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EX-31.2 - EXHIBIT 31.2 - CSP INC /MA/ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - CSP INC /MA/ex31-1.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, 2012.
   
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 7, 2012, the registrant had 3,432,554 shares of common stock issued and outstanding.
 
 
1

 
 
INDEX
 
   
Page
     
PART I. FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
3
     
 
Consolidated Balance Sheets as of March 31, 2012 (unaudited) and September 30, 2011
3
     
 
Consolidated Statements of Operations (unaudited) for the three and six months ended March 31, 2012 and 2011
4
     
 
Consolidated Statement of Shareholders’ Equity (unaudited) for the six months ended March 31, 2012
5
     
 
Consolidated Statements of Cash Flows (unaudited) for the six months ended March 31, 2012 and 2011
6
     
 
Notes to Consolidated Financial Statements (unaudited)
7
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
13
     
Item 4.
Controls and Procedures
25
     
PART II. OTHER INFORMATION
 
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
25
     
Item 6.
Exhibits
26

 
2

 
 
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CSP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except par value)
 
   
March 31,
2012
 
September 30,
2011
   
(Unaudited)
   
ASSETS
       
Current assets:
       
Cash and cash equivalents
  $ 14,833     $ 15,874  
Accounts receivable, net of allowances of $278 and $302
    14,215       13,148  
Inventories
    5,960       6,777  
Refundable income taxes
    120       231  
Deferred income taxes
    104       158  
Other current assets
    2,862       1,690  
Total current assets
    38,094       37,878  
Property, equipment and improvements, net
    947       833  
                 
Other assets:
               
Intangibles, net
    533       574  
Deferred income taxes
    633       663  
Cash surrender value of life insurance
    3,098       2,918  
Other assets
    225       242  
Total other assets
    4,489       4,397  
Total assets
  $ 43,530     $ 43,108  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable and accrued expenses
  $ 10,758     $ 12,103  
Deferred revenue
    4,162       2,937  
Pension and retirement plans
    691       709  
Income taxes payable
    160       121  
Total current liabilities
    15,771       15,870  
Pension and retirement plans
    9,085       9,056  
Other long term liabilities
    299       286  
Total liabilities
    25,155       25,212  
                 
Commitments and contingencies
               
                 
Shareholders’ equity:
               
Common stock, $.01 par value per share; authorized, 7,500 shares; issued and outstanding 3,432 and 3,417 shares, respectively
    34       34  
Additional paid-in capital
    10,867       10,880  
Retained earnings
    13,446       12,885  
Accumulated other comprehensive loss
    (5,972 )     (5,903 )
Total shareholders’ equity
    18,375       17,896  
Total liabilities and shareholders’ equity
  $ 43,530     $ 43,108  
 
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,
2012
 
March 31,
2011
 
March 31,
2012
 
March 31,
2011
Sales:
               
Product
  $ 12,125     $ 12,767     $ 27,279     $ 28,058  
Services
    6,904       4,862       12,843       10,198  
Total sales
    19,029       17,629       40,122       38,256  
                                 
Cost of sales:
                               
Product
    10,610       9,961       23,375       23,376  
Services
    3,704       3,419       7,209       6,103  
Total cost of sales
    14,314       13,380       30,584       29,479  
                                 
Gross profit
    4,715       4,249       9,538       8,777  
                                 
Operating expenses:
                               
Engineering and development
    474       508       857       1,018  
Selling, general and administrative
    3,572       3,310       7,248       6,685  
Total operating expenses
    4,046       3,818       8,105       7,703  
Operating income
    669       431       1,433       1,074  
                                 
Other income (expense):
                               
Foreign exchange gain (loss)
    (10 )     12       (26 )     8  
Other income (expense), net
    (26 )     (13 )     (44 )     (30 )
Total other income (expense), net
    (36 )     (1 )     (70 )     (22 )
Income before income taxes
    633       430       1,363       1,052  
Income tax expense
    191       144       460       377  
Net income
  $ 442     $ 286     $ 903     $ 675  
Net income attributable to common stockholders
  $ 434     $ 282     $ 888     $ 666  
Net income per share – basic
  $ 0.13     $ 0.08     $ 0.26     $ 0.19  
Weighted average shares outstanding – basic
    3,363       3,437       3,360       3,455  
Net income per share – diluted
  $ 0.13     $ 0.08     $ 0.26     $ 0.19  
Weighted average shares outstanding – diluted
    3,401       3,471       3,398       3,491  
 
