi-20180331xex321.htm
EX-31.2 - EXHIBIT 31.2 - CSP INC /MA/cspi-20180331xex312.htm
EX-31.1 - EXHIBIT 31.1 - CSP INC /MA/cspi-20180331xex311.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, 2018
 
 
or
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 or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
175 Cabot Street - Suite 210, Lowell, MA
01854
(Address of principle executive offices)
(Zip Code)
 
 
(978)-954-5038
(Registrant's telephone number, including area code)
 
 
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. (Check one)
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 9, 2018, the registrant had 4,006,084 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,
2018
 
September 30,
2017
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
11,967

 
$
13,885

Accounts receivable, net of allowances of $264 and $261
22,657

 
27,630

Unbilled accounts receivable
1,861

 
772

Inventories
4,749

 
5,971

Deferred costs
3,065

 
929

Refundable income taxes
581

 

Other current assets
2,215

 
1,139

Total current assets
47,095

 
50,326

Property, equipment and improvements, net
1,560

 
1,508

 
 
 
 
Other assets:
 

 
 

Intangibles, net
108

 
167

Deferred costs
528

 
609

Deferred income taxes
2,370

 
2,827

Cash surrender value of life insurance
3,483

 
3,300

Other assets
194

 
191

Total other assets
6,683

 
7,094

Total assets
$
55,338

 
$
58,928

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
13,743

 
$
18,845

Deferred revenue
9,469

 
6,202

Pension and retirement plans
552

 
534

Income taxes payable

 
442

Total current liabilities
23,764

 
26,023

Pension and retirement plans
12,212

 
11,818

Income taxes payable
561

 

Other long term liabilities
162

 
86

Total liabilities
36,699

 
37,927

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Shareholders’ equity:
 
 
 
Common stock, $.01 par value per share; authorized, 7,500 shares; issued and outstanding 4,006 and 3,935 shares, respectively
41

 
40

Additional paid-in capital
14,116

 
13,717

Retained earnings
14,735

 
17,407

Accumulated other comprehensive loss
(10,253
)
 
(10,163
)
Total shareholders’ equity
18,639

 
21,001

Total liabilities and shareholders’ equity
$
55,338

 
$
58,928


See accompanying notes to unaudited consolidated financial statements.

3


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

 
For the three months ended
 
For the six months ended
 
March 31,
2018
 
March 31,
2017
 
March 31,
2018
 
March 31,
2017
Sales:
 
 
 
 
 
 
 
Product
$
15,184

 
$
18,684

 
$
30,827

 
$
33,322

Services
6,798

 
6,632

 
13,154

 
11,910

Total sales
21,982

 
25,316

 
43,981

 
45,232

 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
Product
12,559

 
15,878

 
25,589

 
28,103

Services
4,493

 
3,743

 
8,329

 
6,982

Total cost of sales
17,052

 
19,621

 
33,918

 
35,085

 
 
 
 
 
 
 
 
Gross profit
4,930

 
5,695

 
10,063

 
10,147

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Engineering and development
759

 
573

 
1,457

 
1,169

Selling, general and administrative
4,894

 
4,500

 
9,322

 
8,458

Total operating expenses
5,653

 
5,073

 
10,779

 
9,627

 
 
 
 
 
 
 
 
Operating income (loss)
(723
)
 
622

 
(716
)
 
520

 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
Foreign exchange gain (loss)
(9
)
 
28

 
(101
)
 
82

Other income (expense), net
10

 
(11
)
 
(3
)
 
(21
)
Total other income (expense)
1

 
17

 
(104
)
 
61

Income (loss) before income taxes
(722
)
 
639

 
(820
)
 
581

Income tax expense (benefit)
(128
)
 
211

 
974

 
196

Net income (loss)
$
(594
)
 
$
428

 
$
(1,794
)
 
$
385

Net income (loss) attributable to common stockholders
$
(594
)
 
$
410

 
$
(1,794
)
 
$
357

Net income (loss) per share – basic
$
(0.16
)
 
$
0.11

 
$
(0.47
)
 
$
0.10

Weighted average shares outstanding – basic
3,823

 
3,724

 
3,795

 
3,697

Net income (loss) per share – diluted
$
(0.16
)
 
$
0.11

 
$
(0.47
)
 
$
0.09

Weighted average shares outstanding – diluted
3,823

 
3,847

 
3,795

 
3,807

 
See accompanying notes to unaudited consolidated financial statements.

4


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

 
 
For the three months ended
 
For the six months ended
 
 
March 31,
2018
 
March 31,
2017
 
March 31,
2018
 
March 31,
2017
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(594
)
 
$
428

 
$
(1,794
)
 
$
385

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation gain (loss) adjustments
 
(86
)
 
(76
)
 
(90
)
 
62

Other comprehensive income (loss)
 
(86
)
 
(76
)
 
(90
)
 
62

Total comprehensive income (loss)
 
$
(680
)
 
$
352

 
$
(1,884
)
 
$
447


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, 2018:
(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, 2017
3,935

 
$
40

 
$
13,717

 
$
17,407

 
$
(10,163
)
 
$
21,001

Net loss

 

 

 
(1,794
)
 

 
(1,794
)
Other comprehensive loss

 

 

 

 
(90
)
 
(90
)
Exercise of stock options
5

 

 
22

 

 

 
22

Stock-based compensation

 

 
299

 

 

 
299

Restricted stock cancellation
(13
)
 

 

 

 

 

Restricted stock issuance
71

 
1

 

 

 

 
1

Issuance of shares under employee stock purchase plan
8

 

 
78

 

 

 
78

Cash dividends paid on common stock ($0.22 per share)

 

 

 
(878
)
 

 
(878
)
Balance as of March 31, 2018
4,006

 
$
41

 
$
14,116

 
$
14,735

 
$
(10,253
)
 
$
18,639

 
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,
2018
 
March 31,
2017
Cash flows used in operating activities:
 
 
 
Net income (loss)
$
(1,794
)
 
$
385

Adjustments to reconcile net income (loss) to net cash used in operating activities:
 

 
 

Depreciation and amortization
274

 
268

Amortization of intangibles
59

 
61

Loss on sale of fixed assets, net
6

 
5

Foreign exchange gain (loss)
101

 
(82
)
Non-cash changes in accounts receivable
(4
)
 
69

Non-cash changes in inventories
261

 
81

Stock-based compensation expense on stock options and restricted stock awards
299

 
249

Deferred income taxes
490

 
(4
)
Increase in cash surrender value of life insurance
(34
)
 
(50
)
Changes in operating assets and liabilities:
 

