10-Q 1 cspi_10q-033113.htm FORM 10-Q cspi_10q-033113.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, 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 May 9, 2013, the registrant had 3,452,842 shares of common stock issued and outstanding.
 
 
 

 
 
INDEX
 

   
Page
     
     
PART I. FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets (unaudited) as of March 31, 2013 and September 30, 2012
3
     
 
Consolidated Statements of Operations (unaudited) for the three and six months ended March 31, 2013 and 2012
4
     
 
Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended March 31, 2013 and 2012
5
     
 
Consolidated Statement of Shareholders’ Equity (unaudited) for the six months ended March 31, 2013
6
     
 
Consolidated Statements of Cash Flows (unaudited) for the six months ended March 31, 2013 and 2012
7
     
 
Notes to Consolidated Financial Statements (unaudited)
8
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
14
     
Item 4.
Controls and Procedures
27
     
PART II. OTHER INFORMATION
 
     
Item 6.
Exhibits
28
 
 
2

 
 
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CSP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except par value)
 
   
March 31,
2013
   
September 30,
2012
 
   
(Unaudited)
       
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 15,291     $ 20,493  
Accounts receivable, net of allowances of $247 and $243
    20,312       12,145  
Officer life insurance settlement receivable
          2,172  
Inventories
    4,516       6,276  
Refundable income taxes
    114       121  
Deferred income taxes
    1,258       1,284  
Other current assets
    3,201       2,215  
Total current assets
    44,692       44,706  
Property, equipment and improvements, net
    1,247       991  
                 
Other assets:
               
Intangibles, net
    451       492  
Deferred income taxes
    2,371       2,373  
Cash surrender value of life insurance
    2,422       2,181  
Other assets
    222       323  
Total other assets
    5,466       5,369  
Total assets
  $ 51,405     $ 51,066  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable and accrued expenses
  $ 13,241     $ 13,574  
Deferred revenue
    4,263       3,693  
Pension and retirement plans
    696       717  
Income taxes payable
    392       184  
Total current liabilities
    18,592       18,168  
Pension and retirement plans
    9,108       9,431  
Other long term liabilities
    447       426  
Total liabilities
    28,147       28,025  
                 
Commitments and contingencies
               
                 
Shareholders’ equity:
               
Common stock, $.01 par value per share; authorized, 7,500 shares; issued and outstanding 3,453 and 3,399 shares, respectively
    34       34  
Additional paid-in capital
    10,942       10,875  
Retained earnings
    18,910       18,744  
Accumulated other comprehensive loss
    (6,628 )     (6,612 )
Total shareholders’ equity
    23,258       23,041  
Total liabilities and shareholders’ equity
  $ 51,405     $ 51,066  
 
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,
2013
   
March 31,
2012
   
March 31,
2013
   
March 31,
2012
 
Sales:
                               
Product
  $ 19,537     $ 12,125     $ 34,842     $ 27,279  
Services
    6,286       6,904       11,851       12,843  
Total sales
    25,823       19,029       46,693       40,122  
                                 
Cost of sales:
                               
Product
    15,676       10,610       28,900       23,375  
Services
    4,380       3,704       7,849       7,209  
Total cost of sales
    20,056       14,314       36,749       30,584  
                                 
Gross profit
    5,767       4,715       9,944       9,538  
                                 
Operating expenses:
                               
Engineering and development
    380       474       824       857  
Selling, general and administrative
    4,165       3,572       7,725       7,248  
Total operating expenses
    4,545       4,046       8,549       8,105  
Operating income
    1,222       669       1,395       1,433  
                                 
Other income (expense):
                               
Foreign exchange gain (loss)
    (8 )     (10 )     5       (26 )
Other income (expense), net
    (17 )     (26 )     29       (44 )
Total other income (expense), net
    (25 )     (36 )     34       (70 )
Income before income taxes
    1,197       633       1,429       1,363  
Income tax expense
    457       191       574       460  
Net income
  $ 740     $ 442     $ 855     $ 903  
Net income attributable to common stockholders
  $ 724     $ 434     $ 838     $ 888  
Net income per share – basic
  $ 0.21     $ 0.13     $ 0.25     $ 0.26  
Weighted average shares outstanding – basic
    3,375       3,363       3,369       3,360  
Net income per share – diluted
  $ 0.21     $ 0.13     $ 0.25     $ 0.26  
Weighted average shares outstanding – diluted
    3,424       3,401       3,416       3,398  
 
