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CSP INC /MA/ - 10-K - 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. CSP Inc. operates in two segments:.

Edgar Online, Inc.

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 2012 Results of Operations

CSP Inc. 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.



Highlights include:

• Revenue increased by approximately $11.2 million, or 15%, to $84.8 million for

the year ended September 30, 2012 versus $73.6 million for the year ended

September 30, 2011.



  • For the year ended September 30, 2012, we had an operating profit of

approximately $5.0 million versus an operating profit of approximately $0.8

    million for the year ended September 30, 2011, for an increase of
    approximately $4.2 million.


• For the year ended September 30, 2012, net income was approximately $6.6

    million, which includes $1.7 million of tax benefit versus net income of
    approximately $0.4 million for the year ended September 30, 2011, for an
    increase of approximately $6.2 million.


• Net cash provided by operating activities was approximately $6.3 million for

the year ended September 30, 2012 compared to net cash provided by operating

    activities of $1.5 million for the year ended September 30, 2011.





The increase in revenues of $11.2 million referred to above resulted from
significant growth in revenues from both our Systems and our Service and System
Integration segments. Revenues in the Systems segment increased from $7.8
million for fiscal 2011 to $11.1 million for fiscal 2012 for an increase of
approximately $3.3 million, while, in our Service and System Integration segment
revenues increased by approximately $7.8 million from $65.8 million the year
ended September 30, 2011 to $73.7 million for the year ended September 30, 2012.

The revenue increase in the Systems segment was largely driven by higher royalty
revenues which were $6.4 million for fiscal 2012 versus $1.7 million in fiscal
2011. 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 $4.7 million increase in royalty revenue was partially offset by
lower product revenue in fiscal 2012 versus fiscal 2011 which decreased product
revenue by $1.4 million.

In the Service and System Integration segment we experienced significant growth
in both product and service revenues. Product revenues for the segment increased
by $6.3 million which was a 13% increase from $49.1 million in fiscal 2011 to
$55.4 million in fiscal 2012. Service revenue in the segment increased by $1.6
million which was a 9% increase from $16.7 million in fiscal 2011 to $18.3
million in fiscal 2012. The product revenue increase was derived in large part
from our German operation, where product sales increased by $4.1 million. This
increase was due substantially to a significant contract with a large European
telecommunications customer, pursuant to which we were engaged as a significant
supplier for their global IT security infrastructure build out. The increase in
services revenue in the segment was derived entirely from our German operation
and was also as a result of this telecommunications customer.

In assessing the outlook for fiscal 2013, anticipating that we will not realize
significant royalty revenue, we must assume a less optimistic view for the
Systems segment for next year in comparison to the robust operating results we
realized for fiscal 2012. In addition, based on the risks associated with the
economic environment within the defense market, we plan to manage the Systems
segment assuming relatively weak demand for fiscal 2013. In the Service and
System Integration segment, we will continue to have a cautiously optimistic
outlook for fiscal 2013, 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 business and away from
low margin business as we move forward. While this may put pressure on sales
growth in fiscal 2013, we believe this strategy will achieve profitable growth
for the long term.


                                       17
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The following table details our results of operations in dollars and as a percentage of sales for the years ended September 30, 2012 and 2011:

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                                            September           %            September           %
                                             30, 2012        of sales         30, 2011        of sales
                                                          (Dollar amounts in thousands)
Sales                                      $     84,807            100 %    $     73,645            100 %
Costs and expenses:
Cost of sales                                    64,386             76 %          57,276             78 %
Engineering and development                       1,720              2 %           1,785              2 %
Selling, general and administrative              15,847             19 %          13,775             19 %
Total costs and expenses                         81,953             97 %          72,836             99 %
Income from proceeds of officer life
insurance settlement                              2,115              3 %               -              -
Operating income                                  4,969              6 %             809              1 %
Other expense                                      (100 )            -               (94 )            -
Income before income taxes                        4,869              6 %             715              1 %
Income tax expense (benefit)                     (1,740 )           (2 )%            346              -
Net income                                 $      6,609              8 %    $        369              1 %




