CSPI- 10Q 2013.12.31

United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q 
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended
December 31, 2013
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             .
 
Commission File Number 0-10843
 
 
CSP Inc.
(Exact name of Registrant as specified in its Charter)
 

Massachusetts
04-2441294
(State of incorporation)
(I.R.S. Employer Identification No.)
 
43 Manning Road
Billerica, Massachusetts 01821-3901
(978) 663-7598
(Address and telephone number of principal executive offices)
 
 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  o.
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o.
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
 
As of February 12, 2014, the registrant had 3,571,041 shares of common stock issued and outstanding.

1

INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CSP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except par value) 
 
December 31,
2013
 
September 30,
2013
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
13,942

 
$
18,619

Accounts receivable, net of allowances of $292 and $242
16,963

 
13,529

Inventories
6,599

 
4,791

Refundable income taxes
565

 
624

Deferred income taxes
1,350

 
1,313

Other current assets
2,852

 
2,042

Total current assets
42,271

 
40,918

Property, equipment and improvements, net
1,510

 
1,420

 
 
 
 
Other assets:
 

 
 

Intangibles, net
642

 
410

Deferred income taxes
1,779

 
1,771

Cash surrender value of life insurance
2,520

 
2,481

Other assets
156

 
225

Total other assets
5,097

 
4,887

Total assets
$
48,878

 
$
47,225

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
11,942

 
$
10,503

Deferred revenue
3,548

 
3,816

Pension and retirement plans
757

 
746

Deferred income taxes
149

 
—

Income taxes payable
—

 
60

Total current liabilities
16,396

 
15,125

Pension and retirement plans
8,714

 
8,660

Deferred income taxes
103

 
—

Other long term liabilities
415

 
405

Total liabilities
25,628

 
24,190

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Shareholders’ equity:
 
 
 
Common stock, $.01 par value per share; authorized, 7,500 shares; issued and outstanding 3,571 and 3,496 shares, respectively
36

 
35

Additional paid-in capital
11,212

 
11,137

Retained earnings
17,717

 
17,728

Accumulated other comprehensive loss
(5,715
)
 
(5,865
)
Total shareholders’ equity
23,250

 
23,035

Total liabilities and shareholders’ equity
$
48,878

 
$
47,225

See accompanying notes to unaudited consolidated financial statements.

3

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

 
For the three months ended
 
December 31,
2013
 
December 31,
2012
Sales:
 
 
 
Product
$
14,749

 
$
15,305

Services
6,583

 
5,565

Total sales
21,332

 
20,870

 
 
 
 
Cost of sales:
 
 
 
Product
12,583

 
13,224

Services
4,078

 
3,469

Amortization of inventory step-up and intangibles
138

 
—

Total cost of sales
16,799

 
16,693

 
 
 
 
Gross profit
4,533

 
4,177

 
 
 
 
Operating expenses:
 
 
 
Engineering and development
635

 
444

Selling, general and administrative
4,020

 
3,560

Total operating expenses
4,655

 
4,004

 
 
 
 
Bargain purchase gain on acquisition
462

 
—

 
 
 
 
Operating income
340

 
173

 
 
 
 
Other income (expense):
 
 
 
Foreign exchange gain (loss)
(26
)
 
13

Other income (expense), net
—

 
46

Total other income (expense), net
(26
)
 
59

Income before income taxes
314

 
232

Income tax expense (benefit)
(32
)
 
117

Net income
$
346

 
$
115

Net income attributable to common stockholders
$
335

 
$
113

Net income per share – basic
$
0.10

 
$
0.03

Weighted average shares outstanding – basic
3,431

 
3,363

Net income per share – diluted
$
0.10

 
$
0.03

Weighted average shares outstanding – diluted
3,474

 
3,407

 
See accompanying notes to unaudited consolidated financial statements.

4

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

 
 
For the three months ended
 
 
December 31,
2013
 
December 31,
2012
 
 
 
 
 
Net income
 
$
346

 
$
115

Other comprehensive income:
 
 
 
 
Foreign currency translation gain adjustments
 
150

 
56

Other comprehensive income
 
150

 
56

Total comprehensive income
 
$
496

 
$
171


See accompanying notes to unaudited consolidated financial statements.


5

CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
For the three Months Ended December 31, 2013:
(Amounts in thousands)
 
 
Shares
 
Amount
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
other
comprehensive
loss
 
Total
Shareholders’
Equity
Balance as of September 30, 2013
3,496

 
$
35

 
$
11,137

 
$
17,728

 
$
(5,865
)
 
$
23,035

Net income
—

 
—

 
—

 
346

 
—

 
346

Other comprehensive income
—

 
—

 
—

 
—

 
150

 
150

Exercise of stock options
1

 
—

 
6

 
—

 
—

 
6

Stock-based compensation
—

 
—

 
69

 
—

 
—

 
69

Restricted stock issuance
74

 
1

 
—

 
—

 
—

 
1

Cash dividends on common stock ($0.10 per share)
—

 
—

 
—

 
(357
)
 
—

 
(357
)
Balance as of December 31, 2013
3,571

 
$
36

 
$
11,212

 
$
17,717

 
$
(5,715
)
 
$
23,250

 
See accompanying notes to unaudited consolidated financial statements.

