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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

 

EXCHANGE ACT OF 1934

 

 

 

For the Fiscal Year Ended September 30, 2019.

 

 

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 000‑10843

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, Lowell, Massachusetts 01854

(Address of principal executive offices)

(978) 954‑5038

(Registrant’s telephone number including area code)

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

 

 

 

Title of Each Class

    

Trading Symbol(s)

    

Name of each exchange on which registered

Common Stock, par value $0.01 per share

 

CSPI

 

Nasdaq Global Market

 

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes  ☐    No  ☒

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  ☒    No  ☐.

Indicate by check mark whether the registrant has submitted electronically 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 such files).   Yes  ☒    No  ☐.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K(§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10‑K or any amendment to this Form 10‑K. ☒

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   ☐

Accelerated filer   ☐

Non-accelerated filer   ☒

Smaller Reporting Company   ☒

 

Emerging Growth Company   ☐

 

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.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act).   Yes   ☐    No   ☒

 

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $40,671,108 based on the closing sale price of $11.15 as reported on the Nasdaq Global Market on March 29, 2019.

As of December 3, 2019, we had outstanding 4,153,742 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the information required in Part III of this Form 10‑K are incorporated by reference from our definitive proxy statement for our 2020 annual meeting of stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year ended September 30, 2019.

 

 

 

 

TABLE OF CONTENTS

 

 

 

 

 

Page

 

 

PART I. 

 

Item 1. 

Business

2

Item 1A. 

Risk Factors

11

Item 2. 

Properties

19

Item 3. 

Legal Proceedings

19

Item 4. 

Mine Safety Disclosures

19

 

 

 

PART II. 

 

 

Item 5. 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

20

Item 7. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

Item 8. 

Financial Statements and Supplementary Data

31

Item 9. 

Change in and Disagreements with Accountants on Accounting and Financial Disclosures

32

Item 9A. 

Controls and Procedures

32

Item 9B. 

Other Information

33

 

 

 

PART III. 

 

 

Item 10. 

Directors, Executive Officers and Corporate Governance

33

Item 11. 

Executive Compensation

33

Item 12. 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

33

Item 13. 

Certain Relationships and Related Transactions and Director Independence

34

Item 14. 

Principal Accountant Fees and Services

34

 

 

 

PART IV. 

 

 

Item 15. 

Exhibits and Financial Statement Schedules

34

Item 16. 

Form 10‑K Summary

36

 

Note: Items 1B, 6 and 7A are not required for Smaller Reporting Companies and therefore are not furnished.

 

 

 

i

Special Note Regarding Forward-Looking Statements

This annual report on Form 10‑K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. This information may involve known and unknown risks, uncertainties and other factors that are difficult to predict and may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any 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,” “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 be 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 this Annual Report.

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. We have based the forward-looking statements included in this annual report on Form 10‑K on information available to us on the date of this annual report, and we assume no obligation to update any such forward-looking statements, other than as required by law.

1

PART I

Item 1.     Business

CSP Inc. ("CSPi" or "CSPI" or "the Company" or "we" or "our") was incorporated in 1968 and is based in Lowell, Massachusetts. To meet the diverse requirements of our commercial and defense customers worldwide, CSPi and its subsidiaries develop and market IT integration solutions, advanced security products, managed IT services, cloud services, purpose built network adapters, and high-performance cluster computer systems.

On July 31, 2018, CSPi LTD sold all of the outstanding stock of Modcomp GmbH for $14.4 million cash, and recognized a gain of $16.8 million. The divestiture of our German operations and our increased cash position enables us to focus time and resources on our higher-margin and greater-potential growth opportunities.  We are encouraged by the traction of our managed services business in the U.S. and we intend to continue to invest and focus on our new ARIA SDS cyber security products and to capitalize on the proliferation of our wireless service business.

Segments

CSPI operates in two segments: Technology Solutions ("TS") and High Performance Products ("HPP").

TS Segment

The TS segment consists of our wholly-owned Modcomp subsidiary, which operates in the United States and the United Kingdom.

The TS segment generates product revenues by reselling third-party computer hardware and software as a value added reseller ("VAR"). The TS segment generates service revenues by the delivery of integration services for complex IT environments, including advanced security; unified communications and collaboration; wireless and mobility; data center solutions; and network solutions as well as managed IT services ("MSP") that primarily serve the small and mid-sized business market ("SMB").

Third party products and professional services are marketed and sold through the Company’s direct sales force into a variety of vertical markets, including; automotive; defense; health care; education; federal, state and local government; and maritime.

CSPi sold all of the outstanding stock of Modcomp GmbH to Reply AG on July 31, 2018 for total cash consideration of $14.4 million. CSPi recognized a one-time gain of $16.8 million. The Company determined the German subsidiary met the criteria for discontinued operations under ASC 205. The Consolidated Balance Sheets and Consolidated Statements of Operations reflect the results of Modcomp GmbH classified as discontinued operations at and as of September 30, 2018. See Note 2 to the consolidated financial statements for additional information.

HPP Segment

·

The HPP segment revenue comes from four distinct product lines: (i) a cybersecurity solution marketed as ARIA™ Software-Defined Security (“SDS”), which is offered to commercial, original equipment manufacturers ("OEM") and government customers; (ii) the Myricom® network adapters for commercial, government and OEM customers;  (iii) the ARIA nVoy Series of appliances for Managed Security Service Providers (“MSSPs”) and end-user customers; and (iv) the legacy Multicomputer product portfolio for digital signal processing ("DSP") applications within the defense markets.

 

·

The ARIA SDS solution is a software portfolio starting with the underlying  platform (orchestrator, light-weight instances), and hosted applications, as well as supporting hardware (turn-key security appliances), all developed to secure an organization’s network, enterprise-wide, to better protect critical devices, applications and high-

2

value data, such as personally identifiable information ("PII"), from breaches. Revenue will come from the sale of licenses of our software platform components, hosted applications, turnkey appliances and the required support packages.  The software licenses are renewable on an annual basis. The ARIA SDS platform and applications can be deployed on our separately sold Myricom adapters that can be deployed within our customers servers, or via our turn-key appliances that can be deployed in data centers or within the customers network to provide network security services.  Alternatively, with future releases, organizations will be able deploy ARIA SDS on cloud infrastructure as a service to protect this portion of their IT environment. We had our first sale in the last half of fiscal year 2019 and the pipeline has started to build up for fiscal year 2020. We expect to have additional revenue starting in the second quarter of fiscal year 2020, which we expect will increase throughout the year.

 

·

We anticipate that the ARIA SDS portfolio will be of value to regulated industries, such as financial services or healthcare, due to the rise of data-privacy regulations enforced at the federal, U.S. state, and international level, as well as industry entities. We also believe the unique, patent-pending approach will be attractive to managed security services providers (MSSP) and OEMs that pursue differentiated security services for their customers. While our initial offerings of the ARIA SDS portfolio are available now, the number of offerings will continue to expand over time. 

 

·

The Myricom network adapters (ARC Series and SIA) are optimized for and sold into markets that require high bandwidth and low latency including (i) packet capture, (ii) financial transactions, and (iii) storage interconnect. And with our SIA organizations that require advanced security features added to their production server deployments. Our primary customers for packet capture include government agencies that need to capture, inject, and analyze network traffic at line rate, and OEMs selling into vendors of computer security appliances. Financial institutions, such as banks, and brokerage firms use Myricom adapters to decrease transaction times. Our storage interconnect customers, primarily in the film industry, use our adapters for video capture and film editing.  Organizations that run advanced network security features benefit from the ability to run such applications safely on our adapter preserving server performance for production applications.

 

·

The nVoy Series of appliances (Packet Recorder and Packet Broker) can be deployed as part of an organization’s data security structure as a new component to complement existing systems and provides data breach verification and notification as well as compliance reporting. The primary customers will be OEMs or MSSPs that are looking to expand their product and services offerings of industry regulation compliance and breach response solutions.

 

·

Multicomputer products for DSP applications are no longer being actively developed but will continue to be sold for deployment and supported for several years. Revenue flows come from servicing previously deployed products for a modest number of existing high-value defense customers. Therefore, the revenue from these products, as a percentage of overall Company revenue, is expected to decline over time.

 

Sales Information by Industry Segment

The following table details our sales by operating segment for fiscal years ending September 30, 2019 and 2018. Additional segment and geographical information is set forth in Note 18  to the consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

Segment

    

2019

    

%

    

2018

    

%

 

 

 

(Dollar amounts in thousands)

 

TS

 

$

71,159

 

90

%  

$

62,437

 

86

%

HPP

 

 

7,902

 

10

%  

 

10,479

 

14

%

Total Sales

 

$

79,061

 

100

%  

$

72,916

 

100

%

 

3

TS Segment

Products and Services

Integration Solutions

In the TS segment, we focus on value-added reseller ("VAR") integrated solutions including third-party hardware, software and technical computer-related consulting services and managed services. Our value proposition is our ability to integrate diverse third-party components together into a complete solution to install the system at the customer site and to offer high value IT consulting services to deliver solutions.

Third-Party Hardware and Software

We sell third-party hardware and software products in the information technology market, with a strategic focus on industry standard servers and data center infrastructure solutions, midrange data storage infrastructure products, network products, unified communications, and IT security hardware and software solutions. Our key offerings include products from HPE/Aruba, Cisco Systems, Palo Alto Networks, DellEMC, Juniper Networks, Citrix, Intel, VMWare, Fortinet, Microsoft and Checkpoint. Through our business relationships with these vendors, we are able to offer competitively priced robust products to meet our customers’ diverse technology needs, providing procurement and engineering expertise in server infrastructure, storage, security, unified communications and networking, to the small-to-medium sized businesses ("SMBs") and large enterprise businesses ("LEBs") with complex IT environments. We offer our customers a single point of contact for complex multi-vendor technology purchases. Many of our SMB customers have unique technology needs and may lack technical purchasing expertise or have very limited IT engineering resources on staff. We also provide installation, integration, logistical assistance and other value-added services that customers may require. Our current customers are in web and infrastructure hosting, education, telecommunications, healthcare services, distribution, financial services, professional services and manufacturing. We target SMBs and LEB customers across all industries.

Professional Services

We provide professional IT consulting services in the following areas:

·

Implementation, integration, migration, configuration, installation services and project management.

·

Hyper-Converged Infrastructure ("HCI") - We assist our clients with designing and implementing HCI solutions from multiple vendors including DellEMC, Nutanix, HPE and Cisco. HCI is a software-centric architecture that tightly integrates compute, storage and virtualization resources in a single system. The benefits of an HCI solution are improved performance, scalability and flexibility all in a reduced footprint.

·

Virtualization - We help our customers implement virtualization solutions using products from companies such as VMWare and Citrix that allow one computer to do the job of multiple computers by sharing resources of a single computer across multiple environments. Virtualization eliminates physical and geographical limitations and enables users to host multiple operating systems and applications on fewer servers. Benefits include energy cost savings, lower capital expenditure requirements, high availability of resources, better desktop management, increased security and improved disaster recovery.