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
   
For the six months ended
 
   
March 31,
2013
   
March 31,
2012
   
March 31,
2013
   
March 31,
2012
 
                                 
Net income
  $ 740     $ 442     $ 855     $ 903  
Other comprehensive income (loss):
                               
Foreign currency translation gain (loss) adjustments
    (72 )     45       (16 )     (69 )
Other comprehensive income (loss)
    (72 )     45       (16 )     (69 )
Total comprehensive income
  $ 668     $ 487     $ 839     $ 834  

See accompanying notes to unaudited consolidated financial statements.
 
 
5

 

CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
For the Six Months Ended March 31, 2013:
(Amounts in thousands)
 
   
Shares
   
Amount
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
other
comprehensive
loss
   
Total
Shareholders’
Equity
 
Balance as of September 30, 2012
    3,399     $ 34     $ 10,875     $ 18,744     $ (6,612 )   $ 23,041  
Net income
                      855             855  
Other comprehensive income:
                            (16 )     (16 )
Stock-based compensation
                3                   3  
Restricted stock issuance
    54             64                   64  
Cash dividends on common stock ($0.20 per share)
                      (689 )           (689 )
Balance as of March 31, 2013
    3,453     $ 34     $ 10,942     $ 18,910     $ (6,628 )   $ 23,258  
 
See accompanying notes to unaudited consolidated financial statements.
 
 
6

 
 
CSP INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
 
   
For the six months ended
 
   
March 31,
2013
   
March 31,
2012
 
Cash flows from operating activities:
               
Net income
  $ 855     $ 903  
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation and amortization
    213       181  
Amortization of intangibles
    41       41  
Gain on sale of fixed assets, net
    (15 )      
Foreign exchange (gain) loss
    (5 )     26  
Non-cash changes in accounts receivable
    5       32  
Stock-based compensation expense on stock options and restricted stock awards
    67       69  
Deferred income taxes
    27       82  
Increase in cash surrender value of life insurance
    (45 )     (43 )
Changes in operating assets and liabilities:
               
Increase in accounts receivable
    (8,339 )     (1,103 )
Decrease in officer life insurance receivable
    2,172        
Decrease in inventories
    1,731       827  
Decrease in refundable income taxes
    7       110  
Increase in other current assets
    (838 )     (1,169 )
(Increase) decrease in other assets
    (74 )     17  
Decrease in accounts payable and accrued expenses
    (285 )     (1,368 )
Increase in deferred revenue
    601       1,219  
Decrease in pension and retirement plans liability
    (130 )     (53 )
Increase in income taxes payable
    209       38  
Increase in other long term liabilities
    20       14  
Net cash used in operating activities
    (3,783 )     (177 )
                 
Cash flows from investing activities:
               
Life insurance premiums paid
    (196 )     (137 )
Proceeds from the sale of fixed assets
    17        
Purchases of property, equipment and improvements
    (476 )     (295 )
Net cash used in investing activities
    (655 )     (432 )
                 
Cash flows from financing activities:
               
Dividends paid
    (689 )     (342 )
Purchase of common stock
          (81 )
Net cash used in financing activities
    (689 )     (423 )
Effects of exchange rate on cash
    (75 )     (9 )
Net decrease in cash and cash equivalents
    (5,202 )     (1,041 )
Cash and cash equivalents, beginning of period
    20,493       15,874  
Cash and cash equivalents, end of period
  $ 15,291     $ 14,833  
                 
Supplementary cash flow information:
               
Cash paid for income taxes
  $ 336     $ 326  
Cash paid for interest
  $ 85     $ 85  
 
See accompanying notes to unaudited consolidated financial statements.
 
 
7

 
 
CSP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED MARCH 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, 2012.
 
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.
 