Sales

The following table details our sales by operating segment for the years ended
September 30, 2012 and 2011:

                                                       Service and
                                                         System                       % of
                                         Systems       Integration       Total       Total
                                                   (Dollar amounts in thousands)
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                       % of
                                         Systems       Integration       Total       Total
For the Year Ended September 30, 2011:
Product                                  $  5,624     $      49,110     $ 54,734         74 %
Services                                    2,198            16,713       18,911         26 %
Total                                    $  7,822     $      65,823     $ 73,645        100 %
% of Total                                     11 %              89 %        100 %




                                    Service and
                                      System                          %
                      Systems       Integration       Total        increase
Increase (Decrease)
Product               $ (1,410 )   $       6,259     $  4,849              9 %
Services                 4,729             1,584        6,313             33 %
Total                 $  3,319     $       7,843     $ 11,162             15 %
% increase                  42 %              12 %         15 %




                                       18
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As shown above, total revenues increased by approximately $11.2 million, or 15%,
for the year ended September 30, 2012 compared to the year ended September 30,
2011. Revenue in the Systems segment increased for the current year versus the
prior year by approximately $3.3 million, while revenues in the Service and
System Integration segment increased by approximately $7.8 million.

Product revenues increased by approximately $4.8 million, or 9%, for the year
ended September 30, 2012 compared to the comparable period of the prior fiscal
year. Product revenues in the Service and System Integration segment increased
by approximately $6.3 million while in the Systems segment product revenue
decreased by approximately $1.4 million for the year ended September 30, 2012
versus the year ended September 30, 2011.

In the US division of the Service and System Integration segment, product sales
increased by approximately $0.8 million, sales in this segment's German division
increased by of approximately $4.1 million and in the UK division sales
increased by approximately $1.3 million.

In the US division, product sales were bolstered by sales to several new
customers in both the IT Infrastructure, Higher Education and Healthcare
industry verticals. While we did experience decreases in sales to some of our
prior year large customers across several industry verticals, the acquisition of
new customers was enough to overcome the decreases in product sales to
previously acquired customers. Therefore, while we experienced significant
customer turnover, the pipeline for sales to new customers more than made up for
the turnover.

In Germany, the $4.1 million increase was net of an unfavorable foreign currency
impact of approximately $1.3 million, which means on a volume basis in constant
dollars the increase was approximately $5.4 million. This sales volume increase
was driven by increased sales to the division's largest customer, a large
UK-based wireless carrier, of approximately $4.6 million, and sales to a newly
acquired customer of $5.7 million. There can be no assurance that there will be
significant sales to either or both of these customers in the future. These
increases were offset by decreases to two of the divisions long-term
customers. The aggregate decrease in sales volume to these two customers
amounted to approximately $3.3 million. Additionally, sales to all other
customers in the German division decreased by an aggregate of approximately $1.6
million.

The increase in sales in the UK division was the result of increased third party
product sales versus the prior year. This was the result of the Company's
efforts to start up a third-party reseller business, offering a wider array of
third-party technology products within the UK operation.

The decrease in product revenues in the Systems segment of approximately $1.4
million was due to a decrease in sales to our Japanese defense department
customer of approximately $0.2 million, and a decrease of $1.2 million in sales
of parts, components and spares to existing US defense department customers.

As shown in the table above, service revenues increased by approximately $6.3
million, or 33%. This increase was made up of an increase in the Systems segment
of $4.7 million and an increase in the Service and System Integration segment of
approximately $1.6 million. The increase in the Systems segment service revenue
was due to higher royalty income recorded in the year ended September 30, 2012
which was approximately $6.4 million versus $1.7 million for the year ended
September 30, 2011. The increase in service revenues in the Service and System
Integration segment was primarily from the German division, where service
revenue increased by approximately $1.7 million. In Germany, there was an
unfavorable currency fluctuation impact to service revenues of approximately
$1.0 million, which means sales volume in constant dollars increased by
approximately $2.7 million. This increase in sales volume was driven by
increased service revenues to the German division's largest customer, a UK-based
wireless carrier, of approximately $2.8 million, offset by decreases in service
revenues of approximately $0.1 million of all other customers combined.

