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CSPI > SEC Filings for CSPI > Form 10-K on 24-Dec-2013All Recent SEC Filings

Show all filings for CSP INC /MA/

Form 10-K for CSP INC /MA/


24-Dec-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The discussion below contains certain forward-looking statements related to statements concerning future revenues and future business plans. Actual results may vary from those contained in such forward-looking statements.

Overview of Fiscal 2013 Results of Operations

CSPI operates in two segments:

Systems - the Systems segment consists of our MultiComputer Division which designs, commercially develops and manufactures signal processing computer platforms that are used primarily in military applications and the process control and data acquisition ("PCDA") proprietary hardware business of our Modcomp subsidiary.

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.

Key results include:

Revenue increased by approximately $2.8 million, or 3%, to $87.6 million for the year ended September 30, 2013 versus $84.8 million for the year ended September 30, 2012.

For year ended September 30, 2012 we realized income from proceeds of an officer life insurance settlement of approximately $2.1 million. While no such income was recognized in the ended September 30, 2013, we did receive the settlement during the current fiscal year.

For the year ended September 30, 2013, we had an operating profit of approximately $0.7 million versus an operating profit of approximately $5.0 million for the year ended September 30, 2012, for a decrease of approximately $4.3 million.

For the year ended September 30, 2013, net income was approximately $0.4 million versus net income of approximately $6.6 million for the year ended September 30, 2012, for an decrease of approximately $6.2 million.

Net cash provided by operating activities was approximately $0.2 million for the year ended September 30, 2013 compared to net cash provided by operating activities of $6.3 million for the year ended September 30, 2012.

The increase in revenues of $2.8 million resulted from strong growth in revenues from our Service and System Integration segment partially offset by a decrease in revenues from our Systems segment. Revenues in the Service and System Integration segment increased by approximately $7.0 million from $73.7 million the year ended September 30, 2012 to $80.6 million for the year ended September 30, 2013, while Systems segment revenue decreased from $11.1 million for fiscal 2012 to $7.0 million for fiscal 2013 for a decrease of approximately $4.1 million.
In the Service and System Integration segment we experienced growth in both product and service revenues. Product revenues for the segment increased by $5.0 million, which was a 9% increase from $55.4 million in fiscal 2012 to $60.4 million in fiscal 2013. Service revenue in the segment increased by $2.0 million which was an 11% increase from $18.3 million in fiscal 2012 to $20.3 million in fiscal 2013. The product revenue increase was derived in large part from our U.S. operation, where product sales increased by approximately $14.1 million. The increase in services revenues was due substantially to an increase in the German division, where service revenue increased by approximately $1.2 million and an increase in the US division of approximately $0.7 million. In Germany, the increase was driven by service sales to new customers of approximately $0.8 million and favorable foreign exchange of approximately $0.2 million. In the US division, the increase in service revenues was from higher third party maintenance revenue.
The revenue decrease in the Systems segment was largely the result of lower royalty revenues which were $6.4 million for fiscal 2012 versus $0.8 million in fiscal 2013. Royalty revenues are particularly significant because there is no cost of sales associated with royalty revenues, hence the profit margin is 100% on this revenue. This $5.6 million decrease in royalty revenue was partially offset by higher product revenue in fiscal 2013 versus fiscal 2012 which increased by approximately $1.3 million.

In assessing the outlook for fiscal 2014, we expect to receive orders for royalties to fulfill a full rate production phase of the E2D program during the year. As a result, anticipating that we will realize significant royalty revenue, we are assuming a more optimistic view for the Systems segment for next year in comparison to the operating results we realized for fiscal 2013.


However, based on the risks associated with the economic environment within the defense market, we plan to manage the Systems segment with a cautiously optimistic outlook for fiscal 2014. In the Service and System Integration segment, we also have a cautiously optimistic outlook for fiscal 2014, in terms of revenue, where much will depend upon the level of overall growth in the private sector economy both domestically and in our European markets. We plan to focus our attention and resources in the Service and System Integration segment on higher-margin consulting and managed service business as we move forward. While this may put pressure on sales growth in fiscal 2014, we believe this strategy will achieve profitable growth for the long term.