6

CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
 
For the three months ended
 
December 31,
2013
 
December 31,
2012
Cash flows from operating activities:
 
 
 
Net income
$
346

 
$
115

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

 
 

Bargain purchase gain
(462
)
 
—

Depreciation and amortization
210

 
102

Amortization of intangibles
29

 
21

Gain on sale of fixed assets, net
—

 
(17
)
Foreign exchange (gain) loss
26

 
(13
)
Non-cash changes in accounts receivable
50

 
(49
)
Non-cash changes in inventory
75

 
12

Stock-based compensation expense on stock options and restricted stock awards
69

 
30

Deferred income taxes
(160
)
 
(42
)
Increase in cash surrender value of life insurance
(37
)
 
(26
)
Changes in operating assets and liabilities:
 

 
 

Increase in accounts receivable
(3,366
)
 
(4,101
)
Decrease in officer life insurance receivable
—

 
2,172

(Increase) decrease in inventories
(835
)
 
561

(Increase) decrease in refundable income taxes
62

 
16

Increase in other current assets
(655
)
 
(691
)
(Increase) decrease in other assets
69

 
(135
)
Increase in accounts payable and accrued expenses
1,289

 
150

Decrease in deferred revenue
(309
)
 
(28
)
Decrease in pension and retirement plans liability
(71
)
 
(66
)
Decrease in income taxes payable
(60
)
 
(134
)
Increase in other long term liabilities
10

 
10

Net cash used in operating activities
(3,720
)
 
(2,113
)
Cash flows from investing activities:
 

 
 

Life insurance premiums paid
(2
)
 
(2
)
Proceeds from the sale of fixed assets
—

 
17

Cash paid to acquire business
(500
)
 
—

Purchases of property, equipment and improvements
(273
)
 
(135
)
Net cash used in investing activities
(775
)
 
(120
)
Cash flows from financing activities:
 

 
 

Dividends accrued
(357
)
 
(689
)
Proceeds from issuance of shares from exercise of employee stock options
6

 
—

Net cash used in financing activities
(351
)
 
(689
)
Effects of exchange rate on cash
169

 
144

Net decrease in cash and cash equivalents
(4,677
)
 
(2,778
)
Cash and cash equivalents, beginning of period
18,619

 
20,493

Cash and cash equivalents, end of period
$
13,942

 
$
17,715

Supplementary cash flow information:
 

 
 

Cash paid for income taxes
$
89

 
$
303

Cash paid for interest
$
85

 
$
85

Non-cash acquisition of assets
$
1,214

 
$
—

Non-cash accrual of dividend payable
$
357

 
$
—

 See accompanying notes to unaudited consolidated financial statements.

7

CSP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED DECEMBER 31, 2013 AND 2012

 
Organization and Business
 
CSP Inc. was founded in 1968 and is based in Billerica, Massachusetts. To meet the diverse requirements of its industrial, commercial and defense customers worldwide, CSP Inc. and its subsidiaries (collectively “CSPI” or the “Company”) develop and market IT integration solutions and high-performance cluster computer systems. The Company operates in two segments, its Systems segment and its Service and System Integration segment.
 
1.         Basis of Presentation
 
The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of the interim periods presented. All adjustments were of a normal recurring nature. Certain information and footnote disclosures normally included in the annual financial statements, which are prepared in accordance with accounting principles generally accepted in the United States, have been condensed or omitted. Accordingly, the Company believes that although the disclosures are adequate to make the information presented not misleading, the unaudited financial statements should be read in conjunction with the footnotes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2013.
 
2.        Use of Estimates
 
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates under different assumptions or conditions.
 
3.  Acquired Business  

On November 4, 2013 the Company acquired substantially all of the assets of Myricom, Inc.  Myricom has been integrated into the Systems business segment.  Prior to our acquisition, Myricom was a manufacturer of high performance interconnect computing devices and software.  The Company acquired Myricom in order to obtain (i) Myricom’s interconnect technology, which is critical to our latest MultiComputer products and (ii) a strong base of new customers in commercial growth markets.  The Company also retained key Myricom technical personnel.  Myricom was a key supplier to CSPI’s MultiComputer Division.  Its interconnect technology is an important component of the latest generation MultiComputer products that we currently supply to our customers.

Although Myricom was an established business, prior to our acquisition it had previously sold off a significant portion of its business and was faced with the likelihood of having to shut down operations if it could not find a buyer to purchase its remaining assets.  This was because the revenue that Myricom was able to generate from these remaining assets was not sufficient to support its cost structure so as to enable Myricom to operate at a profit.  These factors contributed to a purchase price that resulted in the recognition of a bargain purchase gain.  The Company paid total cash consideration of approximately $0.5 million to acquire substantially all of the assets of Myricom and incurred approximately $0.1 million for the assumption of certain other liabilities.  The purchase of Myricom resulted in the recognition of a bargain purchase price of approximately $0.5 million.  The bargain purchase price gain is shown net of the federal and state tax effect.