·

Enterprise security intrusion prevention, network access control and unified threat management. Using third-party products from companies like Palo Alto, Aruba Networks, Juniper Networks, Fortinet, Checkpoint and Cisco Systems, our services are designed to ensure data security and integrity through the establishment of virtual private networks, firewalls and other technologies.

·

IT security compliance services. We provide services for IT security compliance with personal privacy laws such as the Payment Card Industry Data Security Standard ("PCI DSS"), the Health Insurance Portability and

4

Accountability Act of 1996 ("HIPAA"), and internal control regulations under the Sarbanes-Oxley Act ("SOX").

·

Unified communications, wireless and routing and switching solutions using Cisco Systems and Aruba Networks products and services.

·

Custom software applications and solutions development and support. We develop custom applications to customer specifications using industry standard platforms such as Microsoft.Net, SharePoint and OnBase. We are a Microsoft Gold Partner.

·

Managed IT services that include monitoring, reporting and management of alerts for the resolution and preventive general IT and IT security support tasks.

·

Maintenance and technical support for third-party products including hardware and software, operating system and user support.

Managed and Cloud Services

As consumption models continue to evolve in our industry, we have developed a robust managed & cloud services offering to provide alternative solutions to traditional capital expenditure investments in IT solutions and IT operations for our clients. Our value is to provide an elastic offering that will allow the client to scale and consume these offerings with monthly billing options that help control costs and provide economies of scale.

We provide managed and cloud services in the following areas:

·

Proactive monitoring and remote management of IT Infrastructure that includes network (both wired and wireless), data center (which includes compute, storage and virtualization), desktops, unified communications platforms and security.

·

Managed and Hosted Unified Communication as a Service via a  Cisco Collaboration offering under an annuity program.

·

Managed Security (firewall, endpoint protection, malware, anti-virus and SIEM).

·

Managed BackUp and Replication.

·

Cloud services that include Microsoft Office 365, Azure, Greencloud and Amazon Web Services.

Markets, Marketing and Dependence on Certain Customers

We are an IT systems integrator and computer hardware and software VAR. We also provide technical services to achieve a value-add to our customers. We operate within the VAR sales channels of major computer hardware and software OEMs, primarily within the geographic areas of our sales offices and across the U.S. We provide innovative IT solutions, including a myriad of infrastructure products with customized integration consulting services and managed services to meet the unique requirements of our customers. We market the products and services we sell through sales offices in the U.S. and the U.K. using our direct sales force.

Competition

Our primary competition in the TS segment is other VARs ranging from small companies that number in the thousands, to large enterprises such as CDW, PC Connection, Insight, Presidio, Dimension Data, and Computacenter Limited. In addition, we compete directly with many of the companies that manufacture the third-party products we sell, including Cisco Systems, IBM, Hewlett Packard (HPE), EMC (now part of Dell) and others. In the network

5

management, security and storage systems integration services business, our competitors are extensive and vary to a certain degree in each of the geographical markets, but they also include such national competitors as HP/EDS, IBM and Cap Gemini.

Nearly all of our product offerings are available through other channels. Favorable competitive factors for the TS segment include procurement capability, product diversity which enables the delivery of complete and custom solutions to our customers and the strength of our key business relationships with the major IT OEMs. We also consider our ability to meet the unique and/or specialized needs of the SMB and LEB markets and our strong knowledge of the IT products that we sell to be a key competitive advantage. Our ability to provide managed services through our network operations center and the professional IT services required to design and install custom IT solutions to address our customers' IT needs are distinct competitive advantages. Unfavorable competitive factors include low name recognition, limited geographic coverage and pricing.

Backlog

The backlog of customer orders and contracts for the TS segment was approximately $4.0 million at September 30, 2019, as compared to $7.2 million at September 30, 2018. Our backlog can fluctuate greatly. These fluctuations can be due to the timing of receiving large orders for third-party products and/or IT services. It is expected that all of the customer orders in backlog will ship and/or be provided during fiscal year 2020.

HPP Segment

Products and Services

The mission of the HPP team is to deliver a differentiated, smarter approach to cybersecurity. Our software-defined platform makes it easier for organizations to achieve enterprise-wide network security and protection of critical assets, applications and devices by improving their network visibility capabilities and accelerating their incident response.

 

Products

The ARIA SDS solution will give organizations an automated, central, and coordinated way to accelerate cyber threat detection and response, implement and enforce security polices, control which applications can access critical assets, and to protect applications and the associated data. The ARIA Orchestrator ("SDSo") and instances ("SDSi"), provide the foundation of the ARIA platform, so that a series of lightweight advanced security applications can be deployed, provisioned and managed uniformly across any sized organization.

 

These instances can be deployed in a variety of scenarios including bare metal servers, virtual machines ("VMs"), and container-based compute environments. The ARIA SDSo will automatically detect any instances and will programmatically execute the specified applications security feature set strengthening an organization's security posture.

 

For customers that desire a turnkey solution, a bundled offering can be created for deployment and opens the possibility for professional services and integration services offerings to our channel.

 

ARIA SDS APPLICATIONS

The deployment of hosted applications bring life to the ARIA SDS platform.  Application availability will expand over time as new products are released. However, the current offerings we believe have significant market potential.

 

1) ARIA SDS Packet Intelligence: The ARIA Packet Intelligence ("PI") application directs all of an organization’s network traffic to existing intrusion detection systems (“IDS”) security tools such as security information and event management solutions ("SIEMs"), user and entity behavior analytics ("UEBA"), or network intrusion protection systems ("NIPS” or “IPS"), and making these tools more effective at detecting network-born threats.

 

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The ARIA PI application will be available as licensed functionality within a low-cost high-availability ("HA") security appliance, or probe, that taps into an organization’s network infrastructure, as well as on the Myricom Secure Intelligent Adapter ("SIA"). The probe will be able to mine data at 10-25G line rates and perform remedial actions to stop threats on a per-traffic stream basis while minimizing impact on network traffic performance. Built-in APIs allow compatible 3rd party threat detection tools to take actions to stop detected threats. It is our belief that competing solutions currently do not provide this mix and level of capability. We will be able to provide a packaged solution by installing 3rd party IPS/IDS applications, onto ARIA hardware appliances that run alongside and are fed by ARIA SDS applications, such as Packet Intelligence. The ARIA PI application will be able to improve IPS or IDS performance by preprocessing the data feeds, allowing such solutions to run effectively at higher line rates.

 

2) ARIA SDS Packet Capture: Our Sniffer10G ("SNF") software is used by intelligence agencies for packet capture, network surveillance applications, and to perform detailed cyber-threat analysis. It’s a recommended solution to increase the Zeek IDS (formerly known as Bro) to support 10G line rates rather than the standard 1G. With the introduction of ARIA SDS and the Myricom SIA, SNF will be upgraded to support a 25G line-rate. When used in conjunction with the Packet Intelligence application, the SNF application can provide the details required to determine the exact type of threat and/or identify the compromised data records.

 

3) ARIA SDS KMS (Key Management Server): The ARIA KMS application will make it easier to add encryption and decryption capabilities to applications which leverage a standards-based key management interoperability protocol ("KMIP") client. For example, each of VMware’s vSphere and vSAN instances leverage a KMIP client to encrypt their application data output. As such, they need to be fed KMIP compatible keys to perform encryption. Depending upon the size of the environment, this could require hundreds of keys per minute. Our KMS key management server solution provides such KMIP keys securely and rapidly at scale while ensuring that the key servers are highly available at all times. Our application was designed to solve the deployment complexity challenges currently associated with key management.

 

4) ARIA AIR (Automated Investigative Response) The ARIA AIR and Packet Recorder applications will make it easier to detect data breaches and exfiltrated data from critical data applications. Used in conjunction with threat intelligence tools which will alert if an internal system is accessing a bad site, we ingest the alert use it to trigger a search our recordings of the traffic flowing from the critical applications to determine if there is a match. This indicates a breach and provides a record of all the records that have been exfiltrated.

 

MYRICOM NETWORK ADAPTERS

 

Myricom ARC Series product line includes a portfolio of Ethernet adapters and specialized software, which is branded as DBL for financial institutions and Sniffer10G ("SNF") for network monitoring. Both are compatible with Linux, Windows, Mac OS X, and VMware ESX. Our adapters act as stand-alone Network Interface Cards ("NIC”) and support purpose-built for applications that provide high bandwidth, low latency and line-rate packet capture, and processing off load for high-frequency financial trading and network traffic analysis applications.

Myricom Secure Intelligent Adapter ("SIA") is our next-generation adapter and will provide additional compute capabilities and specialized hardware to run the ARIA SDS platform and applications. A 25G version of SNF is being developed to deliver higher line rates as required by enterprise and government customers. This will also let these organizations achieve lossless packet capture and packet inspection, which is required for network surveillance use cases and tools, such as lawful intercept, deep packet inspection, forensic tools, and threat detection applications. Other customers for the SIA include OEMs and MSSP partners to run their own applications upon.

 

ARIA SECURITY APPLIANCES

 

ARIA Security Appliances provides a standalone solution that can be either deployed in line to provide network security or within a data center to provide security services. These appliances are built with one or multiple built in SIA adapters. This allows for broader options to deploy our services in a turnkey fashion.

 

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nVoy Series is comprised of a 100G Packet Broker and a 10G Packet Recorder appliance optimized to run our ARIA software. These tools assist customers in the deployment of our ARIA solution into higher speed networks, as well as provide the compute and storage intensive functions needs to provide some of our services such as Packet recording.

 

MULTICOMPUTER PRODUCTS

 

Multicomputer products portfolio includes the 2000 SERIES VME and 3000 SERIES VXS systems. The 2000 SERIES products, based on PowerPC RISC processors with AltiVec™ technology, high-speed memory, and Myrinet-2000™ cluster interconnect, are currently is use by customers in the aerospace, commercial, and defense markets. The 3000 SERIES VXS product line, incorporating the Freescale QorIQ PowerPC processors with AltiVec technology, targets high-performance DSP, signal intelligence ("SIGINT"), and radar and sonar applications in airborne, shipboard, and unmanned aerial vehicle ("UAV") platforms where space, power, and cooling are at a premium. The HPP segment will continue to ship and repair existing Multicomputer products to its customer base and support an installed base of DSP systems.

 

Royalties on Multicomputer products

 

We license the design of certain 2000 SERIES computer processor boards and switch interconnect technology to third parties. In exchange for licensing this technology, we receive a royalty payment for each processor board that utilizes our design for these products.

 

Markets, Marketing and Dependence on Certain Customers

 

Aerospace & Defense Market

 

Our focus for fiscal 2020 and beyond is to continue our support of established Multicomputer and Myricom products allowing system deployments to be made by government entities. These programs have support requirements that often extend beyond twenty years.