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

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                             For the Year ended,
            September 30,                 September 30,                 $ Increase       % Increase
                2012             %            2011             %        (Decrease)       (Decrease)
                                         (Dollar amounts in thousands)
Americas   $        47,163        56 %   $        43,528        59 %   $      3,635                8 %
Europe              34,053        40 %            26,273        36 %          7,780               30 %
Asia                 3,591         4 %             3,844         5 %           (253 )             (7 )%
Totals     $        84,807       100 %   $        73,645       100 %   $     11,162               15 %



The increase in Americas revenue for the year ended September 30, 2012 versus
the year ended September 30, 2011 was primarily the result of the fluctuations
described above in the Systems segment where combined product and service sales
to US customers increased by an aggregate $3.6 million.

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


                                       19
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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, 2012 and 2011:

                                                           Service and
                                                             System                            % of
                                            Systems        Integration         Total          Total
                                                          (Dollar amounts in thousands)
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 %
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 %

For the Year Ended September 30, 2011:
Cost of Sales:
Product                                    $   2,391      $      42,419      $  44,810              78 %
Services                                         330             12,136         12,466              22 %
Total                                      $   2,721      $      54,555      $  57,276             100 %
% of Total                                         5 %               95 %          100 %
% of Sales                                        35 %               83 %           78 %
Gross Profit:
Product                                    $   3,233      $       6,691      $   9,924              61 %
Services                                       1,868              4,577          6,445              39 %
Total                                      $   5,101      $      11,268      $  16,369             100 %
% of Total                                        31 %               69 %          100 %
Gross Margins:
Product                                           57 %               14 %           18 %
Services                                          85 %               27 %           34 %
Total                                             65 %               17 %           22 %

Increase (decrease)
Cost of Sales:
Product                                    $     117      $       5,299      $   5,416              12 %
Services                                         (47 )            1,741          1,694              14 %
Total                                      $      70      $       7,040      $   7,110              12 %
% Increase (decrease)                              3 %               13 %           12 %
% of Sales                                       (10 )%               1 %           (2 )%
Gross Profit:
Product                                    $  (1,527 )    $         960      $    (567 )            (6 )%
Services                                       4,776               (157 )        4,619              72 %
Total                                      $   3,249      $         803      $   4,052              25 %
% increase (decrease)                             64 %                7 %           25 %
Change in Gross Margin percentage:
Product                                          (17 )%               -             (2 )%
Services                                          11 %               (3 )%          10 %
Total                                             10 %               (1 )%           2 %




                                       20
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Total cost of sales increased by approximately $7.1 million when comparing the
year ended September 30, 2012 versus the year ended September 30, 2011.  This
increase in cost of sales of 12% overall is consistent with the increase in
sales of 15% overall as described previously. The resulting higher gross profit
margin ("GPM") of 24% for the year ended September 30, 2012 versus 22% for 2011
was due to several factors which are discussed below.

In the Service and System Integration segment, the overall GPM was 16% for the
year ended September 30, 2012 versus 17% for the prior year. Product GPM in the
segment remained unchanged at 14% when comparing the year ended September 30,
2012 to the year ended September 30, 2011, while the segment's service GPM
decreased from 27% to 24%. This decrease in service GPM was attributable
primarily to increased costs of training new billable service engineer employees
due to significant employee turnover in the German division of the
segment. Additionally, we experienced greater use of contractors versus in-house
resources to provide billable services in Germany.

In the Systems segment, the overall GPM increased from 65% to 75% as shown in
the table above. This was because in the current year period, royalty revenue,
which carries a 100% GPM, made up a much greater percentage of total Systems
segment revenue (57%), versus the prior year royalty revenue which was 21% of
total Systems segment revenue. Offsetting the favorable GPM impact of the
greater royalty revenue in the current year however, was the impact of
significantly lower product GPM in the current year versus the prior year. As
shown in the table above, the GPM on product sales was 40% for the current year
versus the prior year product GPM of 57%. This is due to the current year lower
volume of production and product sales resulting in proportionately lower
absorption of fixed factory overhead, therefore these fixed costs were
proportionately higher versus production and sales volume, which resulted in the
low GPM on product sales in the current year. In addition, we incurred
significantly higher nonrecurring engineering charges for re-tooling and other
services from our outside fabrication houses for the year ended September 30,
2012 versus the prior year.