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, 2012:
(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, 2011
    3,417     $ 34     $ 10,880     $ 12,885     $ (5,903 )   $ 17,896      
Comprehensive income (loss):
                                                   
Net income
                      903             903     $ 903
Other comprehensive income:
                                                     
Effect of foreign currency translation
                            (69 )     (69 )     (69)
Total comprehensive income
                                                  $ 834
Stock-based compensation
                13                   13        
Purchase of common stock
    (23 )           (81 )                 (81 )      
Restricted stock issuance
    38             55                   55        
Cash dividends on common stock ($0.10 per share)
                      (342 )           (342 )      
Balance as of March 31, 2012
    3,432     $ 34     $ 10,867     $ 13,446     $ (5,972 )   $ 18,375        
 
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,
2012
 
March 31,
2011
Cash flows from operating activities:
       
Net income
  $ 903     $ 675  
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation and amortization
    181       182  
Amortization of intangibles
    41       56  
Loss on disposal of fixed assets, net
          3  
Foreign exchange loss (gain)
    26       (8 )
Non-cash changes in accounts receivable
    32       34  
Stock-based compensation expense on stock options and restricted stock awards
    69       92  
Deferred income taxes
    82        
Increase in cash surrender value of life insurance
    (43 )     (41 )
Changes in operating assets and liabilities:
               
Increase in accounts receivable
    (1,103 )     (202 )
(Increase) decrease in inventories
    827       (2,442 )
Decrease in refundable income taxes
    110       502  
Increase in other current assets
    (1,169 )     (601 )
Decrease in other assets
    17       52  
Increase (decrease) in accounts payable and accrued expenses
    (1,368 )     386  
Increase in deferred revenue
    1,219       509  
Increase (decrease) in pension and retirement plans liability
    (53 )     83  
Increase in income taxes payable
    38       127  
Increase in other long term liabilities
    14        
Net cash used in operating activities
    (177 )     (593 )
                 
Cash flows from investing activities:
               
Life insurance premiums paid
    (137 )     (137 )
Purchases of property, equipment and improvements
    (295 )     (211 )
Net cash used in investing activities
    (432 )     (348 )
                 
Cash flows from financing activities:
               
Dividends paid
    (342 )      
Proceeds from issuance of shares under employee stock purchase plan
          75  
Purchase of common stock
    (81 )     (395 )
Net cash used in financing activities
    (423 )     (320 )
Effects of exchange rate on cash
    (9 )     102  
Net decrease in cash and cash equivalents
    (1,041 )     (1,159 )
Cash and cash equivalents, beginning of period
    15,874       15,531  
Cash and cash equivalents, end of period
  $ 14,833     $ 14,372  
                 
Supplementary cash flow information:
               
Cash paid for income taxes
  $ 326     $ 251  
Cash paid for interest
  $ 85     $ 85  
 
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, 2012 AND 2011

 
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, 2011.
 
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:
 
 
7

 
 
 
   
For the three months ended
 
For the six months ended
   
March 31,
2012
   
March 31,
2011
 
March 31,
2012
 
March 31,
2011
   
(Amounts in thousands except per share data)
Net income
  $ 442     $ 286     $ 903     $ 675  
Less: Net income attributable to nonvested common stock
    8       4       15       9  
Net income attributable to common stockholders
  $ 434     $ 282     $ 888     $ 666  
                                 
Weighted average total shares outstanding – basic
    3,425       3,492       3,417       3,504  
Less: weighted average non-vested shares outstanding
    62       55       57       49  
Weighted average number of common shares outstanding – basic
    3,363       3,437       3,360       3,455  
Potential common shares from non-vested stock awards and the assumed exercise of stock options
    38       34       38       36  
Weighted average common shares outstanding – diluted
    3,401       3,471       3,398       3,491  
                                 
Net income per share – basic
  $ 0.13     $ 0.08     $ 0.26     $ 0.19  
Net income per share – diluted
  $ 0.13     $ 0.08     $ 0.26     $ 0.19  
 
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, 2012, 195,000 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,
2012
   
September 30,
2011
 
   
(Amounts in thousands)
 
Raw materials
  $ 1,363     $ 886  
Work-in-process
    675       539  
Finished goods
    3,922       5,352  
Total
  $ 5,960     $ 6,777  
 
Finished goods includes inventory that has been shipped, but for which all revenue recognition criteria has not been met of approximately $1.6 million and $3.4 million as of March 31, 2012 and September 30, 2011, respectively.
 