 

Financial Transactions Market

 

Myricom network adapters with DBL application software address the need for the ultra-low latency required in the world of financial trading. Running DBL on the Myricom ARC Series provides acceleration for 10G Ethernet environments, with benchmarked application-to-application latency in the single digit microsecond range for Linux and Microsoft Windows operating systems.

 

Packet Capture Market

 

Myricom Sniffer10G, and in development, the 25G software, running on Myricom Ethernet adapters, provides enterprise and government customers and partners the ability to capture, inject, and analyze network traffic at line rate for all Ethernet packet sizes, with low-cost CPU overhead. Sniffer10G serves the following market segments: network surveillance, monitoring and analysis, testing, measurement, and packet generation, as well as a technology component within intrusion detection systems ("IDS"), forensic tools, and threat detection and response solutions.

 

Storage Interconnect Market

 

Myricom ARC Series network adapters are used in a wide range of networked applications, including those that connect to storage subsystems using Ethernet. Many of these customers are using content-creation applications requiring high-performance networking from the storage system to video-editing workstations.

 

 

 

 

8

Cyber Security Products Market

 

The ARIA SDS solution is targeted at organizations that need to get additional functionality out of their current cyber security solutions to find and stop intrusion threats, while also reducing their operating costs. While our ARIA SDS solutions will be offered through our direct sales channel, it is more likely that sales will come through via independent software vendor channels to the end customers. These value added resellers will find ARIA appealing to expand their portfolio of security products and services and replace less-effective tools and processes in their customer environments.

 

OEMs in the cyber security segments will be candidates for ARIA SDS deployments. These vendors can benefit from integrating the ARIA applications as internal solution toolsets to allow their application to scale, add critical functionality, or solve particular problems, such as poor performance. OEMs are interested in the Myricom Adapters including our SIA running our ARIA SDS applications, for use as Smart NICs within their appliances. We believe this will be a large growing market we can participate in in the coming years.

 

Another target for the ARIA solution will be the managed security services providers, as these providers’ desire simple, yet differentiated, solutions that can be deployed across their customer bases. The orchestration and automation capabilities found in ARIA SDS are valuable as they allow these security service providers to scale their offerings while increasing the productivity of their security operation center staff.

 

Competition

 

CSPi’s competition in the cybersecurity space comes primarily from the large, traditional security vendors like Dell, IBM, and Intel. Due to the ARIA’s approach to network and data security, we also face competition from traditional security tools and current approaches to finding network based attacks. The competition includes common firewall manufacturers with broad portfolios such as Palo Alto or Cisco, and in the case of data packet brokers, Gigamon and Ixia. Competitors for ARIA SDS encryption include applications and appliances provided by Thales, HPE’s Voltaic group, and other smaller market players.

 

In the crowded security products market, our history of supporting defense and government military programs, strong security application expertise, and the ability to develop optimized products for OEMs will help set us apart. However, we must continually develop new features and solutions to stay abreast of evolving customer requirements and leverage advances in technology. One example is Intel’s chip-level roadmap that may provide additional functionality for our ARIA SDS solution but our competitors could also attempt to leverage this. Some of these competitors may also be potential go-to-market partners or OEM customers looking to integrate our capabilities within their products and solutions.

 

Customers who need a combination of advanced data protection features and who require optimized application performance are best suited to the ARIA solution. Security adapter products will also leverage previous generation Myricom ARC Series network adapter capabilities that include advanced filtering, support for kernel bypass technologies, lossless packet capture, and precision time stamping. These new capabilities will offer a variety of security service combinations that our customers can put to use.

 

Manufacturing, Assembly and Testing

 

Currently, all Multicomputer products are shipped to our customers directly from our plant in Lowell, Massachusetts. Our manufacturing activities consist mainly of final assembly and testing of printed circuit boards and systems that are designed by us and fabricated by outside third-party vendors.

 

Upon our receipt of material and components from outside suppliers, our quality assurance technicians inspect these products and components. During manufacture and assembly, both sub-assemblies and completed systems are subjected to extensive testing, including burn-in and environmental stress screening designed to minimize equipment failure at delivery and over the useful service life of the system. We also use diagnostic programs to detect and isolate

9

potential component failures. A comprehensive log is maintained of past failures to monitor the ongoing reliability of our products and improve design standards.

 

Currently, Myricom products, including the nVoy appliances and Myricom network adapters, are shipped to our customers directly from our plant in Lowell, Massachusetts. The packet recorder and packet broker appliances are sourced from third-party partners, integrated with CSPi software and resold under the CSPi brand. Our network adapters are designed in-house and fabricated by outside third party vendors. Material and components received from outside suppliers are inspected by our quality assurance technicians.

 

The ARIA SDS solution (platform and applications) will be downloaded and licensed from servers or content-delivery services directly controlled by CSPi. The ARIA software can be sold in conjunction with the Myricom SIA, or our appliances, which may be preloaded with the appropriate images. Licensing will be handled by the ARIA SDSo which will be accessible by CSPi’s licensing severs to allow proper flexible services feature set activation and payment.

 

We provide a warranty covering defects arising from the sale of Multicomputer and Myricom products, which varies from 90 days to three years, depending upon the particular unit in question.

 

Sources and Availability of Raw Materials

 

Several components used in our HPP segment products are obtained from sole-source suppliers. We are dependent on key vendors such as Xilinx or NXP for a variety of processors for certain products and Wind River Systems, Inc. for VxWorks operating system software. Despite our dependence on these sole-source suppliers, based on our current forecast and our projected sales obligations, we believe we have adequate inventory on hand and our current near-term requirements can be met in the existing supply chain.

 

Research and Development

For the year ended September 30, 2019, our expenses for R&D were approximately $2.8 million compared to approximately $3.3 million for fiscal year 2018. Expenditures for R&D are expensed as they are incurred. Product development efforts in fiscal year 2019 involved development of the ARIA SDS product set, and enhancements to our Myricom products, in which we expect to continue to make investments related to the development of new hardware adapter products and the ARIA SDS software that enables the hardware to meet the needs of specific applications. Our current R&D plan is intended to extend the usefulness and marketability of these products by adding features and capabilities to meet the needs of our markets.

Intellectual Property

We rely on a combination of trademark and trade secret laws in the United States and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property rights. We have two pending patents for the ARIA SDS software and will be pursuing additional patent rights over time.

 

Backlog

The backlog of customer orders and contracts in the HPP segment was approximately $0.5 million at September 30, 2019 as compared to $1.0 million at September 30, 2018. Our backlog can fluctuate greatly. These possible large fluctuations can be due to the timing of receipt of large orders often for purchases from prime contractors for sales to the government. It is expected that all of the customer orders in backlog will ship within the next twelve months from September 30, 2019.

 

10

Significant Customers

See Note 18 in the notes to the consolidated financial statements for detailed information regarding customers which comprised 10% or more of consolidated revenues for the years ended September 30, 2019 and 2018.

Employees

As of September 30, 2019, we had approximately 114 full time equivalent employees worldwide for our consolidated operations. None of our employees are represented by a labor union and we have had no work stoppages in the last three fiscal years. We consider relations with our employees to be good.

Company Website

The Company’s internet address is http://www.cspi.com. Through that address, the Company’s Annual Report on Form 10‑K, quarterly reports on Form 10‑Q, current reports on Form 8‑K and amendments to those reports are available free of charge as soon as reasonably practicable after they are filed with the United States Securities and Exchange Commission (Securities and Exchange Commission or Commission). The information contained on the Company’s website is not included in, nor incorporated by reference into, this annual report on Form 10‑K.

Financial Information about Geographic Areas

Information regarding our sales by geographic area and percentage of sales based on the location to which the products are shipped or services rendered are in Note 18 of the notes to the consolidated financial statements.

Item 1A.     Risk Factors

If any of the risks and uncertainties set forth below actually materialize, our business, financial condition and/or results of operations could be materially and adversely affected, the trading price of our common stock could decline and a stockholder could lose all or part of its, his or her investment. The risks and uncertainties set forth below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations.

We depend on a small number of customers for a significant portion of our revenue and loss of any customer could significantly affect our business.

Both the HPP and TS segments are reliant upon a small number of significant customers, and the loss of or significant reduction in sales to any one of which could have a material adverse effect on our business.  For the fiscal year ended September 30, 2019, one customer accounted for approximately $10.2 million in revenue, or 13% of our total revenues for the fiscal year. In addition, our revenues are largely dependent upon the ability of our customers to continue to grow or need services or to develop and sell products that incorporate our products. No assurance can be given that our customers will not experience financial or other difficulties that could adversely affect their operations and, in turn, our results of operations.

We depend on key personnel and skilled employees and face competition in hiring and retaining qualified employees.

We are largely dependent upon the skills and efforts of our senior management, managerial, sales and technical employees.  None of our senior management personnel or other key employees are subject to any employment contracts except Victor Dellovo, our Chief Executive Officer and President.  The loss of services of any of our executives or other key personnel could have a material adverse effect on our business, financial condition and results of operations.  Our future success will depend to a significant extent on our ability to attract, train, motivate and retain highly skilled technical professionals.  Our ability to maintain and renew existing engagements and obtain new business depends, in large part, on our ability to hire and retain technical personnel with the skills that keep pace with continuing changes in our industry standards and technologies.  The inability to hire additional qualified personnel could impair our ability to

11

satisfy or grow our client base.  There can be no assurance that we will be successful in retaining current or future employees.

Our success depends in part on our timely introduction of new products and technologies and our results can be impacted by the effectiveness of our significant investments in new products and technologies

We have made significant investments in our Aria SDS cyber security products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for Aria products, services, and technologies. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses may not be as high as the margins we have experienced historically. Developing new technologies and products is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue.

We depend on contracts with the federal government, primarily with the Department of Defense ("DoD"), for a significant portion of our revenue, and our business could be seriously harmed if the government significantly decreased or ceased doing business with us.

We derived 4% of our total revenue in fiscal year 2019 and 6% of our total revenue in fiscal year 2018 from the DoD as a subcontractor.  We expect that the DoD contracts will continue to be important to our business for the foreseeable future.  If we were suspended or debarred from contracting with the federal government generally, the General Services Administration, or any significant agency in the intelligence community or the DoD,  if our reputation or relationship with government agencies were to be impaired, or if the government otherwise ceased doing business with us or significantly decreased the amount of business it does with us, our business, prospects, financial condition and operating results would be materially and adversely affected.

To be successful, we must respond to the rapid changes in technology.  If we are unable to do so on a timely basis our business could be materially adversely affected.

