CSP INC /MA/ - Quarter Report: 2008 June (Form 10-Q)

Unassociated Document

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 June 30, 2008.

¨	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 þ No ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer (Do not check if a smaller reporting company) ¨ Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

As of July 31, 2008, the registrant had 3,757,176 shares of common stock issued and outstanding.

INDEX

		Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

	Consolidated Balance Sheets as of June 30, 2008 (unaudited) and September 30, 2007	3

	Consolidated Statements of Operations (unaudited) for the three and nine months ended June 30, 2008 and 2007	4

	Consolidated Statement of Shareholders’ Equity (unaudited) for the nine months ended June 30, 2008	5

	Consolidated Statements of Cash Flows (unaudited) for the nine months ended June 30, 2008 and 2007	6

	Notes to Consolidated Financial Statements (unaudited)	7-12

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		13-24

Item 3. Quantitative and Qualitative Disclosures about Market Risk		24

Item 4. Controls and Procedures		25

PART II. OTHER INFORMATION

Item 1A. Risk Factors		26

Item 6. Exhibits		27

CSP INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except par value)

	June 30, 2008			September 30, 2007
ASSETS	(Unaudited)
Current assets:
Cash and cash equivalents	$	15,787		$	13,687
Short-term investments		450			7,690
Accounts receivable, net of allowances of $106 and $133		10,616			10,678
Inventories		6,533			6,072
Refundable income taxes		1,216			27
Deferred income taxes		229			229
Other current assets		1,537			1,587
Total current assets		36,368			39,970
Property, equipment and improvements, net		1,034			1,044

Other assets:
Long term investments		4,800			−
Goodwill		2,779			2,779
Deferred income taxes		280			254
Cash surrender value of life insurance		2,248			2,045
Other assets		296			349
Total other assets		10,403			5,427
Total assets	$	47,805		$	46,441

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses	$	9,819		$	9,073
Deferred revenue		2,449			3,461
Pension and retirement plans		472			495
Income taxes payable		1,055			552
Deferred income taxes		280			279
Total current liabilities		14,075			13,860
Pension and retirement plans		7,288			6,859
Deferred income taxes		449			388
Other non current liabilities		260			−
Total liabilities		22,072			21,107

Commitments and contingencies
Shareholders’ equity:
Common stock, $.01 par; 7,500 shares authorized, 3,764 and 3,812 shares issued and outstanding , respectively		38			39
Additional paid-in capital		11,522			11,707
Retained earnings		15,714			15,236
Accumulated other comprehensive loss		(1,541	)		(1,648	)
Total shareholders’ equity		25,733			25,334
Total liabilities and shareholders’ equity	$	47,805		$	46,441

See accompanying notes to unaudited consolidated financial statements.

CSP INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except for per share data)

	For the three months ended						For the nine months ended
	June 30, 2008			June 30, 2007			June 30, 2008			June 30, 2007
Sales:
Product	$	14,730		$	21,871		$	46,254		$	54,929
Services		4,425			4,073			12,455			10,964
Total sales		19,155			25,944			58,709			65,893

Cost of sales:
Product		12,339			16,837			38,246			42,217
Services		3,385			3,405			9,520			8,131
Total cost of sales		15,724			20,242			47,766			50,348
Gross profit		3,431			5,702			10,943			15,545

Operating expenses:
Engineering and development		471			665			1,650			1,838
Selling, general and administrative		3,113			3,762			9,875			10,317
Total operating expenses		3,584			4,427			11,525			12,155
Operating income (loss)		(153	)		1,275			(582	)		3,390

Other income (expense):
Foreign exchange gain (loss)		5			(1	)		28			(1	)
Other income, net		118			333			436			503
Total other income, net		123			332			464			502
Income (loss) before income taxes		(30	)		1,607			(118	)		3,892
Income tax expense (benefit)		(22	)		725			(40	)		1,777
Net income (loss)	$	(8	)	$	882		$	(78	)	$	2,115
Net income (loss) per share – basic	$	-		$	0.23		$	(0.02	)	$	0.56
Weighted average shares outstanding – basic		3,778			3,810			3,790			3,761
Net income (loss) per share – diluted	$	-		$	0.22		$	(0.02	)	$	0.54
Weighted average shares outstanding – diluted		3,778			3,967			3,790			3,926

See accompanying notes to unaudited consolidated financial statements

CSP INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

For the Nine Months Ended June 30, 2008

(Amounts in thousands)

	Shares			Amount			Additional Paid-in Capital			Retained Earnings			Accumulated other comprehensive income (loss)			Total Shareholders’ Equity			Comprehensive income (loss)

Balance as of September 30, 2007		3,812		$	39		$	11,707		$	15,236		$	(1,648	)	$	25,334
Comprehensive income:
Net loss		—			—			—			(78	)		—			(78	)	$	(78	)
Other comprehensive income
Effect of foreign currency translation		—			—			—			—			45			45			45
Minimum pension liability		—			—			—			—			62			62			62
Total Comprehensive income		—			—			—			—			—			—		$	29

Exercise of stock options		27			—			112			—			—			112
Stock-based compensation								230			—			—			230
Issuance of shares under employee stock purchase plan		29			—			170			—			—			170
Purchase of treasury stock		(104	)		(1	)		(697	)		—			—			(698	)
Cumulative impact from adoption of FIN 48		—			—			—			556			—			556
Balance as of June 30, 2008		3,764		$	38		$	11,522		$	15,714		$	(1,541	)	$	25,733

See accompanying notes to unaudited consolidated financial statements

CSP INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

	For the nine months ended
	June 30, 2008			June 30, 2007
Cash flows from operating activities:
Net income (loss)	$	(78	)	$	2,115
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		428			486
Insurance settlement gain		—			(240	)
Loss on disposal of fixed assets, net		4			1
Non-cash changes in accounts receivable		1			96
Non-cash compensation expense related to stock options		230			257
Deferred income taxes		47			994
Increase in cash surrender value of life insurance		(58	)		—
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable		577			(1,823	)
Increase in inventories		(453	)		(1,945	)
Increase in refundable income taxes		(1,181	)		(60	)
Decrease in other current assets		140			145
Decrease in other assets		54			54
Increase in accounts payable and accrued expenses		411			1,254
(Decrease) increase in deferred revenue		(1,132	)		375
Increase in pension and retirement plans		134			247
Increase in income taxes payable		1,272			730
Net cash provided by operating activities		396			2,686
Cash flows from investing activities:
Purchases of held-to-maturity securities		(16,550	)		(3,786	)
Maturities of held-to-maturity securities		18,990			2,589
Premiums paid on officer life insurance		(144	)		—
Change in cash surrender value of officer life insurance		—			(48	)
Purchases of property, equipment and improvements		(396	)		(406	)
Net cash provided by (used in) investing activities		1,900			(1,651	)

Cash flows from financing activities:
Proceeds from stock issued from the exercise of options		112			363
Proceeds from issuance of stock under employee stock purchase plan		170			193
(Purchase) issuance of common stock		(698	)		7
Net cash provided by (used in) financing activities		(416	)		563
Effects of exchange rate changes on cash		220			396
Net increase in cash and cash equivalents		2,100			1,994
Cash and cash equivalents, beginning of period		13,687			8,683
Cash and cash equivalents, end of period	$	15,787		$	10,677
Supplementary Cash flow information:
Cash paid for income taxes	$	214		$	104
Cash paid for interest	$	89		$	97

See accompanying notes to unaudited consolidated financial statements.