 
 

(Increase) decrease in accounts receivable
4,477

 
(5,207
)
Decrease in life insurance receivable

 
413

(Increase) decrease in inventories
998

 
(1,028
)
Increase in deferred costs
(1,976
)
 
(1,131
)
Increase in refundable income taxes
(579
)
 
(3
)
Increase in other current assets
(1,023
)
 
(278
)
Increase (decrease) in accounts payable and accrued expenses
(5,388
)
 
2,821

Increase in deferred revenue
2,967

 
2,786

Decrease in pension and retirement plans liabilities
(51
)
 
(23
)
Increase (decrease) in income taxes payable
111

 
(104
)
Increase in other long term liabilities
72

 
4

Net cash used in operating activities
(734
)
 
(768
)
Cash flows used in investing activities:
 

 
 

Life insurance premiums paid
(150
)
 
(150
)
Purchases of property, equipment and improvements
(305
)
 
(178
)
Net cash used in investing activities
(455
)
 
(328
)
Cash flows used in financing activities:
 

 
 

Dividends paid
(878
)
 
(858
)
Proceeds from issuance of shares under equity compensation plans
100

 
106

Net cash used in financing activities
(778
)
 
(752
)
Effects of exchange rate on cash
49

 
(217
)
Net decrease in cash and cash equivalents
(1,918
)
 
(2,065
)
Cash and cash equivalents, beginning of period
13,885

 
13,103

Cash and cash equivalents, end of period
$
11,967

 
$
11,038

Supplementary cash flow information:
 

 
 

Cash paid for income taxes
$
880

 
$
272

Cash paid for interest
$
72

 
$
75


 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, 2018 AND 2017

 
Organization and Business
 
CSP Inc. ("CSPI" or "the Company" or "we" or "our") was incorporated in 1968 and is based in Lowell, Massachusetts. CSPI and its subsidiaries develop and market IT integration solutions, advanced security and managed services, purpose built network adapters, and high-performance cluster computer systems to meet the diverse requirements of its commercial and defense customers worldwide. The Company operates in two segments, its High Performance Products (“HPP”) segment and its Technology Solutions (“TS”) 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, 2017.

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 (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income (loss) 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 (loss) 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 (loss) attributable to common stockholders are as follows:
 
For the three months ended
 
For the six months ended
 
March 31, 2018
 
March 31, 2017
 
March 31, 2018
 
March 31, 2017
 
(Amounts in thousands except per share data)
Net income (loss)
$
(594
)
 
$
428

 
$
(1,794
)
 
$
385

Less: net income attributable to nonvested common stock

 
18

 

 
28

Net income (loss) attributable to common stockholders
$
(594
)
 
$
410

 
$
(1,794
)
 
$
357

 
 
 
 
 
 
 
 
Weighted average total shares outstanding – basic
3,823

 
3,888

 
3,795

 
3,986

Less: weighted average non-vested shares outstanding

 
164

 

 
289

Weighted average number of common shares outstanding – basic
3,823

 
3,724

 
3,795

 
3,697

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

 
123

 

 
110

Weighted average common shares outstanding – diluted
3,823

 
3,847

 
3,795

 
3,807

 
 
 
 
 
 
 
 
Net income (loss) per share – basic
$
(0.16
)
 
$
0.11

 
$
(0.47
)
 
$
0.10

Net income (loss) per share – diluted
$
(0.16
)
 
$
0.11

 
$
(0.47
)
 
$
0.09

 
Non-vested restricted stock awards of 168,000 and 169,000 shares were excluded from the diluted loss per share calculation for the three and six months ended March 31, 2018, respectively, as there was a net loss and their inclusion would have been anti-dilutive.

4.    Inventories

Inventories consist of the following:
 
March 31, 2018
 
September 30, 2017
 
(Amounts in thousands)
Raw materials
$
1,067

 
$
1,334

Work-in-process
279

 
260

Finished goods
3,403

 
4,377

Total
$
4,749

 
$
5,971

     
Finished goods includes inventory that has been shipped, but for which all revenue recognition criteria has not been met, of approximately $0.2 million and $0.4 million as of March 31, 2018 and September 30, 2017, respectively.

Total inventory balances in the table above are shown net of reserves for obsolescence of approximately $3.4 million and $3.1 million as of March 31, 2018 and September 30, 2017, respectively.
 
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.



9


6.    Accumulated Other Comprehensive Loss
 
The components of accumulated other comprehensive loss are as follows:
 
 
March 31, 2018
 
September 30, 2017
 
 
(Amounts in thousands)
Cumulative effect of foreign currency translation
 
$
(3,304
)
 
$
(3,214
)
Cumulative unrealized loss on pension liability
 
(6,949
)
 
(6,949
)
Accumulated other comprehensive loss
 
$
(10,253
)
 
$
(10,163
)

7.    Income Taxes
 
On December 22, 2017, the United States enacted tax reform legislation commonly known as the Tax Cuts and Jobs Act (the “Tax Act”), resulting in significant modifications to existing law. The Company follows the guidance in SEC Staff Accounting Bulletin 118 (“SAB 118”), which provides additional clarification regarding the application of ASC Topic 740 in situations where the Company does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Tax Act for the reporting period in which the Tax Act was enacted. SAB 118 provides for a measurement period beginning in the reporting period that includes the Tax Act’s enactment date and ending when the Company has obtained, prepared, and analyzed the information needed in order to complete the accounting requirements but in no circumstances should the measurement period extend beyond one year from the enactment date.
 
During the three months ended March 31, 2018, the Company recorded an income tax benefit of $128 thousand. The tax expense for the six months ended March 31, 2018 was $974 thousand. During the three months ended December 31, 2017, the Company recorded a provisional net income tax expense of approximately $1.1 million related to Tax Act. This included a provisional estimate in the amount of $649 thousand related to the one-time deemed repatriation transition tax on unrepatriated foreign earnings. The provisional amount was based on information currently available, including estimated tax earnings and profits from foreign investments. The Company also recorded a provisional estimate for a one-time tax expense of $490 thousand which consisted primarily of the remeasurement of deferred tax assets and liabilities from 34% to 21%. These expenses were recorded discretely in the three months ended December 31, 2017.
The Company is using a blended federal rate of roughly 24% for the fiscal year ending September 30, 2018 and will use the 21% for periods after fiscal year 2018.
The provisions above are estimates, and accordingly, changes to these estimates will be recorded in subsequent quarters as more information and guidance becomes available.