 
The purchase price was allocated as follows:

8

 
 
(Amounts in Thousands)
Inventory
$
1,030

Property & equipment
17

Intangibles
260

Gross assets acquired
1,307

Product warranty liability assumed
(93
)
Net assets acquired
1,214

Less: asset purchase price
500

Bargain purchase gain before tax
714

Deferred tax on bargain purchase gain
(252
)
Bargain purchase gain, net of tax effect
$
462

 
Management's estimates and assumptions are subject to change upon the finalization of the valuation and may be adjusted. The purchase price allocation from which the inventory, property and intangible assets were derived has not been finalized. The preliminary allocation of the purchase price for accounting purposes was based upon preliminary estimates and assumptions that are subject to change upon the finalization of the valuations.

The results of operations of Myricom for the period November 4 - December 31, 2013, are included in the Company’s consolidated statement of operations for the three months ended December 31, 2013.

The following proforma condensed combined financial information gives effect to the acquisition of Myricom as if it were consummated on October 1, 2012 (the beginning of the comparable prior reporting period), and includes proforma adjustments related to the bargain purchase gain, amortization of inventory step-up and acquired intangible assets. The proforma condensed combined financial information is presented for informational purposes only. The proforma condensed combined financial information is not intended to represent or be indicative of the results of operations that would have been reported had the acquisition occurred on October 1, 2012 and should not be taken as representative of future results of operations of the combined company.
The following table presents the proforma condensed combined financial information (in thousands, except per share amounts):

 
For the three months ended
 
December 31, 2013
 
December 31, 2012
 
(Amounts in thousands except per share data)
Revenue
$
21,951

 
$
22,747

Net income (loss)
$
35

 
$
(834
)
Net income (loss) per share – basic
$
0.01

 
$
(0.24
)
Net income (loss) per share – diluted
$
0.01

 
$
(0.24
)

 

4.        Earnings Per Share of Common Stock
 
Basic net income per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per common share reflects the maximum dilution that would have resulted from the assumed exercise and share repurchase related to dilutive stock options and is computed by dividing net income by the assumed weighted average number of common shares outstanding.
 
We are required to present earnings per share, or EPS, utilizing the two class method because we had outstanding, non-vested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, which are considered participating securities.
 

9

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

 
For the three months ended
 
December 31, 2013
 
December 31, 2012
 
(Amounts in thousands except per share data)
Net income
$
346

 
$
115

Less: Net income attributable to nonvested common stock
11

 
2

Net income attributable to common stockholders
$
335

 
$
113

 
 
 
 
Weighted average total shares outstanding – basic
3,545

 
3,426

Less: weighted average non-vested shares outstanding
114

 
63

Weighted average number of common shares outstanding – basic
3,431

 
3,363

Potential common shares from non-vested stock awards and the assumed exercise of stock options
43

 
44

Weighted average common shares outstanding – diluted
3,474

 
3,407

 
 
 
 
Net income per share – basic
$
0.10

 
$
0.03

Net income per share – diluted
$
0.10

 
$
0.03

 
All anti-dilutive securities, including certain stock options, are excluded from the diluted income per share computation. For the three months ended December 31, 2013 and 2012, 49,000 and 197,000 options, respectively, were excluded from the diluted income per share calculation because their inclusion would have been anti-dilutive.

5.         Inventories
 
Inventories consist of the following:
 
December 31, 2013
 
September 30, 2013
 
(Amounts in thousands)
Raw materials
$
2,379

 
$
1,587

Work-in-process
1,204

 
404

Finished goods
3,016

 
2,800

Total
$
6,599

 
$
4,791

 
Finished goods includes inventory that has been shipped, but for which all revenue recognition criteria has not been met, of approximately $0.3 million and $0.5 million as of December 31, 2013 and September 30, 2013, respectively.
 
Total inventory balances in the table above are shown net of reserves for obsolescence of approximately $4.5 million and $4.6 million as of December 31, 2013 and September 30, 2013, respectively.
 

6.        Accumulated Other Comprehensive Loss
 
 The components of accumulated other comprehensive loss are as follows:


10

 
 
December 31, 2013
 
September 30, 2013
 
 
(Amounts in thousands)
Cumulative effect of foreign currency translation
 
$
(2,006
)
 
$
(2,156
)
Additional minimum pension liability
 
(3,709
)
 
(3,709
)
Accumulated other comprehensive loss
 
$
(5,715
)
 
$
(5,865
)


7.         Pension and Retirement Plans
 
The Company has defined benefit and defined contribution plans in the United Kingdom, Germany and the U.S. In the United Kingdom and Germany, the Company provides defined benefit pension plans and defined contribution plans for the majority of its employees. In the U.S., the Company provides benefits through supplemental retirement plans to certain current and former employees. The domestic supplemental retirement plans have life insurance policies which are not plan assets but were purchased by the Company as a vehicle to fund the costs of the plan. Domestically, the Company also provides for officer death benefits through post-retirement plans to certain officers.  All of the Company’s defined benefit plans are closed to newly hired employees and have been for the two years ended September 30, 2013 and for the three months ended December 31, 2013.

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.
 