CSP INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED June 30, 2008 AND 2007

Organization and Business

CSP Inc. (CSPI or the Company) was founded in 1968 and is based in Billerica, Massachusetts. To meet the diverse requirements of its industrial, commercial, scientific, and defense customers worldwide, CSPI and its subsidiaries 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 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 of America, 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 September 30, 2007.

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.

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

	For the Three Months Ended					For the Nine Months Ended
	June 30, 2008			June 30, 2007		June 30, 2008			June 30, 2007
	(Amounts in thousands, except per share data)

Net income (loss)	$	(8	)	$	882	$	(78	)	$	2,115

Weighted average number of shares outstanding – basic		3,778			3,810		3,790			3,761
Incremental shares from the assumed exercise of stock options		—			157		—			165
Weighted average number of shares outstanding – diluted		3,778			3,967		3,790			3,926
Net income (loss) per share – basic	$	—		$	0. 23	$	(0.02	)	$	0.56
Net income (loss) per share - diluted	$	—		$	0. 22	$	(0.02	)	$	0.54

For the three and nine months ended June 30, 2008, options of 323,000 and 249,000, respectively, were excluded from the diluted net income per share calculation because their impact would have been anti-dilutive. For the three and nine months ended June 30, 2007, options of 325,000 and 339,000, respectively, were excluded from the diluted net income per share calculation because their impact would have been anti-dilutive.

4. Inventories

Inventories consist of the following:

	June 30, 2008		September 30, 2007
	(Amounts in thousands)
Raw materials	$	1,603	$	1,716
Work-in-progress		366		351
Finished goods		4,564		4,005
Total	$	6,533	$	6,072

5. Long-Term Investments

As of June 30, 2008, we held investments totaling $5.25 million (par value) which consist of long-term debt instruments with variable interest rates that periodically reset through an auction process ("auction rate securities"). All of our auction rate securities were originally acquired as held to maturity investments, during the six months ended March 31, 2008 and have final maturity dates ranging from 2027 to 2057.

Recent auctions for our auction rate securities have failed. An auction failure, which is not a default in the underlying debt instrument, occurs when there are more sellers than buyers at a scheduled interest rate auction date and parties desiring to sell their securities are unable to do so. When an auction fails, the interest rate is adjusted according to the provisions of the associated security agreement, which generally results in an interest rate that is higher than the interest rate the issuer pays in connection with successful auctions. Because of these failed auctions, we reclassified our entire $5.25 million investment portfolio to available-for-sale securities during the six months ended March 31, 2008. Accordingly, these investments are classified as available-for-sales as of June 30, 2008.

Our investment in auction rate securities as of June 30, 2008 was diversified across six separate issues and each issue maintains scheduled interest rate auctions in either 7-day or 28-day intervals. All of our auction rate securities are currently rated Aaa by Moody's, AAA by Standard & Poor's and/or AAA by Fitch, which are the highest ratings issued by each respective rating agency. An aggregate $4.8 million (par value) of our auction rate securities which are classified as long term investments were issued by state agencies and are supported by student loans, for which repayment is substantially guaranteed by the U.S. government under the Federal Family Education Loan Program ("FFELP") or MBIA Insurance Co. The remaining $450 thousand is a closed end, preferred auction security secured by the assets of the closed end funds. These funds are legally required to maintain assets of 200% of the face value of the preferred auction securities. The $450 thousand will be redeemed in the near future, although no specific date has been set by the issuer.

Auction failures and the resulting lack of liquidity are affecting the entire auction rate securities market and we are currently unable to determine whether these conditions will be temporary. Some issuers have recently refinanced their auction rate securities and other issuers are in the process of doing so. We are currently unable to determine whether other issuers of our auction rate securities will attempt and/or be able to refinance. Several of the financial institutions that conduct auctions and broker auction rate securities have indicated that they plan to develop secondary markets for auction rate securities, but we are currently unable to determine whether such plans will succeed or if alternate markets that provide for orderly purchases and sales of auction rate securities will otherwise develop. Although we acquired our auction rate securities with the intention of selling them in the near term, due to the aforementioned uncertainties, all of our auction rate securities not redeemed or not intended to be redeemed, have been classified as long-term investments. Assets so classified totaled $4.8 million as of June 30, 2008. The $450 thousand closed end, preferred auction rate security that is expected to be redeemed within the next twelve months was classified as short term investments and are included in current assets as of June 30, 2008.

6. Comprehensive Income

The components of comprehensive income are as follows:

	For the Three Months Ended					For the Nine Months Ended
	June 30, 2008			June 30, 2007		June 30, 2008			June 30, 2007
	(Amounts in thousands, except per share data)
Net income (loss)	$	(8	)	$	882	$	(78	)	$	2,115
Effect of foreign currency translation		(11	)		62		45			290
Minimum pension liability		10			−		62			−
Comprehensive income (loss)	$	(9	)	$	944	$	29		$	2,405

The components of Accumulated Other Comprehensive Loss are as follows:

	June 30, 2008			September 30, 2007
	(Amounts in thousands)
Cumulative effect of foreign currency translation	$	(662	)	$	(707	)
Additional minimum pension liability		(879	)		(941	)
Accumulated Comprehensive loss	$	(1,541	)	$	(1,648	)

7. Pension and Retirement Plans

In the United Kingdom and Germany, the Company provides defined benefit pension plans and defined contribution plans for the majority of its employees. Domestically, the Company also provides benefits through supplemental retirement plans to certain current and former employees. These supplemental plans provide benefits derived out of cash surrender values relating to current and former employee and officer life insurance policies, equal to the difference between the amounts that would have been payable under the defined benefit pension plans, in the absence of legislation limiting pension benefits and earnings that may be considered in calculating pension benefits, and the amounts actually payable under the defined benefit pension plans. Domestically, the Company provides for officer death benefits through post-retirement plans to certain officers.

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 sheet.

Our pension plan in the United Kingdom is the only plan with plan assets. The plan assets comprise a diversified mix of assets including corporate equity securities, government securities and corporate debt securities.

