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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF

THE SECURITIES EXCHANGE ACT OF 1934

For The Fiscal Year Ended September 30, 2003

Commission File Number 0-10843

CSP Inc.

(Exact name of registrant as specified in its charter)

43 Manning Road, Billerica, Massachusetts 01821-3901 (978) 663-7598

(Address and telephone number of principal executive offices)

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act

Common Stock (par value $0.01 per share)

Indicate by check mark whether 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 x    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes ¨    No x

As of December 8, 2003, there were 3,155,566 shares of Common Stock outstanding. The aggregate market value of shares of such Common Stock (based upon the last sale price of $6.00 per share as reported for December 8, 2003 on the NASDAQ National Market System) held by non-affiliates was approximately $18,933,396.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the Registrant’s Proxy Statement to be used in connection with the Registrant’s Annual Meeting of Stockholders to be held January 27, 2004 are incorporated by reference in Part III hereof. That way, you avoid having to make sure that the date you use for the Proxy Statement (which might change) does not have to be changed here.

PART I

Item 1.    Business

(a)  General Development of Business

CSP Inc. (“CSPI” or the “Company”) was founded in 1968 and is based in Billerica, Massachusetts, just off Route 128 in the Boston computer corridor. To meet the diverse requirements of its industrial, commercial, scientific and defense customers worldwide, CSPI and its subsidiaries develop and market software for E-business and messaging solutions and image processing software, network management, security and storage systems integration services and high-performance cluster computer systems.

CSPI operates in four segments. The four segments are: I) systems, which include manufactured hardware products, II) systems integration and services, which includes maintenance and integration and sale of third-party hardware products and services, III) E-business software and IV) other software products that are developed by the Company.

MODCOMP, Inc. is a multinational business operation that develops and markets E-business and messaging solutions and provides network management, storage systems and security integration services including consulting, system integration and outsourcing. MODCOMP expanded its United States of America reseller operations for hardware and software with the acquisition of certain assets of Technisource Hardware, Inc. (“Technisource”) on May 30, 2003. Technisource will operate as the System and Solutions Division of the Company. MODCOMP announced OpenXport and enterprise level message broker based on Dresdner Kleinwort Wasserstein’s open source messaging adapter technology and MODCOMP’s software development expertise to offer customized communication solutions. This expands our messaging products which includes Xport, a messaging server that handles high throughput messages between host systems and client devices like fax, email and telex. In addition, MODCOMP develops and markets ViewMax, which is a development software that allows companies to rapidly re-engineer and integrate their legacy application with Internet technologies and AIM66, which is a multichannel transaction server software that supports WAP, GPRS, I-mode and UMTS which are critical for the 3G wireless deployment in Europe. The company sells all of its products through its own direct sales force in the United States of America (the “U.S.”), Germany and United Kingdom. It also sells their products and services through distributors in the rest of the world.

The Company has another business operation, Scanalytics, Inc., which develops and markets imaging systems for molecular and cell biology. Its revenues are reported in the other software segment. Scanalytics specializes in the development and marketing of highly sophisticated image capture and analysis software products used by researchers in the biological and physical sciences. By integrating these software products with a diverse group of image-capture devices, Scanalytics is able to solve application-specific problems in biotechnology and life science research, including Digital Microscopy, Genomics, and High-Throughput Screening. Scanalytics sells both directly and through a network of distributors and resellers.

The CSPI MultiComputer Division of CSP Inc. is another business operation that reports its activity in the systems segment. The MultiComputer Division helps its customers solve high-performance computing problems in the medical imaging and defense markets by supplying very dense multiprocessing systems distinguished by elegant packaging and high-speed node-to-node communications in a completely integrated architecture. These systems are used in a broad array of applications, including radar, sonar and surveillance signal processing. The MultiComputer Division sells all products through its own direct sales force in the U.S. and via distributors in the rest of the world.

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(b)  Financial Information about Industry Segments

The Company operates in four segments, Systems, Systems integration and services, E-business Software, and Other Software. The following table presents sales by each segment:

(c)  Narrative Description of Business

The Company and its subsidiaries develop and market Internet software for E-business solutions, image-processing software, network management integration services and high-performance cluster computer systems.