The following table details our results of operations in dollars and as a percentage of sales for the years ended September 30, 2013 and 2012:

                                                                      %                                     %
                                           September 30, 2013      of sales      September 30, 2012     of sales
                                                               (Dollar amounts in thousands)
Sales                                     $           87,619         100  %     $           84,807        100  %
Costs and expenses:
Cost of sales                                         69,036          79  %                 64,386         76  %
Engineering and development                            1,857           2  %                  1,720          2  %
Selling, general and administrative                   16,025          18  %                 15,847         19  %
Total costs and expenses                              86,918          99  %                 81,953         97  %
Income from proceeds of officer life
insurance settlement                                       -           -  %                  2,115          3  %
Operating income                                         701           1  %                  4,969          6  %
Other expense                                            (12 )         -  %                   (100 )        -  %
Income before income taxes                               689           1  %                  4,869          6  %
Income tax expense (benefit)                             321           -  %                 (1,740 )       (2 )%
Net income                                $              368           1  %     $            6,609          8  %

Sales

The following table details our sales by operating segment for the years ended
September 30, 2013 and 2012:
                                                      Service and
                                                         System                     % of
                                          Systems     Integration       Total      Total
                                                  (Dollar amounts in thousands)
For the Year Ended September 30, 2013:
Product                                  $ 5,483     $     60,361     $ 65,844       75 %
Services                                   1,517           20,258       21,775       25 %
Total                                    $ 7,000     $     80,619     $ 87,619      100 %
% of Total                                     8 %             92 %        100 %



                                                       Service and
                                                          System                     % of
                                          Systems      Integration       Total      Total
For the Year Ended September 30, 2012:
Product                                  $  4,214     $     55,369     $ 59,583       70 %
Services                                    6,927           18,297       25,224       30 %
Total                                    $ 11,141     $     73,666     $ 84,807      100 %
% of Total                                     13 %             87 %        100 %


                                     Service and
                                       System                       %
                        Systems      Integration      Total      increase
Increase (Decrease)
Product               $  1,269      $     4,992     $ 6,261        11  %
Services                (5,410 )          1,961      (3,449 )     (14 )%
Total                 $ (4,141 )    $     6,953     $ 2,812         3  %
% increase                 (37 )%             9 %         3 %

As shown above, total revenues increased by approximately $2.8 million, or 3%, for the year ended September 30, 2013 compared to the year ended September 30, 2012. Revenue in the Service and System Integration segment increased by approximately $7.0 million, while revenues in the Systems segment decreased for the current year versus the prior year by approximately $4.1 million.

Product revenues increased by approximately $6.3 million, or 11%, for the year ended September 30, 2013 compared to the prior fiscal year. Product revenues in the Service and System Integration segment increased by approximately $5.0 million while in the Systems segment product revenue increased by approximately $1.3 million for the year ended September 30, 2013 versus the year ended September 30, 2012.

In the US division of the Service and System Integration segment, product sales increased by approximately $14.1 million, sales in this segment's German division decreased by approximately $8.2 million and in the UK division product sales decreased by approximately $0.9 million.

In the US division, the increase in product sales was due in part to sales to new customers (customers to which no sales were made in the prior year), which totaled approximately $5.0 million for the year ended September 30, 2013. In addition, sales increased to large existing customers in the IT hosting vertical by an aggregate of approximately $13.6 million. These increases were partially offset by aggregate net decreases to existing customers across all other verticals of approximately $4.5 million.