Our pension plan in the United Kingdom is the only plan with plan assets. The plan assets consist of an investment in a commingled fund which in turn comprises a diversified mix of assets including corporate equity securities, government securities and corporate debt securities.
 
The components of net periodic benefit costs related to the U.S. and international plans are as follows:
 
 
For the Three Months Ended December 31,
 
2013
 
2012
 
Foreign
 
U.S.
 
Total
 
Foreign
 
U.S.
 
Total
 
(Amounts in thousands)
Pension:
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
11

 
$
—

 
$
11

 
$
15

 
$
—

 
$
15

Interest cost
190

 
17

 
207

 
173

 
16

 
189

Expected return on plan assets
(115
)
 
—

 
(115
)
 
(104
)
 
—

 
(104
)
Amortization of:
 

 
 

 
 

 
 

 
 

 
 

Prior service gain
—

 
—

 
—

 
—

 
—

 
—

Amortization of net gain
23

 
(2
)
 
21

 
36

 
6

 
42

Net periodic benefit cost
$
109

 
$
15

 
$
124

 
$
120

 
$
22

 
$
142

 
 
 
 
 
 
 
 
 
 
 
 
Post Retirement:
 

 
 

 
 

 
 

 
 

 
 

Service cost
$
—

 
$
3

 
$
3

 
$
—

 
$
—

 
$
—

Interest cost
—

 
11

 
11

 
—

 
9

 
9

Amortization of net gain
—

 
(36
)
 
(36
)
 
—

 
(46
)
 
(46
)
Net periodic benefit cost
$
—

 
$
(22
)
 
$
(22
)
 
$
—

 
$
(37
)
 
$
(37
)
 


11



8.        Segment Information
 
The following table presents certain operating segment information.
 
 
 
 
Service and System Integration Segment
 
 
For the Three Months Ended December 31,
 
Systems
Segment
 
Germany
 
United
Kingdom
 
U.S.
 
Total
 
Consolidated
Total
 
 
(Amounts in thousands)
2013
 
 
 
 
 
 
 
 
 
 
 
 
Sales:
 
 
 
 
 
 
 
 
 
 
 
 
Product
 
$
1,006

 
$
1,401

 
$
647

 
$
11,695

 
$
13,743

 
$
14,749

Service
 
1,283

 
4,188

 
328

 
784

 
5,300

 
6,583

Total sales
 
2,289

 
5,589

 
975

 
12,479

 
19,043

 
21,332

Profit (loss) from operations
 
142

 
(81
)
 
31

 
248

 
198

 
340

Assets
 
15,304

 
13,134

 
3,379

 
17,061

 
33,574

 
48,878

Capital expenditures
 
61

 
87

 
23

 
102

 
212

 
273

Depreciation and amortization
 
52

 
46

 
4

 
137

 
187

 
239

 
 
 
 
 
 
 
 
 
 
 
 
 
2012
 
 

 
 

 
 

 
 

 
 

 
 

Sales:
 
 

 
 

 
 

 
 

 
 

 
 

Product
 
$
96

 
$
2,064

 
$
154

 
$
12,991

 
$
15,209

 
$
15,305

Service
 
957

 
3,204

 
302

 
1,102

 
4,608

 
5,565

Total sales
 
1,053

 
5,268

 
456

 
14,093

 
19,817

 
20,870

Profit (loss) from operations
 
(373
)
 
(147
)
 
—

 
693

 
546

 
173

Assets
 
16,914

 
13,527

 
3,524

 
16,849

 
33,900

 
50,814

Capital expenditures
 
41

 
55

 
3

 
36

 
94

 
135

Depreciation and amortization
 
37

 
42

 
5

 
39

 
86

 
123

 
 
 
 
 
 
 
 
 
 
 
 
 
Profit (loss) from operations consists of sales less cost of sales, engineering and development, selling, general and administrative expenses but is not affected by either non-operating charges/income or by income taxes. Non-operating charges/income consists principally of investment income and interest expense.  All intercompany transactions have been eliminated.
 
The following table lists customers from which the Company derived revenues in excess of 10% of total revenues for the three-month periods ended December 31, 2013, and 2012.

 
 
For the three months ended,
 
 
December 31, 2013
 
December 31, 2012
 
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
(dollars in millions)
Customer A
 
$
6.1

 
29
%
 
$
5.1

 
24
%
Customer B
 
$
3.3

 
15
%
 
$
2.6

 
12
%
 


12

9.        Fair Value Measures
 
Assets and Liabilities measured at fair value on a recurring basis are as follows:
 
 
Fair Value Measurements Using
 
Level 1
 
Level 2
 
Level 3
 
Total
Balance
 
As of December 31, 2013
 
(Amounts in thousands)
Assets:
 
 
 
 
 
 
 
Money Market funds
$
1,255

 
$
—

 
$
—

 
$
1,255

Total assets measured at fair value
$
1,255

 
$
—

 
$
—

 
$
1,255

 
 
 
 
 
 
 
 
 
 
As of September 30, 2013
 
(Amounts in thousands)
Assets:
 

 
 

 
 

 
 

Money Market funds
$
3,503

 
$
—

 
$
—

 
$
3,503

Total assets measured at fair value
$
3,503

 
$
—

 
$
—

 
$
3,503

 
These assets are included in cash and cash equivalents in the accompanying consolidated balance sheets.  All other monetary assets and liabilities are short-term in nature and approximate their fair value. The Company did not have any transfers between Level 1, Level 2 or Level 3 measurements.
 