Our future success will depend in large part on our ability to enhance our current products and to develop new commercial products on a timely and cost-effective basis in order to respond to technological developments and changing customer needs.  The design-in process is typically lengthy and expensive and there can be no assurance that we will be able to continue to meet the product specifications of our customers in a timely and adequate manner.  In addition, if we fail to anticipate or to respond adequately to changes in technology and customer preferences, or if there is any significant delay in product developments or introductions, this could have a material adverse effect on our business, financial condition and results of operations, including the risk of inventory obsolescence.  Because of the complexity of our products, we have experienced delays from time to time in completing products on a timely basis.  If we are unable to design, develop or introduce competitive new products on a timely basis, our future operating results would be adversely affected, particularly in our HPP segment.  There can be no assurance that we will be successful in developing new products or enhancing our existing products on a timely or cost-effective basis, or that such new products or product enhancements will achieve market acceptance.

We rely on single sources for supply of certain components and our business may be seriously harmed if our supply of any of these components or other components is disrupted.

Several components used in our HPP products are currently obtained from sole-source suppliers. We are dependent on key vendors like Mellanox Technologies for our high-speed interconnect components.  Generally, suppliers may terminate our purchase orders without cause upon 30 days’ notice and may cease offering products to us upon 180 days’ notice. Although we do not consider the risk of interruption of supply to be a significant risk in the near term, if in the future, Mellanox Technologies were to limit or reduce the sale of such components to us, or if these or other

12

component suppliers, some of which are small companies, were to experience future financial difficulties or other problems which could prevent them from supplying the necessary components, such events could have a material adverse effect on our business, financial condition and results of operations. These sole source and other suppliers are each subject to quality and performance risks, materials shortages, excess demand, reduction in capacity and other factors that may disrupt the flow of goods to us or our customers, which thereby may adversely affect our business and customer relationships.

We have no guaranteed supply arrangements with our suppliers and there can be no assurance that our suppliers will continue to meet our requirements. If our supply arrangements are interrupted, there can be no assurance that we would be able to find another supplier on a timely or satisfactory basis. Any shortage or interruption in the supply of any of the components used in our products, or the inability to procure these components from alternate sources on acceptable terms, could have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that severe shortages of components will not occur in the future. Such shortages could increase the cost or delay the shipment of our products, which could have a material adverse effect on our business, financial condition and results of operations. Significant increases in the prices of these components would also materially adversely affect our financial performance since we may not be able to adjust product pricing to reflect the increase in component costs. We could incur set-up costs and delays in manufacturing should it become necessary to replace any key vendors due to work stoppages, shipping delays, financial difficulties or other factors and, under certain circumstances, these costs and delays could have a material adverse effect on our business, financial condition and results of operations.

Our international operation is subject to a number of risks.

We market and sell our products in certain international markets and we have established operations in the U.K.  The sale of our German operation in fiscal year 2018 is treated as discontinued operations in our 2018 financial statements.  Foreign-based revenue is determined based on the location to which the product is shipped or services are rendered and represented 8% and 17% of our total revenue for the fiscal years ended September 30, 2019 and 2018, respectively.  If revenues generated by foreign activities are not adequate to offset the expense of establishing and maintaining these foreign activities, our business, financial condition and results of operations could be materially adversely affected.  In addition, there are certain risks inherent in transacting business internationally, such as changes in applicable laws and regulatory requirements, export and import restrictions, export controls relating to technology, tariffs and other trade barriers, longer payment cycles, problems in collecting accounts receivable, political instability, fluctuations in currency exchange rates, expatriation controls and potential adverse tax consequences, any of which could adversely impact the success of our international activities.  In particular, it is possible activity in the United Kingdom and the rest of Europe will be adversely impacted and that we will face increased regulatory and legal complexities, including those related to tax, trade, and employee relations as a result of Brexit.  A portion of our revenues are from sales to foreign entities, including foreign governments, which are primarily paid in the form of foreign currencies.  There can be no assurance that one or more of such factors will not have a material adverse effect on our future international activities and, consequently, on our business, financial condition or results of operations.

Systems failures may disrupt our business and have an adverse effect on our results of operations.

Any systems failures, including network, software or hardware failures, whether caused by us, a third party service provider, unauthorized intruders and hackers, computer viruses, natural disasters, power shortages or terrorist attacks, could cause loss of data or interruptions or delays in our business or that of our clients and reputational harm as a security provider.  Like other companies, we have experienced cyber security threats to our data and systems, our company sensitive information, and our information technology infrastructure, including malware and computer virus attacks, unauthorized access, systems failures and temporary disruptions.  We may experience similar security threats at customer sites that we operate and manage as a contractual requirement.  Prior cyber attacks directed at us have not had a material adverse impact on our business or our financial results, and we believe that our continuing commitment toward threat detection and mitigation processes and procedures will avoid such impact in the future.  Due to the evolving nature of these security threats, however, the impact of any future incident cannot be predicted.

13

In addition, the failure or disruption of our email, communications or utilities could cause us to interrupt or suspend our operations or otherwise harm our business.  Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption and, as a result, our actual results could differ materially and adversely from those anticipated.

The systems and networks that we maintain for our clients, although highly redundant in their design, could also fail.  If a system or network we maintain were to fail or experience service interruptions, we might experience loss of revenue or face claims for damages or contract termination.  Our errors and omissions liability insurance may be inadequate to compensate us for all the damages that we might incur and, as a result, our actual results could differ materially and adversely from those anticipated.

We face competition that could adversely affect our sales and profitability.

The markets for our products are highly competitive and are characterized by rapidly changing technology, frequent product performance improvements and evolving industry standards.   Many of our competitors are substantially larger than we are and have greater access to capital and human resources and in many cases price their products and services less than ours.  In addition, due to the rapidly changing nature of technology, new competitors may emerge.  Competitors may be able to offer more attractive pricing or develop products that could offer performance features that are superior to our products, resulting in reduced demand for our products.  Such competitors could have a negative impact on our ability to win future business opportunities.  There can be no assurance that a new competitor will not attempt to penetrate the various markets for our products and services.  Their entry into markets historically targeted by us could have a material adverse effect on our business, financial condition and results of operations.

Our business could be adversely affected by changes in budgetary priorities of the federal government.

Because we derive a significant percentage of our revenue from contracts with the federal government, changes in federal government budgetary priorities could directly affect our financial performance.  A significant decline in government expenditures, a shift of expenditures away from programs that we support or a change in federal government contracting policies could cause federal government agencies to reduce their purchases under contracts, to exercise their right to terminate contracts at any time without penalty or not to exercise options to renew contracts.

In years when Congress does not complete its budget process before the end of its fiscal year  (September 30), government operations are funded through a continuing resolution ("CR") that temporarily funds federal agencies.  Recent CRs have generally provided funding at the levels provided in the previous fiscal year and have not authorized new spending initiatives.  When the federal government operates under a CR, delays can occur in the procurement of products and services.  Historically, such delays have not had a material effect on our business; however, should funding of the federal government by CR be prolonged or extended, it could have significant consequences to our business and our industry.

Additionally, our business could be seriously affected if changes in DoD priorities reduces the demand for our services on contracts supporting some operations and maintenance activities or if we experience an increase in set-asides for small businesses, which could result in our inability to compete directly for contracts.

U.S. Federal government contracts contain numerous provisions that are unfavorable to us.

U.S. Federal government contracts contain provisions and are subject to laws and regulations that give the government rights and remedies, some of which are not typically found in commercial contracts, including allowing the government to:

·

cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable;

·

claim rights in systems and software developed by us;

14

·

suspend or debar us from doing business with the federal government or with a governmental agency;

·

impose fines and penalties and subject us to criminal prosecution; and

·

control or prohibit the export of our data and technology.

If the government terminates a contract for convenience, we may recover only our incurred or committed costs, settlement expenses and profit on work completed prior to the termination.  If the government terminates a contract for default, we may be unable to recover even those amounts, and instead may be liable for excess costs incurred by the government in procuring undelivered items and services from another source.  Depending on the value of a contract, such termination could cause our actual results to differ materially and adversely from those anticipated.

As is common with government contractors, we have experienced and continue to experience occasional performance issues under certain of our contracts.  Depending upon the value of the matters affected, a performance problem that impacts our performance of a program or contract could cause our actual results to differ materially and adversely from those anticipated.

We may be unsuccessful in protecting our intellectual property rights which could result in the loss of a competitive advantage.

Our ability to compete effectively against other companies in our industry depends, in part, on our ability to protect our current and future proprietary technology under patent, copyright, trademark, trade secret and unfair competition laws. We cannot assure that our means of protecting our proprietary rights in the United States or abroad will be adequate, or that others will not develop technologies similar or superior to our technology or design around our proprietary rights. In addition, we may incur substantial costs in attempting to protect our proprietary rights.

Also, despite the steps taken by us to protect our proprietary rights, it may be possible for unauthorized third parties to copy or reverse-engineer aspects of our products develop similar technology independently or otherwise obtain and use information that we regard as proprietary and we may be unable to successfully identify or prosecute unauthorized uses of our technology.  Furthermore, with respect to our issued patents and patent applications, we cannot assure that patents from any pending patent applications (or from any future patent applications) will be issued, that the scope of any patent protection will exclude competitors or provide competitive advantages to us, that any of our patents will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents (and patent applications) and other proprietary rights held by us.

If we become subject to intellectual property infringement claims, we could incur significant expenses and could be prevented from selling specific products.

We may become subject to claims that we infringe the intellectual property rights of others in the future. We cannot assure that, if made, these claims will not be successful. Any claim of infringement could cause us to incur substantial costs defending against the claim even if the claim is invalid, and could distract management from other business. Any judgment against us could require substantial payment in damages and could also include an injunction or other court order that could prevent us from offering certain products.

Our need for continued or increased investment in research and development may increase expenses and reduce our profitability.

Our industry is characterized by the need for continued investment in research and development. If we fail to invest sufficiently in research and development, our products could become less attractive to potential customers and our business and financial condition could be materially and adversely affected. As a result of the need to maintain or increase spending levels in this area and the difficulty in reducing costs associated with research and development, our operating results could be materially harmed if our research and development efforts fail to result in new products or if revenues fall below expectations. In addition, as a result of our commitment to invest in research and development, spending levels of research and development expenses as a percentage of revenues may fluctuate in the future.

15

Our results of operations are subject to fluctuation from period to period and may not be an accurate indication of future performance.

We have experienced fluctuations in operating results in large part due to the sale of products and services in relatively large dollar amounts to a relatively small number of customers. Customers specify delivery date requirements that coincide with their need for our products and services. Because these customers may use our products and services in connection with a variety of defense programs or other projects with different sizes and durations, a customer’s orders for one quarter generally do not indicate a trend for future orders by that customer. As such, we have not been able in the past to consistently predict when our customers will place orders and request shipments so that we cannot always accurately plan our manufacturing, inventory, and working capital requirements. As a result, if orders and shipments differ from what we predict, we may incur additional expenses and build excess inventory, which may require additional reserves and allowances and reduce our working capital and operational flexibility. Any significant change in our customers’ purchasing patterns could have a material adverse effect on our operating results and reported earnings per share for a particular quarter. Thus, results of operations in any period should not be considered indicative of the results to be expected for any future period.