The components of net periodic benefit costs related to the U.S. and international plans are as follows:

	For the Three Months Ended June 30
	2008								2007
	Foreign			U.S.		Total			Foreign			U.S.		Total
	(Amounts in thousands)
Pension:
Service cost	$	21		$	2	$	23		$	30		$	2	$	32
Interest cost		183			35		218			166			35		201
Expected return on plan assets		(125	)		—		(125	)		(122	)		—		(122	)
Amortization of:
Prior service costs		8			5		13			11			12		23
Net transition asset		(2	)		—		(2	)		(1	)		—		(1	)
Net periodic benefit cost	$	85		$	42	$	127		$	84		$	49	$	133

	For the Three Months Ended June 30
	2008						2007
	Foreign		U.S.		Total		Foreign		U.S.		Total
	(Amounts in thousands)
Post Retirement:
Service cost	$	—	$	16	$	16	$	—	$	14	$	14
Interest cost		—		13		13		—		10		10
Amortization of:
Prior service costs		—		—		—		—		7		7
Net periodic benefit cost	$	—	$	29	$	29	$	—	$	31	$	31

	For the Nine Months Ended June 30
	2008								2007
	Foreign			U.S.		Total			Foreign			U.S.		Total
	(Amounts in thousands)
Pension:
Service cost	$	64		$	6	$	70		$	89		$	5	$	94
Interest cost		553			104		657			495			107		602
Expected return on plan assets		(375	)		-		(375	)		(362	)		—		(362	)
Amortization of:
Prior service costs		25			14		39			33			35		68
Net transition asset		(5	)		-		(5	)		(4	)		—		(4	)
Net periodic benefit cost	$	262		$	124	$	386		$	251		$	147	$	398


Post Retirement:
Service cost	$	—		$	48	$	48		$	—		$	42	$	42
Interest cost		—			39		39			—			30		30
Amortization of:
Prior service costs		—			1		1			—			22		22
Net periodic benefit cost	$	—		$	88	$	88		$	—		$	94	$	94

8. Income Taxes

On October 1, 2007, we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which clarifies the accounting for uncertainty in income tax positions. This interpretation requires us to recognize in the consolidated financial statements only those tax positions determined to be more-likely-than-not of being sustained upon examination, based on the technical merits of the positions as of the reporting date. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the position are recognized. This is a different standard for recognition than was previously required. The more-likely-than-not threshold must continue to be met in each reporting period to support continued recognition of a benefit. At adoption of FIN 48, companies must adjust their financial statements to reflect only those tax positions that are more-likely-than-not to be sustained as of the adoption date. Any necessary adjustment is recorded directly to opening retained earnings in the period of adoption. The cumulative effect of adoption of FIN 48, as of October 1, 2007, resulted in an increase to retained earnings of $556,000.

As of October 1, 2007, the total amount of unrecognized tax benefits was $260,000, all of which would affect our effective tax rate if recognized. We recognize interest and potential penalties accrued related to unrecognized tax benefits in our provision for income taxes. There were no accrued interest and/or penalties in our tax provision for the quarter ended December 31, 2007, nor were there any accrued penalties and interest included in our liabilities for uncertain tax positions as of October 1, 2007 and June 30, 2008.

We file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. We have not been notified of intent to audit, nor are we currently undergoing an income tax audit in any jurisdiction. With few exceptions, our returns are no longer subject to U.S. federal, state, or non-U.S. income tax examinations for the years before 2004.

9. Segment Information

The following table presents certain operating segment information.

	Systems			Service and System Integration		Consolidated Total
Three Months Ended June 30, 2008
Sales:
Product	$	1,193		$	13,537	$	14,730
Service		102			4,323		4,425
Total sales	$	1,295		$	17,860	$	19,155
Operating Income (loss)	$	(615	)	$	462	$	(153	)
Total assets	$	16,621		$	31,184	$	47,805
Capital expenditures	$	17		$	109	$	126
Depreciation	$	55		$	89	$	144

Three Months Ended June 30, 2007
Sales:
Product	$	5,241		$	16,630	$	21,871
Service		106			3,967		4,073
Total sales	$	5,347		$	20,597	$	25,944
Operating Income	$	1,230		$	45	$	1,275
Total assets	$	19,302		$	26,312	$	45,614
Capital expenditures	$	72		$	50	$	122
Depreciation	$	64		$	99	$	163

Nine Months Ended June 30, 2008
Sales:
Product	$	3,248		$	43,006	$	46,254
Service		231			12,224		12,455
Total sales	$	3,479		$	55,230	$	58,709
Operating Income (loss)	$	(2,826	)	$	2,244	$	(582	)
Total assets	$	16,621		$	31,184	$	47,805
Capital expenditures	$	101		$	295	$	396
Depreciation	$	168		$	260	$	428

Nine Months Ended June 30, 2007
Sales:
Product	$	12,551		$	42,378	$	54,929
Service		796			10,168		10,964
Total sales	$	13,347		$	52,546	$	65,893
Operating Income	$	2,637		$	753	$	3,390
Total assets	$	19,302		$	26,312	$	45,614
Capital expenditures	$	258		$	148	$	406
Depreciation	$	199		$	287	$	486

Operating income (loss) is equal to sales, less: cost of sales, engineering and development and 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.

Total assets include deferred income tax assets and other financial instruments owned by the Company.

The following table lists customers from which the Company derived revenues in excess of 10% of total revenues for the three and nine month periods ended June 30, 2008 and 2007.

	For the Three Months Ended											For the Nine Months Ended
	June 30, 2008						June 30, 2007					June 30, 2008					June 30, 2007
	Amount			% of Revenues			Amount		% of Revenues			Amount		% of Revenues			Amount		% of Revenues
	(Amounts in millions)
Raytheon Corporation	$	-	*		-	%	$	4.4		17	%	$	-*		-	%	$	9.5		14	%
Atos Origin GmbH	$	2.5			13	%	$	3.5		14	%	$	7.0		12	%	$	8.6		13	%
Kabel Deutschland	$	0.3			2	%	$	4.4		17	%	$	4.4		7	%	$	6.9		10	%

* Less than $100 thousand

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The discussion below contains certain forward-looking statements related to, among others, but not limited to, statements concerning future revenues and future business plans. Actual results may vary from those contained in such forward-looking statements.

Markets for our products and services are characterized by rapidly changing technology, new product introductions and short product life cycles. These changes can adversely affect our business and operating results. Our success will depend on our ability to enhance our existing products and services and to develop and introduce, on a timely and cost effective basis, new products that keep pace with technological developments and address increasing customer requirements. The inability to meet these demands could adversely affect our business and operating results.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates, including those related to uncollectible receivables, inventory valuation, goodwill, income taxes, deferred compensation and retirement plans, 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, 2007 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 nine months ended June 30, 2008 Results of Operations

CSP Inc. operates in two segments:

•

Systems - the Systems segment consists of our MultiComputer division which designs, develops and manufactures signal processing computer platforms which are used primarily in military applications and the process control and data acquisition hardware business of our Modcomp division.

•

Service and System Integration - the Service and System Integration segment includes the computer systems’ maintenance and integration services and third-party computer hardware and software products businesses of our Modcomp subsidiary.

Highlights include:

•

Revenue decreased by approximately $7.2 million, or 11%, to $58.7 million for the nine months ended June 30, 2008 versus $65.9 million for the nine months ended June 30, 2007.

•

The operating loss for the nine months ended June 30, 2008 was $582 thousand versus operating income of $3.4 million for the nine months ended June 30, 2007, for a decrease of approximately $4.0 million, or 117%.

•

The net loss for the nine months ended June 30, 2008 was $78 thousand versus net income of $2.1 million for the nine months ended June 30, 2007, for a decrease of approximately $2.2 million, or 104%.

•

Net cash provided by operating activities was approximately $396 thousand for the nine months ended June 30, 2008 compared to net cash provided by operating activities of $2.7 million for the comparable period of 2007.

