csp_10q-033111.htm


 
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________
 
FORM 10-Q
__________________
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended March 31, 2011.
 
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  ¨.
 
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  ¨    No  ¨.
 
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
¨
Accelerated filer
¨
       
Non-accelerated filer
¨  (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  ¨    No  x
 
As of May 2, 2011,  the registrant had 3,486,510 shares of common stock issued and outstanding.
 
 


 
 
 
 

INDEX
 
   
Page
 
PART I. FINANCIAL INFORMATION
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets as of March 31, 2011 (unaudited) and September 30, 2010
3
     
 
Consolidated Statements of Operations (unaudited) for the three and six months ended March 31, 2011 and 2010
4
     
 
Consolidated Statement of Shareholders’ Equity (unaudited) for the six months ended March 31, 2011
5
     
 
Consolidated Statements of Cash Flows (unaudited) for the six months ended March 31, 2011 and 2010
6
     
 
Notes to Consolidated Financial Statements (unaudited)
7-11
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
12-22
     
Item 4.
Controls and Procedures
23
     
PART II. OTHER INFORMATION
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
24
     
Item 6.
Exhibits
25

 
2

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CSP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except par value)
 
   
March 31,
2011
   
September 30,
2010
 
   
(Unaudited)
       
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 14,372     $ 15,531  
Accounts receivable, net of allowances of $322 and $288
    12,610       12,190  
Inventories
    8,314       5,862  
Refundable income taxes
    228       721  
Deferred income taxes
    126       124  
Other current assets
    2,186       1,523  
Total current assets
    37,836       35,951  
Property, equipment and improvements, net
    920       873  
                 
Other assets:
               
Intangibles, net
    631       687  
Deferred income taxes
    903       880  
Cash surrender value of life insurance
    2,867       2,689  
Other assets
    250       299  
Total other assets
    4,651       4,555  
Total assets
  $ 43,407     $ 41,379  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable and accrued expenses
  $ 10,577     $ 10,049  
Deferred revenue
    3,678       3,078  
Pension and retirement plans
    454       441  
Income taxes payable
    508       380  
Total current liabilities
    15,217       13,948  
Pension and retirement plans
    9,199       8,928  
Capital lease obligation
    24       24  
Total liabilities
    24,440       22,900  
                 
Commitments and contingencies
               
                 
Shareholders’ equity:
               
Common stock, $.01 par; authorized, 7,500 shares; issued and outstanding 3,485 and 3,520 shares, respectively
    35       35  
Additional paid-in capital
    11,052       11,280  
Retained earnings
    13,191       12,516  
Accumulated other comprehensive loss
    (5,311 )     (5,352 )
Total shareholders’ equity
    18,967       18,479  
Total liabilities and shareholders’ equity
  $ 43,407     $ 41,379  
 
 
See accompanying notes to unaudited consolidated financial statements.
 
 
3

 

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

   
For the three months ended
   
For the six months ended
 
   
March 31,
2011
   
March 31,
2010
   
March 31,
2011
   
March 31,
2010
 
Sales:
                       
Product
  $ 15,726     $ 20,551     $ 33,150     $ 35,796  
Services
    3,483       3,370       8,169       6,786  
Total sales
    19,209       23,921       41,319       42,582  
                                 
Cost of sales:
                               
Product
    12,457       15,960       27,750       29,576  
Services
    2,503       2,471       4,792       5,212  
Total cost of sales
    14,960       18,431       32,542       34,788  
                                 
Gross profit
    4,249       5,490       8,777       7,794  
                                 
Operating expenses:
                               
Engineering and development
    508       430       1,018       902  
Selling, general and administrative
    3,310       3,411       6,685       6,468  
Total operating expenses
    3,818       3,841       7,703       7,370  
                                 
Operating income
    431       1,649       1,074       424  
                                 
Other income (expense):
                               
Foreign exchange gain (loss)
    12       (3 )     8       (10 )
Other income (expense), net
    (13 )     (13 )     (30 )     (26 )
Total other income (expense), net
    (1 )     (16 )     (22 )     (36 )
                                 
Income before income taxes
    430       1,633       1,052       388  
Income tax expense
    144       644       377       141  
Net income
  $ 286     $ 989     $ 675     $ 247  
                                 
Net income attributable to common shareholders
  $ 282     $ 979     $ 666     $ 245  
                                 
Net income per share – basic
  $ 0.08     $ 0.28     $ 0.19     $ 0.07  
Weighted average shares outstanding – basic
    3,437       3,552       3,455       3,544  
Net income per share – diluted
  $ 0.08     $ 0.27     $ 0.19     $ 0.07  
Weighted average shares outstanding – diluted
    3,471       3,581       3,491       3,573  


See accompanying notes to unaudited consolidated financial statements.

 
4

 

CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
For the Six Months Ended March 31, 2011
(Amounts in thousands)
 
   
Shares
   
Amount
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
other
comprehensive
loss
   
Total
Shareholders’
Equity
   
Comprehensive
Income
 
Balance as of September 30, 2010
    3,520     $ 35     $ 11,280     $ 12,516     $ (5,352 )   $ 18,479        
Comprehensive income (loss):
                                                     
Net income
                      675             675     $ 675  
Other comprehensive loss:
                                                       
Effect of foreign currency translation
                            41       41       41  
Total comprehensive income
                                                  $ 716  
                                                         
Stock-based compensation
                46                   46          
Issuance of shares under employee stock purchase plan
    25             75                   75          
Restricted stock shares issued
    37       1       45                   46          
Purchase of common stock
    (97 )     (1 )     (394 )                 (395 )        
                                                         
Balance as of March 31, 2011
    3,485     $ 35     $ 11,052     $ 13,191     $ (5,311 )   $ 18,967          
 
 
See accompanying notes to unaudited consolidated financial statements.