 
8

 
 
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, 2013
   
March 31, 2012
   
March 31, 2013
   
March 31, 2012
 
   
(Amounts in thousands except per share data)
 
Net income
  $ 740     $ 442     $ 855     $ 903  
Less: Net income attributable to nonvested common stock
    16       8       17       15  
Net income attributable to common stockholders
  $ 724     $ 434     $ 838     $ 888  
                                 
Weighted average total shares outstanding – basic
    3,448       3,425       3,437       3,417  
Less: weighted average non-vested shares outstanding
    73       62       68       57  
Weighted average number of common shares outstanding – basic
    3,375       3,363       3,369       3,360  
Potential common shares from non-vested stock awards and the assumed exercise of stock options
    49       38       47       38  
Weighted average common shares outstanding – diluted
    3,424       3,401       3,416       3,398  
                                 
Net income per share – basic
  $ 0.21     $ 0.13     $ 0.25     $ 0.26  
Net income per share – diluted
  $ 0.21     $ 0.13     $ 0.25     $ 0.26  
 
All anti-dilutive securities, including certain stock options, are excluded from the diluted income per share computation. For the three months ended March 31, 2013 and  2012, 183,000 and 195,000 options, respectively, were excluded from the diluted income per share calculation because their inclusion would have been anti-dilutive. For the six months ended March 31, 2013 and  2012, 190,000 and 200,000 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, 2013
   
September 30, 2012
 
   
(Amounts in thousands)
 
Raw materials
  $ 1,185     $ 941  
Work-in-process
    636       1,407  
Finished goods
    2,695       3,928  
Total
  $ 4,516     $ 6,276  
 
Finished goods includes inventory that has been shipped, but for which all revenue recognition criteria has not been met, of approximately $0.6 million and $1.4 million as of March 31, 2013 and September 30, 2012, respectively.
 
Total inventory balances in the table above are shown net of reserves for obsolescence of approximately $4.5 million and $4.4 million as of March 31, 2013 and September 30, 2012, respectively.
 
 
9

 
 
5.        Accumulated Other Comprehensive Income (Loss)
 
 The components of accumulated other comprehensive loss are as follows:
 
   
March 31, 2013
   
September 30, 2012
 
   
(Amounts in thousands)
 
Cumulative effect of foreign currency translation
  $ (2,289 )   $ (2,273 )
Additional minimum pension liability
    (4,339 )     (4,339 )
Accumulated other comprehensive loss
  $ (6,628 )   $ (6,612 )


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 the two years ended September 30, 2012 and for the six months ended March 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.
 
 
10

 
 
The components of net periodic benefit costs related to the U.S. and international plans are as follows:
 
   
For the Three Months Ended March 31,
 
   
2013
   
2012
 
   
Foreign
   
U.S.
   
Total
   
Foreign
   
U.S.
   
Total
 
   
(Amounts in thousands)
 
Pension:
                                   
Service cost
  $ 15     $     $ 15     $ 15     $ 3     $ 18  
Interest cost
    173       16       189       178       20       198  
Expected return on plan assets
    (104 )           (104 )     (104 )           (104 )
Amortization of:
                                               
Prior service gain
                                   
Amortization of net gain
    36       6       42       22       8       30  
Net periodic benefit cost
  $ 120     $ 22     $ 142     $ 111     $ 31     $ 142  
                                                 
Post Retirement:
                                               
Service cost
  $     $     $     $     $     $  
Interest cost
          9       9             18       18  
Amortization of net gain
          (46 )     (46 )           17       17  
Net periodic benefit cost
  $     $ (37 )   $ (37 )   $     $ 35     $ 35  
 
   
For the Six Months Ended March 31,
 
   
2013
   
2012
 
   
Foreign
   
U.S.
   
Total
   
Foreign
   
U.S.
   
Total
 
   
(Amounts in thousands)
 
Pension:
                                   
Service cost
  $ 30     $     $ 30     $ 32     $ 5     $ 37  
Interest cost
    346       32       378       357       42       399  
Expected return on plan assets
    (208 )           (208 )     (209 )           (209 )
Amortization of:
                                               
Prior service gain
                                   
Amortization of net gain
    72       12       84       44       15       59  
Net periodic benefit cost
  $ 240     $ 44     $ 284     $ 224     $ 62     $ 286  
                                                 
Post Retirement:
                                               
Service cost
  $     $     $     $     $     $  
Interest cost
          18       18             36       36  
Amortization of net gain
          (92 )     (92 )           35       35  
Net periodic benefit cost
  $     $ (74 )   $ (74 )   $     $ 71     $ 71  
 
 
11

 

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

         
Service and System Integration Segment
       
For the Three Months Ended March 31,
 
Systems
Segment
   
Germany
   
United
Kingdom
   
U.S.
   