The following table details our results of operations in dollars and as a percentage of sales for the nine months ended June 30, 2008 and 2007:

	June 30, 2008			% of sales			June 30, 2007		% of sales
Sales	$	58,709			100	%	$	65,893		100	%
Costs and expenses:
Cost of sales		47,766			81	%		50,348		76	%
Engineering and development		1,650			3	%		1,838		3	%
Selling, general and administrative		9,875			17	%		10,317		16	%
Total costs and expenses		59,291			101	%		62,503		95	%

Operating income (loss)		(582	)		(1	)%		3,390		5	%
Other income		464			1	%		502		1	%
Income (loss) before income taxes		(118	)		-	%		3,892		6	%
Provision for income taxes		(40	)		-	%		1,777		3	%
Net income (loss)	$	(78	)		-	%	$	2,115		3	%

Sales

The following table details our sales by operating segment for the nine months ended June 30, 2008 and 2007:

	Systems			Service and System Integration			Total			% of Total
For the nine months ended June 30, 2008:
Product	$	3,248		$	43,006		$	46,254			79	%
Services		231			12,224			12,455			21	%
Total	$	3,479		$	55,230		$	58,709			100	%
% of Total		6	%		94	%		100	%

		Systems			Service and System Integration			Total			% of Total
For the nine months ended June 30, 2007:
Product	$	12,551		$	42,378		$	54,929			83	%
Services		796			10,168			10,964			17	%
Total	$	13,347		$	52,546		$	65,893			100	%
% of Total		20	%		80	%		100	%

		Systems			Service and System Integration			Total			% increase (decrease)
Increase (Decrease)
Product	$	(9,303	)	$	628		$	(8,675	)		(16	)%
Services		(565	)		2,056			1,491			14	%
Total	$	(9,868	)	$	2,684		$	(7,184	)		(11	)%
% increase (decrease)		(74	)%		5	%		(11	)%

Total revenues decreased by approximately $7.2 million or 11%, in the first nine months of fiscal year 2008 compared to the same period of fiscal year 2007. Systems segment revenue decreased by approximately $9.9 million while Service and System Integration segment revenues increased by approximately $2.7 million.

Product revenues decreased by approximately $8.7 million, or 16% in the first nine months of fiscal year 2008 compared to the first nine months of fiscal 2007. Systems segment product revenue decreased by approximately $9.3 million, while Service and System Integration segment product revenue increased by approximately $628 thousand.

The $9.3 million decrease in the Systems segment product revenue was primarily due to the decrease in sales to Raytheon of $9.4 million over the prior year period. Prior year sales to Raytheon were in connection with an order for sixteen systems that were shipped over the course of fiscal 2007. Sales to Raytheon for the nine months ended June 30, 2008 were approximately $78,000 consisting of spare parts and repairs. In addition, sales to Kyokuto Boeki Kaisha (“KBK”) decreased by approximately $664 thousand for the nine months ended June 30, 2008 versus the prior year comparable period, while product sales to Lockheed Martin and General Dynamics increased by $605 thousand and $189 thousand, respectively.

The $628 thousand increase in the Service and System Integration segment product revenue was due to a $2.9 million increase in product sales from the segment’s US operations offset by a $2.3 million decrease in shipments in the segment’s German operations. In the US operation, the increase was driven primarily by increased new-customer sales versus prior year new-customer sales, which accounted for approximately $3.1 million of the increase. This increase was offset by total net decreases to all other customers totaling approximately $200 thousand. The German division decrease was due to lower sales volume of $4.4 million offset by an increase due to the stronger Euro versus the US dollar during the nine months ended June 30, 2008 versus the comparable period of fiscal 2007, which totaled approximately $2.1 million. The decrease in sales volume was due to lower sales to large customers, Kabel Deutschland, Atos Origin and Bytemobile. Sales to these customers decreased by $3.0 million, $2.6 million and $700 thousand, respectively. These decreases were due to large project wins in the prior year, which did not recur in the current year due to the lack of significant IT investment and projects in fiscal year 2008. Offsetting these decreases, were sales to two new customers, UnityMedia which totaled approximately $2.0 million and Bayer which totaled approximately $700 thousand. The remaining $800 thousand decrease was from decreases to all other customers combined.

Service revenues increased by approximately $1.5 million, or 14% for the first nine months of fiscal year 2008 compared to the first nine months of fiscal 2007. Service and System Integration segment service revenues increased by approximately $2.1 million, while service revenue in the Systems segment decreased by approximately $565 thousand. In the Service and System Integration segment, service revenues from the German division increased by approximately $2.6 million, approximately $1.0 million of which was the result of the foreign currency fluctuation impact and approximately $1.6 million was due to increased sales volume. The increase in sales volume was due to higher levels of professional services for consulting work in archiving and identity and access management. Offsetting the increased services revenues in Germany, service revenue in the UK subsidiary of the Service and System Integration segment decreased by approximately $663 thousand, resulting from the non-recurrence of a large development project to a single customer, NCH, delivered in the third quarter of fiscal 2007. Service revenues in the Systems segment decreased primarily as a result of the absence of any royalty revenue from Lockheed Martin which totaled approximately $522 thousand for the nine months ended June 30, 2007.

Our sales by geographic area, based on the location to which the products were shipped or services rendered, are as follows:

	For the Nine Months Ended
	(Amounts in thousands)
	June 30, 2008		%			June 30, 2007		%			$ Increase/ (Decrease)			% Increase/ (Decrease)
North America	$	27,246		46	%	$	34,460		52	%	$	(7,214	)		(21	)%
Europe		28,210		48	%		28,666		44	%	$	(456	)		(2	)%
Asia Pacific		3,253		6	%		2,767		4	%	$	486			18	%
Totals	$	58,709		100	%	$	65,893		100	%	$	(7,184	)

North American revenue, in the first nine months of fiscal 2008, decreased versus the comparable period of fiscal 2007, largely due to the decrease in sales in the Systems segment related to the decrease in sales to Raytheon of $9.4 million offset by the increases in sales to General Dynamics of approximately $189 thousand, referred to above combined with the increases in product sales in the US operation of Service and System Integration segment to domestic customers, which totaled $1.8 million.

The decrease in revenues in Europe for the nine months ended June 30, 2008 versus the comparable period of fiscal 2007 was due primarily to the reasons set forth above with respect to sales volumes and foreign exchange rate fluctuations in the German operations of the Service and System Integration segment. To summarize the data presented above, approximately $2.8 million of the decrease was related to decreased sales volume from the German division and approximately $700 thousand was due to lower sales volume in from the UK division. Offsetting these decreases, the foreign exchange rate change of a stronger Euro versus the US dollar accounted for an increase in Europe sales of $3.1 million. The increase in sales in Asia Pacific was due to sales from the US division of the Service and System Integration segment of approximately $1.1 million offset by lower sales in the Systems segment to KBK in the nine month period ended June 30, 2008 versus the nine months ended June 30, 2007 of approximately $664 thousand.