High quarterly book-ship ratios may pressure inventory and cash flow management, necessitating increased inventory balances to ensure quarterly revenue attainment. Increased inventory balances tie up additional capital, limiting our operational flexibility. Some of our customers may have become conditioned to wait until the end of a quarter to place orders in the expectation of receiving a discount. Customers conditioned to seek quarter-end discounts increase risk and uncertainty in our financial forecasting and decrease our margins and profitability.

Our quarterly results may be subject to fluctuations resulting from a number of other factors, including:

·

delays in completion of internal product development projects;

·

delays in shipping hardware and software;

·

delays in acceptance testing by customers;

·

a change in the mix of products sold to our served markets;

·

changes in customer order patterns;

·

production delays due to quality problems with outsourced components;

·

inability to scale quick reaction capability products due to low product volume;

·

shortages and costs of components;

·

the timing of product line transitions;

·

declines in quarterly revenues from previous generations of products following announcement of replacement products containing more advanced technology;

·

inability to realize the expected benefits from acquisitions and restructurings, or delays in realizing such benefits;

·

potential asset impairment, including goodwill and intangibles, write-off of deferred tax assets or restructuring charges; and

·

changes in estimates of completion on fixed price service engagements.

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In addition, from time to time, we have entered into contracts, referred to as development contracts, to engineer a specific solution based on modifications to standard products. Gross margins from development contract revenues are typically lower than gross margins from standard product revenues. We intend to continue to enter into development contracts and anticipate that the gross margins associated with development contract revenues will continue to be lower than gross margins from standard product sales.

Another factor contributing to fluctuations in our quarterly results is the fixed nature of expenditures on personnel, facilities and marketing programs. Expense levels for these programs are based, in significant part, on expectations of future revenues. If actual quarterly revenues are below management’s expectations, our results of operations will likely be adversely affected.  Further, the preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates, and changes in estimates in subsequent periods could cause our results of operations to fluctuate.

Changes in regulations could materially adversely affect us.

Our business, results of operations, or financial condition could be materially adversely affected if laws, regulations, or standards relating to us or our products are newly implemented or changed. In addition, our compliance with existing regulations may have a material adverse impact on us. Under applicable federal securities laws, we are required to evaluate and determine the effectiveness of our internal control structure and procedures. If we have a material weakness in our internal controls, our results of operations or financial condition may be materially adversely affected or our stock price may decline.  

If we experience a disaster or other business continuity problem, we may not be able to recover successfully, which could cause material financial loss, loss of human capital, regulatory actions, reputational harm, or legal liability.

If we experience a local or regional disaster or other business continuity problem, such as a hurricane, earthquake, terrorist attack, pandemic or other natural or man-made disaster, our continued success will depend, in part, on the availability of our personnel, our office facilities, and the proper functioning of our computer, telecommunication and other related systems and operations. As we attempt to grow our operations, the potential for particular types of natural or man-made disasters, political, economic or infrastructure instabilities, or other country- or region-specific business continuity risks increases.

If we suffer any data breaches involving the designs, schematics, or source code for our products or other sensitive information, our business and financial results could be adversely affected.

We securely store our designs, schematics, and source code for our products as they are created. A breach, whether physical, electronic or otherwise, of the systems on which this sensitive data is stored could lead to damage or piracy of our products. If we are subject to data security breaches from external sources or from an insider threat, we may have a loss in sales or increased costs arising from the restoration or implementation of additional security measures, either of which could adversely affect our business and financial results. Other potential costs could include loss of brand value, incident response costs, loss of stock market value, regulatory inquiries, litigation, and management distraction. In addition, a security breach that involved classified information could subject us to civil or criminal penalties, loss of a government contract, loss of access to classified information, or debarment as a government contractor. Similarly, a breach that involved loss of customer-provided data could subject us to loss of a customer, loss of a contract, litigation costs and legal damages, and reputational harm.

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We need to continue to expend resources on research and development ("R&D") efforts, particularly our HPP segment, to meet the needs of our customers.  If we are unable to do so, our products could become less attractive to customers and our business could be materially adversely affected.

Our industry requires a continued investment in R&D.  As a result of our need to maintain or increase our spending levels for R&D in this area and the difficulty in reducing costs associated with R&D, our operating results could be materially harmed if our revenues fall below expectations.  In addition, as a result of CSPI’s commitment to invest in R&D, spending as a percent of revenues may fluctuate in the future.  Further, if we fail to invest sufficiently in R&D or our R&D does not produce competitive results, our products may become less attractive to our customers or potential customers, which could materially harm our business and results of operations.

Our business could be adversely impacted if we have deficiencies in our disclosure controls and procedures or internal controls over financial reporting.

Effective internal control over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial and other reports and effectively prevent fraud. These types of controls are designed to provide reasonable assurance regarding the reliability of financial reporting and the proper preparation of our financial statements, as well as regarding the timely reporting of material information. If we cannot maintain effective internal control over financial reporting or disclosure controls and procedures, or provide reliable financial statements or SEC reports or prevent fraud, investors may lose confidence in our reported financial information, our common stock could be subject to delisting on the stock exchange where it is traded, our operating results and the trading price of our common stock could suffer and we might become subject to litigation.

While our management will continue to review the effectiveness of our internal control over financial reporting and disclosure controls and procedures, there is no assurance that our disclosure controls and procedures or our internal control over financial reporting will be effective in accomplishing all control objectives, including the prevention and detection of fraud, all of the time.

Our stock price may continue to be volatile

Historically, the market for technology stocks has been extremely volatile. Our common stock has experienced and may continue to experience substantial price volatility. The following factors could cause the market price of our common stock to fluctuate significantly:

·

loss of a major customer;

·

loss of a major supplier;

·

the addition or departure of key personnel;

·

variations in our quarterly operating results;

·

announcements by us or our competitors of significant contracts, new products or product enhancements;

·

acquisitions, distribution partnerships, joint ventures or capital commitments;

·

regulatory changes;

·

sales of our common stock or other securities in the future;

·

changes in market valuations of technology companies; and

·

fluctuations in stock market prices and volumes.

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In addition, the stock market in general and the NASDAQ Global Market and technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of such companies. These broad market and industry factors may materially adversely affect the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against such companies.  If any shareholders were to issue a lawsuit, we could incur substantial costs defending the lawsuit and the attention of management could be diverted.

Item 2.     Properties

Listed below are our principal facilities as of September 30, 2019. Management considers all facilities listed below to be suitable for the purpose(s) for which they are used, including manufacturing, research and development, sales, marketing, service and administration.

 

 

 

 

 

 

 

 

    

 

    

Owned

    

 

 

 

 

 

or

 

Approximate

Location

 

Principal Use

 

Leased

 

Floor Area

TS Segment Properties:

 

  

 

 

 

  

Modcomp, Inc.

 

Division Headquarters

 

Leased

 

11,815 S.F.

1182 East Newport Center Drive

 

Sales, Marketing and

 

 

 

  

Deerfield Beach, FL 33442

 

Administration

 

 

 

  

 

 

 

 

 

 

 

Modcomp, Ltd.

 

Sales, Marketing and

 

Leased

 

887 S.F.

Trinity Court, Molly Millars Lane

 

Administration

 

  

 

  

Wokingham, Berkshire

 

  

 

  

 

  

United Kingdom

 

  

 

  

 

  

 

 

 

 

 

 

 

HPP Segment Properties:

 

  

 

 

 

  

CSP Inc.

 

Corporate Headquarters

 

Leased

 

13,515 S.F.

175 Cabot Street, Suite 210

 

Manufacturing, Sales,

 

 

 

  

Lowell, MA 01854

 

Marketing and

 

 

 

  

 

 

Administration

 

 

 

 

 

 

 

 

 

 

 

 

 

Item 3.     Legal Proceedings

We are currently not a party to any material legal proceedings.

Item 4.     Mine Safety Disclosures

Not Applicable.

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PART II

Item 5.     Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market information.   Our common stock is traded on the Nasdaq Global Market under the symbol CSPI. The following table provides the high and low sales prices of our common stock as reported on the Nasdaq Global Market for the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

Fiscal Year:

    

High

    

Low

    

High

    

Low

1st Quarter

 

$

13.45

 

$

8.78

 

$

17.00

 

$

10.60

2nd Quarter

 

$

11.92

 

$

9.31

 

$

18.89

 

$

10.41

3rd Quarter

 

$

15.50

 

$

10.30

 

$

12.18

 

$

8.75

4th Quarter

 

$

15.18

 

$

12.21

 

$

14.87

 

$

9.71

 

Stockholders.    We had approximately 65 holders of record of our common stock as of December 3, 2019. This number does not include stockholders for whom shares were held in a “nominee” or “street” name. We believe the number of beneficial owners of our shares of common stock (including shares held in street name) at that date was approximately 1,450.

Dividends.   For the fiscal years ended September 30, 2019 and 2018, the Company declared and paid cash dividends as follows:

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

    

 

    

Amount Paid

Fiscal Year

 

Date Declared

 

Record Date

 

Date Paid

 

Per Share

2018

 

12/19/2017

 

12/29/2017

 

1/16/2018

 

$

0.11

2018

 

2/12/2018

 

2/28/2018

 

3/16/2018

 

$

0.11

2018

 

5/9/2018

 

5/31/2018

 

6/15/2018

 

$

0.11

2018

 

8/13/2018

 

8/31/2018

 

9/14/2018

 

$

0.15

2019

 

12/27/2018

 

1/7/2019

 

1/22/2019

 

$

0.15

2019

 

2/12/2019

 

2/28/2019

 

3/14/2019

 

$

0.15

2019

 

5/8/2019

 

5/31/2019

 

6/14/2019

 

$

0.15

2019

 

8/7/2019

 

8/30/2019

 

9/13/2019

 

$

0.15

 

 

Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

This management’s discussion and analysis of financial condition and results of operations and other portions of this filing contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by the forward-looking information.  You should review the “Special Note Regarding Forward Looking Statements” and “Risk Factors” sections of this annual report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. The following discussion should be read in conjunction with our financial statements and the related notes included elsewhere in this filing.

Overview of Fiscal 2019 Results of Continuing Operations

Revenue increased by approximately $6.2 million, or 8%, to $79.1 million for the fiscal year ended September 30, 2019 versus $72.9 million for the fiscal year ended September 30, 2018.

Our gross profit margin percentage decreased overall, from 25% of revenues for the fiscal year ended September 30, 2018 to 23% for the fiscal year ended September 30, 2019.

20

We generated an operating loss of approximately $0.8 million for fiscal year ended September 30, 2019 as compared to an operating loss of approximately $1.6 million for fiscal year ended September 30, 2018.