8.    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 U.S. 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. The Company also provides for officer death benefits through post-retirement plans to certain officers of the Company in the U.S.  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,
 
2018
 
2017
 
Foreign
 
U.S.
 
Total
 
Foreign
 
U.S.
 
Total
 
(Amounts in thousands)
Pension:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
10

 
$

 
$
10

 
$
10

 
$

 
$
10

Interest cost
121

 
7

 
128

 
93

 
11

 
104

Expected return on plan assets
(79
)
 

 
(79
)
 
(65
)
 

 
(65
)
Amortization of:
 

 
 

 
 

 
 

 
 

 
 

Amortization of net gain (loss)
64

 
(1
)
 
63

 
91

 
(1
)
 
90

Net periodic benefit cost
$
116

 
$
6

 
$
122

 
$
129

 
$
10

 
$
139

 
 
 
 
 
 
 
 
 
 
 
 
Post Retirement:
 

 
 

 
 

 
 

 
 

 
 

Service cost
$

 
$
10

 
$
10

 
$

 
$
10

 
$
10

Interest cost

 
12

 
12

 

 
10

 
10

Amortization of net gain (loss)

 
(4
)
 
(4
)
 

 
4

 
4

Net periodic cost
$

 
$
18

 
$
18

 
$

 
$
24

 
$
24

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Six Months Ended March 31,
 
2018
 
2017
 
Foreign
 
U.S.
 
Total
 
Foreign
 
U.S.
 
Total
 
(Amounts in thousands)
Pension:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
20

 
$

 
$
20

 
$
19

 
$

 
$
19

Interest cost
238

 
13

 
251

 
188

 
22

 
210

Expected return on plan assets
(154
)
 

 
(154
)
 
(131
)
 

 
(131
)
Amortization of:
 
 
 
 
 

 
 
 
 
 
 

Amortization of net gain (loss)
124

 
(1
)
 
123

 
182

 
(2
)
 
180

Net periodic benefit cost
$
228

 
$
12

 
$
240

 
$
258

 
$
20

 
$
278

 
 
 
 
 
 
 
 
 
 
 
 
Post Retirement:
 

 
 

 
 

 
 

 
 

 
 

Service cost
$

 
$
21

 
$
21

 
$

 
$
19

 
$
19

Interest cost

 
24

 
24

 

 
22

 
22

Amortization of net gain (loss)

 
(10
)
 
(10
)
 

 
8

 
8

Net periodic cost
$

 
$
35

 
$
35

 
$

 
$
49

 
$
49



    
    

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, 2018
 
September 30, 2017
 
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
$
51

 
$
51

 
$

 
$

 
$
62

 
$
62

 
$

 
$

Pooled funds
8,647

 
8,647

 

 

 
8,177

 
8,177

 

 

Total plan assets
$
8,698

 
$
8,698

 
$

 
$

 
$
8,239

 
$
8,239

 
$

 
$

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 

9.    Segment Information

The following tables present certain operating segment information for the three months ended March 31, 2018 and March 31, 2017.
 
 
 
 
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)
2018
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
1,480

 
$
1,135

 
$
756

 
$
11,813

 
$
13,704

 
$
15,184

Service
 
315

 
4,243

 
115

 
2,125

 
6,483

 
6,798

Total sales
 
1,795

 
5,378

 
871

 
13,938

 
20,187

 
21,982

Income (loss) from operations
 
(1,057
)
 
140

 
(233
)
 
427

 
334

 
(723
)
Assets
 
15,036

 
21,172

 
2,792

 
16,338

 
40,302

 
55,338

Capital expenditures
 
36

 
64

 

 
96

 
160

 
196

Depreciation and amortization
 
57

 
35

 
1

 
69

 
105

 
162

 
 
 
 
 
 
 
 
 
 
 
 
 
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

 
 
 
 
 
 
 
 
 
 
 
 
 

12


 
 
 
 
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)
2018
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
3,087

 
$
3,109

 
$
3,298

 
$
21,333

 
$
27,740

 
$
30,827

Service
 
1,178

 
7,638

 
280

 
4,058

 
11,976

 
13,154

Total sales
 
4,265

 
10,747

 
3,578

 
25,391

 
39,716

 
43,981

Income (loss) from operations
 
(1,440
)
 
(17
)
 
(91
)
 
832

 
724

 
(716
)
Assets
 
15,036

 
21,172

 
2,792

 
16,338

 
40,302

 
55,338

Capital expenditures
 
46

 
129

 

 
130

 
259

 
305

Depreciation and amortization
 
113

 
82

 
2

 
136

 
220

 
333

 
 
 
 
 
 
 
 
 
 
 
 
 
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


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 three and six months ended March 31, 2018, and 2017.
 
 
For the three months ended March 31,
 
For the six months ended March 31,
 
 
2018
 
2017
 
2018
 
2017
 
 
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
 
$
2.7

 
12
%
 
$
3.7

 
15
%
 
$
3.9

 
9
%
 
$
6.6

 
14
%
Customer B
 
$
2.9

 
13
%
 
$
3.8

 
15
%
 
$
5.4

 
12
%
 
$
6.0

 
13
%

In addition, accounts receivable from Customer A totaled approximately $2.7 million, or 12%, and approximately $2.4 million, or 9%, of total consolidated accounts receivable as of March 31, 2018 and September 30, 2017, respectively. Accounts receivable from Customer B totaled approximately $6.6 million, or 29%, and approximately $3.9 million, or 14%, of total consolidated accounts receivable as of March 31, 2018 and September 30, 2017, respectively.

One additional customer, C, accounted for accounts receivable of 10% or more, but did not account for revenue of 10% or more. Accounts receivable from customer C totaled approximately $2.7 million, or 12%, of consolidated accounts receivable as of March 31, 2018. We believe that the Company is not exposed to any significant credit risk with respect to the

13


accounts receivable with these customers as of March 31, 2018. No other customers accounted for 10% or more of total consolidated accounts receivable as of March 31, 2018.

10.    Dividends
        
On December 19, 2017, the Company's board of directors declared a cash dividend of $0.11 per share which was paid on January 16, 2018 to shareholders of record as of December 29, 2017, the record date.

On February 12, 2018, the Company's board of directors declared a cash dividend of $0.11 per share which was paid on March 16, 2018 to shareholders of record as of February 28, 2018, the record date.