                                       21
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Engineering and Development Expenses

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The following table details our engineering and development expenses by operating segment for the year ended September 30, 2012 and 2011:



                                               For the Year ended,
                         September 30,         % of         September 30,         % of
                             2012             Total             2011             Total         $ Decrease       % Decrease
                                                           (Dollar amounts in thousands)
By Operating Segment:
Systems                 $         1,720            100 %   $         1,785            100 %   $        (65 )             (4 )%
Service and System
Integration                           -              -                   -              -                -                -
Total                   $         1,720            100 %   $         1,785            100 %   $        (65 )             (4 )%



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

Selling, General and Administrative


The following table details our selling, general and administrative ("SG&A")
expense by operating segment for the years ended September 30, 2012 and 2011:


                                               For the Year ended,
                         September 30,         % of         September 30,         % of
                             2012             Total             2011             Total         $ Increase       % Increase
                                                           (Dollar amounts in thousands)
By Operating Segment:
Systems                 $         5,515             35 %   $         3,908             28 %   $      1,607               41 %
Service and System
Integration                      10,332             65 %             9,867             72 %            465                5 %
Total                   $        15,847            100 %   $        13,775            100 %   $      2,072               15 %



The increase in SG&A expense in the Systems segment was was due in part to
approximately $0.7 million in higher incentive compensation expense resulting
from the higher revenues, gross profit and operating results for the year ended
September 30, 2012, versus the prior year and a decrease in the cash surrender
value of officer life insurance policies of approximately $1.0 million, related
to a policy on our former chief executive, who became deceased in fiscal
2012. The increase in the Service & System Integration segment was due to an
increase in incentive compensation expense from the more favorable
revenue, gross profit and overall operating results for the year ended
September 30, 2012 versus the comparable period in the prior year.

Proceeds from officer life insurance settlement


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. We received the cash proceeds from this settlement subsequent to year end,
in October 2012.


                                       22
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Other Income/Expenses


The following table details our other income/expenses for the years ended
September 30, 2012 and 2011:


                                        For the Year ended,
                                September 30,         September 30,        Increase
                                    2012                  2011            (Decrease)
                                               (Amounts in thousands)
Interest expense               $           (85 )     $           (86 )   $          1
Interest income                             44                    44                -
Foreign exchange gain (loss)               (60 )                 (16 )            (44 )
Other income (expense), net                  1                   (36 )             37
Total other expense, net       $          (100 )     $           (94 )   $         (6 )



Other income (expense), net, for the years ended September 30, 2012 and 2011was
not significant nor was the change from the prior year period to that of the
current year.

Income Taxes

The Company recorded an income tax benefit of approximately $1.7 million, which
reflected an effective tax benefit rate of (36)% for the year ended
September 30, 2012, compared to income tax expense of approximately $0.3 million
for the year ended September 30, 2011, which reflected an effective tax rate of
48%.

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 reduced the valuation allowance on our deferred tax assets, which had been
accumulated over the past several years. 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
project future profitability beyond fiscal year 2012 in the U.S. and cumulative
losses incurred in recent years in the United Kingdom represented sufficient
negative evidence to record a valuation allowance against certain deferred tax
assets.

As of September 30, 2012, 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,
2012, we have concluded that our US deferred tax asset is more likely than not
to be realized. Therefore, we reversed the U.S. valuation allowance of $3.0
million, resulting in an overall tax benefit for the year ended September 30,
2012. 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
in the form of cumulative losses is present.

We continue to maintain a full valuation allowance against our United Kingdom
deferred tax assets as we have experienced 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
assets may change.

Liquidity and Capital Resources


Our primary source of liquidity is our cash and cash equivalents, which
increased by approximately $4.6 million to $20.5 million as of September 30,
2012 from $15.9 million as of September 30, 2011. At September 30, 2012, cash
equivalents consisted of money market funds which totaled $3.5 million.