 
5

 

CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)

   
For the six months ended
 
   
March 31,
2011
   
March 31,
2010
 
Cash flows from operating activities:
           
Net income
  $ 675     $ 247  
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation and amortization
    182       200  
Amortization of intangibles
    56       57  
Loss on disposal of fixed assets, net
    3       1  
Foreign exchange loss (gain)
    (8 )     10  
Non-cash changes in accounts receivable
    34       (21 )
Stock-based compensation expense on stock options and restricted stock awards
    92       107  
Deferred income taxes
    -       (60 )
Increase in cash surrender value of life insurance
    (41 )     (41 )
Changes in operating assets and liabilities:
               
Increase in accounts receivable
    (202 )     (7,718 )
Increase in inventories
    (2,442 )     (705 )
(Increase) decrease in refundable income taxes
    502       (68 )
(Increase) decrease in other current assets
    (601 )     175  
Decrease in other assets
    52       5  
Increase in accounts payable and accrued expenses
    386       1,445  
Increase in deferred revenue
    509       358  
Increase in pension and retirement plans liability
    83       110  
Increase in income taxes payable
    127       145  
Decrease in other long term liabilities
    -       (14 )
Net cash used in operating activities
    (593 )     (5,767 )
                 
Cash flows from investing activities:
               
Life insurance premiums paid
    (137 )     (64 )
Purchases of property, equipment and improvements
    (211 )     (172 )
Net cash used in investing activities
    (348 )     (236 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of shares under employee stock purchase plan
    75       61  
Purchase of common stock
    (395 )     (40 )
Net cash provided by (used in) financing activities
    (320 )     21  
                 
Effects of exchange rate on cash
    102       (636 )
                 
Net decrease in cash and cash equivalents
    (1,159 )     (6,618 )
Cash and cash equivalents, beginning of period
    15,531       18,904  
Cash and cash equivalents, end of period
  $ 14,372     $ 12,286  
                 
Supplementary cash flow information:
               
Cash paid for income taxes
  $ 251     $ 146  
                 
Cash paid for interest
  $ 85     $ 89  

 
See accompanying notes to unaudited consolidated financial statements.
 
 
6

 
 
CSP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED MARCH 31, 2011 AND 2010
 
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, 2010.
 
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.
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.
 
Basic and diluted earnings per share computations for the Company’s reported net income attributable to common stockholders are as follows:
 
   
For the Three Months Ended
   
For the Six Months Ended
 
   
March 31,
2011
   
March 31,
2010
   
March 31,
2011
   
March 31,
2010
 
   
(Amounts in thousands, except per share data)
 
Net income
  $ 286     $ 989     $ 675     $ 247  
Less: Net income attributable to nonvested common stock
    4       10       9       2  
Net income attributable to common stockholders
    282       979       666       245  
                                 
Weighted average total shares outstanding – basic
    3,492       3,591       3,504       3,577  
Less: weighted average non-vested shares outstanding
    55       39       49       33  
Weighted average number of common shares outstanding – basic
    3,437       3,552       3,455       3,544  
Potential common shares from non-vested stock awards and the assumed exercise of stock options
    34       29       36       29  
Weighted average common shares outstanding – diluted
    3,471       3,581       3,491       3,573  
                                 
Net income per share – basic
  $ 0.08     $ 0.28     $ 0.19     $ 0.07  
                                 
Net income per share – diluted
  $ 0.08     $ 0.27     $ 0.19     $ 0.07  
 
 
7

 
 
All anti-dilutive securities, including stock options, are excluded from the diluted income per share computation. For the three and six months ended March 31, 2011, 208,000 and 211,000 options, respectively, were excluded from the diluted income per share calculation because their inclusion would have been anti-dilutive.
 
4.           Inventories
 
Inventories consist of the following:
 
   
March 31,
2011
   
September 30,
2010
 
   
(Amounts in thousands)
 
Raw materials
  $ 1,162     $ 1,029  
Work-in-process
    808       439  
Finished goods
    6,344       4,394  
Total
  $ 8,314     $ 5,862  

Finished goods includes inventory that has been shipped, but for which all revenue recognition criteria has not been met of approximately $3.6 million and $2.4 million as of March 31, 2011 and September 30, 2010, respectively.
 
Total inventory balances in the table above are shown net of reserves for obsolescence of approximately $4.2 million and $4.1 million as of March 31, 2011 and September 30, 2010, respectively.
 
5.
Accumulated Other Comprehensive Loss
 
The components of comprehensive income (loss) are as follows:
 
   
For the Three Months Ended
   
For the Six Months Ended
 
   
March 31,
2011
   
March 31,
2010
   
March 31,
2011
   
March 31,
2010
 
   
(Amounts in thousands)
 
Net income
  $ 286     $ 989     $ 675     $ 247  
Effect of foreign currency translation
    102       (297 )     41       (356 )
Minimum pension liability
                       
Comprehensive income (loss)
  $ 388     $ 692     $ 716     $ (109 )
 
 The components of Accumulated Other Comprehensive Loss are as follows:
 
   
March 31,
2011
   
September 30,
2010
 
   
(Amounts in thousands)
 
Cumulative effect of foreign currency translation
  $ (2,092 )   $ (2,133 )
Additional minimum pension liability
    (3,219 )     (3,219 )
Accumulated Other Comprehensive Loss
  $ (5,311 )   $ (5,352 )
 
6.           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 fiscal years 2009, 2010 and for the six months ended March 31, 2011.
 
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.
 
 
8

 
 
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 March 31
 
   
2011
   
2010
 
   
Foreign
   
U.S.
   
Total
   
Foreign
   
U.S.
   