Products and Services

CSPI Systems

The CSPI MultiComputer Division designs, manufactures, sells and services cluster computer systems and real-time embedded computer systems. These systems are characterized by high-performance, high-density, low power consumption, standards-based hardware and software components ideally suited for use in the aerospace and defense market and the high-end scientific/technical computing market. The incorporation of open and standard technologies ensures that customers receive systems based on the latest technology while reducing the risks associated with proprietary solutions.

Applications expertise, product innovation, strong technical support, and dedicated customer service make CSPI one of the industry’s providers of high-performance cluster computer systems.

Hardware Products

The CSPI MultiComputer Division produces very dense, high-performance cluster computer systems incorporating tens to hundreds of processors, all interconnected by a very high-bandwidth network. These systems are specifically designed for analysis of complex signals and images in real time or in modeling and simulations. Typical computationally intense applications requiring these products include RADAR, SONAR, and command, control, communications, computers, intelligence, surveillance, and reconnaissance (C⁴ISR) within the defense market segment.

CSPI MultiComputer products offer customers an open hardware platform based upon the most advanced processors, large memory subsystems and high-bandwidth networking components. These systems are scalable and easy to upgrade, allowing for continuous insertion of the latest technologies. The superior architectural design of the MultiComputer products is based on Motorola^™ G4 PowerPC RISC processors with AltiVec^™ technology, high-speed memory and Myrinet-2000^™ cluster interconnect. These products meet the demands of mission-critical applications by incorporating high-availability features including instant booting from a cold start, error-correcting memory, hot-swappable hardware, extended environmental specifications and built-in self-test. Products ship in a variety of configurations ranging from small desktop systems to multiple-chassis systems with over 400 processors.

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The newest members of the MultiComputer product line, the four processor 2942 MultiComputer and the StarGate Model 2923 I/O Bridge, employ the MPC7457 processors which doubles performance levels over previous generation products while delivering more efficient power consumption. The StarGate I/O Bridge complements the increased processor performance with two fast PCI buses per processor enabling concurrent I/O streaming and data processing.

Software Products

Supporting both open source Linux and the industry standard VxWorks^™ real-time operating system (RTOS), MultiComputer products afford the user a choice in selecting the software environment best suited to their application requirements.

VxWorks provides the best foundation for rapid development and execution of complex applications in real time. This efficient RTOS incorporates such features as a scalable run-time kernel to conserve code space and support for many different Application Programming Interfaces (API’s). Integrated communication routines support data transmission over the Myrinet fabric. TCP/IP is supported throughout the Myrinet network permitting standard services across heterogeneous processors.

Other applications are better served by Linux, which provides an open source UNIX like operating system environment with a POSIX implementation including true multitasking, virtual memory, shared libraries, demand loading, work load balancing, and support for TCP/IP networking. The Linux operating system is easily integrated with clustering software such as MPI and includes a full suite of GNU compiler tools to facilitate development.

All MultiComputer systems use the best of open systems technologies incorporating, Message Passing Interface (MPI) software for interprocessor communications, and the highly optimized industry standard math libraries: Industry Standard Signal Processing Library (ISSPL-ALT) and Vector Signal and Image Processing Library (VSIPL). These libraries facilitate the development of truly portable code for seamless reuse across applications, while taking advantage of optimized performance on the PowerPC with AltiVec.

Legacy Products

Acknowledging the long development and deployment cycles associated with critical applications within the defense industry, the CSPI MultiComputer Division provides support for older products on an “as available” basis.

Specifically, the MultiComputer SuperCard products, initially released more than a decade ago, are still in use on U.S. Navy programs currently in deployment. SuperCards are deployed in sonar computers handling the coordination of information from hydraphone sensor arrays in both ship-based and shore-based installations. The deployment phases of most other programs incorporating SuperCards are now completed. SuperCards are also sold to medical imaging equipment suppliers on an OEM basis. No new SuperCard based programs are anticipated.

The Company sells all products through its own direct sales force in the U.S. and via distributors in the rest of the world.