11.    New accounting standards not adopted as of March 31, 2018

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. The new standard is effective for the Company on October 1, 2018, and it does not plan to early adopt this ASU. The standard outlines a five-step model whereby revenue is recognized as performance obligations within a contract are satisfied. The standard also requires new, expanded disclosures regarding revenue recognition. We are utilizing a bottom-up approach to analyze the standard's impact on our contract portfolio, comparing our historical accounting policies and practices, and identifying potential differences from applying the requirements of the new standard to our contracts. While this assessment continues, we have not yet completed our determination of the impacts of the standard or the effect of these impacts on our consolidated financial statements. The Company has selected the modified retrospective approach as its transition method. Because the new standard will impact our business processes, systems and controls, we are developing a comprehensive change management project plan to guide the implementation.

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 and 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 February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), an amendment of the FASB Accounting Standards Codification. This ASU requires lessees to recognize a right-of-use asset and lease liability for most lease arrangements. The new standard is effective for the Company on October 1, 2019. The standard mandates a modified retrospective transition method for all entities and early adoption is permitted. The Company is evaluating the effect that ASU 2016-02 will have on its consolidated financial statements and related disclosures.

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 August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments, an amendment of the FASB Accounting Standards Codification. This ASU will reduce diversity in practice for classifying cash payments and receipts in the statement of cash flows for a number of common transactions. It will also clarify when identifiable cash flows should be separated versus classified based on their predominant source or use. This ASU is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The Company is evaluating the effect that ASU 2016-15 will have on its consolidated financial statements and related disclosures.


14


In October 2016, the FASB issued ASU No. 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, an amendment of the FASB Accounting Standards Codification. This ASU requires the seller and buyer to recognize at the transaction date the current and deferred income tax consequences of intercompany asset transfers (except transfers of inventory). Under current GAAP, the seller and buyer defer the consolidated tax consequences of an intercompany asset transfer from the period of the transfer to a future period when the asset is transferred out of the consolidated group, or otherwise affects consolidated earnings. This standard will cause volatility in companies’ effective tax rates, particularly for those that transfer intangible assets to foreign subsidiaries. For public entities, the new standard is effective for annual and interim periods in fiscal years beginning after December 15, 2017. An entity may early adopt the standard but only at the beginning of an annual period for which it has not issued or made available for issuance financial statements (interim or annual). The Company is evaluating the effect that ASU 2016-16 will have on its consolidated financial statements and related disclosures.

In January 2017, FASB issued ASU No. 2017-01, “Business Combinations Clarifying the Definition of a Business" (Topic 805) (“ASU No. 2017-01”). ASU 2017-01 provides a framework to use in determining when a set of assets and activities is a business. ASU 2017-01 provides more consistency in applying the business combination guidance, reduces the costs of application, and makes the definition of a business more operable. ASU 2017-01 is effective for interim and annual periods within those annual periods beginning after December 15, 2017. The Company is currently evaluating the impact ASU 2017-01 will have on the Company’s results of operations, financial position and disclosures.

In March 2017, the FASB issued ASU No. 2017-07, Compensation Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, an amendment of the FASB Accounting Standards Codification. This ASU requires employers that sponsor defined benefit pension and/or other post-retirement benefit plans to report the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. Employers are required to present the other components of net benefit costs in the income statement separately from the service cost component and outside a subtotal of income from operations. Additionally, only the service cost component of net periodic pension cost will be eligible for asset capitalization. For public entities, the new standard is effective for annual periods beginning after December 15, 2017, including interim periods within that annual period. Early adoption is permitted as of the beginning of an annual period for which financial statements (interim or annual) have not been issued or made available for issuance. This ASU should be applied retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement and prospectively, on and after the effective date, for the capitalization of the service cost component of net periodic pension cost and net periodic postretirement benefit in assets. The Company is evaluating the effect that ASU 2017-07 will have on its consolidated financial statements and related disclosures.

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 including, 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, 2017. 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, intense competition in the market segments in which we operate, and the recent changes in the U.S. Tax laws which are still under review by us. 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, 2017.
  

15


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, 2017 in the “Critical Accounting Policies” section contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Results of Operations

Overview of the three months ended March 31, 2018

     Our revenues decreased by approximately $3.3 million, or 13%, to $22.0 million for the three months ended March 31, 2018 as compared to $25.3 million for the three months ended March 31, 2017. The decrease in revenue is the result of a decrease of $1.7 million in our TS segment, combined with a $1.6 million decrease in our HPP segment. Our gross margin percentage was unchanged at 22% of revenues for the three months ended March 31, 2018 as compared to the three months ended March 31, 2017. Operating income decreased by approximately $1.3 million from operating income of $622 thousand for the three months ended March 31, 2017 to an operating loss of $723 thousand for the three months ended March 31, 2018, primarily as a result of a $765 thousand decrease in gross profit combined with an increase of $580 thousand in operating expenses. The increase in operating expenses was primarily the result of higher variable compensation costs and increased costs for sales and engineering hires in our U.S division of the TS segment and increased engineering costs in our HPP segment. Our income tax expense decreased by approximately $339 thousand resulting in an income tax benefit of $128 thousand for the three months ended March 31, 2018 as compared to an income tax expense of $211 thousand for the three months ended March 31, 2017. The decrease to the income tax expense was primarily due to the decrease in operating income.

The following table details our results of operations in dollars and as a percentage of sales for the three months ended:
 
 
 
March 31, 2018
 
%
of sales
 
March 31, 2017
 
%
of sales
 
 
(Dollar amounts in thousands)
Total sales
 
$
21,982

 
100
 %
 
$
25,316

 
100
%
Costs and expenses:
 
 

 
 

 
 

 
 

Cost of sales
 
17,052

 
78
 %
 
19,621

 
78
%
Engineering and development
 
759

 
3
 %
 
573

 
2
%
Selling, general and administrative
 
4,894

 
22
 %
 
4,500

 
18
%
Total costs and expenses
 
22,705

 
103
 %
 
24,694

 
98
%
Operating income (loss)
 
(723
)
 
(3
)%
 
622

 
2
%
Other income
 
1

 
 %
 
17

 
%
Income (loss) before income taxes
 
(722
)
 
(3
)%
 
639

 
2
%
Income tax expense (benefit)
 
(128
)
 
(1
)%
 
211

 
1
%
Net income (loss)
 
$
(594
)
 
(3
)%
 
$
428

 
1
%

Revenues

     Our revenues decreased by approximately $3.3 million to $22.0 million for the three months ended March 31, 2018 as compared to $25.3 million of revenues for the three months ended March 31, 2017. TS segment revenues decreased by $1.7 million, and HPP segment revenues decreased by $1.6 million.