Total
 
   
(Amounts in thousands)
 
Pension:
                                   
Service cost
  $ 18     $ 2     $ 20     $ 15     $ 2     $ 17  
Interest cost
    172       25       197       168       30       198  
Expected return on plan assets
    (126 )     —        (126 )     (111 )     —        (111 )
Amortization of:
                                               
Prior service gain
    —        —        —        —        —        —   
Amortization of net gain
    17       8       25       11       7       18  
Net periodic benefit cost
  $ 81     $ 35     $ 116     $ 83     $ 39     $ 122  
                                                 
Post Retirement:
                                               
Service cost
  $     $ 5     $ 5     $     $ 5     $ 5  
Interest cost
    —        17       17       —        17       17  
Amortization of net gain
    —        12       12       —        16       16  
Net periodic benefit cost
  $     $ 34     $ 34     $     $ 38     $ 38  

   
For the Six Months Ended March 31
 
   
2011
   
2010
 
   
Foreign
   
U.S.
   
Total
   
Foreign
   
U.S.
   
Total
 
   
(Amounts in thousands)
 
Pension:
                                   
Service cost
  $ 36     $ 4     $ 40     $ 31     $ 4     $ 35  
Interest cost
    342       50       392       345       58       403  
Expected return on plan assets
    (251 )     —        (251 )     (227 )     —        (227 )
Amortization of:
                                               
Prior service gain
    —        —        —        —        —        —   
Amortization of net gain
    34       16       50       22       15       37  
Net periodic benefit cost
  $ 161     $ 70     $ 231     $ 171     $ 77     $ 248  
                                                 
Post Retirement:
                                               
Service cost
  $     $ 10     $ 10     $     $ 9     $ 9  
Interest cost
    —        34       34       —        34       34  
Amortization of net gain
    —        24       24       —        33       33  
Net periodic benefit cost
  $     $ 68     $ 68     $     $ 76     $ 76  

 
9

 
 
7.
Segment Information
 
The following table presents certain operating segment information.

         
Service and System Integration Segment
       
Three Months Ended March 31,
 
Systems
Segment
   
Germany
   
United Kingdom
   
U.S.
   
Total
   
Consolidated
Total
 
   
(Amounts in thousands)
 
2011
                                   
Sales:
                                   
Product
  $ 1,931     $ 4,390     $ 61     $ 9,344     $ 13,795     $ 15,726  
Service
    368       2,213       364       538       3,115       3,483  
Total sales
    2,299       6,603       425       9,882       16,910       19,209  
                                                 
Profit from operations
    72       39       15       305       359       431  
Assets
    13,335       13,150       3,847       13,075       30,072       43,407  
Capital expenditures
    77       11       1       11       23       100  
Depreciation and amortization
    21       45       7       45       97       118  
                                                 
2010
                                               
Sales:
                                               
Product
  $ 4,136     $ 3,485     $ 25     $ 12,905     $ 16,415     $ 20,551  
Service
    432       2,040       459       439       2,938       3,370  
Total sales
    4,568       5,525       484       13,344       19,353       23,921  
                                                 
Profit from operations
    1,431       47       18       153       218       1,649  
Assets
    13,926       10,340       4,001       13,475       27,816       41,742  
Capital expenditures
    5       103       4       10       117       122  
Depreciation and amortization
    30       44       6       50       100       130  


         
Service and System Integration Segment
       
Six Months Ended March 31,
 
Systems
Segment
   
Germany
   
United Kingdom
   
U.S.
   
Total
   
Consolidated
Total
 
   
(Amounts in thousands)
 
2011
                                   
Sales:
                                   
Product
  $ 2,240     $ 8,560     $ 72     $ 22,278     $ 30,910     $ 33,150  
Service
    1,884       4,355       696       1,234       6,285       8,169  
Total sales
    4,124       12,915       768       23,512       37,195       41,319  
                                                 
Profit (loss) from operations
    186       151       (15 )     752       888       1,074  
Assets
    13,335       13,150       3,847       13,075       30,072       43,407  
Capital expenditures
    133       47       3       28       78       211  
Depreciation and amortization
    41       92       14       91       197       238  
                                                 
2010
                                               
Sales:
                                               
Product
  $ 4,529     $ 7,699     $ 51     $ 23,517     $ 31,267     $ 35,796  
Service
    493       4,495       845       953       6,293       6,786  
Total sales
    5,022       12,194       896       24,470       37,560       42,582  
                                                 
Profit from operations
    136       48       14       226       288       424  
Assets
    13,926       10,340       4,001       13,475       27,816       41,742  
Capital expenditures
    15       135       9       13       157       172  
Depreciation and amortization
    64       79       12       102       193       257  
 
 
10

 
 
Profit (loss) from operations is 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 and six month periods ended March 31, 2011 and 2010.
 
   
For the Three Months Ended
   
For the Six Months Ended
 
   
March 31,
2011
   
March 31,
2010
   
March 31,
2011
   
March 31,
2010
 
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
 
   
(Dollar amounts in millions)
 
Vodafone
  $ 3.4       18 %   $ 2.3       9 %   $ 5.1       12 %   $ 4.9       11 %
Verio
  $ 2.1       11 %   $ 5.8       24 %   $ 4.8       12 %   $ 7.8       18 %
Raytheon
  $ 0.1       - %   $ 3.7       16 %   $ 0.1       - %   $ 3.8       9 %
 
8.
Fair Value Measures
 
Assets and Liabilities measured at fair value on a recurring basis are as follows:
 
   
Fair Value Measurements Using
 
   
Quoted Prices in
Active
Markets for Identical
Instruments
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Input
(Level 3)
   
Total
Balance
   
Gain
or
(loss)
 
   
As of March 31, 2011
 
   
(Amounts in thousands)
 
Assets:
                             
Money Market funds
  $ 3,488     $     $     $ 3,488     $  
Total assets measured at fair value
  $ 3,488     $     $     $ 3,488     $  
                                         
   
As of September 30, 2010
 
   
(Amounts in thousands)
 
Assets:
                                       
Money Market funds
  $ 3,482     $     $     $ 3,482     $  
Total assets measured at fair value
  $ 3,482     $     $     $ 3,482     $  
 
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 had no liabilities measured at fair value as of March 31, 2011. The Company had no assets or liabilities measured at fair value on a non recurring basis as of March 31, 2011.
 