Cost of Sales and Gross Margins

The following table details our cost of sales by operating segment for the nine months ended June 30, 2008 and 2007:

	Systems			Service and Systems Integration			Total			% of Total
For the nine months ended June 30, 2008:
Product	$	1,956		$	36,290		$	38,246			80	%
Services		91			9,429			9,520			20	%
Total	$	2,047		$	45,719		$	47,766			100	%
% of Total		4	%		96	%		100	%
% of Sales		59	%		83	%		81	%

Gross Margins:
Product		40	%		16	%		17	%
Services		61	%		23	%		24	%
Total		41	%		17	%		19	%

		Systems			Service and Systems Integration			Total			% of Total
For the nine months ended June 30, 2007:
Product	$	4,965		$	37,252		$	42,217			84	%
Services		190			7,941			8,131			16	%
Total	$	5,155		$	45,193		$	50,348			100	%
% of Total		10	%		90	%		100	%
% of Sales		39	%		86	%		76	%
Gross Margins:
Product		60	%		12	%		23	%
Services		76	%		22	%		26	%
Total		61	%		14	%		24	%

		Systems			Service and Systems Integration			Total			% increase (decrease)
Increase (decrease)
Product	$	(3,009	)	$	(962	)	$	(3,971	)		(9	)%
Services		(99	)		1,488			1,389			17	%
Total	$	(3,108	)	$	526		$	(2,582	)		(5	)%
% Increase		(60	)%		1	%		(5	)%
% of Sales		20	%		(3	)%		5	%

Gross Margins:
Product		(20	)%		4	%		(6	)%
Services		(15	)%		1	%		(2	)%
Total		(20	)%		3	%		(5	)%

Total cost of sales decreased by approximately $2.6 million for the nine months ended June 30, 2008, over the comparable period in fiscal 2007, to $47.8 million, down from $50.3 million in the prior year period. The decrease in cost of sales was due, overall, to the decrease in sales, but reflected an overall 5% decline in gross margin to 19% for the current year nine month period versus 24% in the prior year nine month period. This decrease in the overall gross margin was due to (i) the lower level of Systems segment sales as discussed above, coupled with the significant decline in the gross margins in the Systems segment which decreased from 61% gross margin for the nine months ended June 30, 2007 to 41% for the nine months ended June 30, 2008, a decline of 20% in the gross margin. The decline was due, in large part to low production levels associated with the low level of sales in the segment, resulting in a higher volume of unabsorbed overhead charged to cost of sales, and also to prior year Systems segment revenues having included approximately $522 thousand in royalty revenue, which carry no cost of sales; versus no royalty revenue in the nine months ended June 30, 2008.

The gross profit margin for the Service and System Integration segment increased by 3% gross margin from 14% for the prior year nine-month period to 17% for the nine month period ended June 30, 2008. This increase was due primarily to a greater number of smaller orders, which generally carry higher gross margin than large, high volume orders, coupled with greater sales volume of products that carry higher margins than those sold in the prior year nine month period. In addition, a greater percentage of Service and System Integration segment sales were from services (22%) in the Fiscal 2008 nine-month period versus the prior year nine-month period (19%). Gross margin on service revenues ranged from between 22% to 23% versus product gross margins which ranged from between 12% to 16%, in the Service and System Integration segment.

Engineering and Development Expenses

The following table details our engineering and development expenses by operating segment for the nine months ended June 30, 2008 and 2007:

	For the Nine Months Ended
	June 30, 2008		% of Total			June 30, 2007		% of Total			$ (Decrease)			% (Decrease)
	(Amounts in thousands)
By Operating Segment:
Systems	$	1,650		100	%	$	1,767		96	%	$	(117	)		(7	)%
Service and System Integration		-		-	%		71		4	%		(71	)		(100	)%
Total	$	1,650		100	%	$	1,838		100	%	$	(188	)		(10	)%

Engineering and development expenses decreased by $188 thousand, or approximately 10%, in the first nine months of fiscal 2008 compared to the first nine months of fiscal 2007, due primarily to lower consulting costs in connection with reduced R&D activities in the Systems segment and lower costs in the Service and System Integration segment due to reduction in headcount in the UK division.

Selling, General and Administrative Expenses

The following table details our selling, general and administrative expenses by operating segment for the nine months ended June 30, 2008 and 2007:

	For the Nine Months Ended
	June 30, 2008		% of Total			June 30, 2007		% of Total			$ Increase/ (Decrease)			% Increase/ (Decrease)
	(Amounts in thousands)
By Operating Segment:
Systems	$	2,608		26	%	$	3,788		37	%	$	(1,180	)		(31	)%
Service and System Integration		7,267		74	%		6,529		63	%	$	738			11	%
Total	$	9,875		100	%	$	10,317		100	%	$	(442	)		(4	)%

Total selling, general and administrative (“SG&A”) expenses decreased by approximately $442 thousand, or 4%, for the first nine months of 2008 compared to the corresponding period of fiscal 2007. The decrease in Systems segment SG&A as shown above, resulted from lower commission and bonus expense of approximately $505 thousand, and lower audit fees of approximately $614 thousand. The increase in SG&A expenses in the Service and System Integration segment as shown in the table above resulted from higher commission expense of approximately $385 thousand, due primarily to the higher sales volume in the US operations. SG&A expenses were higher in the German division of the Service and System integration segment due to higher sales and marketing headcount, which accounted for $259 thousand of the increase and the foreign currency fluctuation impact related to the higher Euro vs. the US dollar, which accounted for $260 thousand of the increase in expense. SG&A expenses in the UK division decreased by approximately $218 thousand due a reduction in headcount versus the prior year

Other Income/Expenses

The following table details our other income/expenses for the nine months ended June 30, 2008 and 2007:

	For the Nine Months Ended
	June 30, 2008			June 30, 2007			$ Increase (Decrease)
	(Amounts in thousands)
Interest expense	$	(68	)	$	(72	)	$	4
Interest income		519			357			162
Foreign exchange gain (loss)		28			(1	)		29
Insurance settlement gain ent gain		-			240			(240	)
Other expense, net		(15	)		(22	)		7
Total other income, net	$	464		$	502		$	(38	)

Total other income decreased by $38 thousand for the first nine months of fiscal 2008 compared to the first nine months of fiscal 2007, as shown above. The increase in interest income was due to larger holdings of investments and interest bearing deposits in the current year period. The increase in interest income was offset by a decrease due to the non-recurrence of the insurance settlement gain that was realized in the prior year nine-month period. This gain resulted from the death benefit received by the Company exceeding the carrying cash surrender value on the policy.

Overview of the quarter ended June 30, 2008 Results of Operations

Highlights include:

•

Revenue decreased by approximately $6.8 million, or 26%, to $19.2 million for the quarter ended June 30, 2008 versus $25.9 million for the quarter ended June 30, 2007.

•

Operating income decreased by approximately $1.4 million, or 112%, to an operating loss of $153 thousand for the quarter ended June 30, 2008 versus operating income of $1.3 million for the quarter ended June 30, 2007.

•

Net income decreased by $890 thousand, or 101%, to a net loss of $8 thousand for the quarter ended June 30, 2008 versus net income of $882 thousand for the quarter ended June 30, 2007.