16


HPP segment revenue change was as follows for the three months ended March 31, 2018 and 2017:
 
 
 
 
 
 
Decrease
 
 
2018
 
2017
 
$
 
%
 
 
(Dollar amounts in thousands)
 
 
Products
 
$
1,480

 
$
1,993

 
$
(513
)
 
(26
)%
Services
 
315

 
1,427

 
(1,112
)
 
(78
)%
Total
 
$
1,795

 
$
3,420

 
$
(1,625
)
 
(48
)%

The decrease in HPP product revenues of $513 thousand is primarily attributed to decreased Multicomputer product shipments. The decrease in HPP services revenues is primarily attributed to a $1.1 million decrease in royalties on high-speed processing boards related to the E2D program shipped for the three months ended March 31, 2018 as compared to the three months ended March 31, 2017.

TS segment revenue change was as follows for the three months ended March 31, 2018 and 2017:
 
 
 
 
 
 
Increase (decrease)
 
 
2018
 
2017
 
$
 
%
 
 
(Dollar amounts in thousands)
 
 
Products
 
$
13,704

 
$
16,691

 
$
(2,987
)
 
(18
)%
Services
 
6,483

 
5,205

 
1,278

 
25
 %
Total
 
$
20,187

 
$
21,896

 
$
(1,709
)
 
(8
)%

The decrease in TS segment product revenues of $3.0 million during the period was primarily the result of a decrease in product revenues of $1.4 million in our U.K. division, combined with decreases of $1.2 million and $0.4 million in our German and U.S divisions, respectively. The $1.4 million decrease in the U.K. division product revenues was primarily the result of decreased product shipments to a major customer. The decrease in TS segment product revenues was partially offset by an increase in TS segment service revenues of $1.3 million during the period. The increase in TS segment service revenues for the period ended March 31, 2018 as compared to the prior fiscal year three month period was due primarily to an increase of $1.2 million in our U.S. division. The $1.2 million increase in the U.S. division service revenues was substantially the result of a $900 thousand increase in internal services and additional third party maintenance revenues of $300 thousand.

      Our revenues by geographic area, which is based on the customer location to which the products were shipped or services rendered, were as follows for the three months ended March 31, 2018 and March 31, 2017:
 
 
 
 
Decrease
 
 
2018
 
%
 
2017
 
%
 
$
 
%
 
 
(Dollar amounts in thousands)
Americas
 
$
15,206

 
69
%
 
$
15,600

 
62
%
 
$
(394
)
 
(3
)%
Europe
 
6,562

 
30
%
 
8,910

 
35
%
 
(2,348
)
 
(26
)%
Asia
 
214

 
1
%
 
806

 
3
%
 
(592
)
 
(73
)%
Totals
 
$
21,982

 
100
%
 
$
25,316

 
100
%
 
$
(3,334
)
 
(13
)%

The $2.3 million decrease in revenue to Europe is primarily the result of decreased sales by our TS segment U.K. division of $1.3 million to a U.S. division multi-national customer, combined with decreased sales by our TS segment German division of $1.0 million. The 0.6 million decrease in revenue to Asia is primarily the result of decreased multicomputer product sales by our HPP segment to a major customer as the result of a large one time order in the three months ended March 31, 2017.


17


Gross Margins

     Our gross margin ("GM") decreased by $0.8 million to $4.9 million for the three months ended March 31, 2018 as compared to a gross margin of $5.7 million for the three months ended March 31, 2017. The GM as a percentage of revenue was 22% for the three months ended March 31, 2018, unchanged from the three months ended March 31, 2017.
 
 
 
2018
 
2017
 
Increase (decrease)
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
 
 
(Dollar amounts in thousands)
HPP
 
$
839

47
%
 
$
2,172

64
%
 
$
(1,333
)
 
(17
)%
TS
 
4,091

20
%
 
3,523

16
%
 
568

 
4
 %
Total
 
$
4,930

22
%
 
$
5,695

22
%
 
$
(765
)
 
 %
    
    
The impact of product mix within our HPP segment on gross margin for the period was as follows:
 
 
 
2018
 
2017
 
Decrease
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
 
 
(Dollar amounts in thousands)
Products
 
$
547

37
%
 
$
782

39
%
 
$
(235
)
 
(2
)%
Services
 
292

93
%
 
1,390

97
%
 
(1,098
)
 
(4
)%
Total
 
$
839

47
%
 
$
2,172

64
%
 
$
(1,333
)
 
(17
)%

The overall HPP segment gross margin as a percentage of sales decreased to 47% for the three months ended March 31, 2018 from 64% for the three months ended March 31, 2017. The 17% decrease in gross margin as a percentage of sales in the HPP segment was primarily attributed to decreased high margin royalty revenues and a sharper decline in higher margin services in the overall product mix.

The impact of product mix within our TS segment on gross margin for the three months ended March 31, 2018 and 2017 was as follows:
 
 
2018
 
2017
 
Increase
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
 
 
(Dollar amounts in thousands)
Products
 
$
2,078

15
%
 
$
2,024

12
%
 
$
54

 
3
%
Services
 
2,013

31
%
 
1,499

29
%
 
514

 
2
%
Total
 
$
4,091

20
%
 
$
3,523

16
%
 
$
568

 
4
%

     The overall TS segment gross margin as a percentage of sales increased to 20% for the three month period ended March 31, 2018 from 16% for the three month period ended March 31, 2017. The overall TS segment gross margin as a percentage of sales increase was primarily due to increased product margins and increased higher margin service revenue in our U.S. division.

Operating Expenses

Engineering and Development Expenses
 
The engineering and development expenses incurred by our HPP segment were $0.8 million and $0.6 million for the three months ended March 31, 2018 and 2017, respectively. The current period expenses were primarily for Myricom product engineering expenses incurred in connection with the development of the new Myricom ARIA security products. The increased engineering and development expenses for the three month period ended March 31, 2018 as compared to the three month period ended March 31, 2017 is primarily attributed to an increase in engineering headcount related expenses.
 

18


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, 2018 and 2017:
 
 
For the three months ended March 31,
 
 
 
 
 
2018
 
% of
Total
 
2017
 
% of
Total
 
$ Increase (decrease)
 
% Increase (decrease)
 
(Dollar amounts in thousands)
By Operating Segment:
 
 
 
 
 
 
 
 
 
 
 
HPP segment
$
1,137

 
23
%
 
$
1,231

 
27
%
 
$
(94
)
 
(8
)%
TS segment
3,757

 
77
%
 
3,269

 
73
%
 
488

 
15
 %
Total
$
4,894

 
100
%
 
$
4,500

 
100
%
 
$
394

 
9
 %
 
SG&A expenses increased by $0.4 million, or 9%, for the three months ended March 31, 2018 as compared to the three months ended March 31, 2017. The increase in SG&A expenses was primarily due to a rise in the TS segment SG&A expenses attributed to increases in variable compensation in our U.S. division as a result of increased margins, and sales and engineering hires in our U.S. division, which was partially offset by a decrease in HPP segment SG&A expenses resulting substantially from decreased variable compensation costs.