Total inventory balances in the table above are shown net of reserves for obsolescence of approximately $4.3 million and $4.3 million as of March 31, 2012 and September 30, 2011, respectively.
 
5.          Accumulated Other Comprehensive Loss
 
The components of comprehensive income (loss) are as follows:
 
 
8

 


   
For the Three Months Ended
 
For the Six Months Ended
   
March 31,
2012
   
March 31,
2011
 
March 31,
2012
 
March 31,
2011
   
(Amounts in thousands)
Net income
  $ 442     $ 286     $ 903     $ 675  
Effect of foreign currency translation
    45       102       (69 )     41  
Minimum pension liability
                       
Comprehensive income (loss)
  $ 487     $ 388     $ 834     $ 716  
 
The components of Accumulated Other Comprehensive Loss are as follows:
 
   
March 31,
2012
 
September 30,
2011
   
(Amounts in thousands)
Cumulative effect of foreign currency translation
 
$
(2,297
)
 
$
(2,228
)
Additional minimum pension liability
 
(3,675
)
 
(3,675
)
Accumulated Other Comprehensive Loss
 
$
(5,972
)
 
$
(5,903
)


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, 2011 and for the six months ended March 31, 2012.

The Company funds its pension plans in amounts sufficient to meet the requirements set forth in applicable employee benefits laws and local tax laws. Liabilities for amounts in excess of these funding levels are accrued and reported in the consolidated balance sheets.
 
Our pension plan in the United Kingdom is the only plan with plan assets. The plan assets consist of an investment in a commingled fund which in turn comprises a diversified mix of assets including corporate equity securities, government securities and corporate debt securities.
 
The components of net periodic benefit costs related to the U.S. and international plans are as follows:
 
 
9

 
 
   
For the Three Months Ended March 31,
 
   
2012
   
2011
 
   
Foreign
   
U.S.
   
Total
   
Foreign
   
U.S.
   
Total
 
   
(Amounts in thousands)
 
Pension:
                                   
Service cost
  $ 15     $ 3     $ 18     $ 18     $ 2     $ 20  
Interest cost
    178       20       198       172       25       197  
Expected return on plan assets
    (104 )           (104 )     (126 )           (126 )
Amortization of:
                                               
Prior service gain
                                   
Amortization of net gain
    22       8       30       17       8       25  
Net periodic benefit cost
  $ 111     $ 31     $ 142     $ 81     $ 35     $ 116  
                                                 
Post Retirement:
                                               
Service cost
  $     $     $     $     $ 5     $ 5  
Interest cost
          18       18             17       17  
Amortization of net gain
          17       17             12       12  
Net periodic benefit cost
  $     $ 35     $ 35     $     $ 34     $ 34  
 

   
For the Six Months Ended March 31,
 
   
2012
   
2011
 
   
Foreign
   
U.S.
   
Total
   
Foreign
   
U.S.
   
Total
 
   
(Amounts in thousands)
 
Pension:
                                   
Service cost
  $ 32     $ 5     $ 37     $ 36     $ 4     $ 40  
Interest cost
    357       42       399       342       50       392  
Expected return on plan assets
    (209 )           (209 )     (251 )           (251 )
Amortization of:
                                               
Prior service gain
                                   
Amortization of net gain
    44       15       59       34       16       50  
Net periodic benefit cost
  $ 224     $ 62     $ 286     $ 161     $ 70     $ 231  
                                                 
Post Retirement:
                                               
Service cost
  $     $     $     $     $ 10     $ 10  
Interest cost
          36       36             34       34  
Amortization of net gain
          35       35             24       24  
Net periodic benefit cost
  $     $ 71     $ 71     $     $ 68     $ 68  


7.          Segment Information
 
The following table presents certain operating segment information.
 