Total
   
Consolidated
Total
 
   
(Amounts in thousands)
 
2013
                                               
Sales:
                                               
Product
  $ 2,494     $ 3,794     $ 110     $ 13,139     $ 17,043     $ 19,537  
Service
    143       4,571       429       1,143       6,143       6,286  
Total sales
    2,637       8,365       539       14,282       23,186       25,823  
Profit (loss) from operations
    149       368       (15 )     720       1,073       1,222  
Assets
    15,945       15,869       3,359       16,232       35,460       51,405  
Capital expenditures
    98       72       3       168       243       341  
Depreciation and amortization
    39       46       2       44       92       131  
                                                 
2012
                                               
Sales:
                                               
Product
  $ 223     $ 3,968     $ 718     $ 7,216     $ 11,902     $ 12,125  
Service
    2,141       3,703       292       768       4,763       6,904  
Total sales
    2,364       7,671       1,010       7,984       16,665       19,029  
Profit from operations
    443       164       91       (29 )     226       669  
Assets
    12,628       16,523       2,571       11,808       30,902       43,530  
Capital expenditures
    88       90       6       26       122       210  
Depreciation and amortization
    25       42       7       38       87       112  

         
Service and System Integration Segment
       
For the Six Months Ended March 31,
 
Systems
Segment
   
Germany
   
United
Kingdom
   
U.S.
   
Total
   
Consolidated
Total
 
   
(Amounts in thousands)
 
2013
                                               
Sales:
                                               
Product
  $ 2,590     $ 5,858     $ 264     $ 26,130     $ 32,252     $ 34,842  
Service
    1,100       7,775       731       2,245       10,751       11,851  
Total sales
    3,690       13,633       995       28,375       43,003       46,693  
Profit (loss) from operations
    (224 )     221       (15 )     1,413       1,619       1,395  
Assets
    15,945       15,869       3,359       16,232       35,460       51,405  
Capital expenditures
    139       127       6       204       337       476  
Depreciation and amortization
    76       88       7       83       178       254  
                                                 
2012
                                               
Sales:
                                               
Product
  $ 1,462     $ 7,819     $ 1,071     $ 16,927     $ 25,817     $ 27,279  
Service
    3,248       7,290       608       1,697       9,595       12,843  
Total sales
    4,710       15,109       1,679       18,624       35,412       40,122  
Profit from operations
    471       439       117       406       962       1,433  
Assets
    12,628       16,523       2,571       11,808       30,902       43,530  
Capital expenditures
    117       116       25       37       178       295  
Depreciation and amortization
    48       81       14       79       174       222  

 
12

 

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 and six-month periods ended March 31, 2013, and 2012.


   
For the three months ended,
   
For the six months ended
 
   
March 31, 2013
   
March 31, 2012
   
March 31, 2013
   
March 31, 2012
 
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
   
Amount
   
% of
Revenues
 
   
(dollars in millions)
 
Customer A
  $ 4.8       18 %   $ 5.8       30 %   $ 7.4       16 %   $ 10.3       26 %
Customer B
  $ 5.9       23 %   $ 1.5       8 %   $ 11.0       23 %   $ 6.7       17 %
Customer C
  $ 0.2       1 %   $ 2.2       12 %   $ 1.0       2 %   $ 3.4       9 %
Customer D
  $ 3.0       12 %   $ 0.2       1 %   $ 4.2       9 %   $ 0.8       2 %
 
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
Inputs
(Level 3)
   
Total
Balance
   
Gain
or
(loss)
 
   
As of March 31, 2013
 
   
(Amounts in thousands)
 
Assets:
                                       
Money Market funds
  $ 3,500     $     $     $ 3,500     $  
Total assets measured at fair value
  $ 3,500     $     $     $ 3,500     $  
 

   
As of September 30, 2012
 
   
(Amounts in thousands)
 
Assets:
                                 
Money Market funds
  $ 3,498     $     $     $ 3,498     $  
Total assets measured at fair value
  $ 3,498     $     $     $ 3,498     $  
 
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.
 
 
13

 
 
The Company had no liabilities measured at fair value as of March 31, 2013 or September 30, 2012. The Company had no assets or liabilities measured at fair value on a non recurring basis as of March 31, 2013 or September 30, 2012.
 