Computer Hardware

In 1988, MODCOMP, Inc. systems began selling RealStar family of computers, based on open systems VME and Motorola 68k and 88k processor technology. This was a direct result of faster processing technology and customer demand. MODCOMP provides migration paths for CLASSIC proprietary customers with these systems. Prices range from $15,000 to $100,000.

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In July 1997, the Company introduced its RealStar II line of computer systems. This is a line of third-party hardware based on Pentium processor technology. This hardware is specially configured for optimum performance with MODCOMP’s REAL/IX PX operating system. MODCOMP adds additional components and software to these systems such as RAID subsystems, interface cards, disks, video displays, to optimize them for the real-time, process control market place. During fiscal year 1999, the Company purchased a license for ScadaBase from Access Ware in order to complement the capabilities of the REAL/IX operating system. ScadaBase has also been programmed to work with the LINUX operating system for applications like the monitoring of Internet Service Provider’s (ISP’s) facilities. Prices for these systems range from $6,000 to $25,000.

MODCOMP also continues to offer refurbished CLASSIC (legacy computer systems) and MODACS proprietary systems as well as parts and services from its Fort Lauderdale headquarters. The CLASSIC systems are mini and supermini computers designed specifically to support real-time applications. The MODACS and MODACSX products are data acquisition and control systems. Prices range from $15,000 to $150,000.

Service and System Integration

Integration Services

In recent years, the Company’s product offering has shifted away from the sales of systems produced (proprietary and open architecture) hardware toward integration solutions including hardware, software, special engineering, and third-party hardware and software. The Company’s value proposition is integrating these components together into a complete solution and installing the system at the customer site. These services are offered by all MODCOMP locations. In particular, the German subsidiary has had significant successes in the telecommunication market with the recent deregulation of that industry.

The Company continues to sell refurbished legacy systems and components, especially as it relates to servicing current customers with replacement and/or upgraded systems. The old legacy computer systems generally can be expanded without major redesign as customer requirement’s change.

The legacy computer systems are generally utilized in industrial plants, research laboratories, and data processing applications and operate in real-time.

The purchase prices of legacy computer systems are typically priced from $6,000 to $150,000, depending upon customer requirements.

Computer Software and Computer Programming

Legacy computers are supported by high-level operating software, referred to as MAX, REAL/IX, REAL/IX PX and ScadaBase. This software is designed specifically for optimum real-time performance. The Company’s software enables customers to write their own real-time application software. These applications, when combined with legacy computers or third-party computers, create systems which simultaneously perform different control functions, program tests and a batch processing operation with response and interrupt times that are required in this marketplace. Prices range from $3,000 to $35,000.

Internet Integration and Security Solutions

The Company also offers its own and third-party software products as well as specialized programming and engineering services to supply customers with customized legacy-to-web, E-business solutions, virtual private networks and Internet security solutions.

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MODCOMP Systems and Solutions

In May of fiscal year 2003, the Company acquired certain assets of Technisource Hardware, Inc. (“Technisource”). This acquisition, formally organized as MODCOMP Systems and Solutions, further expands MODCOMP’s third-party offerings and professional services in the IT market with a strategic focus on storage, security, networking and communications. Key partners include Computer Associates, IBM, Dell, Citrix, ADIC, EMC, Microsoft, Captaris, and NetScreen.

The Company offers competitively priced best-of-breed products from a wide variety of vendors to meet customer’s diverse systems and technology needs, providing sales and engineering expertise in storage, security and networking to the Small-to-medium sized businesses (SMBs). These SMBs have unique technology needs, and typically lack technical purchasing expertise or have very limited engineering resources on staff. MODCOMP Systems and Solutions offers SMBs a single point of contact for complicated multi-vendor technology purchases. The company also provides installation, integration, logistical assistance and other value-added services that customers may require. Current customers are in education, health services, distribution, financial, manufacturing and entertainment. The company targets the SMB market across all industries. Systems and Solutions average sale is $50,000.