The Company had no liabilities measured at fair value as of December 31, 2013 or September 30, 2013. The Company had no assets or liabilities measured at fair value on a non recurring basis as of December 31, 2013 or September 30, 2013.
 
10.    Dividend
On December 17, 2013, our board of directors declared a cash dividend of $0.10 per share which was paid on January 7, 2014 to stockholders of record as of December 27, 2013, the record date.


13




Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
The discussion below contains certain forward-looking statements related to, among others, but not limited to, statements concerning future revenues and future business plans. In addition, forward-looking statements include statements in which we use words such as “expect,” “believe,” “anticipate,” “intend,” or similar expressions. Although we believe the expectations reflected in such forward-looking statements are based on reasonable assumptions, we cannot assure you that these expectations will prove to have been correct, and  actual results may vary from those contained in such forward-looking statements.
 
Markets for our products and services are characterized by rapidly changing technology, new product introductions and short product life cycles. These changes can adversely affect our business and operating results. Our success will depend on our ability to enhance our existing products and services and to develop and introduce, on a timely and cost effective basis, new products that keep pace with technological developments and address increasing customer requirements. The inability to meet these demands could adversely affect our business and operating results.
 
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, income taxes, deferred compensation and retirement plans, estimated selling prices used for revenue recognition 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. A description of our critical accounting policies is contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 in the “Critical Accounting Policies” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Results of Operations
 
Overview of the three months ended December 31, 2013 Results of Operations
 
Overview:

 Revenue increased by approximately $0.5 million, or 2%, to $21.3 million for the three months ended December 31, 2013 versus $20.9 million for the three months ended December 31, 2012. Our gross profit margin increased overall, from 20% for the three months ended December 31, 2012 to 21% for the three months ended December 31, 2013. Operating income also increased to approximately $0.3 million for the three-month period ended December 31, 2013 versus $0.2 million for the three months ended December 31, 2012. This increase in operating income was due to an increase in gross profit of approximately $0.3 million, a bargain purchase gain of $0.5 million on the acquisition of Myricom, Inc during the three months ended December 31, 2013 and was partially offset by an increase in operating expenses of approximately $0.6 million, due in large part to the operating expenses of Myricom. Net income was $0.3 million for three-month period ended December 31, 2013 versus $0.1 million for the three months ended December 31, 2012.


14

The following table details our results of operations in dollars and as a percentage of sales for the three months ended December 31, 2013 and 2012:
 
 
 
December 31, 2013
 
%
of sales
 
December 31, 2012
 
%
of sales
 
 
(Dollar amounts in thousands)
Sales
 
$
21,332

 
100
 %
 
$
20,870

 
100
%
Costs and expenses:
 
 

 
 

 
 

 
 

Cost of sales
 
16,799

 
79
 %
 
16,693

 
80
%
Engineering and development
 
635

 
3
 %
 
444

 
2
%
Selling, general and administrative
 
4,020

 
19
 %
 
3,560

 
17
%
Total costs and expenses
 
21,454

 
101
 %
 
20,697

 
99
%
Bargain purchase gain
 
462

 
2
 %
 
—

 
—
%
Operating income
 
340

 
2
 %
 
173

 
1
%
Other income (expense)
 
(26
)
 
—
 %
 
59

 
—
%
Income before income taxes
 
314

 
2
 %
 
232

 
1
%
Income tax expense (benefit)
 
(32
)
 
—
 %
 
117

 
—
%
Net income
 
$
346

 
2
 %
 
$
115

 
1
%
 

Sales
 
The following table details our sales by operating segment for the three months ended December 31, 2013 and 2012:
 
 
 
Systems
 
Service and
System
Integration
 
Total
 
% of
Total
 
 
(Dollar amounts in thousands)
For the three Months Ended December 31, 2013:
 
 
 
 
 
 
 
 
Product
 
$
1,006

 
$
13,743

 
$
14,749

 
69
%
Services
 
1,283

 
5,300

 
6,583

 
31
%
Total
 
$
2,289

 
$
19,043

 
$
21,332

 
100
%
% of Total
 
11
%
 
89
%
 
100
%
 
 

 
 
 
Systems
 
Service and
System
Integration
 
Total
 
% of
Total
For the three Months Ended December 31, 2012:
 
 

 
 

 
 

 
 

Product
 
$
96

 
$
15,209

 
$
15,305

 
73
%
Services
 
957

 
4,608

 
5,565

 
27
%
Total
 
$
1,053

 
$
19,817

 
$
20,870

 
100
%
% of Total
 
5
%
 
95
%
 
100
%
 
 

 

15

 
 
Systems
 
Service and
System
Integration
 
Total
 
%
increase (decrease)
Increase (Decrease)
 
 

 
 

 
 

 
 

Product
 
$
910

 
$
(1,466
)
 
$
(556
)
 
(4
)%
Services
 
326

 
692

 
1,018

 
18
 %
Total
 
$
1,236

 
$
(774
)
 
$
462

 
2
 %
% increase (decrease)
 
117
%
 
(4
)%
 
2
%
 
 

 
Total revenues increased by approximately $0.5 million, or 2%, for the three months ended December 31, 2013 compared to the three months ended December 31, 2012.  Revenue in the Systems segment increased for the current year three- month period versus the prior year three-month period by approximately $1.2 million, while revenues in the Service and System Integration segment decreased by approximately $0.8 million.
 