On July 31, 2018, we completed the sale of all the outstanding stock of our Germany division of our TS segment.  The one time gain recorded due to the sale of all the stock of Modcomp GmbH was approximately $16.8 million.  No income taxes were provided as the transaction was a tax-free exchange in the U.K.  The Modcomp GmbH’s results have been recorded as discontinued operations in the accompanying consolidated balance sheets and consolidated statements of operations for all periods presented.

The following table details our results of operations in dollars and as a percentage of sales for the fiscal years ended: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

%

 

 

 

 

%

 

 

    

September 30, 2019

    

of sales

    

September 30, 2018

    

of sales

 

 

 

(Dollar amounts in thousands)

 

Sales

 

$

79,061

 

100

%  

$

72,916

 

100

%

Costs and expenses:

 

 

  

 

  

 

 

  

 

  

 

Cost of sales

 

 

61,035

 

77

%  

 

54,517

 

75

%

Engineering and development

 

 

2,800

 

 4

%  

 

3,277

 

 4

%

Selling, general and administrative

 

 

16,052

 

20

%  

 

16,723

 

23

%

Total costs and expenses

 

 

79,887

 

101

%  

 

74,517

 

102

%

Operating loss

 

 

(826)

 

(1)

%  

 

(1,601)

 

(2)

%

Other income

 

 

384

 

 —

%  

 

495

 

 1

%

Loss before income taxes

 

 

(442)

 

(1)

%  

 

(1,106)

 

(2)

%

Income tax (benefit) expense

 

 

(71)

 

 —

%  

 

882

 

 1

%

Net loss from continuing operations

 

 

(371)

 

(1)

%  

 

(1,988)

 

(3)

%

Gain on sale of discontinued operations

 

 

 —

 

 —

%  

 

16,838

 

23

%

Net loss from discontinued operations

 

 

 —

 

 —

%  

 

(410)

 

(1)

%

Total income from discontinued operations

 

 

 —

 

 —

%  

 

16,428

 

22

%

Net (loss) income

 

$

(371)

 

(1)

%  

$

14,440

 

19

%

 

Revenues

Revenue increased by approximately $6.2 million, or 8%, to $79.1 million for the fiscal year ended September 30, 2019 versus $72.9 million for the fiscal year ended September 30, 2018.  Our HPP segment revenue decreased by approximately $2.6 million primarily due to a decline of $1.7 million in royalty revenues, a decline of $0.2 million in Multicomputer service revenues, and a decline of $1.6 million in Myricom product revenues, partially offset by a  $0.9 million increase in Multicomputer product revenues. Our TS segment revenue increased by approximately $8.7 million from an increase of $11.5 million in our U.S. division, partially offset with a decrease of  $2.8 million in our U.K. division.

TS segment revenue change by product and services lines for the fiscal years ended September 30 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Increase

 

 

    

2019

    

2018

    

$

    

%

 

 

 

(Dollar amounts in thousands)

 

Products

 

$

59,611

 

$

52,647

 

$

6,964

 

13

%

Services

 

 

11,548

 

 

9,790

 

 

1,758

 

18

%

Total

 

$

71,159

 

$

62,437

 

$

8,722

 

14

%

 

The TS segment total revenue increased by approximately $8.7 million due to an increase of $11.5 million in our U.S. division partially offset by a decrease of  $2.8 million in our U.K. division. The $7.0 million increase in TS

21

segment product revenue is attributed to an increase of $9.5 million in our U.S. division offset by a decrease of $2.5 million in our U.K. division. The increase in our U.S. division was primarily associated with two major customers and the decrease in the U.K. division was primarily associated with a decrease with one major customer. The $1.8 million service revenue increase is related to an increase in the U.S. division of $2.0 million, partially offset by a decrease in the U.K. division of $0.2 million.

HPP segment revenue change by product and services lines for the fiscal years ended September 30 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

 

 

 

 

Decrease

 

 

 

2019

    

2018

    

$

    

%

 

 

 

(Dollar amounts in thousands)

 

Products

 

$

6,406

 

$

7,014

 

$

(608)

 

(9)

%

Services

 

 

1,496

 

 

3,465

 

 

(1,969)

 

(57)

%

Total

 

$

7,902

 

$

10,479

 

$

(2,577)

 

(25)

%

 

The decrease in HPP product revenues for the period of $0.6 million was primarily the result of an approximately $1.5 million decrease in Myricom product line shipments, partially offset by an increase in Multicomputer product line shipments of approximately $0.9 million for the fiscal year ended September 30, 2019 as compared to the fiscal year ended September 30, 2018. The decrease in HPP services revenues of approximately $2.0 million for the period was primarily the result of an approximately $1.7 million decrease in royalty revenues on high-speed processing boards related to the E2D program during the fiscal year ended September 30, 2019 as compared to the fiscal year ended September 30, 2018.

Our total revenues by geographic area based on the location to which the products were shipped or services rendered were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Increase (Decrease)

 

 

    

2019

    

%

    

2018

    

%

    

$

    

%

 

 

 

(Dollar amounts in thousands)

 

Americas

 

$

72,522

 

92

%  

$

60,458

 

83

%  

$

12,064

 

20

%

Europe

 

 

4,056

 

 5

%  

 

10,325

 

14

%  

 

(6,269)

 

(61)

%

Asia

 

 

2,483

 

 3

%  

 

2,133

 

 3

%  

 

350

 

16

%

Totals

 

$

79,061

 

100

%  

$

72,916

 

100

%  

$

6,145

 

 8

%

 

The $12.1 million increase in the Americas revenues for the fiscal year ended September 30, 2019 as compared to the fiscal year ended September 30, 2018 is primarily due to increased revenues by our TS segment of approximately $15.2 million, partially offset with decreased sales by our HPP segment of approximately $3.1 million. The $6.3 million decrease in Europe revenue is primarily due to decreased sales by our UK division of approximately $5.5 million combined with a decrease by our TS segment’s US division of approximately $0.3 million and a decrease in our HPP segment of approximately $0.5 million. The decrease in sales to Europe is due to one large customer that had significantly lower activity for the year ended September 30, 2019 when compared to September 30, 2018. The $0.4 million increase in Asia is primarily the result of increased revenues by our HPP segment of $1.1 million partially offset with a $0.7 million decrease in our TS segment.

Gross Margins

Our gross margins ("GM") decreased by approximately $0.4 million to $18.0 million in fiscal year 2019 as compared to gross margins of $18.4 million in fiscal year 2018.

 

22

The following table summarizes GM changes by segment for fiscal years 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

 

Increase (Decrease)

 

 

 

(Dollar amounts in thousands)

 

 

    

GM$

    

GM%

    

GM$

    

GM%

    

GM$

    

GM%

 

TS

 

$

13,889

 

20

%  

$

12,262

 

20

%  

$

1,627

 

 —

%

HPP

 

 

4,137

 

52

%  

 

6,137

 

59

%  

 

(2,000)

 

(7)

%

Total

 

$

18,026

 

23

%  

$

18,399

 

25

%  

$

(373)

 

(2)

%

 

The impact of product mix within our TS segment on gross margins for the fiscal years ended September 30 was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

 

Increase

 

 

    

GM$

    

GM%

    

GM$

    

GM%

    

GM$

    

GM%

 

 

 

(Dollar amounts in thousands)

 

Products

 

$

7,462

 

13

%  

$

6,886

 

13

%  

$

576

 

 —

%

Services

 

 

6,427

 

56

%  

 

5,376

 

55

%  

 

1,051

 

 1

%

Total

 

$

13,889

 

20

%  

$

12,262

 

20

%  

$

1,627

 

 —

%

 

The overall TS segment gross margin as a percentage of sales remained the same in fiscal year 2019 when compared to fiscal year 2018. The  $0.6 million increase in our TS segment product gross margins resulted from an   increase in product revenues in the U.S. division, partially offset by a decrease in the U.K division. The $1.1 million increase in the TS segment service gross margins primarily resulted from increased service revenues in the U.S. division.

The impact of product mix on gross margins within our HPP segment for the fiscal years ended September 30 was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2019

 

2018

 

Increase (Decrease)

 

 

 

(Dollar amounts in thousands)

 

 

    

GM$

    

GM%

    

GM$

    

GM%

    

GM$

    

GM%

 

Products

 

$

2,719

 

42

%  

$

2,775

 

40

%  

$

(56)

 

 2

%

Services

 

 

1,418

 

95

%  

 

3,362

 

97

%  

 

(1,944)

 

(2)

%

Total

 

$

4,137

 

52

%  

$

6,137

 

59

%  

$

(2,000)

 

(7)

%

 

The overall HPP segment gross margins as a percentage of sales decreased to 52% in fiscal year 2019 from 59% in fiscal year 2018.  The 7%  decrease in gross margin as a percentage of sales in the HPP segment was primarily attributed to the impact of a decrease of $1.7 million in high margin Multicomputer royalty revenues.

Engineering and Development Expenses

The following table details our engineering and development expenses by operating segment for the fiscal years ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Year ended September 30, 

 

 

 

 

 

 

 

    

 

 

    

% of

    

 

 

    

% of

    

 

 

    

 

 

(Dollar amounts in thousands)

 

2019

 

Total

 

2018

 

Total

 

$ Decrease

 

% Decrease

 

 

 

(Dollar amounts in thousands)

 

By Operating Segment:

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

TS

 

$

 —

 

 —

%  

$

 —

 

 —

%  

$

 —

 

 —

%

HPP

 

 

2,800

 

100

%  

 

3,277

 

100

%  

 

(477)

 

(15)

%

Total

 

$

2,800

 

100

%  

$

3,277

 

100

%  

$

(477)

 

(15)

%

 

Engineering and development expenses decreased by $0.5 million to $2.8 million for the fiscal year ended September 30, 2019 as compared to $3.3 million for the fiscal year ended September 30, 2018.  The current fiscal year expenses were primarily for product engineering expenses incurred in connection with the development of the new

23

ARIA SDS cyber security products. The decreased engineering and development expenses for the fiscal year ended September 30, 2019 as compared to the fiscal year ended September 30, 2018 is primarily attributed to a decrease in consulting related expenses.

Selling, General and Administrative

The following table details our selling, general and administrative (“SG&A”) expenses by operating segment for the years ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the year ended September 30, 

 

 

 

 

 

 

 

 

 

 

 

% of

 

 

 

 

% of

 

$ Increase

 

% Increase

 

 

    

2019

    

Total

    

2018

    

Total

    

 (Decrease)

    

     (Decrease)

 

 

 

(Dollar amounts in thousands)

 

By Operating Segment:

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

TS segment

 

$

11,630

 

72

%  

$

11,086

 

66

%  

$

544

 

 5

%

HPP segment

 

 

4,422

 

28

%  

 

5,637

 

34

%  

 

(1,215)

 

(22)

%

Total

 

$

16,052

 

100

%  

$

16,723

 

100

%  

$

(671)

 

(4)

%

 

For fiscal year 2019 compared to fiscal year 2018, the TS segment SG&A spending increase of approximately $0.5 million is substantially the result of an increase in our U.S. division of $1.2 million primarily attributed to variable selling expenses and additional engineering and sales hires. This was partially offset by  a $0.7 million decrease in the U.K. division attributed to reduction in staff and variable compensation expense.