In Germany, the $8.2 million decrease in product revenue was driven by decreased sales to the division's largest customer, a large UK-based wireless carrier, to which product sales decreased by approximately $3.2 million. In addition, product sales to another of the division's largest customers from the previous year decreased by approximately $5.3 million. Partially offsetting these decreases, new customer sales totaled approximately $1.2 million. Sales to all other customers decreased by a net of approximately $0.9 million. The decrease in product sales in the UK division was the result of weaker demand from our UK customer base in the current-year.

The increase in product revenues in the Systems segment of approximately $1.3 million was due to an increase of $1.4 million in sales of parts, components and spares to existing US defense department customers, and an increase of $0.6 million due to hardware sales to a commercial customer. These increases were partially offset by a decrease in sales to our Japanese defense department customer of approximately $0.7 million.

As shown in the table above, service revenues decreased by approximately $3.4 million, or 14%. This decrease was made up of a decrease in the Systems segment of $5.4 million and an increase in the Service and System Integration segment of approximately $2.0 million. The decrease in the Systems segment service revenue was due to lower royalty revenue recorded in the year ended September 30, 2013 which was approximately $0.8 million versus $6.4 million for the year ended September 30, 2012. The increase in service revenues in the Service and System Integration segment was primarily from the German division, where service revenue increased by approximately $1.2 million and an increase in the US division of approximately $0.7 million. In Germany, the increase was driven by service sales to new customers of approximately $0.8 million and favorable foreign exchange of approximately $0.2 million. In the US division, the increase in service revenues was from higher third party maintenance revenue.


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

                                       For the Year ended,
                       September 30,                September 30,               $ Increase      % Increase
                            2013            %            2012           %       (Decrease)      (Decrease)
                                                  (Dollar amounts in thousands)
Americas              $       59,116        68 %   $       47,163       56 %   $    11,953           25  %
Europe                        25,512        29 %           34,053       40 %        (8,541 )        (25 )%
Asia                           2,991         3 %            3,591        4 %          (600 )        (17 )%
Totals                $       87,619       100 %   $       84,807      100 %   $     2,812            3  %

The increase in Americas revenue for the year ended September 30, 2013 versus the year ended September 30, 2012 was from an increase in the US division of the Service and System Integration segment to customers in the Americas of approximately $15.5 million, partially offset by decreases in sales to US customers in the Systems segment of approximately $3.6 million.

The decrease in sales in Europe was primarily the result of the lower sales in the German and UK divisions of the Service and System Integration segment. The decrease in Asia sales was the result of the decrease in sales to our existing customer that supplies a large Japanese defense program (see discussion above).

Cost of Sales, Gross Profit and Gross Margins The following table details our cost of sales, gross profit and gross margins by operating segment for the fiscal years ended September 30, 2013 and 2012:

                                                     Service and
                                                        System                      % of
                                        Systems      Integration        Total      Total
                                                 (Dollar amounts in thousands)
For the Year Ended September 30, 2013:
Cost of Sales:
Product                                $ 2,439      $    51,584      $ 54,023       78  %
Services                                   270           14,743        15,013       22  %
Total                                  $ 2,709      $    66,327      $ 69,036      100  %
% of Total                                   4  %            96  %        100  %
% of Sales                                  39  %            82  %         79  %
Gross Profit:
Product                                $ 3,044      $     8,777      $ 11,821       64  %
Services                                 1,247            5,515         6,762       36  %
Total                                  $ 4,291      $    14,292      $ 18,583      100  %
% of Total                                  23  %            77  %        100  %
Gross Margins:
Product                                     56  %            15  %         18  %
Services                                    82  %            27  %         31  %
Total                                       61  %            18  %         21  %

For the Year Ended September 30, 2012:
Cost of Sales:
Product                                $ 2,508      $    47,718      $ 50,226       78  %
Services                                   283           13,877        14,160       22  %
Total                                  $ 2,791      $    61,595      $ 64,386      100  %
% of Total                                   4  %            96  %        100  %
% of Sales                                  25  %            84  %         76  %