Product revenues decreased by approximately $0.6 million, or 4%, for the three months ended December 31, 2013 compared to the comparable period of the prior fiscal year. Product revenues in the Service and System Integration segment decreased by approximately $1.5 million while in the Systems segment, product revenue increased by approximately $0.9 million for the three-month period ended December 31, 2013 versus the three month period ended December 31, 2012.

The increase in product revenues in the Systems segment of approximately $0.9 million was due substantially to revenues from the acquisition of Myricom, Inc., which the Company acquired during the three months ended December 31, 2013. Myricom revenues for the period were in excess of $0.8 million.

In the US and German divisions of the Service and System Integration segment, product sales decreased by approximately $1.3 million, and approximately $0.7 million, respectively, while in the UK division product sales increased by approximately $0.5 million.
 
In the US division's existing customer base, product sales in the IT Hosting and Healthcare verticals decreased by approximately $0.5 million and $1.0 million, respectively, while product sales in all other verticals combined decreased by an aggregate of approximately $0.4 million. These decreases were partially offset by new customer sales of approximately $0.6 million.

In Germany, the $0.7 million decrease in product revenue was driven by decreased sales in the division’s telecommunications vertical, while in the UK, the increase in product sales of approximately $0.5 million is attributable to the hiring of increased sales resources focused on increasing product sales in that region.

Service revenues increased by approximately $1.0 million, or 18%.  This increase was made up of an increase in the Systems segment of $0.3 million and an increase in the Service and System Integration segment of approximately $0.7 million. The increase in the Systems segment service revenue was due to higher royalty income recorded in the three months ended December 31, 2013 which was approximately $1.1 million versus $0.7 million for the three months ended December 31, 2012.

The increase in service revenues in the Service and System Integration segment was due to an increase in the German division, where service revenue increased by approximately $1.0 million, partially offset by a decrease in service revenues of approximately $0.3 million in the US division. In Germany, the increase in service sales was driven by increased service revenues in the division's telecommunications vertical. The decrease in service revenue in the US division of the segment was primarily from lower professional service project revenue of approximately $0.2 million and lower third party maintenance revenue of approximately $0.1 million for the three months ended December 31, 2013 versus the three months ended December 31, 2012.
 
Our sales by geographic area, based on the location to which the products were shipped or services rendered, are as follows:
 

16

 
 
For the three months ended,
 
 
 
 
 
 
December 31, 2013
 
%
 
December 31, 2012
 
%
 
$ Increase
(Decrease)
 
% Increase
(Decrease)
 
 
(Dollar amounts in thousands)
Americas
 
$
14,444

 
68
%
 
$
14,942

 
72
%
 
$
(498
)
 
(3
)%
Europe
 
6,594

 
31
%
 
5,743

 
27
%
 
851

 
15
 %
Asia
 
294

 
1
%
 
185

 
1
%
 
109

 
59
 %
Totals
 
$
21,332

 
100
%
 
$
20,870

 
100
%
 
$
462

 
2
 %
 
The decrease in Americas revenue for the three months ended December 31, 2013 versus the three months ended December 31, 2012 was primarily the result of the an overall decrease in sales to the Americas in the Service and System Integration segment where combined product and service sales to US customers decreased by an aggregate $1.3 million, while in the Systems segment, sales to US customers to the Americas increased by approximately $0.8 million, which was driven by Myricom sales to US customers of approximately $0.5 million and the royalty sales increase of approximately $0.4 million. The change in sales into Europe was from an increase of approximately $0.3 million from the Systems segment, attributable to Myricom sales and an increase in sales from the European divisions of the Service and System Integration segment of approximately $0.6 million of which $0.3 million was from favorable foreign exchange rate fluctuation in the Euro versus the US dollar.
 


17

Cost of Sales and Gross Margins

The following table details our cost of sales and gross profit margins by operating segment for the three months ended December 31, 2013 and 2012:
 
 
Systems
 
Service and
System
Integration
 
Total
 
% of
Total
 
(Dollar amounts in thousands)
For the three Months Ended December 31, 2013:
 
 
 
 
 
 
 
Product
$
756

 
$
11,827

 
$
12,583

 
75
 %
Services
47

 
4,031

 
4,078

 
24
 %
Amortization of inventory step-up and intangibles
138

 
—

 
138

 
1
 %
Total
$
941

 
$
15,858

 
$
16,799

 
100
 %
% of Total
6
 %
 
94
 %
 
100
 %
 
 

% of Sales
41
 %
 
83
 %
 
79
 %
 
 

Gross Margins:
 