9.
Common Stock Repurchase
 
On February 3, 2009, the Board of Directors (the “Board”) authorized the Company to purchase up to 350 thousand additional shares of the Company’s outstanding common stock at market price. As of September 30, 2010, there remained approximately 145 thousand shares pursuant to this authorization.  On February 8, 2011, the Board authorized the Company to purchase up to 250 thousand additional shares of the Company’s outstanding common stock at market price.  Pursuant to this and the prior authorization by the Board, the Company repurchased approximately 97 thousand shares of its outstanding common stock during the six months ended March 31, 2011.  As of March 31, 2011, approximately 298 thousand shares remain authorized for repurchase under the Company’s stock repurchase program.
 
 
11

 
 
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. 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, 2010 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 six months ended March 31, 2011 Results of Operations
 
Highlights include:
 
 
Revenue decreased by approximately $1.3 million, or 3%, to $41.3 million for the six months ended March 31, 2011 versus $42.6 million for the six months ended March 31, 2010.
 
 
For the six months ended March 31, 2011, operating income was approximately $1.1 million versus operating income of approximately $0.4 million for the six months ended March 31, 2010.
 
 
For the six months ended March 31, 2011, net income was approximately $0.7 million versus net income of approximately $0.2 million for the six months ended March 31, 2010.
 
The following table details our results of operations in dollars and as a percentage of sales for the six months ended March 31, 2011 and 2010:
 
   
March 31,
2011
   
%
of sales
   
March 31,
2010
   
%
of sales
 
   
(Dollar amounts in thousands)
 
Sales
  $ 41,319       100 %   $ 42,582       100 %
Costs and expenses:
                               
Cost of sales
    32,542       79 %     34,788       82 %
Engineering and development
    1,018       2 %     902       2 %
Selling, general and administrative
    6,685       16 %     6,468       15 %
Total costs and expenses
    40,245       97 %     42,158       99 %
                                 
Operating income
    1,074       3 %     424       1 %
Other expense
    (22 )     %     (36 )     %
Income before income taxes
    1,052       3 %     388       1 %
Income tax expense
    377       1 %     141       %
Net income
  $ 675       2 %   $ 247       1 %
 
 
12

 

Sales
 
The following table details our sales by operating segment for the six months ended March 31, 2011 and 2010:
 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
For the six months ended March 31, 2011:
                       
Product
  $ 2,240     $ 30,910     $ 33,150       80 %
Services
    1,884       6,285       8,169       20 %
Total
  $ 4,124     $ 37,195     $ 41,319       100 %
% of Total
    10 %     90 %     100 %        
                                 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
For the six months ended March 31, 2010:
                               
Product
  $ 4,529     $ 31,267     $ 35,796       84 %
Services
    493       6,293       6,786       16 %
Total
  $ 5,022     $ 37,560     $ 42,582       100 %
% of Total
    12 %     88 %     100 %        
   
Systems
   
Service and
System
Integration
   
Total
   
%
increase (decrease)
 
Increase (Decrease)
                               
Product
  $ (2,289 )   $ (357 )   $ (2,646 )     (7 )%
Services
    1,391       (8 )     1,383       20 %
Total
  $ (898 )   $ (365 )   $ (1,263 )     (3 )%
% decrease
    (18 )%     (1 )%     (3 )%        
 
As shown above, total revenues decreased by approximately $1.3 million, or 3%, for the six months ended March 31, 2011 compared to the same period of fiscal year 2010. Revenues in the Systems segment decreased for the current year six month period versus the prior year six month period by approximately $0.9 million, while revenues in the Service and System Integration segment decreased by approximately $0.4 million, resulting in the overall decrease of approximately $1.3 million.
 
Product revenues decreased by approximately $2.6 million, or 7%, for the six months ended March 31, 2011 compared to the comparable period of fiscal 2010. This change in product revenues was made up of a decrease in product revenues in the Systems segment of approximately $2.3 million over the prior year six months, and a decrease in product revenues in the Service and System Integration segment of approximately $0.3 million versus the prior year six months.
 
The decrease in product revenues in the Systems segment of $2.3 million was due to having shipped a large order in the six month period ended March 31, 2010, for approximately $3.6 million, consisting of two major systems, which was a follow on order for a major US defense program, that we began supplying to one of our customers in fiscal 2007.  No sales of this nature were made in the six month period ended March 31, 2011.  Offsetting this decrease, we realized an increase of approximately $1.1 million in product sales in the current year six month period versus the prior year six month period, to an existing customer that supplies equipment to the Japanese defense market, and an increase in product sales to another customer that supplies a US defense program, of $0.2 million.
 
The decrease in the Service and System Integration segment product sales of approximately $0.3 million was due primarily to a decrease in product sales in the U.S. division of the segment of approximately $1.2 million, offset by an increase in this segment’s German division of approximately $0.9 million.
 
 
13

 
 
In the US division, product sales to our two largest customers decreased by a total of approximately $5.0 million, consisting of a decrease in sales to our largest customer of $3.0 million and a decrease in product sales to our second largest customer of approximately $2.0 million. These customers are both IT managed service providers, which did not require the level of expansion of capacity as in prior years due to lost customers and a general leveling off of the size of their infrastructure. These decreases were partially offset by an increase in product sales to a large number of smaller customers, with smaller deal sizes than the sales to those larger customers.  In Germany, sales volume was up $1.3 million in constant dollars versus the prior year. This constant dollar increase in sales was due primarily to an increase in sales to one of our largest telecommunications customers. Offsetting these increases in sales was the unfavorable impact of currency fluctuation of approximately $0.4 million affecting a stronger US dollar versus the Euro for the six months ended March 31, 2011 versus 2010.
 