The following table details our results of operations in dollars and as a percentage of sales for the quarters ended June 30, 2008 and 2007:

	June 30, 2008			% of sales			June 30, 2007		% of sales
Sales	$	19,155			100	%	$	25,944		100	%
Costs and expenses:
Cost of sales		15,724			82	%		20,242		78	%
Engineering and development		471			3	%		665		3	%
Selling, general and administrative		3,113			16	%		3,762		14	%
Total costs and expenses		19,308			101	%		24,669		95	%
Operating income		(153	)		(1	)%		1,275		5	%
Other income		123			1	%		332		1	%

Income before income taxes		(30	)		-	%		1,607		6	%
Provision for income taxes		(22	)		-	%		725		3	%
Net income	$	(8	)		-	%	$	882		3	%

Sales

The following table details our sales by operating segment for the three months ended June 30, 2008 and 2007:

	Systems			Service and System Integration			Total			% of Total
For the three months ended June 30, 2008:
Product	$	1,193		$	13,537		$	14,730			77	%
Services		102			4,323			4,425			23	%
Total	$	1,295		$	17,860		$	19,155			100	%
% of Total		7	%		93	%		100	%

		Systems			Service and Systems Integration			Total			% of Total
For the three months ended June 30, 2007:
Product	$	5,241		$	16,630		$	21,871			84	%
Services		106			3,967			4,073			16	%
Total	$	5,347		$	20,597		$	25,944			100	%
% of Total		21	%		79	%		100	%

		Systems			Service and System Integration			Total			% increase
Increase (Decrease)
Product	$	(4,048	)	$	(3,093	)	$	(7,141	)		(33	)%
Services		(4	)		356			352			9	%
Total	$	(4,052	)	$	(2,737	)	$	(6,789	)		(26	)%
% increase (decrease)		(76	)%		(13	)%		(26	)%

As shown above, total revenues decreased by approximately $6.8 million, or 26%, for the quarter ended June 30, 2008 compared to the same period of fiscal year 2007. Systems segment revenues decreased by approximately $4.1 million for the current year quarter versus the prior year quarter and Service and System Integration segment revenues decreased by approximately $2.7 million.

Product revenues decreased by approximately $7.1 million, or 33% for the quarter ended June 30, 2008 compared to the comparable period of fiscal 2007. This change in product revenues was made up of a decrease in product revenues in the Service and System Integration segment of approximately $3.1 million over the prior year quarter and a decrease in product revenues in the Systems segment of $4.0 million versus the prior year quarter.

The decrease in the Service and System Integration segment product revenue was primarily due to a decrease in product sales in the German operation of $4.2 million, offset by an increase of approximately $1.1 million in product sales in our US operations of this segment. The $4.2 million decrease from the German operations, consisted of a decrease of approximately $5.0 million caused by lower sales volume, offset by an increase of approximately $800 thousand due to the effect of a stronger Euro versus the US dollar, during the quarter ended June 30, 2008 versus the quarter ended June 30, 2007. The decrease in sales volume was due to lower sales to large customers, Kabel Deutschland and Atos Origin. Sales to these customers decreased by $4.2 million and $2.0 million, respectively. These decreases were due to large project wins realized in the prior year quarter, which did not recur in the current year quarter due to the lack of significant IT investment and projects in fiscal year 2008. Offsetting these decreases, were sales to two new customers, UnityMedia which totaled approximately $507 thousand and Bayer which totaled approximately $647 thousand.

The decrease in the Systems segment product revenues of approximately $4.0 million for the quarter ended June 30, 2008 versus the comparable period in fiscal 2007 was primarily due to the decrease in sales to Raytheon of approximately $4.4 million over the prior year period. Prior year sales to Raytheon were in connection with an order for sixteen systems that were shipped over the course of fiscal 2007. Sales to Raytheon for the three months ended June 30, 2008 were approximately $40 thousand consisting of spare parts and repairs. In addition, sales to Lockheed Martin decreased by approximately $133 thousand, while sales to KBK increased by approximately $562 thousand for the three months ended June 30, 2008 versus the prior year comparable period.

As shown in the table above, service revenues increased by approximately $352 thousand, or 9% for the quarter ended June 30, 2008 compared to the comparable quarter of fiscal 2007. This increase was substantially from the Service and System Integration segment wherein service revenue increased by approximately $356 thousand. This increase was driven primarily from the German division wherein service revenue increased by approximately $1.2 million, approximately $409 thousand of which was the result of the foreign currency fluctuation impact and approximately $791 thousand was due to increased sales volume. The increase in sales volume was to higher levels of professional services for consulting work in archiving and identity and access management. Offsetting the increased services revenues in Germany, service revenue in the UK subsidiary of the Service and System Integration segment decreased by approximately $754 thousand, resulting from the non-recurrence of a large development project to a single customer, NCH, delivered in the third quarter of fiscal 2007.

Our sales by geographic area, based on the location to which the products were shipped or services rendered, are as follows:

	For the Three Months Ended
	(Amounts in thousands)
	June 30, 2008		%			June 30, 2007		%			$ Increase/ (Decrease)			% Increase(Decrease)
North America	$	8,026		42	%	$	12,654		49	%	$	(4,628	)		(37	)%
Europe		8,867		46	%		12,706		49	%		(3,839	)		(30	)%
Asia Pacific		2,262		12	%		584		2	%		1,678			287	%
Totals	$	19,155		100	%	$	25,944		100	%	$	(6,789	)		(26	)%

The decrease in North American revenue in for quarter ended June 30, 2008 versus the prior year quarter, was due to the decrease in sales to Raytheon of $4.4 million.

The decrease in revenues in Europe for the three months ended June 30, 2008 versus the comparable period of fiscal 2007 was due primarily to the reasons set forth above with respect to sales volumes and foreign exchange rate fluctuations in the German operations of the Service and System Integration segment. To summarize the data presented above approximately $4.2 million of the decrease was related to decreased sales volume from the German division and approximately $754 thousand was due to lower sales volume in from the UK division. Offsetting these decreases, there was an increase of $1.2 million related to the foreign exchange rate change of a stronger Euro versus the US dollar.

The increase in sales in Asia Pacific was due to sales from the US division of the Service and System Integration segment of approximately $1.1 million plus increased sales in the Systems segment to KBK in the quarter ended June 30, 2008 versus the quarter ended June 30, 2007 of approximately $562 thousand.