 
 

 
 

 
 

Product
25
 %
 
14
 %
 
15
 %
 
 

Services
96
 %
 
24
 %
 
38
 %
 
 

Total
59
 %
 
17
 %
 
21
 %
 
 

 
 
 
 
 
 
 
 
For the three Months Ended December 31, 2012:
 

 
 

 
 

 
 

Product
$
17

 
$
13,207

 
$
13,224

 
79
 %
Services
87

 
3,382

 
3,469

 
21
 %
Amortization of inventory step-up and intangibles
—

 
—

 
—

 
—
 %
Total
$
104

 
$
16,589

 
$
16,693

 
100
 %
% of Total
1
 %
 
99
 %

100
 %
 
 

% of Sales
10
 %
 
84
 %
 
80
 %
 
 

Gross Margins:
 

 
 

 
 

 
 

Product
82
 %
 
13
 %
 
14
 %
 
 

Services
91
 %
 
27
 %
 
38
 %
 
 

Total
90
 %
 
16
 %
 
20
 %
 
 

 
 
 
 
 
 
 
 
Increase (decrease)
 

 
 

 
 

 
 

Product
$
739

 
$
(1,380
)

$
(641
)
 
(5
)%
Services
$
(40
)
 
$
649

 
$
609

 
18
 %
Amortization of inventory step-up and intangibles
$
138

 
$
—

 
$
138

 
—
 %
Total
$
837

 
$
(731
)
 
$
106

 
1
 %
% Increase (decrease)
805
 %
 
(4
)%

1
 %
 
 

% of Sales
31
 %
 
(1
)%
 
(1
)%
 
 

Gross Margins:
 

 
 

 
 

 
 

Product
(57
)%
 
1
 %
 
1
 %
 
 

Services
5
 %
 
(3
)%
 
—
 %
 
 

Total
(31
)%
 
1
 %
 
1
 %
 
 

 
Total cost of sales increased by approximately $0.1 million when comparing the three months ended December 31, 2013 versus the three months ended December 31, 2012.   This increase in cost of sales was due to amortization expenses in the three months ended December 31, 2013 related to a step-up in inventory value and purchased intangibles in connection with the acquisition of Myricom. The gross profit margin ("GPM") for the three months ended December 31, 2013 excluding the

18

amortization expense was 22%. While sales increased by 2% , cost of sales increased by 1%, and would not have increased at all, had it not been for the amortization expense described herein. The more favorable GPM of 21% for the three months ended December 31, 2013 versus 20% for 2012 was attributable to a greater proportion of Systems segment revenue (11%) for the three months ended December 31, 2013 versus the three months ended December 31, 2012 (5%) and higher GPM in the Service and System Integration segment of 17% in the current year quarter versus 16% in the corresponding prior year quarter.
 
In the Service and System Integration segment, the overall GPM was 17% for the three months ended December 31, 2013 and 16% for the prior year three-month period. The increase in GPM in the Service and System Integration segment was due primarily to higher utilization of in-house service engineers in providing billable services and more favorable product mix in Germany.
 
In the Systems segment, the overall GPM decreased from 90% to 59% as shown in the table above.  This was due to two primary factors; (i) the aforementioned amortization expense negatively impacted the GPM in the segment by six percentage points (that is, without this expense, the GPM would've been 65% for the three months ended December 31, 2013), and (ii) royalty revenue, which carries a 100% GPM, made up a much lower percentage (49%) of total Systems segment revenue whereas in the prior year three-month period, royalty revenue was 71% of total Systems segment revenue.

Engineering and Development Expenses
 
The following table details our engineering and development expenses by operating segment for the three months ended December 31, 2013 and 2012:
 
 
For the three months ended,
 
 
 
 
 
December 31, 2013
 
% of
Total
 
December 31, 2012
 
% of
Total
 
$ Increase
 
% Increase
 
(Dollar amounts in thousands)
By Operating Segment:
 
 
 
 
 
 
 
 
 
 
 
Systems
$
635

 
100
%
 
$
444

 
100
%
 
$
191

 
43
%
Service and System Integration
—

 
—

 
—

 
—

 
—

 
—

Total
$
635

 
100
%
 
$
444

 
100
%
 
$
191

 
43
%
 
The increase shown in the table above was due to engineering expenses of Myricom, which the Company acquired during the three months ended December 31, 2013.
 
Selling, General and Administrative
 
The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the three months ended December 31, 2013 and 2012:
 
 
For the three months ended,
 
 
 
 
 
December 31, 2013
 
% of
Total
 
December 31, 2012
 
% of
Total
 
$ Increase
 
% Increase
 
(Dollar amounts in thousands)
By Operating Segment:
 
 
 
 
 
 
 
 
 
 
 
Systems
$
1,033

 
26
%
 
$
878

 
25
%
 
$
155

 
18
%
Service and System Integration
2,987

 
74
%
 
2,682

 
75
%
 
305

 
11
%
Total
$
4,020

 
100
%
 
$
3,560

 
100
%
 
$
460

 
13
%
 
SG&A expenses increased in the Systems segment due to the acquisition of Myricom. The increase in the Service and System Integration segment was due primarily from the US division of the segment due to higher compensation expense of approximately $0.1 million due to headcount increases, and approximately $0.1 million in increased

19

bad debt expense.
 
