CSP INC /MA/ - Quarter Report: 2002 March (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            March 31, 2002      

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.)

                 43 Manning Road, Billerica, Massachusetts                              01821-3901
                (Address of principal executive offices)                                        (Zip Code)

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

                                                                        August 31, 2001                                                                     
                      (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 May 14, 2002
           Common Stock, $.01 par value                                                3,522,095 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 31, 2001.

1. Change in Fiscal Year

Effective on September 1, 2001 the Company changed its fiscal year end from August 31 to September 30. This change was effective for the one-month period ended September 30, 2001. The following table presents the (unaudited) condensed results of operations for the one-month ended September 30, 2001:

Inventories consist of the following (amounts in thousands):

On October 9, 1986, the Board of Directors authorized the Company to repurchase up to 344,892 additional shares of the outstanding stock at market price. On September 28, 1995, the Board of Directors authorized the Company to repurchase up to 199,650 additional shares of the outstanding stock at market price. The timing of stock purchases are made at the discretion of management. On October 19, 1999, the Board of Directors authorized the Company to repurchase up to 200,000 additional shares of the outstanding stock at market price. At March 31, 2002, the Company has repurchased 570,875 or 77% of the total shares authorized to be purchased.

The reconciliation of the numerators and denominators of the basic and diluted net loss per share computations for the Company's reported net loss is as follows:

Options to purchase 429,049 and 381,026 shares of common stock at March 31, 2002 and February 28, 2001, respectively, were outstanding but were not included in the year-to-date calculation of diluted net loss per share because the effect would have been antidilutive.

The components of Accumulated Other Comprehensive Income are as follows:

Each segment is broken down by related business activities, which crosses different business operations. These segments are based on the different customer activity of the Company. CSPI has four major segments: systems which includes company manufactured hardware products, systems and service integration which includes maintenance of the Company and other systems sold and integration and sale of third party hardware products and services, E-Commerce software, and other software products which are developed by the Company.

Profit 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 for the three and six months ended March 31, 2002 and loss on disposal of French operations, investment income and interest expense for the three and six months February 28, 2001. In calculating profit from operations for individual operating segments, sales and administrative expenses incurred at the operating level for CSP and Scanalytics are allocated to Systems and Other software segments, respectively. Sales and administrative expenses incurred at the operating level for MODCOMP are allocated to the E-Commerce software segment based upon employee headcount and the remaining balance is allocated to the Systems and System and Service Integration segments based upon sales revenue.

All intercompany transactions have been eliminated.

Identifiable assets include deferred income tax assets and other financial instruments managed by the Company. Capital expenditures common to more than one segment are allocated on a sales basis.

         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 20 and 21).

        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.

        Our discussion and analysis of our financial condition and results of operations is 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 judgements 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, intangible assets, income taxes, restructuring costs 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.

        We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: revenue recognition; valuation allowances, specifically the allowance for doubtful accounts and deferred tax assets valuation allowance; inventory valuation and goodwill impairment.

Revenue recognition. Our revenues are primarily generated from the sale of e-business solutions and image processing software, network management and storage systems integration services and high-performance cluster computer systems. In accordance with generally accepted accounting principles in the United States, CSPI recognizes revenue as follows:

Revenue from the sale of hardware products is recognized at the time of shipment.

Revenue from the sale of software products is recognized in accordance with AICPA Statement of Position ("SOP") 97-2, as amended by SOP 98-9. The Company recognizes revenue from software license sales when all services, including customization and training, are delivered.

For software licenses sold separately without modification and training, revenue is recognized upon delivery.

The Company generally recognizes revenue from software licenses when persuasive evidence of an arrangement exits, delivery of the product has occurred, no significant Company obligations with regard to customization or implementation remain, the fee is fixed or determinable, and collectibility is probable. If collectibility is not considered probable, revenue is recognized when cash is collected.

Revenue derived from consulting services rendered in connection with the integration of third party hardware and third party software is generally recognized when the services have been completed.

Valuation Allowances. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required.

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. We consider the scheduled reversals of deferred tax liabilities and projected taxable income in making this assessment. Based on the projections of taxable income over the next several years, we believe that the deferred tax assets recognized net of the valuation allowance will not expire unused. Based on our projections for future income over the periods in which the temporary differences are deductible, we believe it is more likely than not that we will realize these differences. The amount of the deferred tax asset considered realizable however can be reduced in the near future if estimates of future taxable income during the carry-forward period are reduced. Such reductions could have a material adverse affect on our statement of operations resulting from an income tax charge required to reflect an increased valuation allowance against deferred income taxes.

