CSP Inc. — Q3 FY2017 Form 10-Q
Business context and period. CSP Inc. develops IT integration solutions and high-performance cluster computer systems through its High Performance Products (HPP) and Technology Solutions (TS) segments. This unaudited report covers the three and nine months ended June 30, 2017; the balance sheet compares June 30, 2017 with September 30, 2016.
Key financial results
| Metric | Three months ended June 30 | Nine months ended June 30 |
|---|---|---|
| Sales | $30.5 million, up 13% from $26.9 million | $75.8 million, down 3% from $77.7 million |
| Gross profit / margin | $6.8 million / 22%, versus $7.2 million / 27% | $16.9 million / 22%, versus $18.7 million / 24% |
| Operating income | $1.1 million, versus $1.9 million | $1.6 million, versus $3.1 million |
| Net income | $0.7 million, versus $1.3 million; diluted EPS $0.17 versus $0.32 | $1.1 million, versus $2.0 million; diluted EPS $0.27 versus $0.52 |
| Operating cash flow | $4.4 million for nine months, versus $2.5 million |
Balance sheet and liquidity. Cash and cash equivalents were $16.0 million, up from $13.1 million at September 30, 2016. Current assets were $51.1 million and current liabilities $26.5 million. Total liabilities were $40.2 million, including $14.1 million of current and long-term pension and retirement plan liabilities. The filing does not provide a clear balance-sheet borrowing or total debt value. Cash increased by $2.9 million over the nine-month period; cash dividends paid were $1.3 million, or $0.33 per share.
Changes and management commentary
- Quarterly sales growth came from TS, up $5.9 million, partly offset by HPP sales declining $2.3 million. TS growth was principally attributed to U.S. customer order timing. HPP product shipments and royalties were lower than in the prior-year quarter.
- For the nine months, HPP sales declined $2.4 million while TS sales increased $0.4 million. Lower HPP product sales and weaker TS service revenue contributed to the overall decline.
- Gross margin fell in both comparison periods. Management cited the shift toward lower-margin TS revenue for the quarterly decline; nine-month TS product and service margins also weakened. Nine-month HPP margin percentage improved, helped by higher high-margin royalties and fewer inventory write-offs.
- Working capital movements were significant: accounts payable and accrued expenses increased $7.5 million, while inventory increased $3.7 million, accounts receivable $1.5 million and deferred costs $1.5 million.
Outlook, risks and unusual items
- Management expected royalty revenue in fiscal Q4 2017 for an equivalent number of high-speed processing boards used in two aircraft. No broader numerical revenue or earnings guidance is provided.
- Management said available cash, operating cash generation and credit-line availability should meet working-capital and capital-expenditure needs for the foreseeable future, while noting that additional financing may not be available on acceptable terms if needed.
- Customer concentration is material: Customer A represented 27% of quarterly sales and 20% of nine-month sales; Customer B represented 11% of nine-month sales. The company also cites reliance on U.S. federal government contracts, certain single-source suppliers and intense competition as risks.
- Disclosure controls and procedures were deemed ineffective as of June 30, 2017. An unremediated material weakness relates to foreign-subsidiary revenue recognition, including whether recognition criteria are met and whether revenue should be reported gross or net. Management had added review procedures and upgraded international accounting staff but could not conclude remediation was complete.
- The company reported a $68,000 foreign-exchange gain for the nine months, compared with a $118,000 loss a year earlier. Management noted ongoing estimates and judgments in areas including revenue recognition, inventory reserves, taxes and pension liabilities.
Important facts for investors to verify
- Whether the foreign-subsidiary revenue-recognition material weakness has been remediated and whether any prior-period revenue requires adjustment.
- Whether the expected Q4 royalty revenue was recognized, and the timing and sustainability of HPP royalties and TS customer orders.
- Customer concentration, order timing, and the effect of lower-margin TS mix on consolidated margins and earnings.
- The drivers and persistence of working-capital growth, particularly inventory, deferred costs and the large increase in accounts payable and accrued expenses.
- Availability and terms of credit lines, given the filing does not state a clear borrowing or total debt balance.