Other Income/Expenses
 
The following table details our other income (expense) for the three months ended December 31, 2013 and 2013:
 
 
For the three months ended,
 
 
 
December 31, 2013
 
December 31, 2012
 
Increase (decrease)
 
(Amounts in thousands)
Interest expense
$
(21
)
 
$
(21
)
 
$
—

Interest income
2

 
13

 
(11
)
Foreign exchange gain (loss)
(26
)
 
13

 
(39
)
Gain on sale of fixed assets
—

 
17

 
(17
)
Other income (expense), net
19

 
37

 
(18
)
Total other income (expense), net
$
(26
)
 
$
59

 
$
(85
)
 
Other income (expense), net, for the three month periods ended December 31, 2013 and 2013 was not significant.

Income Taxes
 
Income Tax Provision
 
The Company recorded an income tax benefit of approximately $32 thousand for the quarter ended December 31, 2013, reflecting an effective income tax benefit rate of 10% for the period compared to income tax expense of approximately $0.1 million for the quarter ended December 31, 2012, which reflected an effective tax rate of 50%. The tax benefit on book income for the quarter ended December 31, 2013, was because the bargain purchase gain related to the Myriom acquisition gave rise to a deferred tax charge which is netted against the gain for book purposes, as opposed to showing as income tax expense.

In assessing the realizability of deferred tax assets, we considered our taxable future earnings and the expected timing of the reversal of temporary differences. Accordingly, we have recorded a valuation allowance which reduces the gross deferred tax asset to an amount that we believe will more likely than not be realized. We maintained a substantial valuation allowance against our United Kingdom 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.
 
Liquidity and Capital Resources
 
Our primary source of liquidity is our cash and cash equivalents, which decreased by $4.7 million to $13.9 million as of December 31, 2013 from $18.6 million as of September 30, 2013. At December 31, 2013, cash equivalents consisted of money market funds which totaled $1.3 million.
 
Significant uses of cash for the three months ended December 31, 2013 included an increase in accounts receivable of approximately $3.4 million, an increase in inventories of approximately $0.8 million, a bargain purchase gain in connection with the acquisition of Myricom of approximately $0.5 million, an increase in other current assets of approximately $0.7 million, cash paid to acquire Myricom of $0.5 million and dividends of approximately $0.4 million. Significant sources of cash included net income of approximately $0.3 million and an increase in accounts payable and accrued expenses of approximately $1.3 million.
 
Cash held by our foreign subsidiaries located in Germany and the United Kingdom totaled approximately $5.2 million as of December 31, 2013 and $6.6 million as of September 30, 2013. This cash is included in our total cash and cash equivalents reported above. We consider this cash to be permanently reinvested into these foreign locations because repatriating it would result in unfavorable tax consequences.  Consequently, it is not available for activities that would require it to be repatriated to the U.S.

20

 
If cash generated from operations is insufficient to satisfy working capital requirements, we may need to access funds through bank loans 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.


21

Item 4.          Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
The Company evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2013. 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 Securities Exchange Act of 1934, as amended, or  the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including our 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 December 31, 2013, the Company’s chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
 
Changes in Internal Controls over Financial Reporting
 
During the period covered by this report, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



22

PART II.   OTHER INFORMATION

Item 6.           Exhibits
 
Number
 
Description
31.1*
 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2*
 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1*
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101*
 
Interactive Data Files regarding (a) our Consolidated Balance Sheets as of December 31, 2013 and September 30, 2013, (b) our Consolidated Statements of Operations for the three months ended December 31, 2013 and 2012, (c) our Consolidated Statements of Comprehensive Income for the three months ended December 31, 2013 and 2012, (d) our Consolidated Statement of Shareholders’ Equity for the three months ended December 31, 2013, (e) our Consolidated Statements of Cash Flows for the three months ended December 31, 2013 and 2012 and (f) the Notes to such Consolidated Financial Statements.

 
 
*Filed Herewith


23

SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
CSP INC.
 
 
 
Date: February 14, 2014
By:
/s/ Victor Dellovo
 
 
Victor Dellovo
 
 
Chief Executive Officer,
 
 
President and Director
 
 
 
Date: February 14, 2014
By:
/s/ Gary W. Levine
 
 
Gary W. Levine
 
 
Chief Financial Officer


24

Exhibit Index
 
Number
 
Description
31.1*
 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2*
 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1*
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101*
 
Interactive Data Files regarding (a) our Consolidated Balance Sheets as of December 31, 2013 and September 30, 2013, (b) our Consolidated Statements of Operations for the three months ended December 31, 2013 and 2012, (c) our Consolidated Statements of Comprehensive Income for the three months ended December 31, 2013 and 2012, (d) our Consolidated Statement of Shareholders’ Equity for the three months ended December 31, 2013, (e) our Consolidated Statements of Cash Flows for the three months ended December 31, 2013 and 2012 and (f) the Notes to such Consolidated Financial Statements.

 
*Filed Herewith

25