Cost of Sales

The following table details our cost of sales by operating segment for the three months ended June 30, 2008 and 2007:

	Systems			Service and System Integration			Total			% of Total
For the three months ended June 30, 2008:
Product	$	629		$	11,710		$	12,339			78	%
Services		20			3,365			3,385			22	%
Total	$	649		$	15,075		$	15,724			100	%
% of Total		4	%		96	%		100	%
% of Sales		50	%		84	%		82	%

Gross Margins:
Product		47	%		13	%		16	%
Services		80	%		22	%		24	%
Total		50	%		16	%		18	%

		Systems			Service and System Integration			Total			% of Total
For the three months ended June 30, 2007:
Product	$	2,083		$	14,753		$	16,836			83	%
Services		18			3,388			3,406			17	%
Total	$	2,101		$	18,141		$	20,242			100	%

		Systems			Service and System Integration			Total		% of Total
% of Total		10	%		90	%		100	%
% of Sales		39	%		88	%		78	%

Gross Margins:
Product		60	%		11	%		23	%
Services		84	%		15	%		16	%
Total		61	%		12	%		22	%

		Systems			Service and System Integration			Total		% of Total
Increase (Decrease)
Product	$	(1,454	)	$	(3,043	)	$	(4,497	)	(27	)%
Services		2			(23	)		(21	)	(1	)%
Total	$	(1,452	)	$	(3,066	)	$	(4,518	)	(22	)%

% Increase (decrease)		(69	)%		(17	)%		(22	)%
% of Sales		11	%		(4	)%		4	%

Gross Margins:
Product		(13	)%		2	%		(7	)%
Services		(4	)%		7	%		8	%
Total		(11	)%		4	%		(4	)%

Total cost of sales decreased by approximately $4.5 million for the quarter ended June 30, 2008, versus the quarter ended June 30, 2007, to $15.7 million down from $20.2 million in the prior year quarter. The decrease in cost of sales was due, overall, to the decrease in sales volume and revenues, but reflects an overall 4% decline in gross margin to 18% for the current year quarter versus 22% in the prior year quarter. This decrease in the overall gross margin was due to (i) the lower level of System segment sales as discussed above, coupled with a 11% decline in the gross margin in the Systems segment which decreased from 61% gross margin for the quarter ended June 30, 2007 to 50% for the quarter ended June 30, 2008. The decline was due to the low production levels in the quarter ended June 30, 2008 associated with the low level of sales resulting in a higher volume of unabsorbed overhead charged to cost of sales.

Gross profit margins for the Service and System Integration segment increased by 4% gross margin from 12% for the prior year quarter to 16% for the current year quarter ended June 30, 2008. This increase was due primarily to a greater number of smaller orders, which generally carry higher gross margin than large, high volume orders, coupled with greater sales volume of products that carry higher margins than those sold in the prior year quarter.

Engineering and Development Expenses

The following table details our engineering and development expenses by operating segment for the three months ended June 30, 2008 and 2007:

	For the Three Months Ended
	June 30, 2008		% of Total			June 30, 2007		% of Total			$ Decrease			% Decrease
	(Amounts in thousands)
By Operating Segment:
Systems	$	470		100	%	$	625		94	%	$	(155	)		(25	)%
Service and System Integration		-		-	%		40		6	%		(40	)		(100	)%
Total	$	470		100	%	$	665		100	%	$	(195	)		(29	)%

Engineering and development expenses decreased by $195 thousand, or approximately 29%, in the third quarter of fiscal 2008 compared to the third quarter of fiscal 2007, due primarily to lower consulting costs in connection with reduced R&D activities in the Systems segment and lower costs in the Service and System Integration segment due to reduction in headcount in the UK division.

Selling, General and Administrative

The following table details our selling, general and administrative expense by operating segment for the three months ended June 30, 2008 and 2007:

	For the Three Months Ended
	June 30, 2008		% of Total			June 30, 2007		% of Total			$ (Decrease)			% (Decrease)
	(Amounts in thousands)
By Operating Segment:
Systems	$	790		25	%	$	1,391		37	%	$	(601	)		(43	)%
Service and System Integration		2,323		75	%		2,371		63	%		(48	)		(2	)%
Total	$	3,113		100	%	$	3,762		100	%	$	(649	)		(17	)%

Total selling, general and administrative (“SG&A”) expenses decreased by $649 thousand, or 17%, in the quarter ended June 30, 2008 compared to the corresponding quarter of fiscal 2007. The Systems segment SG&A expenses decreased by approximately $601 thousand, while SG&A expenses in the Services and System Integration segment decreased by approximately $48 thousand. The decrease in the System segment expense was due to a decrease in audit fees of $183 thousand, which were higher in the fiscal quarter ended June 30, 2007 due to compliance issues related to the completion of our statutory filings for the prior fiscal year that did not recur, lower commissions and bonus expense of approximately $315 thousand, due to lower sales volume and earnings, lower legal fees of approximately $39 thousand and more favorable increase in cash surrender value on officer life insurance of approximately $65 thousand.

Other Income/Expenses

The following table details our other income/expenses for the three months ended June 30, 2008 and 2007:

	For the Three Months Ended
	June 30, 2008			June 30, 2007			$ Increase/ (Decrease)
	(Amounts in thousands)
Interest expense	$	(22	)	$	(24	)		2
Interest income		134			117			17
Foreign exchange gain (loss)		5			(2	)		7
Insurance settlement gain		−			240			(240	)
Other income, net		6			1			5
Total other income, net	$	123		$	332			(209	)

Total other income decreased by $209 thousand for the three months ended June 30, 2008 compared to the same period of fiscal 2007, as shown above. The increase in interest income was due to larger holdings of investments and interest bearing deposits in the current year quarter. The increase in interest income was offset by a decrease due to the non-recurrence of the insurance settlement gain that was realized in the prior year three-month period. This gain resulted from the death benefit received by the Company exceeding the carrying cash surrender value on the policy.

Income Taxes

Income Tax Provision

The company recorded income tax benefit of $22 thousand and $40 thousand for the quarter and nine months ended June 30, 2008, respectively, reflecting an effective income tax benefit rate of 34% for the nine months ended June 30, 2008, compared to income tax expense of $725 thousand and $1.8 million for the quarter and nine months ended June 30, 2007, respectively, reflecting an effective tax rate of 46% for the nine months ended June 30, 2007. The tax benefit for the nine months ended June 30, 2008 was due to the carryback of the operating loss of our US operation for the nine month period. For the nine months ended June 30, 2007, our effective tax rate was higher than the U.S. statutory rate due to the increased profitability in the U.S. plus profitability of our European subsidiaries, primarily Germany.

In assessing the realizability of deferred tax assets, we considered our taxable future earnings and the expected timing of the reversal of temporary differences. Accordingly, we have recorded a valuation allowance which reduces the gross deferred tax asset to an amount which we believe will more likely than not be realized. Our inability to project future profitability beyond fiscal year 2008 in the U.S. and cumulative losses incurred in recent years in the U.K. represent sufficient negative evidence under SFAS 109 to record a valuation allowance against certain deferred tax assets. We maintained a substantial valuation allowance against our U.K. deferred tax assets as we have experienced continued cumulative losses and do not have any indication that the operation will be profitable in the future to an extent that will allow us to utilize much of our net operating loss carryforwards. To the extent that actual experience deviates from our assumptions, our projections would be affected and hence our assessment of realizability of our deferred tax asset may change.

Liquidity and Capital Resources

Our primary source of liquidity is our cash, cash equivalents and short term investments, which decreased by approximately $5.1 million to approximately $16.2 million as of June 30, 2008 as compared to approximately $21.4 million as of September 30, 2007. Significant items that account for this reduction in cash and short term investments include (i) the reclassification of auction rate security investments totaling $4.8 million, which historically were classified as short term, to long term investments; (ii) cash provided by operating activities of approximately $396 thousand, (iii) cash used by financing activities of approximately $416 thousand, (iv) cash used to purchase property, plant and equipment of $396 thousand and (v) a use of cash to pay premiums on officers’ life insurance of $144 thousand.