As shown in the table above, service revenues increased by approximately $1.4 million for the six months ended March 31, 2011 compared to the comparable six months of fiscal 2010. This increase in service revenue was substantially all within the Systems segment, reflecting an increase in royalty revenue from a large US defense program supplier which was approximately $1.6 million for the six months ended March 31, 2011, versus approximately $0.2 million for the six months ended March 31, 2010.
 
Our sales by geographic area, based on the location to which the products were shipped or services rendered, are as follows:
 
   
For the Six Months Ended
             
   
March 31,
2011
   
%
   
March 31,
2010
   
%
   
$ Increase
(Decrease)
   
% Increase
(Decrease)
 
   
(Dollar amounts in thousands)
 
Americas
  $ 25,536       62 %   $ 28,194       66 %   $ (2,658 )     (9 )%
Europe
    13,647       33 %     13,427       32 %     220       2 %
Asia
    2,136       5 %     961       2 %     1,175       122 %
Totals
  $ 41,319       100 %   $ 42,582       100 %   $ (1,263 )     (3 )%
 
The decrease in Americas revenue for the six months ended March 31, 2011 versus the six months ended March 31, 2010 was primarily the result of the changes in revenues described above in the Systems segment relating to product and services sales to US defense programs, which accounted for approximately $2.1 million of the decrease and the decreases in sales to customers in the Americas from the U.S. division of our Service and System Integration segment, which accounted for the remaining $0.5 million of the decrease.
 
The increase in sales in Europe was primarily the result of the higher sales described above from the German division of the Service and System Integration segment which accounted for approximately $0.7 million in increased sales to Europe, offset by decreases in sales to European customers of approximately $0.3 million and $0.2 million from the US and UK divisions of the Service and System Integration segment, respectively. The increase in Asia sales was the result of the increase in sales described above to our existing customer which supplies a large Japanese defense program.

 
14

 

Cost of Sales and Gross Margins
 
The following table details our cost of sales by operating segment for the six months ended March 31, 2011 and 2010:
 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
For the six months ended March 31, 2011:
                       
Product
  $ 995     $ 26,755     $ 27,750       85 %
Services
    137       4,655       4,792       15 %
Total
  $ 1,132     $ 31,410     $ 32,542       100 %
                                 
% of Total
    3 %     97 %     100 %        
% of Sales
    27 %     84 %     79 %        
Gross Margins:
                               
Product
    56 %     13 %     16 %        
Services
    93 %     26 %     41 %        
Total
    73 %     16 %     21 %        
                                 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
For the six months ended March 31, 2010:
                               
Product
  $ 1,928     $ 27,648     $ 29,576       85 %
Services
    150       5,062       5,212       15 %
Total
  $ 2,078     $ 32,710     $ 34,788       100 %
                                 
% of Total
    6 %     94 %     100 %        
% of Sales
    41 %     87 %     82 %        
Gross Margins:
                               
Product
    57 %     12 %     17 %        
Services
    70 %     20 %     23 %        
Total
    59 %     13 %     18 %        
                                 
Decrease
                               
Product
  $ (933 )   $ (893 )   $ (1,826 )     (6 )%
Services
    (13 )     (407 )     (420 )     (8 )%
Total
  $ (946 )   $ (1,300 )   $ (2,246 )     (6 )%
                                 
% Decrease
    (46 )%     (4 )%     (6 )%        
% of Sales
    (14 )%     (3 )%     (3 )%        
Gross Margins:
                               
Product
    (1 )%     1 %     (1 )%        
Services
    23 %     6 %     18 %        
Total
    14 %     3 %     3 %        
 
Total cost of sales decreased by approximately $2.2 million when comparing the six months ended March 31, 2011 versus the six months ended March 31, 2010.   This decrease in cost of sales of 6% overall, compares with a decrease in sales of 3%.  The primary reason that cost of sales decreased by a proportionally higher amount than the decrease in sales was due in large part to the fact that royalty revenue in the Systems segment increased by approximately $1.4 million. There is zero cost of sales on royalty revenue.  In addition, the sales mix in the Service and System Integration segment resulted in a greater decrease in cost of sales versus the decrease in sales, as shown in the tables above and described in more detail below.
 
Cost of sales in the Systems segment decreased by approximately $0.9 million, or 46%, when comparing the current year six month period versus the prior year six month period, while sales in the Systems segment also decreased by approximately $0.9 million, or 18%.   This proportionately larger decrease in cost of sales versus sales in the Systems segment was due to the fact that royalty revenue increased by $1.4 million. Royalty revenue carries no cost of sales.
 
 
15

 
 
Cost of sales in the Service and System Integration segment decreased by approximately $1.3 million, which is a 4% decrease when comparing the current year six months versus the prior year six months. While this trend is consistent with the decrease in sales over the prior year, the rate of decrease of 4% is greater than the rate of decrease in sales, which was 1%.  The reason for this is two-fold.  First, on the product sales side we experienced smaller deal size with better margins (i.e., higher relative prices per unit).  In the prior year, a higher percentage of our sales were to higher-volume-lower-margin customers, particularly in the US division.  Secondly, we had better utilization of service resources in the six months ended March 31, 2011 versus the prior year six month period, which resulted in lower cost as a percent of revenue.
 
The overall gross profit margin for the six months ended March 31, 2011 was 21% compared to 18% for the six months ended March 31, 2010.  The gross margin in the Systems segment improved to 73% from 59% which was driven by the royalty revenue which is referred to above.  The gross margin in the Service and System Integration segment increased from 13% for the six months ended March 31, 2010 to 16% for the six months ended March 31, 2011.  This increase in gross profit margin for the Service and System Integration segment was due to the reasons described in the preceding paragraph.
 