In assessing the realizability of our deferred tax assets, we consider and rely upon projections of future income. The key assumptions in our projections include sales growth rates, including potential contract wins, and expected levels of operating expenditures in addition to factors discussed in the section "Factors That May Affect Future Performance". These assumptions are subject to variation based upon both internal and external factors, many of which are beyond the control of the Company. To the extent that actual experience deviates from our assumptions, our projections would be affected and hence our assessment of realizability of our deferred tax asset may change.

Inventory Valuation. The recoverability of inventories is based upon the types and levels of inventories held forecasted demand, pricing, competition and changes in technology. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-down may be required.

Goodwill Impairment. Our long-lived assets include goodwill of $647,000 as of March 31, 2002. During the six months ended March 31, 2002, we evaluated the recoverability of our goodwill in accordance with Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which generally required us to assess these assets for recoverability when events or circumstances indicate a potential impairment by estimating the future discounted cash flows to be generated from the use of these assets. No impairment losses were recorded related to goodwill during the six months ended March 31, 2002. In evaluating the impairment of goodwill, we consider and rely on our discounted cash flow projections. Our key assumptions include sales growth and expected levels of operating expenditures which are subject to variation based on both internal and external factors. To the extent that actual experience deviates from the projections, our assessment regarding impairment may change. Such a change could have a material adverse affect on the statement of operations. We are adopting SFAS 142 effective October 1, 2002.

The following table details the Company's sales by operating segment for the three and six months ended March 31, 2002 and February 28, 2001.

CSPI considers its products to be in four segment classifications. Each segment is broken down by related business activities, which crosses different business operations. These segments are based on the different customer activity of the Company. CSPI has four major segments: Systems which includes company manufactured hardware products, System and Service Integration which includes maintenance of the Company and other systems sold and integration and sale of third party hardware products and services, E-Commerce software which includes WAP66™ and ViewMax®, and Other Software products which are developed by the Company primarily in the Scanalytics operation.

       The Company reported net sales of $6.2 million and $12.7 million for the three and six-month periods ended March 31, 2002 compared to $9.4 million and $20.8 million for the three and six-month periods ended February 28, 2001. This represented a decrease of 34% or $3.2 million for the three-month period and 39% or $8.1 million for the six-month period. The reduced revenue was due to the following factors: reductions in system and integration sales due to the reduction in revenue from our key European telecom customers, elongated cycles in US defense procurements which has caused a decline in our systems sales, and the continued weak global economy.

        System sales were $1.7 million and $3.4 million of total sales for the three and six months ended March 31, 2002, compared to $2.2 million and $4.8 million for the three and six months ended February 28, 2001. This represents a decrease of approximately $489,000 or 22% and $1.4 million or 29%, respectively. The decrease in system sales was due primarily to the continued decline in Department of Defense procurements. The widely anticipated improvement in Defense spending has yet to be realized due to the protracted approval process for the fiscal year 2002 Appropriation bill in Congress, extended deployment incubation periods and uncertainties concerning funding for new Homeland Security programs. The CSPI Series 2000 product line accounted for 40% and 50% of system sales for the three and six-month periods ended March 31, 2002 compared to 75% and 63% for the three and six months ended February 28, 2001.The SuperCard product line accounted for 2% and 12% of system sales for the three and six months ended March 31, 2002 compared to 9% and 11% for the three and six months ended February 28, 2001. During the quarter the Company completed the end-of-life for the SuperCard and MODCOMP Classic legacy systems, its real-time process control products, for which the Company accepted orders up to January 31, 2002. Those orders received will be shipped over the remainder of the fiscal year. The Classic systems product line represented 16 % and 10 % of the current quarter and year to date system sales compared to 14% and 24% for the prior comparable periods.

        Sales for System and Service Integration were $3.5 million or 57% and $7.7 million or 60% of total sales for the three and six months ended March 31, 2002, compared to $6.1 million or 65% and $13.8 million or 67% for the comparable periods ended February 28, 2001. This represents a decrease from the prior comparable periods of $2.6 million or 42% and $6.2 million or 45%, respectively. This decrease was due to the continued decline in European business as our customers have dramatically reduced their technology budgets. In addition, one customer initiated a temporary capital-spending freeze due to the retrenchment of IT spending after the events of September 11, 2001.

        E-Commerce Software sales were $576,000 or 9% and $887,000 or 7% of total sales for the three and six months ended March 31, 2002 compared to $619,000 or 7% and $1,236,000 or 6% for the three and six month comparable periods ended February 28, 2001. This represents a decrease of $43,000 or 7% for the comparable three month periods and $349,000 or 28% year to date. This segment's revenue decline is mainly due to market conditions.