                                       23
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Significant sources of cash for the year ended September 30, 2012 included net
income of approximately $6.6 million, an increase in A/P and accrued expenses of
approximately $1.6 million, an increase in deferred revenue of approximately
$0.8 million, a decrease in inventories of approximately $0.5 million, a
decrease in accounts receivable of approximately $0.8 million, a decrease in
cash surrender value of officers' life insurance of approximately $0.9 million
and depreciation and amortization of approximately $0.4 million.  Offsetting
these sources of cash, significant uses of cash were an increase in officer life
insurance settlement receivable of approximately $2.2 million, a decrease in
deferred tax assets of approximately $2.9 million, an increase in other assets
of approximately $0.7 million, purchases of property and equipment of $0.6
million and payment of dividends of approximately $0.8 million.

Cash held by our foreign subsidiaries located in Germany and the United Kingdom
totaled approximately $9.8 million as of September 30, 2012 and $5.6 million as
of September 30, 2011. This cash is included in our total cash and cash
equivalents reported above. We consider this cash to be permanently reinvested
into these foreign locations because repatriating it would result in unfavorable
tax consequences. Consequently, it is not available for activities that would
require it to be repatriated to the U.S.

If cash generated from operations is insufficient to satisfy working capital
requirements, we may need to access funds through bank loans 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 the
Company's available cash and cash equivalents, the cash generated from
operations and availability on our lines of credit will be sufficient to provide
for the Company's working capital and capital expenditure requirements for the
foreseeable future.


                                       24
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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 and intangibles, income taxes, deferred compensation, revenue
recognition, retirement plans, restructuring costs and contingencies. We base
our estimates on historical performance and on various other assumptions that
are believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.

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

Revenue Recognition


The Company recognizes product revenue from customers at the time of transfer of
title and risk of loss which is generally at the time of shipment, provided that
persuasive evidence of an arrangement exists, the price is fixed or determinable
and collectability of sales proceeds is reasonably assured. We include freight
billed to our customers as sales and the related freight costs as cost of sales.
The Company reduces revenue for estimated customer returns.

The Company recognizes revenue from software licenses when persuasive evidence
of an arrangement exists, delivery of the product has occurred and the fee is
fixed or determinable and collectability is probable. When delivery of services
accompany software sales, and vendor specific objective evidence does not exist,
and the only undelivered element is services that do not involve significant
modification, or customization, of software, then the entire fee is recognized
as the services are performed. If no pattern of performance is discernible, the
fee is recognized straight line over the service period.

The Company also offers training, maintenance agreements and support services.
The Company has established fair value on its training, maintenance and support
services based on prices charged in separate sales to customers at prices
established and published in its standard price lists. These prices are not
discounted. Revenue from these service obligations under maintenance contracts
is deferred and recognized on a straight-line basis over the contractual period,
which is typically three to twelve months, if all other revenue recognition
criteria have been met. Support services provided on a time and material basis
are recognized as provided if all of the revenue recognition criteria have been
met for that element and the support services have been provided. Training
revenue is recognized when performed.

In certain multiple-element revenue arrangements, the Company is obligated to
deliver to its customers multiple products and/or services ("multiple
elements"). In these transactions, the Company allocates the total revenue to be
earned under the arrangement among the various elements based on the Company's
best estimate of the standalone selling price. The allocation is based on vendor
specific objective evidence, third party evidence or estimated selling price
when that element is sold separately. The Company recognizes revenue related to
the delivered products or services only if the above revenue recognition
criteria are met and the delivered element has standalone value.