Engineering and Development Expenses
 
The following table details our engineering and development expenses by operating segment for the six months ended March 31, 2011 and 2010:
 
   
For the Six Months Ended
             
   
March 31,
2011
   
% of
Total
   
March 31,
2010
   
% of
Total
   
$ Increase
   
% Increase
 
   
(Dollar amounts in thousands)
 
By Operating Segment:
                                   
Systems
  $ 1,018       100 %   $ 902       100 %   $ 116       13 %
Service and System Integration
    —        %     —        %     —        %
Total
  $ 1,018       100 %   $ 902       100 %   $ 116       13 %
 
The increase in engineering and development expenses displayed above was due to higher engineering consulting expenditures in connection with the development of the next generation of MultiComputer products in the Systems segment.
 
Selling, General and Administrative
 
The following table details our selling, general and administrative expense by operating segment for the six months ended March 31, 2011 and 2010:
 
   
For the Six Months Ended
             
   
March 31,
2011
   
% of
Total
   
March 31,
2010
   
% of
Total
   
$ Increase (Decrease)
   
% Increase (Decrease)
 
   
(Dollar amounts in thousands)
 
By Operating Segment:
                                   
Systems
  $ 1,788       27 %   $ 1,904       29 %   $ (116 )     (6 )%
Service and System Integration
    4,897       73 %     4,564       71 %     333       7 %
Total
  $ 6,685       100 %   $ 6,468       100 %   $ 217       3 %
 
The decrease in selling, general and administrative (“SG&A”) expenses in the Systems segment displayed above was primarily due to lower commission expense resulting from lower sales in the segment.  In the Service and System Integration segment, SG&A expenses increased due to sales department headcount increases and increased expenses associated with company marketing events and trade show attendance and participation.

 
16

 
 
Other Income/Expenses
 
The following table details our other income/expenses for the six months ended March 31, 2011 and 2010:
 
   
For the Six Months Ended
       
   
March 31,
2011
   
March 31,
2010
   
Increase
(Decrease)
 
   
(Amounts in thousands)
 
Interest expense
  $ (43 )   $ (45 )   $ 2  
Interest income
    16       18       (2 )
Foreign exchange gain (loss)
    8       (10 )     18  
Other income (expense), net
    (3 )     1       (4 )
Total other expense, net
  $ (22 )   $ (36 )   $ 14  
 
Other income (expense), net, for the six month periods ended March 31, 2011 and 2010 was not significant nor was the change from the prior year six month period to that of the current year.
 
Overview of the three months ended March 31, 2011 Results of Operations
 
Highlights include:
 
 
Revenue decreased by approximately $4.7 million, or 20%, to $19.2 million for the three months ended March 31, 2011 versus $23.9 million for the three months ended March 31, 2010.
 
 
For the three months ended March 31, 2011, operating income was approximately $0.4 million versus operating income of approximately $1.6 million for the three months ended March 31, 2010, for a decrease of approximately $1.2 million, or 74%.
 
 
For the three months ended March 31, 2011, net income was approximately $0.3 million versus a net income of approximately $1.0 million for the three months ended March 31, 2010, for a decrease of approximately $0.7 million, or 71%.
 
The following table details our results of operations in dollars and as a percentage of sales for the three months ended March 31, 2011 and 2010:
 
   
March 31,
2011
   
%
of sales
   
March 31,
2010
   
%
of sales
 
   
(Dollar amounts in thousands)
 
Sales
  $ 19,209       100 %   $ 23,921       100 %
Costs and expenses:
                               
Cost of sales
    14,960       78 %     18,431       77 %
Engineering and development
    508       3 %     430       2 %
Selling, general and administrative
    3,310       17 %     3,411       14 %
Total costs and expenses
    18,778       98 %     22,272       93 %
                                 
Operating income
    431       2 %     1,649       7 %
Other expense
    (1 )     %     (16 )     %
                                 
Income before income taxes
    430       2 %     1,633       7 %
Income tax expense
    144       1 %     644       3 %
Net income
  $ 286       1 %   $ 989       4 %
 
 
17

 
 
Sales
 
The following table details our sales by operating segment for the three months ended March 31, 2011 and 2010:
 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
For the three months ended March 31, 2011:
                       
Product
  $ 1,931     $ 13,795     $ 15,726       82 %
Services
    368       3,115       3,483       18 %
Total
  $ 2,299     $ 16,910     $ 19,209       100 %
% of Total
    12 %     88 %     100 %        
                                 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
For the three months ended March 31, 2010:
                               
Product
  $ 4,136     $ 16,415     $ 20,551       86 %
Services
    432       2,938       3,370       14 %
Total
  $ 4,568     $ 19,353     $ 23,921       100 %
% of Total
    19 %     81 %     100 %        
                                 
   
Systems
   
Service and
System
Integration
   
Total
   
%
increase (decrease)
 
Increase (Decrease)
                               
Product
  $ (2,205 )   $ (2,620 )   $ (4,825 )     (23 )%
Services
    (64 )     177       113       3 %
Total
  $ (2,269 )   $ (2,443 )   $ (4,712 )     (20 )%
% decrease
    (50 )%     (13 )%     (20 )%        
 
As shown above, total revenues decreased by approximately $4.7 million, or 20%, for the three months ended March 31, 2011 compared to the three months ended March 31, 2010.  Revenue in the Systems segment decreased for the current year three month period versus the prior year three month period by approximately $2.3 million, while revenues in the Service and System Integration segment decreased by approximately $2.4 million, resulting in the overall decrease of approximately $4.7 million.
 
Product revenues decreased by approximately $4.8 million, or 23% for the three months ended March 31, 2011 compared to the comparable period of the prior fiscal year. This change in product revenues was made up of a decrease in product revenues in the Systems segment of approximately $2.2 million and a decrease in product revenues in the Service and System Integration segment of approximately $2.6 million for the three month period ended March 31, 2011 versus the three month period ended March 31, 2010.
 
The decrease in product revenues in the Systems segment of $2.2 million was due to having shipped a large order in the three month period ended March 31, 2010, for approximately $3.6 million, consisting of two major systems, which was a follow on order for a major US defense program, that we began supplying to our customer in fiscal 2007.  No sales of this nature were made in the three month period ended March 31, 2011.  Offsetting this decrease, we realized an increase of approximately $1.3 million in product sales in the current year three month period versus the prior year three month period, to an existing customer that supplies the Japanese defense market.
 