For fiscal year 2019 compared to fiscal year 2018, the HPP segment SG&A spending decrease of $1.2 million is primarily attributed to decreases in expenses related to the sale of our German operations, audit expenses, and variable compensation.

Other Income/Expenses

The following table details our other income/expenses for the years ended September 30, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

For the year ended

 

 

 

 

 

 

 

 

 

 

 

 

Increase

 

 

    

September 30, 2019

    

September 30, 2018

    

(Decrease)

 

 

 

(Amounts in thousands)

 

Interest expense

 

$

(99)

 

$

(85)

 

$

(14)

 

Interest income

 

 

323

 

 

20

 

 

303

 

Foreign exchange gain (loss)

 

 

157

 

 

263

 

 

(106)

 

Other income, net

 

 

 3

 

 

297

 

 

(294)

 

Total other income (expense), net

 

$

384

 

$

495

 

$

(111)

 

 

The decrease to other income (expenses) for the fiscal year ended September 30, 2019 as compared to the fiscal year ended September 30, 2018 was primarily driven by a decrease in Other income, net of $0.3 million and a decrease of $0.1 million foreign exchange gain (loss), partially offset by an increase of $0.3 million in interest income.

Income Taxes

The Company recorded an income tax benefit of approximately $71 thousand, which reflected an effective tax rate of 16.1% for the year ended September 30, 2019. The tax benefit includes an increase in the valuation allowance for net operating losses for state income tax related in the High Performance Products segment where we also had a reversal of the uncertain tax position of $54 thousand as that the statute of limitations have expired. For the year ended September 30, 2018, the income tax expense was approximately $882 thousand, which reflected an effective tax rate of (79.7%). The impact  of the Tax Reform Act, which was recorded in fiscal year 2018, included remeasurement of the Company’s US deferred tax assets and liabilities to a 24.3% for current and 21% for the non-current portions resulted in

24

a tax expense of approximately $588 thousand consisting of a reduction of the Company’s net deferred tax asset. The Company recorded tax expense of approximately $771 thousand related to the deemed repatriation.

As of September 30, 2019, management assessed the positive and negative evidence in the U.S. operations, and estimated that we will have sufficient future taxable income to utilize the existing deferred tax assets. Significant objective positive evidence included the cumulative profits that we realized in recent fiscal years. This evidence enhances our ability to consider other subjective evidence such as our projections for future growth. Other factors that we considered are the likelihood for continued royalty income in future years, new product revenue from cyber security products, and our expectation that the TS segment will continue to be profitable in future years. On the basis of this evaluation, as of September 30, 2019, we have concluded that our U.S. deferred income tax asset related to net operating losses carryforward for the High Performance Products segment is more likely than not to be realized except for certain state net operating loss carryforwards and tax credit carry forwards. We recorded a $235 thousand valuation allowance for certain state-related assets that are not likely to be realized. It should be noted however, that the amount of the deferred tax asset not to be realized could be adjusted in future years, if estimates of taxable income during the carryforward periods are increased, or if there is objective positive evidence in the form of cumulative earnings.

We also continue to maintain a full valuation allowance against our U.K. deferred tax assets as we have experienced cumulative losses and do not have any indication that the operation will be profitable in the future to an extent that will allow us to utilize much of our net operating loss carryforwards. To the extent that actual experience deviates from our assumptions, our projections would be affected and hence our assessment of realizability of our deferred tax assets may change.

Results of Discontinued Operations

CSPi LTD, a wholly owned indirect subsidiary of the Company, sold all of the outstanding stock of Modcomp GmbH to Reply AG, an affiliate of Reply SpA, a holding company for a worldwide group of companies, on July 31, 2018 for $14.4 million cash, and recognized a gain of $16.8 million. The divestiture of CSPi’s German operations and our increased cash position will enable us to focus time and resources on our higher-margin and greater-potential growth opportunities.  We are encouraged by the traction of our managed services business in the U.S. and we intend to continue to invest and focus on our new ARIA SDS cyber security products and to capitalize on the proliferation of our wireless service business. This divestiture of our German operations is another positive step toward our future growth.

The following table is a summary of the operating results of the Germany division of our TS segment which have been reflected as discontinued operations.  See Note 2 for additional information.

 

 

 

 

 

 

 

 

 

For the year ended

 

    

September 30, 2019

    

September 30, 2018

 

 

(Amounts in thousands)

Revenues

 

$

 —

 

$

18,365

Net loss from discontinued operations, net of tax

 

$

 —

 

$

(410)

 

Liquidity and Capital Resources

Our primary source of liquidity is our cash and cash equivalents, which decreased by approximately $7 million to $18.1 million as of September 30, 2019 from $25.1 million as of September 30, 2018.  

Significant sources of cash for the year ended September 30, 2019 included an increase in accounts payable and accrued expenses of approximately $6.4 million, proceeds from debt of approximately $1.0 million, and a decrease in refundable income taxes of approximately $0.6 million.  More than offsetting these significant sources of cash were an increase in long term receivables of approximately $5.3 million, an increase in other assets and deferred costs of approximately $3.1 million, an increase in accounts receivable of approximately $2.1 million, and payment of dividends of approximately $2.5 million. 

25

Cash held by our foreign subsidiary in the United Kingdom totaled approximately $9.1 million as of September 30, 2019, which consists of 3.1 million euros, 0.2 million British Pounds, and 5.9 million U.S. Dollars. This cash is included in our total cash and cash equivalents reported above.

As of September 30, 2018, the Company maintained a line of credit that allows for borrowings of up to $1.0 million. Availability under the facility was reduced by outstanding borrowings thereunder. The interest rates on outstanding borrowings was London Inter-Bank Offer Rate ("LIBOR") plus 2.5%, with a floor of 4%. Borrowings under the credit agreements are required to be repaid on demand in certain circumstances, upon termination of the agreements, or may be prepaid by the Company without penalty. The Company had no amounts outstanding under the line of credit at September 30, 2018. This line of credit closed during fiscal year 2019.

As of September 30, 2019 and September 30, 2018, the Company also maintained an inventory line of credit that may be used by the TS segment in the U.S. to purchase inventory from approved vendors with payment terms which exceed those offered by the vendors. In fiscal year 2019, HPP gained access to this inventory line of credit, but did not use it. No interest accrues under the inventory line of credit when advances are paid within terms, however, late payments are subject to an interest charge of Prime plus 5%.  The credit agreement for the inventory line of credit contains financial covenants which require the Company to maintain the following TS segment-specific financial ratios: (1) a minimum current ratio of 1.2, (2) tangible net worth of no less than $4.0 million, and (3) a maximum ratio of total liabilities to total net worth of less than 5.0:1.  As of September 30, 2019 and September 30, 2018, Company borrowings under the inventory line of credit were $2.5 million and $3.2 million, respectively, and the Company was in compliance with all covenants.

For more information, please refer to Note 16 - Lines of Credit, in the Notes to our Consolidated Financial Statements contained in this annual report on Form 10‑K.

If cash generated from operations is insufficient to satisfy working capital requirements, we may need to access funds through bank loans, the equity markets, or other means. There is no assurance that we will be able to raise any such capital 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 development or enhancement of 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 the foreseeable future.

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, goodwill and intangibles, income taxes, deferred compensation, revenue recognition, retirement plans, restructuring costs and contingencies. We base our estimates on historical performance and on various other assumptions that are believed 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.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: revenue recognition; valuation allowances, specifically the allowance for doubtful accounts and net deferred tax asset valuation allowance; inventory valuation; intangibles; and pension and retirement plans.

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Revenue Recognition

Effective October 1, 2018, the Company adopted Accounting Standards Update (“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. See Note 1 – Summary of Significant Accounting Policies for effects of initial adoption. The following reflects the accounting policy change for revenue starting on the date of adoption:

We derive revenue from the sale of integrated hardware and software, third-party service contracts, professional services, managed services, financing of hardware and software, and other services.

We recognize revenue from hardware upon transfer of control, which is at a point in time typically upon shipment when title transfers. Revenue from software is recognized at a point in time when the license is granted.

We recognize revenue from third-party service contracts as either gross sales or net sales depending on whether the Company is acting as a principal party to the transaction or simply acting as an agent or broker based on control and timing. The Company is a principal if it controls the good or service before that good or service is transferred to the customer. We record revenue as gross when the Company is a principal party to the arrangement and net of cost when we are acting as a broker or agent. Under gross sales recognition, the entire selling price is recorded in revenue and our cost to the third-party service provider or vendor is recorded in cost of goods sold. Under net sales recognition, the cost to the third-party service provider or vendor is recorded as a reduction to revenue resulting in net sales equal to the gross profit on the transaction. Third-party service contracts are sold in different combinations with hardware, software, and services. We have determined the third-party services contracts are a single performance obligation in each sale. When the Company is an agent, revenue is typically recorded at a point in time. When the Company is the principal, revenue is recognized over the contract term.

Professional services generally include implementation, installation, and training services. Professional services are considered a series of distinct services that form one performance obligation and revenue is recognized over time as services are performed.

Revenue generated from managed services is recognized over the term of the contract. Certain managed services contracts include financing of hardware and software. Revenues from arrangements which include financing are allocated considering relative standalone selling prices of lease and non-lease components within the agreement. The lease components include the hardware and software, which are subject to ASC 840. The non-lease component includes the managed services and is subject to ASC 606.

Other services generally include revenue generated through our royalty, extended warranty, multicomputer repair, and maintenance contracts. Royalty revenue is sales-based and recognized on date of subsequent sale of the product, which occurs on the date of customer shipment. Revenue from extended warranty contracts is recognized evenly over the period of the warranty. Multicomputer repair services revenue is recognized upon control transfer when the customer takes possession of the computer at time of shipping. Revenue generated from maintenance services is recognized evenly over the term of the contract.

Variable consideration is immaterial. Any products sold with right to return exists with the manufacturer. Managed service contracts contain the right to refund if canceled within 30 days of inception. Any products with a standard warranty are treated as a warranty obligation under ASC 460, Guarantees.

The following policies are applicable to our major categories of segment revenue transactions:

TS Segment Revenue

TS Segment revenue is derived from the sale of hardware, software, professional services, third-party service contracts, maintenance contracts, managed services, and financing of hardware and software. Financing revenue is

27

recognized in accordance with ASC 840, Leases. Financing revenue is recorded in revenue as equipment leasing and is part of the Company’s operations.

Third-party service contracts are evaluated to determine whether such service revenue should be recorded as gross sales or net and whether over time or at point in time.

HPP Segment Revenue

HPP segment revenue is derived from the sale of integrated hardware and software, maintenance, and other services through the Multicomputer and Myricom product lines.