9.           Dividend
 
On December 10, 2012, the Company's board of directors declared a cash dividend of $0.20 per share which was paid on December 28, 2012 to stockholders of record as of December 20, 2012, the record date.
 
 
 
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, 2012 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, 2013 Results of Operations
 
Overview:
 
Revenue increased by approximately $6.6 million, or 16%, to $46.7 million for the six months ended March 31, 2013 versus $40.1 million for the six months ended March 31, 2012. This increase in sales volume resulted in our operating income and net income being consistent with the prior-year six-month period, despite a decrease in overall gross profit margin, which decreased from 24% for the six months ended March 31, 2012  to 21% for the six months ended March 31, 2013.  Operating profit was approximately $1.4 million for both  six-month periods ended March 31 in fiscal 2013 and 2012.  Net income was $0.9 million for both six-month periods.  The decrease in gross profit margin was due to the company having realized approximately $3.0 million in royalty revenue in the prior year six-month period compared to $0.8 million in the current year six-month period.
 
 
14

 
 
The following table details our results of operations in dollars and as a percentage of sales for the six months ended March 31, 2013 and 2012:
 
 
   
March 31, 2013
   
%
of sales
   
March 31, 2012
   
%
of sales
 
   
(Dollar amounts in thousands)
 
Sales
  $ 46,693       100 %   $ 40,122       100 %
Costs and expenses:
                               
Cost of sales
    36,749       79 %     30,584       76 %
Engineering and development
    824       2 %     857       2 %
Selling, general and administrative
    7,725       16 %     7,248       19 %
Total costs and expenses
    45,298       97 %     38,689       97 %
Operating income
    1,395       3 %     1,433       3 %
Other income (expense)
    34       %     (70 )     %
Income before income taxes
    1,429       3 %     1,363       3 %
Income tax expense
    574       1 %     460       1 %
Net income
  $ 855       2 %   $ 903       2 %
 

Sales
 
The following table details our sales by operating segment for the six months ended March 31, 2013 and 2012:
 

   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
For the Six Months Ended March 31, 2013:
                               
Product
  $ 2,590     $ 32,252     $ 34,842       75 %
Services
    1,100       10,751       11,851       25 %
Total
  $ 3,690     $ 43,003     $ 46,693       100 %
% of Total
    8 %     92 %     100 %        
 

   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
For the Six Months Ended March 31, 2012:
                               
Product
  $ 1,462     $ 25,817     $ 27,279       68 %
Services
    3,248       9,595       12,843       32 %
Total
  $ 4,710     $ 35,412     $ 40,122       100 %
% of Total
    12 %     88 %     100 %        
 

   
Systems
   
Service and
System
Integration
   
Total
   
%
increase (decrease)
 
Increase (Decrease)
                               
Product
  $ 1,128     $ 6,435     $ 7,563       28 %
Services
    (2,148 )     1,156       (992 )     (8 )%
Total
  $ (1,020 )   $ 7,591     $ 6,571       16 %
% increase (decrease)
    (22 )%     21 %     16 %        
 
 
15

 
 
As shown above, total revenues increased by approximately $6.6 million, or 16%, for the six months ended March 31, 2013 compared to the six months ended March 31, 2012.  Revenue in the Systems segment decreased for the current year six- month period versus the prior year six-month period by approximately $1.0 million, while revenues in the Service and System Integration segment increased by approximately $7.6 million.
 
Product revenues increased by approximately $7.6 million, or 28%, for the six months ended March 31, 2013 compared to the comparable period of the prior fiscal year. Product revenues in the Service and System Integration segment increased by approximately $6.4 million while in the Systems segment product revenue increased by approximately $1.1 million for the six-month period ended March 31, 2013 versus the six month period ended March 31, 2012.

In the US division of the Service and System Integration segment, product sales increased by approximately $9.2 million, offset by decreases in the German division of approximately $2.0 million and in the UK division of approximately $0.8 million.
 
In the US division, the increase was due in part to sales to new customers (customers to which no sales were made in the prior year), which totaled approximately $3.7 million for the six months ended March 31, 2013.  In addition,  sales increased to three large existing customers in the IT hosting vertical by an aggregate of approximately $5.7 million.