In October 2009, the FASB issued Accounting Standards Update ("ASU") 2009-13
- "Multiple-Deliverable Revenue Arrangements-a Consensus of the FASB Emerging
Issues Task Force" ("ASU 2009-13") and ASU 2009-14 - "Certain Revenue
Arrangements that Contain Software Elements." ("ASU 2009-14"). ASU 2009-13
amended previously existing revenue recognition accounting principles regarding
multiple-deliverable revenue arrangements. The consensus provides accounting
principles and application guidance on whether multiple deliverables exist, how
the arrangement should be separated, and how the consideration should be
allocated. This guidance eliminates the requirement to establish verifiable,
objective evidence of the fair value of undelivered products and services and
also eliminates the residual method of allocating arrangement consideration. The
new guidance provides for separate revenue recognition based upon management's
estimate of the selling price for an undelivered item when there is no other
means to determine the fair value of that undelivered item. Under the previous
guidance, if the fair value of all of the elements in the arrangement was not
determinable, then revenue was deferred until all of the items were delivered or
fair value was determined. This pronouncement was effective prospectively for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010, with early adoption permitted.

ASU 2009-14 removes the sale of tangible products containing software components
and non-software components that function together to deliver the tangible
product's essential functionality from the scope of software revenue recognition
guidance. The Company adopted these standards as of October 1, 2009.


                                       25
--------------------------------------------------------------------------------


Adoption of the new revenue recognition guidance has had an impact on the
pattern and timing of revenue recognition. In some cases, revenue that would
have been deferred pursuant to the previously existing multiple-element revenue
recognition guidance, has been recognized pursuant to the newly issued
guidance. This is because in some cases we are not able to determine
vendor-specific objective evidence ("VSOE") or third-party evidence of the
service element in our arrangements. Under the new guidance, because the
requirement to determine fair value of undelivered elements has been eliminated,
and we may use estimated selling price to allocate revenue to elements in an
arrangement, we are now more likely to be able to separate arrangements into
separate units of accounting, and thereby recognize the delivered elements
(typically product revenue) without having delivered the other elements in the
arrangements (typically services).

Description of multiple-deliverable arrangements and Software Elements


In many cases, our multiple-deliverable arrangements involve initial shipment of
hardware (including tangible products that include software and non-software
elements), software products and subsequent delivery of services which add value
to the products that have been shipped. In some instances, services are
performed prior to product shipment, but more typically services are performed
subsequent to shipment of the hardware products. The timing of the delivery and
performance of deliverables may vary case-by-case. We evaluate whether we can
determine VSOE or third-party evidence to allocate revenue among the various
elements in an arrangement. When VSOE or third-party evidence cannot be
determined, we use estimated selling prices to allocate revenue to the various
elements. Estimated selling prices are determined using the targeted gross
margin for each element and calculating the gross revenue for each element that
would have been required to achieve the targeted gross margin, and allocating
revenue to each element based on those relative values.

Typically, product revenue which may consist of hardware (including tangible
products that include software and non-software elements) and/or software
elements are recognized upon shipment, or when risk of loss passes to the
customer. Services elements are typically recognized upon completion for
fixed-price service arrangements, and as services are performed for time and
materials service arrangements. For software elements that include services that
do not involve significant production, modification or customization, and VSOE
does not exist, the entire fee allocable to that element is recognized as the
services are performed. If no pattern of performance is discernible, the fee is
recognized straight line over the service period. The period over which services
are delivered typically ranges from approximately sixty to ninety days, or
longer in some cases.

For tangible products containing software components and non-software
components, we determine whether these elements function together to deliver the
tangible product essential functionality. If the software and non-software
components of the tangible product function together to deliver the tangible
product's essential functionality, software revenue recognition guidance is not
applied, but rather other appropriate revenue recognition guidance as described
above.

The following policies are applicable to the Company's major categories of segment revenue transactions:

Systems Segment Revenue


Revenue in the Systems segment consists of product and service revenue.
Generally, product revenue is recognized when product is shipped, provided that
all revenue recognition criteria are met. Service revenue consists principally
of royalty revenue related to the licensing of certain of the Company's
proprietary system technology and repair services. The Company recognizes
royalty revenues upon notification by the customer of shipment of the systems
produced pursuant to the royalty agreement. Repair service revenue is generally
based upon a fixed price and is recognized upon completion of the repair.

From time to time we enter into multiple element arrangements in the Systems segment. We follow the accounting policies described above for such arrangements.


