CSP INC /MA/ - Quarter Report: 2000 February (Form 10-Q)

(Mark One)

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended            February 29, 2000      

or

[  ]  Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                        to                      

                             Massachusetts                                                             04-2441294  
                  (State or other jurisdiction of                                               (I.R.S. Employer
                  incorporation or organization)                                              Identification No.)

                 40 Linnell Circle, Billerica, Massachusetts                               01821-3901
                (Address of principal executive offices)                                         (Zip Code)

                                                                 (978) 663-7598 
                                      (Registrant's telephone number, including area code)

                                                                         None                                                                        
                      (Former name, former address, former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 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.        [X]  Yes            [  ]  No

                                    APPLICABLE ONLY TO CORPORATE ISSUERS:
     Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

                                Class                                                               Outstanding April 11, 2000
           Common Stock, $.01 par value                                                 3,587,415 shares

See accompanying notes to consolidated financial statements.

See accompanying notes to consolidated financial statements.

The accompanying 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 generally accepted accounting principles, have been condensed or omitted. Accordingly, the Company believes that although the disclosures are adequate to make the information presented not misleading, the 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 August 27, 1999.

On March 2, 2000 the Company made a $2 million investment in exchange for two million shares of VerticalBuyer, Inc. which represents a 11.7% ownership interest. VerticalBuyer is a privately held holding company for a network of Internet sites formed to capitalize on business to business e-commerce opportunities. VerticalBuyer commenced initial operations in February 2000 in the global commercial lighting and electrical markets estimated to be approximately a $140 billion market. The Company has warrants to purchase an additional three million shares for $1 each. The warrants are callable at $.001 per warrant. The first 1,000,000 warrants are callable thirty days after the effective date of the registration. The second 1,000,000 warrants are callable thirty days after the stock has traded at $2 per share for twenty consecutive days. The third 1,000,000 warrants are callable after the stock has traded at $3 per share for twenty consecutive days.

     A summary of the period to period changes in principal items included in the Statements of Operations is shown in Schedules I and II (pages 15 and 16).

     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.

      Sales for the three and six-month periods ended February 29, 2000 were $18,360,000 and $34,094,000 compared to $15,585,000 and $27,100,000 for the three and six-month periods ended February 26, 1999. This represented increases of approximately $2,775,000 or 18% for the three-month and $6,994,000 or 26% for the six-month periods ended February 26, 2000 compared to the same period of the prior fiscal year. This increase in revenue was primarily due to increases in services and systems integration orders shipped by MODCOMP's Germany subsidiary. During the quarter and six months ended February 29, 2000, MODCOMP Germany shipped a large number of systems and provided integration services to E-Plus, a large Telecommunication Company, which represented approximately 41% of total revenue for the three and six-month periods ended February 29, 2000. Sales of MODCOMP's E-commerce software products primarily ViewMax increased $215,000 and $466,000 for the three and six-month periods ended February 29, 2000 compared to the same periods of fiscal year 1999. This represented an increase of 98% and 135% of ViewMax revenue. MODCOMP accounted for 79% and 83% of total revenue for the quarter and six months ended February 29, 2000 compared to 74% and 68% for the prior comparable periods of fiscal 1999. CSP MultiComputer Division (CSPI) products accounted for 17% and 14% of total revenue for the three and six-months ended February 29, 2000 compared to 21% and 28% for the same periods of the prior fiscal year. This decrease was due in part to declines in the older products, such as SuperCards, which programs are ending their procurements and due to extended incubation periods for defense industry procurements for the new Series 2000 products. In addition, in the first quarter of fiscal 1999, CSPI shipped the largest Power PC system (340 processors) to an international customer which represented 53% of systems sales for that quarter. Scanalytics revenues accounted for 3% of total sales for the three and six-month periods ended compared to 5% and 4% for the same periods of fiscal year 1999.