Myricom revenue is derived from the sale of products, which are comprised of both hardware and embedded software which is essential to the products functionality, and post contract maintenance and support. Post contract maintenance and support is considered immaterial in the context of the contract and therefore is not a separate performance obligation.

Significant Judgments

The input method using labor hours expended relative to the total expected hours is used to recognize revenue for professional services. Only the hours that depict the Company’s performance toward satisfying a performance obligation are used for progress. An estimate for professional services is made at the beginning of each contract based on prior experience and monitored throughout the services. This method is most appropriate as it depicts the measure of progress towards satisfaction of the performance obligation.

When product and services are sold together, the allocation of the transaction price to each performance obligation is calculated using a budgeted cost-plus margin approach. Due to the complex nature of these contracts, there is significant judgment in allocating the transaction price. These estimates are periodically reviewed by project managers, engineers, and other staff involved to ensure estimates are appropriate. For items sold separately, including hardware, software, professional services, maintenance contracts, other services, and third-party service contracts, there is no allocation performed as there is one performance obligation.

Contract Assets and Liabilities

When the Company has performed work but does not have an unconditional right to payment, a contract asset is recorded. When the Company has the right to bill a customer, accounts receivable is recorded as an unconditional right exists. Contract liabilities arise when payment is received before the Company transfers a good or service to the customer.

Contract Costs

Incremental costs of obtaining a contract involving customer transactions where the revenue and the related transfer of goods and services are less than a one-year period, are expensed as incurred, utilizing the practical expedient in ASC 340‑40‑25‑4. For a period greater than one year, incremental contract costs are capitalized if the Company expects to recover these costs. These costs are only capitalized if the contract is obtained. The costs are amortized over the contract term and expected renewal periods. The period of amortization is generally three to six years. Incremental costs are related to commissions in the TS portion of the business.

Costs to fulfill a contract are capitalized when the costs are related to a contract or anticipated contract, generate or enhance resources that will be used in satisfying performance obligations in the future, and costs are recoverable. Costs to fulfill a contract are related to the TS portion of the business and involve activities performed before managed services can be completed. Current capitalized fulfillment costs are in the account other current assets on the consolidated balance sheets.

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Other

Projects are typically billed upon completion or at certain milestones. Product and services are typically billed when shipped or as services are being performed. Payment terms are typically 30 days to pay in full except in Europe where it could be up to 90 days. There are certain contracts that do contain a financing component. See Note 3 for details. Most of the Company’s contracts are less than one year. As a practical expedient, the Company has elected not to adjust the amount of consideration for effects of a significant financing component when it is anticipated the promised good or service will be transferred and the subsequent payment will be one year or less. The Company elected to use the optional exemption to not disclose the aggregate amount of the transaction price allocated to performance obligations that have an original expected duration of one year or less. This is due to a low amount of performance obligations less than one year being unsatisfied at each period end. Most of these contracts are related to product sales. The Company has certain contracts that have an original term of more than one year. The royalty agreement is longer than one year and managed service contracts are generally longer than one year.

Product Warranty Accrual

Our product sales generally include a 90‑day to three-year hardware warranty. At time of product shipment, we accrue for the estimated cost to repair or replace potentially defective products. Estimated warranty costs are based upon prior actual warranty costs for substantially similar products.

Engineering and Development Expenses

Engineering and development expenses include payroll, employee benefits, stock-based compensation and other headcount-related expenses associated with product development.  Engineering and development expenses also include third-party development and programming costs. We consider technological feasibility for our software products to be reached upon the release of the software, accordingly, no internal software development costs have been capitalized.

Income Taxes

We use the asset and liability method of accounting for income taxes whereby deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We also reduce deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. This methodology requires estimates and judgments in the determination of the recoverability of deferred tax assets and in the calculation of certain tax liabilities. Valuation allowances are recorded against the gross deferred tax assets that management believes, after considering all available positive and negative objective evidence, historical and prospective, with greater weight given to historical evidence, that it is more likely than not that these assets will not be realized.

In addition, we are required to recognize in the consolidated financial statements, those tax positions determined to be more-likely-than-not of being sustained upon examination, based on the technical merits of the positions as of the reporting date. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the position are recognized.

In addition, the calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. The Company records liabilities for estimated tax obligations in the U.S. and other tax jurisdictions. These estimated tax liabilities include the provision for taxes that may become payable in the future.

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Intangible Assets

Intangible assets that are not subject to amortization are also required to be tested annually, or more frequently if events or circumstances indicate that the asset may be impaired. We did not have intangible assets with indefinite lives at any time during the two years ended September 30, 2019. Intangible assets subject to amortization are amortized over their estimated useful lives, generally three to ten years, and are carried at net book value. The remaining useful lives of intangible assets are evaluated on an annual basis. Intangible assets subject to amortization are also tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. If the fair value of an intangible asset subject to amortization is determined to be less than its carrying value, then an impairment charge is recorded to write down that asset to its fair value.

Inventories

Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out method. The recoverability of inventories is based upon the types and levels of inventories held, forecasted demand, pricing, competition and changes in technology. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Pension and Retirement Plans

The funded status of pension and other post-retirement benefit plans is recognized prospectively on the consolidated balance sheet. Gains and losses, prior service costs and credits and any remaining transition amounts that have not yet been recognized through pension expense will be recognized in accumulated other comprehensive income, net of tax, until they are amortized as a component of net periodic pension/post-retirement benefits expense. Additionally, plan assets and obligations are measured as of our fiscal year-end balance sheet date (September 30).

We have defined benefit and defined contribution plans in the U.K. and in the U.S. In the U.K., the Company provides defined benefit pension plans for certain employees and former employees and defined contribution plans for the majority of the employees. The defined benefit plans in the U.K. are closed to newly hired employees and have been for the two years ended September 30, 2019. In the U.S., the Company provides defined contribution plans that cover most employees and supplementary retirement plans to certain employees and former employees who are now retired. These supplementary retirement plans are also closed to newly hired employees and have been for the two years ended September 30, 2019. These supplementary plans are funded through whole life insurance policies. The Company expects to recover all insurance premiums paid under these policies in the future, through the cash surrender value of the policies and any death benefits or portions thereof to be paid upon the death of the participant. These whole life insurance policies are carried on the balance sheet at their cash surrender values as they are owned by the Company and not assets of the defined benefit plans. In the U.S., the Company also provides for officer death benefits and post-retirement health insurance benefits through supplemental post-retirement plans to certain officers. The Company also funds these supplemental plans’ obligations through whole life insurance policies on the officers.

Pension expense is based on an actuarial computation of current future benefits using estimates for expected return on assets, expected compensation increases and applicable discount rates. Management has reviewed the discount rates and rates of return with our consulting actuaries and investment advisers and concluded they were reasonable.  A decrease in the expected return on pension assets would increase pension expense. Expected compensation increases are estimated based on historical and expected increases in the future. Increases in estimated compensation increases would result in higher pension expense while decreases would lower pension expense. Discount rates are selected based upon rates of return on high quality fixed income investments currently available and expected to be available during the period to maturity of the pension benefit. A decrease in the discount rate would result in greater pension expense while an increase in the discount rate would decrease pension expense.

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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.

Inflation and Changing Prices

Management does not believe that inflation and changing prices had significant impact on sales, revenues or income during fiscal years 2019 or 2018. There is no assurance that the Company’s business will not be materially and adversely affected by inflation and changing prices in the future.

Item 8.     Financial Statements and Supplementary Data

The consolidated financial statements are included herein.

 

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Item 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

None.

Item 9A.     Controls and Procedures

Evaluation of Controls and Procedures

Disclosure Controls and Procedures. The Company evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2019. 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 Securities and Exchange Commission’s ("SEC") 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 September 30, 2019, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.  

Management’s Report on Internal Control over Financial Reporting.

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Rule 13a‑15(f) under the Exchange Act, internal control over financial reporting is a process designed by or under the supervision of a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. It includes those policies and procedures that:

·

pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of a company;

·

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of a company are being made only in accordance with authorizations of management and the board of directors of a company; and

·

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of a company’s assets that could have a material effect on its financial statements.

Management has assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2019. In making its assessment of internal control, management used the criteria described in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations ("COSO") of the Treadway Commission.  As a result of its assessment, management has concluded that the Company’s internal control over financial reporting was effective as of September 30, 2019.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls

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may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

This Annual Report on Form 10‑K does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2019 was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the SEC that call for the Company to provide only management’s report in this Annual Report on Form 10‑K.

Changes in Internal Control over Financial Reporting.

During the quarter ended September 30, 2019, there were no 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.

Item 9B.     Other Information

None.

PART III

Item 10.     Directors, Executive Officers and Corporate Governance

We incorporate the information required by this item by reference to the sections captioned “Nominees for Election”, “Our Board of Directors”, “Our Executive Officers”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance” in our Schedule 14A Proxy Statement for our 2020 Annual Meeting of Stockholders, to be filed with the SEC within 120 days after the end of our fiscal year ended September 30, 2019.

Item 11.     Executive Compensation

We incorporate the information required by this item by reference to the sections captioned “Compensation of Executive Officers” and “Compensation of Non-Employee Directors” in our Schedule 14A Proxy Statement for our 2020 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of our fiscal year ended September 30, 2019.

Item 12.     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Securities Authorized for Issuance Under Equity Compensation Plans.

The equity compensation plans approved by our stockholders consist of the CSP, Inc. 1997 Incentive Stock Option Plan, the 2003 Stock Incentive Plan, the 2007 Stock Incentive Plan, the 2014 Employee Stock Purchase Plan (the "ESPP") and the 2015 Stock Incentive Plan. In fiscal 2019 and 2018, the Company granted to certain key employees, certain officers including its Chief Executive Officer and non-employee directors’ shares of non-vested common stock instead of stock options. The vesting periods for the key employees’, officers’, the Chief Executive Officer’s and the non-employee directors’ non-vested stock awards are four years, three years and one year, respectively. The following

33

table sets forth information as of September 30, 2019 regarding the total number of securities outstanding under these equity compensation plans.

 

 

 

 

 

 

 

 

 

    

(a) (1)(2)

    

(b)

    

(c)

 

 

 

 

 

 

Number of securities

 

 

 

 

 

 

remaining available for future

 

 

Number of securities to be

 

Weighted-average

 

issuance under equity

 

 

issued upon exercise of

 

exercise price of outstanding

 

compensation plans (excluding

 

 

outstanding options,

 

stock options, warrants and

 

securities reflected in column

Plan Category

 

warrants and rights

 

rights

 

(a))(3)

Equity compensation plans approved by security holders

 

192,735

 

$

3.75

 

417,668


(1)

Includes 190,735 non-vested shares issued and 2,000 stock options issued. 

(2)

Does not include purchase rights under the ESPP, as the purchase price and number of shares to be purchased under the ESPP are not determined until the end of the relevant purchase period.

(3)