        Other Software sales were $383,000 or 6% and $763,000 or 6% of total sales for the three and six-month periods ended March 31, 2002 compared to $447,000 or 5% and $923,000 or 4% for the three and six-month comparable periods ended February 28, 2001. This represents a decline of $64,000 or 14% and $160,000 or 17% for the three and six month periods. This decline is mainly due to seasonal fluctuations and market conditions. The other software sales are primarily from sales of life sciences software.

The following table details the Company's sales by geographic region for the three and six months ended March 31, 2002 and February 28, 2001:

                      /---------For the three months ended--------/   /------------For the six months ended-----------/

        European sales account for 63% and 60% of total sales for the three and six-month periods ended March 31, 2002 compared to 55% and 61% for the three and six-month period ended February 28, 2001. European sales were primarily from subsidiaries in Germany and the United Kingdom.

     Cost of sales as a percentage of revenue remained consistent at 75% and 73% for the three and six months ended March 31, 2002 compared to 70% and 71% for the comparable periods ended February 28, 2001. The decrease in the absolute dollar amount of cost of sales resulted primarily from the significant revenue decline. The lower sales volume has also added costs in the system segment because of the decrease in production of inventory which has resulted in unabsorbed overhead costs. During the three and six month periods, the Company reserved approximately $420,000 and $520,000 of obsolete inventory due to end of life status of certain systems products.

Engineering and development expenses increased 4% and decreased 4% for the three and six months ended March 31, 2002 compared to the comparable periods ended February 28, 2001. The year to date decrease was due to lower labor costs from attrition, lower depreciation resulting from more fully depreciated capital equipment, a decrease in materials used in product development, and decreased outside consulting services in Systems. The quarter increase in other software engineering and development was due to the addition of personnel.

Selling, general and administrative expense decreased $316,000 or 13% and $384,000 or 8% for the three and six months ended March 31, 2002 compared to the three and six-month periods ended February 28, 2001. This decrease is mainly due to a reduction in audit and tax services related to the corporate restructure in fiscal 2001, a reduction in trade show and promotional literature expense, a reduction in commission expense due to lower sales volume, a reduction in moving expense, a reduction in depreciation expense on fully depreciated capital equipment, and a reduction of labor and fringe expense due to attrition. These reductions were offset by increased occupancy costs of the new corporate facility.

During the quarter ended March 31, 2002 the Company had a reduction of 8 positions due to the reduction in sales and recorded $44,000 restructuring expense related to the severance and other costs associated with the reduction. The annual savings for this action will be approximately $285,000.

        Other income/expenses, exclusive of the loss on disposal of French operation, for the three and six month periods ended March 31, 2002 was $55,000 and $104,000, respectively. This represents a decline of $23,000 and $53,000 from the prior comparable three and six-month periods ended February 28, 2001. This decline was due in part to the reduction in the interest received on short-term investments due to the decline in rates from last year.

         The Company recorded the federal tax benefit for the current period and the related increase in deferred tax assets as it believes it is more likely than not, considering the level of historical taxable income and expectations for future taxable income, that the operating loss will be utilized in the future to offset taxable income. No benefit has been reflected for state taxes since the Company does not believe it will generate sufficient taxable income through the state carryforward period. If the Company is unable to generate sufficient federal taxable income in future periods it may be necessary to provide a valuation allowance against the deferred tax asset. Through March 31, 2002, the Company had net losses to offset taxable income for federal purposes of $1,686,000. The expiration date for the utilization of these losses range from 2002 to 2021.

        Working capital at March 31, 2002 decreased to $18.6 million compared to $21.9 million at August 31, 2001. This decline relates mainly to reductions in accounts receivables and inventories due to lower sales volume.

        The Company's consolidated net capital expenditures were $298,000 and $351,000 for the three and six-month periods ended March 31, 2002 compared to $51,000 and $340,000 in the three and six-month periods ended February 28, 2001.

        Management believes that the Company's available cash and cash generated from operations and investments will be sufficient to provide for the Company's working capital and capital expenditure requirements for the next twelve months and subsequent foreseeable future.

        Management does not believe that inflation and changing prices had significant impact on sales, revenues or income during the three and six-month periods ended March 31, 2002 or February 28, 2001. There is no assurance that the Company's business will not be materially and adversely affected by inflation and changing prices in the future.

        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.

             None

1. Exhibits

None

2. Reports on Form 8-K

None

     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: May 14, 2002                                        By: /s/ Alexander R. Lupinetti
                                                                                   Chief Executive Officer,
                                                                                   President and Chairman

Date: May 14, 2002                                        By: /s/ Gary W. Levine
                                                                                   Vice President of Finance,
                                                                                   Chief Financial Officer

                                      /---------For the three months ended---------/  /-----For the six months ended------/

                                             /--For the three months ended--/          /--For the six months ended--/
                                                                        March 31, 2002 vs. February 28, 2001