     The Company has changed its fiscal year from the last Friday in August in Fiscal 1999 to the last day in August for Fiscal 2000. In Fiscal 1999 each quarter was 13 weeks in length ending on the last Friday of the quarter. Beginning in Fiscal 2000 each quarter will end on the last day of the last month of the quarter. For Fiscal Year 2000 the second quarter ended on February 29, 2000 compared to February 26, 1999 for the prior year. This resulted in approximately $500,000 of additional revenue at a gross margin of approximately 35% during the period February 26, 2000 through February 29, 2000. Fiscal Year 2000 will be 53 weeks in length compared to 52 weeks in Fiscal 1999. The effect of the change is not expected to have a material effect on the Company's financial statements for Fiscal 2000.

     Cost of sales as a percentage of sales increased to 69% and 73% for the three and six-months ended February 29, 2000 compared to 67% and 61% for the prior comparable periods of fiscal 1999. The increase in cost of sales was due to the change in product mix with the significant increase in service and system integration sales which have higher cost of sales due to the large content of third party products. The software and systems sales have lower costs of sales and they represented a small portion of revenue in fiscal 2000. The increase in integration service sales, which traditionally has a high cost of sales, combined with a decrease in sales of systems, which has lower cost of sales, contributed to the decline in gross margin.

     Engineering and development expenditures were $957,000 and $2,050,000 for the three and six-months ended February 29, 2000 compared to $976,000 and $2,105,000 for the three and six months periods ended February 26, 1999. This represented a slight decrease of approximately 2% for the quarter and 3% year to date. The major portion of the engineering and development expense related to CSPI which accounted for approximately 57% and 52% of the three and six-month expense, respectively. CSPI expenses decreased by 5% and 4% during the three and six-month periods compared to the same periods of fiscal 1999. This decline was mainly attributable to a reduction in staff, outside services and consulting expenses needed to complete the software and hardware work on the Series 2000 products. MODCOMP accounted for 30% and 36% of total engineering and development expenditures for the three and six-month periods ended February 29, 2000 compared to 29% and 32% in the same periods of fiscal 1999. This increase relates to the continued development of the E-Commerce products, ViewMax, which included the new Linux version of the product recently announced and the new WAP66, a server solution to make existing enterprise data available to mobile users as well as the internet, product was completed and announced during the quarter. Scanalytics accounted for 13% and 12% of total engineering and development expenditures for the three and six-month periods ended February 29, 2000 compared to 13% and 11% for the same periods of fiscal 1999.

     Selling, general and administration expenditures were $3,492,000 and $6,681,000 for the three and six-months ended February 29, 2000 compared to $3,498,000 and $6,846,000 for the comparable periods of fiscal 1999, remaining fairly consistent for the quarter and representing a slight decline of 2% year to date. The major portion of total selling, general and administration expense related to MODCOMP which accounted for 53% and 54% of the three and six-months periods ended February 29, 2000 total compared to 58% and 54% for the prior comparable periods of fiscal 1999. CSPI accounted for 39% and 36% of the three and six month expense compared to 33% and 37% for the same periods of fiscal 1999. The reduction in staff, executive bonus, retirement plan and shareholder service expense represented the major portion of the reduction in the expenses. Scanalytics accounted for 8% and 10% of the expense compared to 9% for the same periods of fiscal 1999. This slight increase was mainly due to the addition of a sales person and the costs marketing efforts that included the participation in two trade shows.

     Other income/expense decreased by 55% and 38% for the three and six-months ended February 29, 2000 compared to the three and six-month periods ended February 26, 1999. This decline is mainly due to the Company investing a larger percentage of its cash in short-term non-taxable and taxable instruments, which have lower rates of return on a pre-tax basis than our investments in the prior comparable periods of fiscal 1999.

     The Company had a high effective tax rate of 49% and 47% for the three and six-months ended February 29, 2000, which is above the normal US statutory rate. This was primarily due to a large portion of foreign-based revenue and profits from France and Germany, which have high statutory tax rates. The Company will continue to review strategies with its advisors to reduce our effective rate.