 
10

 
 
         
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)
 
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  
                                                 
2011
                                               
Sales:
                                               
Product
  $ 1,931     $ 2,785     $ 61     $ 7,990     $ 10,836     $ 12,767  
Service
    368       3,401       364       729       4,494       4,862  
Total sales
    2,299       6,186       425       8,719       15,330       17,629  
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  

 
11

 
 
         
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)
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  
                                                 
2011
                                               
Sales:
                                               
Product
  $ 2,240     $ 6,251     $ 72     $ 19,495     $ 25,818     $ 28,058  
Service
    1,884       6,022       696       1,596       8,314       10,198  
Total sales
    4,124       12,273       768       21,091       34,132       38,256  
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  

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, 2012, and 2011.
 
   
For the Three Months Ended
 
For the Six Months Ended
   
March 31, 2012
 
March 31, 2011
 
March 31, 2012
 
March 31, 2011
   
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
 
Amount
 
% of
Revenues
   
(dollars in millions)
Customer A
  $ 5.8     30 %   $ 3.2     18 %   $ 10.3     26 %   $ 4.8     13 %
Customer B
  $ 1.5     8 %   $ 1.8     10 %   $ 6.7     17 %   $ 4.3     11 %
Customer C
  $ 2.2     12 %   $ 0.3     1 %   $ 3.4     9 %   $ 1.7     4 %
 
8.           Fair Value Measures
 
Assets and Liabilities measured at fair value on a recurring basis are as follows:
 
 
12

 
 
   
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, 2012
   
(Amounts in thousands)
Assets:
                     
Money Market funds
  $ 3,495     $   $   $ 3,495   $
Total assets measured at fair value
  $ 3,495     $   $   $ 3,495   $
 
     
   
As of September 30, 2011
   
(Amounts in thousands)
Assets:
                     
Money Market funds
  $ 3,493     $   $   $ 3,493   $
Total assets measured at fair value
  $ 3,493     $   $   $ 3,493   $
 
These assets are included in cash and cash equivalents in the accompanying consolidated balance sheets.  All other monetary assets and liabilities are short-term in nature and approximate their fair value.  The Company did not have any transfers between Level 1, Level 2 or Level 3 measurements.
 
The Company had no liabilities measured at fair value as of March 31, 2012 or September 30, 2011. The Company had no assets or liabilities measured at fair value on a non recurring basis as of March 31, 2012 or September 30, 2011.
 
9.          Common Stock Repurchase
 
Pursuant to prior authorizations by the Board of Directors, the Company repurchased approximately 23 thousand shares of its outstanding common stock during the six months ended March 31, 2012.  As of March 31, 2012, approximately 205 thousand shares remain authorized for repurchase under the Company’s stock repurchase program.

10.        Dividend
 
On January 12, 2012, our Board of Directors declared a cash dividend of $.10 per share which was paid on February 3, 2012 to stockholders of record as of January 27, 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.
 
 
13

 
 
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, 2011 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, 2012 Results of Operations
 
Highlights include:
 
 
Revenue increased by approximately $1.9 million, or 5%, to $40.1 million for the six months ended March 31, 2012 versus $38.3 million for the six months ended March 31, 2011.

 
For the six months ended March 31, 2012, we had an operating profit of approximately $1.4 million versus an operating profit of approximately $1.1 million for the six months ended March 31, 2011, for an increase of approximately $0.4 million, or 33% in our operating result.

 
For the six months ended March 31, 2012, net income was approximately $0.9 million versus net income of approximately $0.7 million for the six months ended March 31, 2011, for an increase of approximately $0.2 million, or 34%.

The following table details our results of operations in dollars and as a percentage of sales for the six months ended March 31, 2012 and 2011:
 
   
March 31,
2012
   
%
of sales
   
March 31,
2011
   
%
of sales
 
   
(Dollar amounts in thousands)
 
Sales
  $ 40,122       100 %   $ 38,256       100 %
Costs and expenses:
                               
Cost of sales
    30,584       76 %     29,479       77 %
Engineering and development
    857       2 %     1,018       3 %
Selling, general and administrative
    7,248       19 %     6,685       17 %
Total costs and expenses
    38,689       97 %     37,182       97 %
Operating income
    1,433       3 %     1,074       3 %
Other expense
    (70 )     %     (22 )     %
Income before income taxes
    1,363       3 %     1,052       3 %
Income tax expense
    460       1 %     377       1 %
Net income
  $ 903       2 %   $ 675       2 %
 
Sales
 
The following table details our sales by operating segment for the six months ended March 31, 2012 and 2011:
 
 
14

 
 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
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
   
% of
Total
For the Six Months Ended March 31, 2011:
                     