                                                  Service and
                                                     System                      % of
                                     Systems      Integration        Total      Total
Gross Profit:
Product                            $  1,706      $     7,651      $  9,357       46  %
Services                              6,644            4,420        11,064       54  %
Total                              $  8,350      $    12,071      $ 20,421      100  %
% of Total                               41  %            59  %        100  %
Gross Margins:
Product                                  40  %            14  %         16  %
Services                                 96  %            24  %         44  %
Total                                    75  %            16  %         24  %

Increase (decrease)
Cost of Sales:
Product                            $    (69 )    $     3,866      $  3,797        8  %
Services                                (13 )            866           853        6  %
Total                              $    (82 )    $     4,732      $  4,650        7  %
% Increase (decrease)                    (3 )%             8  %          7  %
% of Sales                               14  %            (2 )%          3  %
Gross Profit:
Product                            $  1,338      $     1,126      $  2,464       26  %
Services                             (5,397 )          1,095        (4,302 )    (39 )%
Total                              $ (4,059 )    $     2,221      $ (1,838 )     (9 )%
% increase (decrease)                   (49 )%            18  %         (9 )%
Change in Gross Margin percentage:
Product                                  16  %             1  %          2  %
Services                                (14 )%             3  %        (13 )%
Total                                   (14 )%             2  %         (3 )%

Total cost of sales increased by approximately $4.7 million when comparing the year ended September 30, 2013 versus the year ended September 30, 2012. A significant factor which caused this increase in cost of sales was the overall increase in sales as discussed previously, however whereas sales increased by 3%, cost of sales increased by 7% . The resulting lower gross profit margin ("GPM") of 21% for the year ended September 30, 2013 versus 24% for 2012 was due to several factors which are discussed below.

In the Systems segment, the overall GPM decreased from 75% to 61% as shown in the table above. This was because in fiscal year 2013 royalty revenue, which carries a 100% GPM, was $0.8 million, or 11% of total Systems segment revenue, versus the prior year royalty revenue which was $6.4 million or 57% of total Systems segment revenue. Partially offsetting the unfavorable GPM impact of the lower royalty revenue in the current year however, was the impact of higher product GPM in the current year versus the prior year. As shown in the table above, the GPM on product sales was 56% for the current year versus the prior year product GPM of 40%. This is due to the current year higher volume of production and product sales resulting in proportionately greater absorption of fixed factory overhead, therefore these fixed costs were proportionately lower versus production and sales volume, which resulted in the low GPM on product sales in the prior year.

In the Service and System Integration segment, the overall GPM was 18% for the year ended September 30, 2013 versus 16% for the prior year. Product GPM in the segment increased to 15% from 14% when comparing the year ended September 30, 2013 to the year ended September 30, 2012, while the segment's service GPM also increased from 24% to 27%. The increase in the product GPM was due to smaller deal size and more favorable product mix in fiscal year 2013 versus fiscal 2012, while the increase in service GPM was due primarily to higher utilization of in-house service engineers in providing billable services in Germany, and higher third-party maintenance revenue for the current fiscal year versus the prior year.


Engineering and Development Expenses

The following table details our engineering and development expenses by
operating segment for the year ended September 30, 2013 and 2012:
                                             For the Year ended,
                                               % of                               % of
                      September 30, 2013      Total      September 30, 2012      Total       $ Decrease       % Decrease
                                                         (Dollar amounts in thousands)
By Operating
Segment:
Systems              $             1,857        100 %   $             1,720        100 %   $        137            8 %
Service and System
Integration                            -          -                       -          -                -            -
Total                $             1,857        100 %   $             1,720        100 %   $        137            8 %

The $0.1 million increase in engineering and development expenses displayed above was due to higher engineering consulting expenditures in connection with the development of the next generation of MultiComputer products in the Systems segment.