Other Income/Expenses
 
The following table details our other income (expense) for the three months ended March 31, 2018 and 2017:
 
For the three months ended,
 
 
 
March 31, 2018
 
March 31, 2017
 
Increase (decrease)
 
(Amounts in thousands)
Interest expense
$
(18
)
 
$
(18
)
 
$

Interest income
4

 
1

 
3

Foreign exchange gain (loss)
(9
)
 
28

 
(37
)
Other income, net
24

 
6

 
18

Total other income (expense), net
$
1

 
$
17

 
$
(16
)
 
The net change to other income (expenses) of $16 thousand for the three months ended March 31, 2018 as compared to the three months ended March 31, 2017, was primarily driven by the net change of approximately $37 thousand in the foreign exchange gain (loss) on foreign currency holdings in the current period as compared to the prior year period, partially offset by changes in other income of $18 thousand.

Income Taxes

On December 22, 2017, the U.S. Tax Cuts and Jobs Act (H.R. 1) (the “Tax Act”) was enacted into law. In accordance with ASC 740, Income Taxes, the Company is required to recognize the effect of the Tax Act in the period of enactment, which was the Company’s first quarter of fiscal 2018 that ended on December 31, 2017. The many changes in the Tax Act include a permanent reduction in the maximum federal corporate income tax rate from 35% to 21% effective as of January 1, 2018. The statutory federal income tax rate applicable for the Company's fiscal year ending September 30, 2018 is expected to be 24.3% based on a fiscal year blended rate calculation.
Our provision for income tax was a tax benefit of $128 thousand for the three months ended March 31, 2018 as compared to a tax expense of $211 thousand for the three months ended March 31, 2017.


19


Overview of the six months ended March 31, 2018

Our revenues decreased by approximately $1.3 million, or 3%, to $44.0 million for the six months ended March 31, 2018 as compared to $45.2 million for the six months ended March 31, 2017. The decrease in overall revenue for the six month period ended March 31, 2018 as compared to prior fiscal year six month period was the result of an approximately $1.9 million decrease in our HPP segment revenue, partially offset by an increase of approximately $0.6 million in our TS segment. The HPP segment revenue was primarily impacted by lower royalties recognized of approximately $0.8 million on high-speed processing boards during the six months ended March 31, 2018 as compared $2.2 million of royalty revenues for the six month period ended March 31, 2017. Our gross margin percentage increased overall, from 22% of revenues for the six months ended March 31, 2017, to 23% for the six months ended March 31, 2018. Our operating income decreased by approximately $1.2 million to to an operating loss of $0.7 million for the six month period ended March 31, 2018 as compared to operating income of $0.5 million for the six months ended March 31, 2017, primarily as a result of increased selling and marketing expenses and increased engineering expenses. Our income tax expense increased by approximately $778 thousand to an income tax expense of $974 thousand for the six months ended March 31, 2018 as compared to an income tax expense of $196 thousand for the six months ended March 31, 2017. The increase to the income tax expense was primarily due to the Tax Cuts and Jobs Act which was enacted on December 22, 2017.

The following table details our results of operations in dollars and as a percentage of sales for the six months ended:
 
 
 
March 31, 2018
 
%
of sales
 
March 31, 2017
 
%
of sales
 
 
(Dollar amounts in thousands)
Sales
 
$
43,981

 
100
 %
 
$
45,232

 
100
%
Costs and expenses:
 
 

 
 

 
 

 
 

Cost of sales
 
33,918

 
77
 %
 
35,085

 
77
%
Engineering and development
 
1,457

 
3
 %
 
1,169

 
3
%
Selling, general and administrative
 
9,322

 
21
 %
 
8,458

 
19
%
Total costs and expenses
 
44,697

 
101
 %
 
44,712

 
99
%
Operating income (loss)
 
(716
)
 
(2
)%
 
520

 
1
%
Other income (expense)
 
(104
)
 
 %
 
61

 
%
Income (loss) before income taxes
 
(820
)
 
(2
)%
 
581

 
1
%
Income tax expense
 
974

 
2
 %
 
196

 
%
Net income (loss)
 
$
(1,794
)
 
(4
)%
 
$
385

 
1
%


Revenues

     Our total revenues decreased by $1.3 million to $44.0 million for the six months ended March 31, 2018 as compared $45.2 million of revenues for the six months ended March 31, 2017.
    
HPP segment revenue was as follows for the six months ended March 31, 2018 and 2017:
 
 
Decrease
 
 
2018
 
2017
 
$
 
%
 
 
(Dollar amounts in thousands)
 
 
Products
 
$
3,087

 
$
3,520

 
$
(433
)
 
(12
)%
Services
 
1,178

 
2,651

 
(1,473
)
 
(56
)%
Total
 
$
4,265

 
$
6,171

 
$
(1,906
)
 
(31
)%

The decrease in HPP product revenues for the period of $0.4 million was primarily the result of a decrease of approximately $0.8 million in Multicomputer product line shipments, partially due to a large shipment in the prior fiscal year period, partially offset by an increase in Myricom product line shipments of $0.4 million for the six months ended March 31, 2018 as compared to the six months ended March 31, 2017. The decrease in HPP services revenues of $1.5 million for the

20


period was primarily the result of a decrease of approximately $1.4 million in royalty revenues on high-speed processing boards related to the E2D program during the six months ended March 31, 2018 as compared to the six months ended March 31, 2017.
  
TS segment revenue was as follows for the six months ended March 31, 2018 and 2017:
 
 
Increase (decrease)
 
 
2018
 
2017
 
$
 
%
 
 
(Dollar amounts in thousands)
 
 
Products
 
$
27,740

 
$
29,802

 
$
(2,062
)
 
(7
)%
Services
 
11,976

 
9,259

 
2,717

 
29
 %
Total
 
$
39,716

 
$
39,061

 
$
655

 
2
 %

The decrease in TS segment product revenues of $2.1 million during the period was primarily the result of a decrease in product revenues of $1.3 million and $1.2 million in our German and U.S. divisions, respectively, partially offset by an increase in product revenues of $0.4 million in our U.K division. The $1.3 million decrease in the German division product revenues was primarily the result of lowers sales volume to a major customer due to customer orders being deferred into the third quarter of 2018. The $1.2 million decrease in the U.S. division product revenues was primarily the result of decreases in product shipments to a major customer. The increase in TS segment service revenues of $2.7 million during the period was primarily the result of an increase of $2.2 million and $0.5 million in our U.S. and German divisions, respectively. The $2.2 million increase in the U.S. division service revenues was primarily due to $1.7 million of increased internal services and increased third party maintenance revenues of $0.6 million.