Product
  $ 2,240     $ 25,818     $ 28,058       73 %
Services
    1,884       8,314       10,198       27 %
Total
  $ 4,124     $ 34,132     $ 38,256       100 %
% of Total
    11 %     89 %     100 %        
 

   
Systems
   
Service and
System
Integration
   
Total
   
%
increase
(decrease)
Increase (Decrease)
                     
Product
  $ (778 )   $ (1 )   $ (779 )     (3 )%
Services
    1,364       1,281       2,645       26 %
Total
  $ 586     $ 1,280     $ 1,866       5 %
% increase
    14 %     4 %     5 %        
 
As shown above, total revenues increased by approximately $1.9 million, or 5%, for the six months ended March 31, 2012 compared to the six months ended March 31, 2011.  Revenue in the Systems segment increased for the current year six month period versus the prior year six month period by approximately $0.6 million, while revenues in the Service and System Integration segment increased by approximately $1.3 million.
 
Product revenues decreased by approximately $0.8 million, or 3%, for the six months ended March 31, 2012 compared to the comparable period of the prior fiscal year. Product revenues in the Service and System Integration segment were unchanged while in the Systems segment product revenue decreased by approximately $0.8 million for the six month period ended March 31, 2012 versus the six month period ended March 31, 2011.

While product sales in the Service and System Integration segment  were unchanged overall, in the U.S. division of the segment, product sales decreased by approximately $2.6 million, offset by increases in sales in this segment’s German division of approximately $1.6 million and in the UK division of approximately $1.0 million.
 
In the US division, product sales to the largest customer of the division, increased by approximately $1.8 million, and sales to a newly acquired IT infrastructure hosting company customer increased by an additional $1.0 million.  However, sales to several other customers decreased by a total of approximately $5.4 million, resulting in the net decrease of $2.6 million. In Germany, the $1.6 million increase was driven primarily by increased sales to the division’s largest customer, while the increase in sales in the UK division was the result of increased third party product sales versus the prior year.
 
The decrease in product revenues in the Systems segment of approximately $0.8 million was due to a decrease in sales to our Japanese defense department customer of approximately $1.2 million, offset by an increase of $0.4 million from the sale of parts, components and spares to existing US defense department customers.
 
As shown in the table above, service revenues increased by approximately $2.6 million, or 26%.  This increase was made up of an increase in the Service and System Integration segment of approximately $1.3 million and an increase in the Systems segment of $1.3 million. The increase in service revenues in the Service and System Integration segment was primarily from the German division’s largest customer, in connection with a large IT security services project. The increase in the Systems segment service revenue was due to higher royalty income recorded in the six months ended March 31, 2012 which was approximately $3.0 million versus $1.6 million for the six months ended March 31, 2011.
 
 
15

 
 
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,
2012
   
%
   
March 31,
2011
   
%
   
$ Increase
(Decrease)
   
% Increase
(Decrease)
 
    (Dollar amounts in thousands)  
Americas
  $ 21,918       55 %   $ 22,901       60 %   $ (983 )     (4 )%
Europe
    17,321       43 %     13,219       34 %     4,102       31 %
Asia
    883       2 %     2,136       6 %     (1,253 )     (59 )%
Totals
  $ 40,122       100 %   $ 38,256       100 %   $ 1,866       5 %
 
The decrease in Americas revenue for the six months ended March 31, 2012 versus the  six months ended March 31, 2011 was primarily the result of the fluctuations described above in the Systems segment and the US division of the Service and System Integration segment.
 
The increase in sales in Europe was primarily the result of the higher sales described above from the German and UK divisions of the Service and System Integration segment. The decrease in Asia sales was the result of the decrease in sales to our existing customer that supplies a large Japanese defense program (see discussion above).