The decrease in the Service and System Integration segment product sales of approximately $2.6 million was due primarily to a decrease in product sales in the U.S. division of the segment of $3.6 million, offset by an increase in this segment’s German division of approximately $1.0 million.
 
 In the US division, product sales to the two largest customers of the division, decreased by a total of approximately $3.6 million, which was primarily the result of a decrease in sales to our largest customer of $2.3 and a decrease in our second largest customer of approximately $1.2 million. These customers are both IT managed service providers, which did not require the level of expansion of capacity as in prior years, due to lost customers and a general leveling off of the size of their infrastructure.  In Germany, the $1.0 million increase was due primarily to increased sales to one of our largest telecommunications customers.
 
As shown in the table above, service revenues increased by approximately $0.1 million, or 3%.  The $0.1 million decrease in service revenue in the Systems segment was due to services provided in the prior year  in connection with the two large system sales referred to above, which did not recur in the three month period ended March 31, 2011.   In the Service and System Integration segment, the $0.2 million increase was from modest increases in service revenue in both the US and German divisions, of approximately $0.1 million in each of those two divisions.
 
 
18

 
 
Our sales by geographic area, based on the location to which the products were shipped or services rendered, are as follows:
 
   
For the three Months Ended
             
   
March 31,
2011
   
%
   
March 31,
2010
   
%
   
$ Increase
(Decrease)
   
% Increase
(Decrease)
 
   
(Dollar amounts in thousands)
 
Americas
  $ 10,227       53 %   $ 17,066       72 %   $ (6,839 )     (40 )%
Europe
    6,985       37 %     6,287       26 %     698       11 %
Asia
    1,997       10 %     568       2 %     1,429       252 %
Totals
  $ 19,209       100 %   $ 23,921       100 %   $ (4,712 )     (20 )%
 
The decrease in Americas revenue for the three months ended March 31, 2011 versus the three months ended March 31, 2010 was primarily the result of the decreases described above in the Systems segment regarding our prior year shipment into a large US defense program and the decreases in sales from the US division of our Service and System Integration segment.
 
The increase in sales in Europe was primarily the result of the higher sales described above from the German division of the Service and System Integration segment. The increase in Asia sales was the result of the increase in sales described above to our existing customer that supplies a large Japanese defense program.

 
19

 

Cost of Sales and Gross Margins
 
The following table details our cost of sales by operating segment for the three months ended March 31, 2011 and 2010:
 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
For the three months ended March 31, 2011:
                       
Product
  $ 750     $ 11,707     $ 12,457       83 %
Services
    63       2,440       2,503       17 %
Total
  $ 813     $ 14,147     $ 14,960       100 %
                                 
% of Total
    5 %     95 %     100 %        
% of Sales
    35 %     84 %     78 %        
Gross Margins:
                               
Product
    61 %     15 %     21 %        
Services
    83 %     22 %     28 %        
Total
    65 %     16 %     22 %        
                                 
 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
For the three months ended March 31, 2010:
                               
Product
  $ 1,584     $ 14,376     $ 15,960       87 %
Services
    102       2,369       2,471       13 %
Total
  $ 1,686     $ 16,745     $ 18,431       100 %
                                 
% of Total
    9 %     91 %     100 %        
% of Sales
    37 %     87 %     77 %        
Gross Margins:
                               
Product
    62 %     12 %     22 %        
Services
    76 %     19 %     27 %        
Total
    63 %     13 %     23 %        
                                 
Increase (decrease)
                               
Product
  $ (834 )   $ (2,669 )   $ (3,503 )     (22 )%
Services
    (39 )     71       32       1 %
Total
  $ (873 )   $ (2,598 )   $ (3,471 )     (19 )%
                                 
% Decrease
    (52 )%     (16 )%     (19 )%        
% of Sales
    (2 )%     (3 )%     1 %        
Gross Margins:
                               
Product
    (1 )%     3 %     (1 )%        
Services
    7 %     3 %     1 %        
Total
    2 %     3 %     (1 )%        
 
Total cost of sales decreased by approximately $3.5 million when comparing the three months ended March 31, 2011 versus the three months ended March 31, 2010.   This decrease in cost of sales of 19% overall, is consistent with the decrease in sales of 20% overall, as described previously.  The resulting lower profit margin of 22% for the three months ended March 31, 2011 versus 23% for 2010, from the slightly smaller proportionate decrease in costs of sales versus sales, was due in large part because in the fiscal 2011 quarter ended March 31, a lower percentage of sales were derived from the Systems segment (12%) versus the prior year quarter ended March 31 (19%).  The Systems segment typically experiences gross profit margins that are four to five times greater than gross profit margins in the Service and System Integration segment.
 
In analyzing the gross profit margins by segment, the service gross margin in the Systems segment for the three months ended March 31, 2011 versus the prior year three month period increased to 83% from 76%.  This was due to the fact that a greater proportion of the service sales in this segment were from higher margin services such as repairs and maintenance versus the prior year, which contained more labor intensive professional services.
 
 
20

 
 
In the Service and System Integration segment, the improvement in the gross profit margin from 13% to 16% was due to a better mix of sales of  higher margin networking products, higher value services being delivered and smaller deal size in the current year three month period ended March 31 versus the prior year.
 
Engineering and Development Expenses
 
The following table details our engineering and development expenses by operating segment for the three months ended March 31, 2011 and 2010:
 
   
For the Three Months Ended
             
   
March 31,
2011
   
% of
Total
   
March 31,
2010
   
% of
Total
   
$ Increase
   
% Increase
 
   
(Dollar amounts in thousands)
 
By Operating Segment:
                                   
Systems
  $ 508       100 %   $ 430       100 %   $ 78       18 %
Service and System Integration
    —        %     —        %     —        %
Total
  $ 508       100 %   $ 430       100 %   $ 78       18 %
 
The increase in engineering and development expenses displayed above was due to higher engineering consulting expenditures in connection with the development of the next generation of MultiComputer products in the Systems segment.
 