      Our revenues by geographic area, which is based on the customer location to which the products were shipped or services rendered, were as follows for the six months ended March 31, 2018 and 2017:

 
 
For the six months ended March 31,
 
Decrease
 
 
2018
 
%
 
2017
 
%
 
$
 
%
 
 
(Dollars in thousands)
Americas
 
$
28,439

 
65
%
 
$
28,723

 
64
%
 
$
(284
)
 
(1
)%
Europe
 
14,880

 
34
%
 
15,407

 
34
%
 
(527
)
 
(3
)%
Asia
 
662

 
1
%
 
1,102

 
2
%
 
(440
)
 
(40
)%
Totals
 
$
43,981

 
100
%
 
$
45,232

 
100
%
 
$
(1,251
)
 
(3
)%

The $1.3 million decrease in total revenues is primarily attributed to our HPP segment. The $0.4 million decrease in Asia is primarily the result of decreased product sales by our HPP segment to a major customer of approximately $0.7 million, partially offset by increased sales by our TS segment of $0.4 million. The $0.3 million decrease in Americas is primarily due to decreased revenues by our HPP segment of approximately $1.2 million, partially offset by increased sales by our TS segment U.S. division of approximately $0.9 million. The $0.5 million decrease in Europe revenue is primarily due to decreased sales by our German division of our TS segment.

Gross Margins

     Our gross margin was unchanged at approximately $10.1 million for the six months ended March 31, 2018 as compared to the six months ended March 31, 2017 as follows:
 
 
2018
 
2017
 
Increase (decrease)
 
 
(Dollars in thousands)
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
HPP
 
$
2,301

54
%
 
$
3,932

64
%
 
$
(1,631
)
 
(10
)%
TS
 
7,762

20
%
 
6,215

16
%
 
1,547

 
4
 %
Total
 
$
10,063

23
%
 
$
10,147

22
%
 
$
(84
)
 
1
 %
    

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The impact of product mix within our HPP segment on gross margin was as follows for the six months ended March 31, 2018 and 2017:
 
 
2018
 
2017
 
Increase (decrease)
 
 
(Dollars in thousands)
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
Products
 
$
1,163

38
%
 
$
1,394

40
%
 
$
(231
)
 
(2
)%
Services
 
1,138

97
%
 
2,538

96
%
 
(1,400
)
 
1
 %
Total
 
$
2,301

54
%
 
$
3,932

64
%
 
$
(1,631
)
 
(10
)%

The overall HPP segment gross margin as a percentage of sales decreased to 54% for the period from 64% in the prior year period. The 10% decrease in gross margin as a percentage of sales in the HPP segment was primarily attributed to a decrease in Multicomputer high margin royalty revenues.

The impact of product mix within our TS segment on gross margin was as follows for the six months ended March 31, 2018 and 2017:
 
 
2018
 
2017
 
Increase
 
 
GM$
GM%
 
GM$
GM%
 
GM$
 
GM%
 
 
(Dollar amounts in thousands)
Products
 
$
4,075

15
%
 
$
3,825

13
%
 
$
250

 
2
%
Services
 
3,687

31
%
 
2,390

26
%
 
1,297

 
5
%
Total
 
$
7,762

20
%
 
$
6,215

16
%
 
$
1,547

 
4
%

     The gross margin as a percentage of sales for TS segment product revenues increased by 2% for the period primarily as a result of an increase in higher gross margin sales for our U.S. division. The 5% increase of gross margin as a percentage of the TS segment services sales is the result of increased margins in our U.K. division.

Engineering and Development Expenses
 
Engineering and development expenses increased by $0.3 million to $1.5 million for the six months ended March 31, 2018 as compared to $1.2 million for the six months ended March 31, 2017. The current period expenses were primarily for Myricom product engineering expenses incurred in connection with the development of the new Myricom ARIA security products. The increased engineering and development expenses for the six month period ended March 31, 2018 as compared to the six month period ended March 31, 2017 is primarily attributed to an increase in engineering headcount related expenses.
 
Selling, General and Administrative Expenses
 
The following table details our SG&A expense by operating segment for the six months ended March 31, 2018 and 2017:
 
For the six months ended March 31,
 
 
 
 
 
2018
 
% of
Total
 
2017
 
% of
Total
 
$ Increase (decrease)
 
% Increase (decrease)
 
(Dollar amounts in thousands)
By Operating Segment:
 
 
 
 
 
 
 
 
 
 
 
HPP segment
$
2,283

 
24
%
 
$
2,349

 
28
%
 
$
(66
)
 
(3
)%
TS segment
7,039

 
76
%
 
6,109

 
72
%
 
930

 
15
 %
Total
$
9,322

 
100
%
 
$
8,458

 
100
%
 
$
864

 
10
 %
     
SG&A expenses increased by $0.9 million, or 10%, for the six months ended March 31, 2018 as compared to the six months ended March 31, 2017. The $0.9 million, or 15%, increase in TS segment expenses is primarily attributed to increases in variable compensation in our U.S. division as a result of increased margins, and increases for sales and engineering hires in

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our U.S. division. The $0.1 million, or 3%, decrease in HPP segment expenses is primarily attributed to decreases in variable compensation and outside consulting costs.
  