The Company's standard sales agreements generally do not include customer
acceptance provisions. However, in certain instances when arrangements include a
customer acceptance provision or there is uncertainty about customer acceptance,
revenue is deferred until the Company has evidence of customer acceptance.
Customers generally do not have the right of return, once customer acceptance
has occurred.

Service and System Integration Segment Revenue

Revenue in the Service and System Integration segment consists of product and service revenue.


Revenue from the sale of third-party hardware and third-party software is
recognized when the revenue recognition criteria are met. The Company's standard
sales agreements generally do not include customer acceptance provisions.
However, in certain instances when arrangements include a customer acceptance
provision or there is uncertainty about customer acceptance, revenue is deferred
until the Company has evidence of customer acceptance. Customers do not have the
right of return.


                                       26
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Service revenue is comprised of information technology consulting development,
installation, implementation and maintenance services. We follow the accounting
policies described above for service transactions. For arrangements that include
a customer acceptance provision, or if there is uncertainty about customer
acceptance of services rendered, revenue is deferred until the Company has
evidence of customer acceptance.

For sales that are financed by customers through leases with a third party, when
risk of loss does not pass to the customer until the lease is executed, revenue
is recognized upon cash receipt and execution of the lease.

We sell certain third party service contracts, which are evaluated to determine
whether the sale of such service revenue should be recorded as gross sales or
net sales in accordance with the sales recognition criteria as required by
accounting principles generally accepted in the U.S. We must determine whether
we act as a principal in the transaction and assume the risks and rewards of
ownership or if we are simply acting as an agent or broker. Under gross sales
recognition, the entire selling price is recorded in sales and our cost to the
third-party service provider or vendor is recorded in cost of goods sold. Under
net sales recognition, the cost to the third-party service provider or vendor is
recorded as a reduction to sales resulting in net sales equal to the gross
profit on the transaction and there are no costs of goods sold. We use the net
sales recognition method for the third party service contracts that we sell when
we are not the primary obligor on the contract. We use the gross sales
recognition for the third party service contracts that we sell when we act as
principal and are the primary obligor.

Product Warranty Accrual


Our product sales generally include a 90-day to one-year hardware warranty. At
time of product shipment, we accrue for the estimated cost to repair or replace
potentially defective products. Estimated warranty costs are based upon prior
actual warranty costs for substantially similar products.

Engineering and Development Expenses

Engineering and development expenses include payroll, employee benefits, stock-based compensation and other headcount-related expenses associated with product development. Engineering and development expenses also include third-party development and programming costs. We consider technological feasibility for our software products to be reached upon the release of the software, accordingly, no internal software development costs have been capitalized.

Income Taxes


We use the asset and liability method of accounting for income taxes whereby
deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. We also reduce deferred tax assets by a valuation allowance if,
based on the weight of available evidence, it is more likely than not that some
portion or all of the recorded deferred tax assets will not be realized in
future periods. This methodology requires estimates and judgments in the
determination of the recoverability of deferred tax assets and in the
calculation of certain tax liabilities. Valuation allowances are recorded
against the gross deferred tax assets that management believes, after
considering all available positive and negative objective evidence, historical
and prospective, with greater weight given to historical evidence, that it is
more likely than not that these assets will not be realized.

In addition, we are required to recognize in the consolidated financial
statements, 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.

In addition, the calculation of the Company's tax liabilities involves dealing
with uncertainties in the application of complex tax regulations in a multitude
of jurisdictions. The Company records liabilities for estimated tax obligations
in the U.S. and other tax jurisdictions. These estimated tax liabilities include
the provision for taxes that may become payable in the future.

Intangible Assets


Intangible assets that are not subject to amortization are also required to be
tested annually, or more frequently if events or circumstances indicate that the
asset may be impaired. We did not have intangible assets with indefinite lives
other than goodwill at any time during the two years ended September 30, 2012.
Intangible assets subject to amortization are amortized over their estimated
useful lives, generally three to ten years, and are carried at cost, less
accumulated amortization. The remaining useful lives of intangible assets are
evaluated on an annual basis. Intangible assets subject to amortization are also
tested for recoverability whenever events or changes in circumstances indicate
that their carrying amount may not be recoverable. If the fair value of an
intangible asset subject to amortization is determined to be less than its
carrying value, then an impairment charge is recorded to write down that asset
to its fair value.