E-Business Software

In fiscal year 1997, the Company launched ViewMax^® in the U.S. ViewMax^® is a development environment that allows MODCOMP to rapidly re-engineer and integrate legacy systems such as mainframe, midrange, and other diverse host systems with Internet technology. Using ViewMax^® technology, the Company creates solutions that extend corporate data to a much wider audience via a corporate Intranet, Extranet, or the Internet. Using ViewMax^®, the Company creates solutions that can also integrate Electronic Commerce transactions with existing legacy Systems. Although the product has broad potential, the initial users of this technology have used it primarily for facilitating Electronic Commerce and creating Extranets. Current ViewMax^® customers are in the travel, insurance, financial, health services education, government, manufacturing and distribution markets. Prices for ViewMax^® range from $40,000 to $250,000.

The Company markets solutions using ViewMax directly to end-users. The direct market is cross industry, to companies of substantial size, and is not dependent on the fluctuations of any particular business segments. ViewMax^® is positioned primarily as an integration solution, with a strong focus on Electronic Commerce, Intranet and Extranet implementations. In the U.S., United Kingdom and Germany, a wide range of companies from a broad spectrum of industry have adopted it, including travel, insurance, automotive, consumer electronics and financial services.

Additionally, the Company provides Internet security consulting and implementation services for enterprise intrusion prevention and protection. Using third-party products from Checkpoint, MODCOMP ensures data security and integrity through the establishment of virtual private networks and firewalls.

In particular, the German subsidiary has had significant successes in the Internet security market in the telecommunications and financial services industries. Offering 7x24 service level agreements are a critical success factor in this market.

ViewMax^®

MODCOMP continues to sell ViewMax^® in the United States as an offering from MODCOMP Systems and Solutions. ViewMax^® is a development environment that allows MODCOMP to rapidly re-engineer and integrate legacy systems such as mainframe, midrange, and other diverse host systems with Internet technology. Using ViewMax^® technology, the Company creates solutions that extend corporate data to a much wider audience via a corporate Intranet, Extranet, or the Internet.

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The direct market is cross industry, to companies of substantial size, and is not dependent on the fluctuations of any particular business segments. ViewMax^® is positioned primarily as an integration solution, with a strong focus on Electronic Commerce, Intranet and Extranet implementations. In the U.S., United Kingdom and Germany, a wide range of companies from a broad spectrum of industries have adopted it, including travel, insurance, automotive, consumer electronics and financial services.

Current ViewMax^® customers are in the travel, insurance, financial, health services education, government, manufacturing and distribution markets. Prices for ViewMax^® range from $40,000 to $250,000.

Wireless Portal Server Software

In fiscal year 2002, MODCOMP Germany extended the WAP66 universal wireless transaction server software to be a multi-channel transaction server software, now supporting all existing technologies from WAP, GPRS, I-mode and UMTS. Now offering true Advanced Internet Mobility support software, WAP66 has been renamed AIM66. This offering will enable MODCOMP to participate in the upcoming mobile services delivery market, which is a critical success factor for the telecommunication industry to succeed with 3G technology in Europe.

Messaging Software

In June 2002, MODCOMP Ltd. acquired the communications business of Sipher Software Ltd.—Sipher is a United Kingdom company specializing in Message Oriented Middleware solutions for companies like Barclays Bank, JP Morgan, Hong Kong Telecom and the BBC.

The Sipher acquisition included the relevant expertise in enterprise level messaging solutions and the Intellectual Property for the core-messaging server called Xport. This product has advanced gateway functionality for handling high throughput messages between host business systems such as IBM mainframes and client devices—fax, email, telex, EDI. The in-line processing engine can be configured to sort, map, filter and transcribe messages before being delivered to client devices, systems, databases or other applications.

Competitors include Topcall and Progress Software as well as EDS, IBM Global Services and Ernst & Young, who provide custom message integration solutions for the banking industry using products like IBM MQ Series and TIBCO.

Other Software

In this segment, Scanalytics gives “sight” to computers by creating software that captures images from digital cameras and scanners and extracts information from those images. The Company integrates those software products with off-the-shelf hardware components to create high-performance vision systems that support scientific researchers in the biological and the physical sciences. During 2003, the other software segment focused its efforts in three applications areas of biotechnology and life science research: Digital Microscopy, Genomics, and High Throughput Screening. Products are sold through two channels: directly to researchers via our own sales force and through a network of international and domestic dealers, OEMs, and VARs.