Other Income/Expenses
 
The following table details our other income (expense) for the six months ended March 31, 2018 and 2017:
 
 
For the six months ended,
 
 
 
March 31, 2018
 
March 31, 2017
 
Increase (decrease)
 
(Amounts in thousands)
Interest expense
$
(36
)
 
$
(37
)
 
$
1

Interest income
9

 
5

 
4

Foreign exchange gain (loss)
(101
)
 
82

 
(183
)
Other income, net
24

 
11

 
13

Total other income (expense), net
$
(104
)
 
$
61

 
$
(165
)
 
The decrease to other income (expenses) for the six months ended March 31, 2018 as compared to the six months ended March 31, 2017 was primarily driven by the net change of approximately $0.2 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 six months ended March 31, 2018, the Company recognized an income tax expense of $974 thousand, which was primarily due to $1.1 million recorded in the first quarter for the Tax Act. The Tax Act required the Company to revalue its U.S. deferred tax assets and liabilities to the new rate in the Company's first quarter of 2018. The Company has recorded a provisional estimate for a one-time tax expense of $490 thousand, for the remeasurement of deferred tax assets and liabilities. The Tax Act also requires a mandatory deemed repatriation of undistributed foreign earnings and profits, at the rate of either 15.5% for cash or 8% for non-liquid assets. The Company has included a provisional estimate in the amount of $649 thousand related to the one-time deemed repatriation transition tax on unrepatriated foreign earnings. As noted, these expenses have been recorded discretely in the three months ended December 31, 2017. The provisional amount is based on information currently available, including estimated tax earnings and profits from foreign investments. The income tax provision for the current period is not comparable to the same period of the prior year due to the impact of the Tax Act, changes in pretax income over many jurisdictions, and the impact of discrete items. Generally, fluctuations in the effective tax rate are primarily due to changes in our geographic pretax income resulting from our business mix and changes in the tax impact of permanent differences, other special items, and other discrete tax items, which may have unique tax implications depending on the nature of the item.

Liquidity and Capital Resources
 
Our primary source of liquidity is our cash and cash equivalents, which decreased by $1.9 million to $12.0 million as of March 31, 2018 from $13.9 million as of September 30, 2017.
 
Significant sources of cash for the six months ended March 31, 2018 included a decrease in accounts receivable of $4.5 million, an increase in deferred revenues of $3.0 million, and a decrease in inventories of $1.0 million.

Significant uses of cash for the six months ended March 31, 2018 included a decrease in accounts payable and accrued expenses of $5.4 million, a decrease in deferred costs of $2.0 million, a net loss of $1.8 million, an increase in other current assets of $1.0 million, and dividends paid of $0.9 million.
 
Cash held by our foreign subsidiaries located in Germany and the United Kingdom totaled approximately $3.7 million as of March 31, 2018 as compared to $4.6 million as of September 30, 2017. This cash is included in our total cash and cash equivalents reported above.
 
If cash generated from operations is insufficient to satisfy working capital requirements, we may need to access funds through lines of credit, the equity markets, or other means. There is no assurance that we will be able to raise any such capital

23


on terms acceptable to us, on a timely basis or at all. If we are unable to secure additional financing, we may not be able to complete the development or enhancement of our products, take advantage of future opportunities, respond to competition or continue to effectively operate our business.
 
Based on our current plans and business conditions, management believes that the Company’s available cash and cash equivalents, the cash generated from operations and availability on our lines of credit will be sufficient to provide for the Company’s working capital and capital expenditure requirements for at least the next twelve months from the date of filing this Quarterly Report on Form 10-Q.

Item 4.          Controls and Procedures

Evaluation of Disclosure Controls and Procedures
 
The Company evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2018. Our Chief Executive Officer, our Chief Financial Officer and other members of our senior management team supervised and participated in this evaluation. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2018, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were not effective, due to the fact that we are not yet able to conclude that the material weakness described below in this Item 4 has been remediated by the changes we made in response to that material weakness.
 
As previously disclosed in Item 9A of our Annual Report on Form 10-K for the period ended September 30, 2017, our management identified a material weakness as of such date. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be able to be prevented or detected in a timely basis. The identified material weakness is in connection with our controls over the revenue recognition process at our foreign subsidiaries, specifically whether revenue recognition criteria have been satisfied prior to recognizing revenue and the failure to sufficiently assess gross versus net revenue indicators to certain revenue transactions. We determined that controls over the revenue recognition process were not operating effectively and the resulting control gap amounted to a material weakness in our controls over financial reporting.

During the periods following our initial identification of the material weakness referred to above, management assessed various alternatives to remediate this material weakness and we implemented changes to our system of internal controls, which included the implementation of enhanced internal auditing procedures, whereby revenue transactions are subjected to an additional review process at the corporate level to ensure the correct accounting methodology is applied to all revenue transactions.  During the three months ended March 31, 2018, management continued to take actions to improve accounting operations in our European divisions. Although we have implemented such changes to our internal controls over financial reporting as described above, at this time, we cannot conclude that the material weakness has been remediated and we will continue to evaluate personnel changes and upgrade systems and processes throughout fiscal year 2018 as necessary.
 
Changes in Internal Control over Financial Reporting.
 
During the three months ended March 31, 2018, management implemented process improvements in order to improve operations in our European division in connection with the identified material weakness noted above. During the three months ended March 31, 2018, there were no other changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


24


PART II.   OTHER INFORMATION

Item 6.           Exhibits
 
Number
 
Description
 
Rule 13(a)-14(a) / 15d-14(a) Certification of Chief Executive Officer
 
 
 
 
Rule 13(a)-14(a) / 15d-14(a) Certification of Chief Financial Officer
 
 
 
 
Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer
101*
 
Interactive Data Files regarding (a) our Consolidated Balance Sheets as of March 31, 2018 and September 30, 2017, (b) our Consolidated Statements of Income for the three and six months ended March, 31, 2018 and 2017, (c) our Consolidated Statements of Comprehensive Income for the three and six months ended March 31, 2018 and 2017, (d) our Consolidated Statement of Shareholders’ Equity for the six months ended March 31, 2018, (e) our Consolidated Statements of Cash Flows for the six months ended March 31, 2018 and 2017 and (f) the Notes to such Consolidated Financial Statements.

 
 
*Filed Herewith


25


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
CSP INC.
 
 
 
May 10, 2018
By:
/s/ Victor Dellovo
 
 
Victor Dellovo
 
 
Chief Executive Officer,
 
 
President and Director
 
 
 
May 10, 2018
By:
/s/ Gary W. Levine
 
 
Gary W. Levine
 
 
Chief Financial Officer


26


Exhibit Index

Number
 
Description
 
Rule 13(a)-14(a) / 15d-14(a) Certification of Chief Executive Officer
 
 
 
 
Rule 13(a)-14(a) / 15d-14(a) Certification of Chief Financial Officer
 
 
 
 
Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer
101*
 
Interactive Data Files regarding (a) our Consolidated Balance Sheets as of March 31, 2018 and September 30, 2017, (b) our Consolidated Statements of Income for the three and six months ended March 31, 2018 and 2017, (c) our Consolidated Statements of Comprehensive Income for the three and six months ended March 31, 2018 and 2017, (d) our Consolidated Statement of Shareholders’ Equity for the six months ended March 31, 2018 (e) our Consolidated Statements of Cash Flows for the six months ended March 31, 2018 and 2017 and (f) the Notes to such Consolidated Financial Statements.

 
*Filed Herewith

27