Cost of Sales and Gross Margins

The following table details our cost of sales by operating segment for the six months ended March 31, 2012 and 2011:
 
 
16

 
 
   
Systems
   
Service and
System
Integration
   
Total
   
% of
Total
 
   
(Dollar amounts in thousands)
 
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 %        
                                 
For the Six Months Ended March 31, 2011:
                               
Product
  $ 995     $ 22,381     $ 23,376       79 %
Services
    137       5,966       6,103       21 %
Total
  $ 1,132     $ 28,347     $ 29,479       100 %
% of Total
    4 %     96 %     100 %        
% of Sales
    27 %     83 %     77 %        
Gross Margins:
                               
Product
    56 %     13 %     17 %        
Services
    93 %     28 %     40 %        
Total
    73 %     17 %     23 %        
                                 
Increase (decrease)
                               
Product
  $ 82     $ (83 )   $ (1 )     %
Services
    (10 )     1,116       1,106       18 %
Total
  $ 72     $ 1,033     $ 1,105       4 %
% Increase
    6 %     4 %     4 %        
% of Sales
    (1 )%     %     (1 )%        
Gross Margins:
                               
Product
    (30 )%     1 %     (3 )%        
Services
    3 %     (2 )%     4 %        
Total
    1 %     %     1 %        
 
Total cost of sales increased by approximately $1.1 million when comparing the six months ended March 31, 2012 versus the six months ended March 31, 2011.   This increase in cost of sales of 4% overall, is consistent with the increase in sales of 5% overall as described previously.  The resulting higher gross profit margin ("GPM") of 24% for the six months ended March 31, 2012 versus 23% for 2011 was due to several factors which are discussed below.
 
In the Service and System Integration segment, the overall GPM was 17% for the six months ended March 31, 2012 versus 17% for the prior year six  month period.  Product GPM in the segment increased from 13% for the six  months ended March 31, 2011, to 14% for the six  months ended March 31, 2012, while the segment’s service GPM decreased from 28% to 26%.  The product GPM increase was due to a more favorable product mix in the current year six month periods versus the prior year.  Current year product sales included more networking and data security products as opposed to sales of servers and other lower margin products in the prior year six month period in both the US and German divisions.  The decrease in service GPM in the Service and System Integration segment from 28% for the six month period ended March 31, 2011 to 26% for the six months ended March 31, 2012 was due to several factors including greater use of contractors versus in-house resources particularly in Germany and lower third party maintenance revenue for which the Company is not the primary obliger, in the six months ended March 31, 2012 versus the six months ended March 31, 2011. (Note, third party maintenance for which the company is not the primary obliger is recorded at net value, with no cost of sales.)
 
 
17

 
 
In the Systems segment, the overall GPM increased from 73% to 74% 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 greater percentage of total revenue (63%), versus the prior year six month period royalty revenue which was 40% of total revenue.  Offsetting the favorable GPM impact of the greater royalty revenue in the current year six month period, however, was the impact of significantly lower product GPM in the current six month period versus the prior year.  As shown in the table above, the GPM on product sales was only 26% for the current year six month period versus the prior year product GPM of 56%.  The reason for this is because in the current six month period the low volume of production and product sales resulted in insufficient absorption of fixed factory overhead, therefore these fixed costs were proportionately higher versus production and sales volume, which resulted in the low GPM on product sales in the current year six month period.

Engineering and Development Expenses
 
The following table details our engineering and development expenses by operating segment for the six months ended March 31, 2012 and 2011:
 
   
For the six months ended,
                 
    March 31,
2012
   
% of
Total
   
March 31,
2011
   
% of
Total
   
$ Decrease
   
% Decrease
 
   
(Dollar amounts in thousands)
 
By Operating Segment:                                                
Systems
  $ 857       100 %   $ 1,018       100 %   $ (161 )     (16 )%
Service and System Integration
                                   
Total
  $ 857       100 %   $ 1,018       100 %   $ (161 )     (16 )%
 
The $0.2 million  decrease in engineering and development expenses displayed above was due to lower 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 (“SG&A”) expense by operating segment for the six months ended March 31, 2012 and 2011:
 
   
For the six months ended,
             
   
March 31,
2012
   
% of
Total
   
March 31,
2011
   
% of
Total
   
$ Increase
   
% Increase
 
   
(Dollar amounts in thousands)
 
By Operating Segment:
                                   
Systems
  $ 2,178       30 %   $ 1,788       27 %   $ 390       22 %
Service and System Integration
    5,070       70 %     4,897       73 %     173       4 %
Total
  $ 7,248       100 %   $ 6,685       100 %   $ 563       8 %
 
The increase in SG&A expense in both segments was primarily the result of an increase in bonus and commission expense owing to the more favorable revenue,  gross profit and overall operating results for the six months ended March 31, 2012 versus the comparable period in the prior year.
 
Other Income/Expenses
 
The following table details our other income/expenses for the six months ended March 31, 2012 and 2011:
 
 
18