Selling, General and Administrative

The following table details our selling, general and administrative ("SG&A")
expense by operating segment for the years ended September 30, 2013 and 2012:
                                              For the Year ended,
                                                % of                                % of
                       September 30, 2013      Total       September 30, 2012      Total      $ Increase      % Increase
                                                         (Dollar amounts in thousands)
By Operating
Segment:
Systems              $              4,037         25 %   $              5,515         35 %   $    (1,478 )        (27 )%
Service and System
Integration                        11,988         75 %                 10,332         65 %         1,656           16  %
Total                $             16,025        100 %   $             15,847        100 %   $       178            1  %

SG&A expenses increased in the Service and System Integration segment by approximately $1.7 million when comparing the fiscal year ended September 30, 2013 versus the prior year. This increase was due primarily to higher commissions and other incentive compensation expense which increased by approximately $0.7 million, due to the higher gross profit, and operating profit in the segment, higher salary expenses for additional headcount and promotions of approximately $0.9 million.
The decrease in SG&A expense in the Systems segment was due in large part to a non-recurring reduction in the cash surrender value of officer life insurance of approximately $0.9 million, related to a policy on our former chief executive, who died in fiscal 2012. In addition, retirement expense was lower by approximately $0.4 million and bonus expense was lower by approximately $0.5 million the year ended September 30, 2013, versus the prior year. The reductions in expenses were partially offset by higher legal expenses of approximately $0.3 million in connection with a proxy challenge during the year ended September 30, 2013.

Proceeds from officer life insurance settlement

In fiscal year 2012, we recognized approximately $2.1 million for the settlement from a life insurance policy for our former chief executive officer, who died during fiscal 2012. No such settlements occurred during for the fiscal year ended September 30, 2013.


Other Income/Expenses

The following table details our other income/expenses for the years ended
September 30, 2013 and 2012:
                                                         For the Year ended,
                                              September 30, 2013      September 30, 2012     Increase (Decrease)
                                                                    (Amounts in thousands)
Interest expense                             $           (86 )       $              (85 )   $             (1 )
Interest income                                           32                         44                  (12 )
Foreign exchange gain (loss)                             (18 )                      (60 )                 42
Other income (expense), net                               60                          1                   59
Total other expense, net                     $           (12 )       $             (100 )   $             88

Other income (expense), net, for the years ended September 30, 2013 and 2012 was not significant nor was the change from the prior year to the current year.

Income Taxes

The Company recorded an income tax expense of approximately $0.3 million, which reflected an effective tax expense rate of 47% for the year ended September 30, 2013, compared to income tax benefit of approximately $1.7 million for the year ended September 30, 2012, which reflected an effective tax benefit rate of 36%. As of September 30, 2013, management assessed the positive and negative evidence in the U.S operations, and estimated we will have sufficient future taxable income to utilize the existing deferred tax assets. Significant objective positive evidence included the cumulative profits that we realized over the most recent years. This evidence enhances our ability to consider other subjective evidence such as our projections for future growth. Other factors we considered are the likelihood for continued royalty income in future years, and our expectation that the Service and Systems Integration segment will continue to be profitable in future years. On the basis of this evaluation, as of September 30, 2013, we have concluded that our US deferred tax asset is more likely than not to be realized. It should be noted however, that the amount of the deferred tax asset realized could be adjusted in future years, if estimates of taxable income during the carryforward periods are reduced, or if objective negative evidence such as cumulative losses is present.

We realized a tax benefit for the year ended September 30, 2012, despite the fact that we had positive earnings before taxes for the year. This was because we reversed the U.S. valuation allowance of $3.0 million on our deferred tax assets, which had been accumulated over the past several years, resulting in this overall tax benefit. The recording and ultimate reversal of valuation allowances for our deferred tax asset requires significant judgment associated with past and projected performance. In assessing the realizability of deferred tax assets, we consider our taxable future earnings and the expected timing of the reversal of temporary differences. In prior years, we recorded a valuation allowance which reduced the gross deferred tax asset to an amount that we believed was more likely than not to be realized because our inability to . . .

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