     The Company still has a solid financial position as working capital increased to $23,762,000 as of February 29, 2000 from $23,469,000 as of August 27, 1999. The Company's accounts receivable increased to $12,023,000 from $7,395,000. This increase is due to the timing of shipments made at the end of the second quarter of fiscal 2000. The Company's inventory increased to $5,933,000 from $5,805,000. The increase of $2,448,000 in accounts payable and accrued expenses was primarily related to the purchases of large integration service orders which represented 90 % of the increase. These purchases related to shipments made at the end of the quarter.

     The Company spent $285,000 and $396,000 on capital improvements for the three and six-months ended February 29, 2000 compared to $371,000 and $512,000 for the same periods of fiscal 1999.

     Management believes that all of the Company's current and foreseeable needs can be met through working capital generated by operations and investments.

     Management does not believe that inflation and changing prices had significant impact on sales, revenues or income from continued operations during the three and six-month periods ended February 29, 2000. There is no assurance, however, that the Company's business will not be materially and adversely affected by inflation and changing prices in the future.

Factors That May Affect Future Performance
     

     This document contains forward-looking statements based on current expectations that involve a number of risks and uncertainties. The factors that could cause actual results to differ materially include the following: general economic conditions and growth rates in the peripheral and computer products, biological imaging software, and the instruments and machine code readers industries; competitive factors and pricing pressures; changes in product mix; the timely development and acceptance of new products; inventory risks due to shifts in market demand; and component constraints and shortages. In response to competitive pressures or new product introductions, the Company may take certain pricing or marketing actions that could adversely affect the Company's operating results. In addition, changes in the mix of old products may cause fluctuations in the Company's gross margin. Due to the potential quarterly fluctuations in operating results, the Company believes that quarter-to-quarter comparisons of its results of operations are not necessarily an indicator of future performance.

     Markets for the Company's products are characterized by rapidly changing technology, new product introductions and short product life cycles. These changes can adversely affect the business and operating results. The Company's success will depend upon its ability to enhance its existing products 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 the Company's business and operating results.

     The Company has reviewed both its internal computer systems and its products that could have been affected by the "Year 2000" issue and has updated some systems and a few products which were affected. The Company with the modification to existing software and conversion to new software, the "Year 2000" issues related to internal computer systems and products did not cause any significant operational or computer problems. Furthermore, the cost of implementing these solutions has been fully expensed in the current fiscal year and management believes that any further financial position or results of operations will not be material.

     The Company has identified alternative remediation if any upgrade or replacement does not correct the "Year 2000" issue.

     The Company continues a formal communication with all of its significant suppliers and large customers to determine the extent to which the Company is vulnerable to those third-parties failure to correct their own " Year 2000" issues. Where practicable, the Company has attempted to mitigate its risks with respect to the failure of suppliers to be "Year 2000" ready. In the event that suppliers are not "Year 2000" compliant, the Company has found alternative sources of supply where practical. There can be no guarantee that the systems of other companies upon which significant supplies and large customers rely will be converted in a timely fashion nor can there be any guarantee that failure to convert by another, will not have a material impact on the Company.

The Company has not experienced any problems related to the "Year 2000" issue as of April 12, 2000.

             The Company held its Annual meeting of Stockholders on Tuesday, January 11, 2000. The following matters were approved by the shareholders:

1) Sandford D. Smith and Robert M. Williams were elected as Class I directors for a terms of three years.

1. Exhibits

27.0 Financial Data Schedule

2. Reports on Form 8-K

                   Form 8-K Change in Fiscal Year dated February 2, 2000

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CSP Inc.
(Registrant)

Date: April 13, 2000                                               By: /s/ Alexander R. Lupinetti
                                                                                       Chief Executive Officer,
                                                                                       President and Chairman

Date: April 13, 2000                                               By: /s/ Gary W. Levine
                                                                                        Vice President of Finance,
                                                                                        Chief Financial Officer

                                               /----------------Three months ended--------/ /--------Six months ended-----------/

                                                     /--For the three months ended---/             /---For the six months ended----/
                                                                                 February 29, 2000 vs. February 26, 1999