Digital Microscopy

IPLab is a general-purpose image analysis software package. It was originally available only on Macintosh computers, where IPLab has been called “the de facto standard in Macintosh image analysis”. Since then, IPLab has also been programmed to work within the Windows operating systems. Add-on modules for IPLab, called Extensions, provide application-specific functionality, making IPLab extremely adaptable for a wide variety of customers and industries. Extensions can easily be written by IPLab customers and third-party developers, as

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well as by our staff. The Company makes and markets individual Extensions for multi-fluorescence microscopy, calcium-ratio imaging, 3-D image visualization, time lapse studies, and microscope automation. The list price of Basic IPLab is $3,495 and extensions range in price from $600 to $3,000.

Genomics

Scanalytics makes several software products oriented towards the genomics imaging market. The new 1Dscan EX, introduced in 2003, is used in biomedical research labs for documentation and analysis of electrophoretic gels. GeneProfiler is a sophisticated tool for DNA fingerprinting. GelLab II+ is used for 2D-gel analysis. Scanalytics recently forged a distribution agreement for 1Dscan EX with Ultra-Lum, Inc., of Claremont, California. 1Dscan EX will be integral in providing image capture and analysis capabilities in Ultra-Lum’s new line of gel imaging systems. Prices for these products range from $1,500 to $2,995.

High Throughput Screening

High Throughput Screening systems are characterized by a high density of samples automated analysis and experimental repeatability. MicroArray Suite, introduced by Scanalytics in 1999, is an extension to IPLab that was developed by and licensed from the National Center for Human Genome Research at the National Institutes of Health. This software package assists researchers in analyzing microarrays, which are devices that let researchers evaluate potential drug candidates by testing them against thousands of DNA fragments simultaneously. MicroArray Suite is priced at $5,000. Scanalytics is continuing development of the ELISpot Imager in collaboration with the Navy Medical Research Center. This system of software and hardware is used for immunological assays. (ELISpot stands for Enzyme Linked Immuno-Spot). ELISpot Imager is priced at $21,000.

Markets, Marketing and Dependence on Certain Customers

Systems

The Company markets its high-performance cluster computer systems into the high-end scientific/technical computing market and the aerospace and defense market with emphasis on applications requiring the analysis of complex signals. The Company distributes its products in these markets as an original equipment manufacturer (OEM) supplier to system integrators; distributors and value added resellers (VARs). In these markets the supplier/customer relationship is viewed as a long-term strategic partnership.

Aerospace & Defense Market

MultiComputer systems are sold primarily to prime contractors within the defense industry and are used in SONAR, RADAR, C⁴ISR systems, simulators, and signal & image analysis computers. Customers in this market segment have unique requirements. A prime contractor will be incorporating the CSPI product into their own future product developments and, therefore, will need early access to low-level, detailed technical specifications; prototype units; form, fit and function compatibility with previous products; and long term product availability and support. As a supplier in this market space, CSPI recognizes that there may be a significant up-front investment of time and resources in building a business partnership, however, the result is a strong potential for long-term revenue streams as products progress from development phases into deployment.

CSPI technologies that support “network centric warfare” and information exchange in real-time are becoming vital to 21^st century military operations. New programs requiring signal/image processing and analysis equipment as well as upgrades to existing military continue to rise at a steady rate. However, the efficiency inherent in today’s technologies reduces the number of platforms required to achieve the same results. Both new and upgraded programs require a substantial period of development and evaluation time before products are deployed into field use. Time from development to deployment varies based on the program, however, it may extend beyond a twenty-four month time period.

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This market segment represents the largest growth potential for the Company as the Department of Defense continues to encourage prime contractors to use commercial-off-the-shelf COTS solutions to contain program costs and improve the time-to-deployment when inserting new technology into existing field equipment. This initiative has lead to wide spread acceptance of standard, open technology products and is now being adopted by other governmental procurement agencies around the world. MultiComputer systems have been shipped to a number of customers developing COTS-based systems or evaluating systems for use in future programs. High-End Scientific/Technical Computing Market

The high-end scientific/technical computing market addressed by CSPI’s MultiComputer products is depicted by rapid technological change and the introduction of new products with superior capabilities at lower pricing. This market segment is driven by cost sensitivity. Moreover, many of the application performance requirements can often be met with general-purpose computers. Larger companies with greater technical resources and high capacity manufacturing facilities are now providing solutions in this space. Lacking the high volume production capabilities of a larger company, and thus not being able to realize the cost savings associated with economies of scale, could adversely affect the ability of CSPI to compete.