                                       27
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Inventories


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

Pension and Retirement Plans


The funded status of pension and other post-retirement benefit plans is
recognized prospectively on the balance sheet. Gains and losses, prior service
costs and credits and any remaining transition amounts that have not yet been
recognized through pension expense will be recognized in accumulated other
comprehensive income, net of tax, until they are amortized as a component of net
periodic pension/post-retirement benefits expense. Additionally, plan assets and
obligations are measured as of our fiscal year-end balance sheet date (September
30).

We have defined benefit and defined contribution plans in the United Kingdom
(the "U.K."), Germany and in the U.S. In the U.K. and Germany, the Company
provides defined benefit pension plans for certain employees and former
employees and defined contribution plans for the majority of the employees. The
defined benefit plans in both the U.K. and Germany are closed to newly hired
employees and have been for the two years ended September 30, 2012. In the U.S.,
the Company also provides defined contribution plans that cover most employees
and supplementary retirement plans to certain employees and former employees who
are now retired. These supplementary retirement plans are also closed to newly
hired employees and have been for the two years ended September 30, 2012. These
supplementary plans are funded through whole life insurance policies. The
Company expects to recover all insurance premiums paid under these policies in
the future, through the cash surrender value of the policies and any death
benefits or portions thereof to be paid upon the death of the participant. These
whole life insurance policies are carried on the balance sheet at their cash
surrender values as they are owned by the Company and not assets of the defined
benefit plans. In the U.S., the Company also provides for officer death benefits
and post-retirement health insurance benefits through supplemental
post-retirement plans to certain officers. The Company also funds these
supplemental plans' obligations through whole life insurance policies on the
officers.

Pension expense is based on an actuarial computation of current future benefits
using estimates for expected return on assets, expected compensation increases
and applicable discount rates. Management has reviewed the discount rates and
rates of return with our consulting actuaries and investment advisor and
concluded they were reasonable. A decrease in the expected return on pension
assets would increase pension expense. Expected compensation increases are
estimated based on historical and expected increases in the future. Increases in
estimated compensation increases would result in higher pension expense while
decreases would lower pension expense. Discount rates are selected based upon
rates of return on high quality fixed income investments currently available and
expected to be available during the period to maturity of the pension benefit. A
decrease in the discount rate would result in greater pension expense while an
increase in the discount rate would decrease pension expense.

The Company funds its pension plans in amounts sufficient to meet the requirements set forth in applicable employee benefits laws and local tax laws. Liabilities for amounts in excess of these funding levels are accrued and reported in the consolidated balance sheets.

New Accounting Pronouncements


In June 2011, the FASB issued Accounting Standards Update 2011-05, Comprehensive
Income (Topic 220) - Presentation of Comprehensive Income ("ASU 2011-05"), which
requires all non-owner changes in stockholders' equity to be presented either in
a single continuous statement of comprehensive income or in two separate but
consecutive statements. ASU 2011-05 is effective for fiscal years and interim
periods within those years beginning after December 15, 2011.

Inflation and Changing Prices


Management does not believe that inflation and changing prices had significant
impact on sales, revenues or income (loss) during fiscal 2012 or 2011. There is
no assurance that the Company's business will not be materially and adversely
affected by inflation and changing prices in the future.


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Item 8. Financial Statements and Supplementary Data

The consolidated financial statements are included herein.


                                                                     Page
Report of Independent Registered Public Accounting Firm               35

Consolidated Balance Sheets as of September 30, 2012 and 2011 36

Consolidated Statements of Operations for the years ended September 30, 2012 and 2011

                                                     37

Consolidated Statements of Shareholders' Equity and Comprehensive income (loss) for the years ended September 30, 2012 and 2011 38

Consolidated Statements of Cash Flows for the years ended September 30, 2012 and 2011

                                                     39

Notes to Consolidated Financial Statements                            40
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