Selling, General and Administrative
 
The following table details our selling, general and administrative expense by operating segment for the three months ended March 31, 2011 and 2010:
 
   
For the Three Months Ended
             
   
March 31,
2011
   
% of
Total
   
March 31,
2010
   
% of
Total
   
$ Increase (Decrease)
   
% Increase (Decrease)
 
   
(Dollar amounts in thousands)
 
By Operating Segment:
                                   
Systems
  $ 906       27 %   $ 1,020       30 %   $ (114 )     (11 )%
Service and System Integration
    2,404       73 %     2,391       70 %     13       1 %
Total
  $ 3,310       100 %   $ 3,411       100 %   $ (101 )     (3 )%
 
The decrease in selling, general and administrative (“SG&A”) expenses displayed above was primarily due to lower commission expense in the Systems segment associated with the lower sales for the three month period ended March 31, 2011 versus the three month period ended March 31, 2010.
 
 Other Income/Expenses
 
The following table details our other income/expenses for the three months ended March 31, 2011 and 2010:
 
   
For the Three Months Ended
       
   
March 31,
2011
   
March 31,
2010
   
Increase
(Decrease)
 
   
(Amounts in thousands)
 
Interest expense
  $ (21 )   $ (22 )   $ 1  
Interest income
    9       7       2  
Foreign exchange gain (loss)
    12       (3 )     15  
Other income (expense), net
    (1 )     2       (3 )
Total other expense, net
  $ (1 )   $ (16 )   $ 15  

Other income (expense), net, for the three month periods ended March 31, 2011 and 2010 was not significant nor was the change from the prior year three month period to that of the current year.
 
Income Taxes
 
Income Tax Provision
 
The Company recorded an income tax provision of approximately $0.1 million for the quarter ended March 31, 2011 reflecting an effective income tax rate of 33% compared to an income tax provision of approximately $0.6 million for the quarter ended March 31, 2010, which reflected an effective income tax rate of 39%.  For the six months ended March 31, 2011, the Company recorded an income tax provision of approximately $0.4 million reflecting an effective income tax rate of 36% compared to an income tax provision of approximately $0.1 million for the six months ended March 31, 2010, which also reflected an effective income tax rate of 36%.
 
 
21

 
 
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. Our inability to project future profitability beyond fiscal year 2011 in the U.S. and cumulative losses incurred in recent years in the United Kingdom represent sufficient negative evidence to record a valuation allowance against certain deferred tax assets. 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 approximately $1.1 million to $14.4 million as of March 31, 2011 from $15.5 million as of September 30, 2010. At March 31, 2011, cash equivalents consisted of money market funds which totaled $3.5 million.
 
Significant sources of cash for the six months ended March 31, 2011 were net income of approximately $0.7 million, an increase in accounts payable and accrued expenses of approximately $0.4 million and an increase in deferred revenue of approximately $0.5 million.  The significant uses of cash during the period were an increase in inventory of approximately $2.4 million, and the repurchase of CSPI common stock of $0.4 million.
 
As of  March 31, 2011 and September 30, 2010, cash held by our foreign subsidiaries located in Germany and the United Kingdom totaled approximately $6.3 million and $6.0 million, respectively. 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.
 
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.

 
22

 

Item 4.
Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
The Company evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2011. 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 March 31, 2011, 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.

 
23

 

PART II. OTHER INFORMATION
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
Share Repurchase Plans. The following table provides information with respect to shares of our common stock that we repurchased during the six months ended March 31, 2011:
 
   
Issuer Purchases of Equity Securities
 
Period
 
Total Number of
Shares Purchased
   
Average Price
Paid per Share
   
Total Number of Shares
Purchased as
Part of Publicly
Announced Plans (1)
   
Maximum Number of
Shares that May
Yet Be
Purchased Under
the Plans
 
October 1-31, 2010
    7,940     $ 4.53       7,940        
November 1-30, 2010
    9,500     $ 4.52       9,500          
December 1-31, 2010
    28,221     $ 3.98       28,221          
January 1-31, 2011
    44,393     $ 3.98       44,393          
February 1-28, 2011
    3,543     $ 4.01       3,543          
March 1-31, 2011
    3,000     $ 4.20       3,000          
Total
    96,597     $ 4.09       96,597       297,959  
 
(1)
All shares were purchased under publicly announced plans. For additional information about these publicly announced plans, please refer to Note 12 of our audited financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2010. On February 8, 2011, the Board of Directors authorized the Company to purchase up to 250 thousand additional shares of the Company’s outstanding common stock at market price.

 
24

 
 
Item 6.
Exhibits
 
Number
Description
   
  3.1
Articles of Organization and amendments thereto (incorporated by reference to Exhibit 3.1 to our Form 10-K for the year ended September 30, 2007)
   
  3.2
By-Laws, as amended (incorporated by reference to Exhibit 3.2 to our Form 10-K for the year ended September 30, 2007)
   
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

 
25

 
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
CSP INC.
     
Date: May 9, 2011
By:
/s/  Alexander R. Lupinetti
   
Alexander R. Lupinetti
   
Chief Executive Officer,
   
President and Chairman
     
Date: May 9, 2011
By:
/s/  Gary W. Levine
   
Gary W. Levine
   
Chief Financial Officer
 

 
26

 

Exhibit Index
 
Number
Description
   
3.1
Articles of Organization and amendments thereto (incorporated by reference to Exhibit 3.1 to our Form 10-K for the year ended September 30, 2007)
   
3.2
By-Laws, as amended (incorporated by reference to Exhibit 3.2 to our Form 10-K for the year ended September 30, 2007)
   
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
 
 
 
27