In Germany, the $2.0 million decrease in product revenue included an unfavorable foreign currency impact of approximately $0.2 million, therefore on a volume basis in constant dollars the decrease was approximately $1.8 million.  This sales volume decrease was driven by decreased sales to the division’s largest customer, a large UK-based wireless carrier.    The decrease in product sales in the UK division was the result of weaker demand from our UK customer base in the current-year six month period versus the prior year six month period.
 
The increase in product revenues in the Systems segment of approximately $1.1 million was due largely to an increase in sales to our Japanese defense department customer of approximately $1.3 million, and a decrease of $0.4 million in sales of parts, components and spares to existing US defense department customers.
 
As shown in the table above, service revenues decreased by approximately $1.0 million, or 8%.  This decrease was made up of an decrease in the Systems segment of $2.1 million and an increase in the Service and System Integration segment of approximately $1.2 million. The decrease in the Systems segment service revenue was due to lower royalty income recorded in the six months ended March 31, 2013 which was approximately $0.8 million versus $3.0 million for the six months ended March 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 $0.5 million, and an increase in service revenues of approximately $0.5 million in the US division.  In Germany, the increase in sales volume was driven by increased service revenues to the German division's largest customer, a UK-based wireless carrier. The increase in service revenue in the US division of the segment was primarily from higher third party maintenance revenue for the six months ended March 31, 2013 versus the six months ended March 31, 2012.
 
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, 2013
   
%
   
March 31, 2012
   
%
   
$ Increase
(Decrease)
   
% Increase
(Decrease)
 
   
(Dollar amounts in thousands)
 
Americas
  $ 29,689       64 %   $ 21,918       55 %   $ 7,771       35 %
Europe
    14,673       31 %     17,321       43 %     (2,648 )     (15 )%
Asia
    2,331       5 %     883       2 %     1,448       164 %
Totals
  $ 46,693       100 %   $ 40,122       100 %   $ 6,571       16 %
 
The increase in Americas revenue for the six months ended March 31, 2013 versus the six months ended March 31, 2012 was primarily the result of the fluctuations described above in the Systems segment where combined product and service sales to US customers decreased by an aggregate $2.6 million while in the US division of the Service and System Integration segment, sales to customers in the Americas were greater by approximately $10.2 million.
 
 
16

 
 
The decrease in sales in Europe was primarily the result of the lower sales described above from the German and UK divisions of the Service and System Integration segment, which made up $2.1 million of the decrease, while Europe sales from the US division of the Service and System Integration segment decreased by approximately $0.5 million. The increase in Asia sales was the result of the increase in sales to our existing customer that supplies a large Japanese defense program (see discussion above).
 
 
17

 
 
Cost of Sales and Gross Margins

The following table details our cost of sales and gross profit margins by operating segment for the six months ended March 31, 2013 and 2012:
 

   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
For the Six Months Ended March 31, 2013:
                               
Product
  $ 979     $ 27,921     $ 28,900       79 %
Services
    127       7,722       7,849       21 %
Total
  $ 1,106     $ 35,643     $ 36,749       100 %
% of Total
    3 %     97 %     100 %        
% of Sales
    30 %     83 %     79 %        
Gross Margins:
                               
Product
    62 %     13 %     17 %        
Services
    88 %     28 %     34 %        
Total
    70 %     17 %     21 %        
                                 
For the Six Months Ended March 31, 2012:
                               
Product
  $ 1,077     $ 22,298     $ 23,375       76 %
Services
    127       7,082       7,209       24 %
Total
  $ 1,204     $ 29,380     $ 30,584       100 %
% of Total
    4 %     96 %     100 %        
% of Sales
    26 %     83 %     76 %        
Gross Margins:
                               
Product
    26 %     14 %     14 %        
Services
    96 %     26 %     44 %        
Total
    74 %     17 %     24 %        
                                 
Increase (decrease)
                               
Product
  $ (98 )   $ 5,623     $ 5,525       24 %
Services
          640       640       9 %
Total
  $ (98 )   $ 6,263     $ 6,165       20 %
% Increase (decrease)
    (8 )%     21 %     20 %        
% of Sales
    4 %     %     3 %        
Gross Margins:
                               
Product
    36 %     (1 )%     3 %        
Services
    (8 )%     2 %     (10 )%        
Total
    (4 )%     %     (3 )%        
 
Total cost of sales increased by approximately $6.2 million when comparing the six months ended March 31, 2013 versus the six months ended March 31, 2012.   This increase in cost of sales was  due to the overall increase in sales as discussed previously, however whereas sales increased by 16% , cost of sales increased by 20%. The resulting lower gross profit margin ("GPM") of 21% for the six months ended March 31, 2013 versus 24% for 2012 was primarily attributable to a greater proportion of Systems segment revenue (12%) for the six months ended March 31, 2012 versus the six months ended March 31, 2013 (8%).
 