We reclassified $4.8 million of auction rate security investments from short term to long term because recent auctions for these securities have failed. Because of these failed auctions, and the uncertainty as to whether future auctions will fail, we can not determine whether we will be able to liquidate these investments over the ensuing one-year period, and therefore have classified these investments to long term. (See also footnote 5, in the footnotes to financial statements and Part II Item 1A Risk Factors.)

Cash provided by operations of approximately $396 thousand was due substantially to a decrease in accounts receivable of approximately $577 thousand, depreciation expense of approximately $428 thousand, increase in accounts payable and accrued expenses of $411 and stock-based compensation of approximately $230 thousand, offset by a decrease in deferred revenue of approximately $1.1 million.

In financing activities, we used $698 thousand to purchase treasury stock and received cash totaling $282 thousand for CSPI common stock issued for stock options exercised pursuant to the Company’s stock option and stock purchase plans.

If cash generated from operations is insufficient to satisfy working capital requirements, we may need to access funds through bank loans, sale of securities or other means. There is no assurance that we will be able to raise any such capital on terms acceptable to us, on a timely basis or at all. If we are unable to secure additional financing, we may not be able to complete development or enhancement of products, take advantage of future opportunities, respond to competition or continue to effectively operate our business.

Based on our current plans and business conditions, management believes that our available cash and investments and cash generated from operations will be sufficient to provide for our working capital and capital expenditure requirements for the foreseeable future.

Inflation and Changing Prices

Management does not believe that inflation and changing prices had significant impact on sales, revenues or income from continued operations during the three and nine month periods ended June 30, 2008 and 2007. There is no assurance that our business will not be materially and adversely affected by inflation and changing prices in the future.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

As disclosed in our Annual Report on Form 10-K for the year ended September 30, 2007, our major market risk exposure relates to adverse fluctuations in interest rates risk and foreign currency exchange risk. We believe our exposure associated with these market risks has not changed materially since September 30, 2007.

We are also exposed to market risk relating to our long-term investments in auction rate securities due to uncertainties in the credit and capital markets. As of June 30, 2008, the fair value of our investments in auction rate securities was $5.25 million of which $4.8 million is classified as long term investments. The balance of $450 thousand is classified as short-term investments and should be redeemed within the next twelve months. The fair value of our long term auction rate securities may change significantly due to events and conditions in the credit and capital markets. The current fair value of our auction rate securities would be significantly lower if the market price of these securities were to decline. Assuming a 10% adverse change in the market price of these securities overall, the fair value would decline approximately $480 thousand. However, each of our auction rate security investments have different features and are subject to different risks and therefore, any market decline would impact these securities to a different degree. While these investments and/or issuers are currently rated AAA by various credit rating agencies as of June 30, 2008, these securities/issuers could be subject to review for possible downgrade. Any downgrade in these credit ratings may result in additional decline in estimated fair value of our auction rate securities. Changes in the various assumptions used to value these securities and any increase in the markets’ perceived risk associated with such investments may also result in a decline in estimated fair value.

Item 4. Controls and Procedures

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2008. Our chief executive officer, our chief financial officer, and other members of our senior management team supervised and participated in this evaluation. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2008, the Company’s chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

This quarterly report is not required to include, and does not include, a report of management’s assessment regarding internal control over financial reporting or an attestation report of the company’s registered public accounting firm.

Changes in Internal Controls over Financial Reporting

During the quarter ended June 30, 2008, there were no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1A. Risk Factors

There are numerous factors that affect our business and results of operations, many of which are beyond our control. In addition to the other information set forth in this quarterly report, you should carefully read and consider "Item 1A. Risk Factors" in Part I and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II of our Annual Report on Form 10-K for the year ended September 31, 2007, which contains descriptions of significant factors that might cause the actual results of operations in future periods to differ materially from those currently anticipated or expected. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended September 31, 2007, except as set forth below:

WE HAVE INVESTED A PORTION OF OUR CASH IN AUCTION RATE SECURITIES, THE MARKET FOR WHICH HAS BECOME ILLIQUID. ALTHOUGH WE ACQUIRED THESE SECURITIES WITH THE INTENTION OF SELLING THEM IN THE NEAR TERM, WE MAY BE REQUIRED TO HOLD THEM INDEFINITELY.

As of June 30, 2008, we held $5.25 million (par value) of which are long-term debt instruments with variable interest rates that periodically reset through an auction process ("auction rate securities"). All of our auction rate securities were originally acquired during the six months ended March 31, 2008 and have final maturity dates ranging from 2027 to 2057.

Our investment in auction rate securities as of June 30, 2008 was diversified across six separate issues and each issue maintains scheduled interest rate auctions in either 7-day or 28-day intervals. All of our auction rate securities are currently rated Aaa by Moody's, AAA by Standard & Poor's and/or AAA by Fitch, which is the highest rating issued by each respective rating agency. An aggregate $4.8 million (par value) of our auction rate securities which are classified as long term investments were issued by state agencies and are supported by student loans for which repayment is substantially guaranteed by the U.S. government under the Federal Family Education Loan Program ("FFELP") or MBIA Insurance Co. The remaining $450 thousand is a closed end preferred auction security secured by the assets of the closed end funds. The fund is legally required to maintain assets of 200% of the face value of the preferred auction securities. The $450 thousand will be redeemed in the near future, although no specific date has been set by the issuer.

Auction failures and the resulting lack of liquidity are affecting the entire auction rate securities market and we are currently unable to determine whether these conditions will be temporary. Some issuers have recently refinanced their auction rate securities and other issuers are in the process of doing so. As noted above, we have been notified that some of our holdings will be redeemed. We are currently unable to determine whether other issuers of our auction rate securities will attempt and/or be able to refinance. Several of the financial institutions that conduct auctions and broker auction rate securities have indicated that they plan to develop secondary markets for auction rate securities, but we are currently unable to determine whether such plans will succeed or if alternate markets that provide for orderly purchases and sales of auction rate securities will otherwise develop. Although we acquired our auction rate securities with the intention of selling them in the near term, due to the aforementioned uncertainties, all of our auction rate securities not intended to be redeemed which total $4.8 million, have been classified as long-term investments on our consolidated balance sheet as of June 30, 2008. The $450 thousand auction rate security that will be redeemed within the next twelve months was classified as short term investments in current assets on our consolidated balance sheet as of June 30, 2008.

We expect to fund short-term and long-term liquidity needs from our cash and cash equivalent and short term investments totaling $16.2 million as of June 30, 2008, operating cash flow and, if necessary, funds borrowed under our $2.5 million unsecured revolving credit facility or other future financing arrangements.

Item 6. Exhibits

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

3.2		By-Laws, as amended (incorporated by reference to Exhibit 3.2 to our Form 10-K for the year ended September 30, 2007)

31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

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

	CSP INC.

Date: August 14, 2008	By:	/s/ Alexander R. Lupinetti
		Alexander R. Lupinetti
		Chief Executive Officer,
		President and Chairman

Date: August 14, 2008	By:	/s/ Gary W. Levine
		Gary W. Levine
		Chief Financial Officer

Exhibit Index

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

3.2		By-Laws, as amended (incorporated by reference to Exhibit 3.2 to our Form 10-K for the year ended September 30, 2007)

31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002