 
18

 
 
In the Service and System Integration segment, the overall GPM was 17% for the six months ended March 31, 2013 and also 17% for the prior year six-month period.  Product GPM in the segment decreased from 14% for the six months ended March 31, 2012, to 13% for the six months ended March 31, 2013, while the segment’s service GPM increased from 26% to 28% .  The product GPM decrease was due to a less favorable product mix in the current year six-month period versus the prior year.  Prior year product sales included more networking and data security products as opposed to sales of servers and other lower margin products in the current year six-month period particularly in the German division.  The increase in service GPM in the Service and System Integration segment from 26% for the six-month period ended March 31, 2012 to 28% for the six months ended March 31, 2013 was due primarily to higher utilization of in-house service engineers in providing billable services in Germany, and higher third-party maintenance revenue for the current year six-month period versus that of the prior year.
 
In the Systems segment, the overall GPM decreased from 74% to 70% as shown in the table above.  This was because in the current year six month period, royalty revenue, which carries a 100% GPM, made up a much lower percentage (22%) of total Systems segment revenue versus the prior year six-month period, wherein royalty revenue was 64% of total Systems segment revenue.

Engineering and Development Expenses
 
The following table details our engineering and development expenses by operating segment for the six months ended March 31, 2013 and 2012:
 

   
For the six months ended,
             
   
March 31, 2013
   
% of
Total
   
March 31, 2012
   
% of
Total
   
$ Decrease
   
% Decrease
 
   
(Dollar amounts in thousands)
 
By Operating Segment:
                                               
Systems
  $ 824       100 %   $ 857       100 %   $ (33 )     (4 )%
Service and System Integration
                                   
Total
  $ 824       100 %   $ 857       100 %   $ (33 )     (4 )%
 
As shown in the table above, engineering and development expenses did not vary significantly for  the for the six months ended March 31, 2013 versus the six-month period ended March 31, 2012, as approximately the same amount of resources were expended in both six-month periods.
 
Selling, General and Administrative
 
The following table details our selling, general and administrative (“SG&A”) expense by operating segment for the six months ended March 31, 2013 and 2012:
 

   
For the six months ended,
             
   
March 31, 2013
   
% of
Total
   
March 31, 2012
   
% of
Total
   
$ Increase (Decrease)
   
% Increase (Decrease)
 
   
(Dollar amounts in thousands)
 
By Operating Segment:
                                               
Systems
  $ 1,984       26 %   $ 2,178       30 %   $ (194 )     (9 )%
Service and System Integration
    5,741       74 %     5,070       70 %     671       13 %
Total
  $ 7,725       100 %   $ 7,248       100 %   $ 477       7 %
 
SG&A expenses increased in the Service and System Integration segment by approximately $0.7 million as shown above, due primarily to higher commissions and bonus expense, primarily due to the higher GP, and operating profit, plus higher sales salary expenses for additional headcount and promotions within the US division. In the Systems segment, SG&A expenses decreased by approximately $0.2 million from lower retirement plan expenses of $0.2 million and lower bonus of $0.3 million offset by expenses incurred for legal and consulting expenses in connection with a proxy contest initiated by a shareholder, of $0.3 million.
 
 
19

 
 
Other Income/Expenses
 
The following table details our other income (expense) for the six months ended March 31, 2013 and 2012:
 

   
For the six months ended,
       
   
March 31, 2013
   
March 31, 2012
   
Increase
 
   
(Amounts in thousands)
 
Interest expense
  $ (43 )   $ (43 )   $  
Interest income
    18       16       2  
Foreign exchange gain
    5       (26 )     31  
Gain on sale of fixed assets
    17             17  
Other income (expense), net
    37       (17 )     54  
Total other income (expense), net
  $ 34     $ (70 )   $ 104