Service and System Integration

MODCOMP supplies and integrates network and storage solutions and designs, services and markets worldwide, high-speed mini-computers worldwide principally for use in demanding real-time applications. These computer systems are used in operations involving process measurement and control, power production and distribution, manufacturing test and inspection, scientific data collection and monitoring, as well as financing and other communications networks. MODCOMP has expanded its product line by including third-party equipment in its sales and servicing offerings. This new focus as a “total solutions company” allows MODCOMP to meet the needs of its customers with a variety of products including internally produced as well as those from third-party manufacturers.

Sales to individual customers constituting 10% or more of total sales consisted of sales to E-Plus of $10,321,000 (32%) in 2003. This customer is a “wireless” telecommunication company in Germany. The Company anticipates that, for the foreseeable future, a significant percentage of its sales will be dependent upon a relatively small number of customers.

The Company markets its products through various sales offices in the U.S., Canada, Germany and United Kingdom (for a detailed list see Item 2 of Form 10-K contained herein). Throughout the remainder of the world, these offices coordinate the activities of independent distributors and manufacturers representatives who represent other company’s product lines not competitive with CSPI and are either paid a commission on units sold or are permitted to buy units at a discount for subsequent resale.

Geographically, Europe accounts for approximately 57% of total sales. Historically, approximately 65% of the Company’s revenue was generated internationally. During the current year, the Company had significant sales from system integration customers in Germany. Accordingly, any adverse changes in market conditions in the European countries in which we operate could significantly affect the Company performance.

Competition

CSPI Systems

The MultiComputer systems market is very competitive. Customer requirements coupled with advancements in technology drive the efforts of the MultiComputer Division in continuously improving existing products and developing new ones. Starting with Intel i860 microprocessor used in the SuperCards of the 1970’s to the Motorola PowerPC’s with AltiVec incorporated in the 2000 SERIES and the addition of Linux open source software on the FastCluster product line, the company has responded with product offerings vital to remaining

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competitive. Product development efforts in fiscal year 2003 included optimizing system software and hardware designs to deliver the maximum performance obtainable from the new 1 GHz processors, enhancing I/O streaming capabilities, expanding peripheral options, and augmenting the product line with new ruggedized packaging options.

Aerospace & Defense Market

The Company’s direct competitors for the MultiComputer systems in the aerospace and defense market are Mercury Computer Inc. and Sky Computers, Inc. DY4, Synergy, Thales Computers and DNA Computing, board manufacturers that specialize in the DSP segment of this market, are indirect competitors. In the low performance segment of the market general-purpose computer and single board computer, manufacturers such as Motorola, Force, Hewlett Packard, IBM and Dell may compete. New companies enter the field periodically, and larger companies with greater technical resources and marketing organizations could decide to compete in the future. The future growth of the MultiComputer systems market depends upon continued growth in strategic partnerships and providing high density and scalability in a compact low-power and cost effective package that can be easily integrated into OEM designs for high performance computation. Since the majority of sales are to OEMs, the principal barrier to gaining market share is the reluctance of established users to redesign their product once it is in production. A key area of opportunity exists in design wins on new programs.

High-End Scientific/Technical Computing Market

Competitors in the high-end scientific/technical cluster computing market include general-purpose computer and single board computer manufacturers such as IBM, Motorola, Force, Hewlett Packard and Dell. Companies manufacturing general-purpose computer systems incorporating multiple processors will be the principal competitors for the CSPI. While CSPI products offer the best overall value in combined performance, features and price, we may not overcome the capabilities of larger companies to address the needs of the cost sensitive customer, where price, not system size/packaging, is the primary factor in the buying decision.

Systems- MODCOMP legacy

MODCOMP’s systems competition in its Process Control and Data Acquisition business crosses product line boundaries. Competition in its proprietary product line is with third-party companies that have developed technical expertise with the CLASSIC computer system family. Direct competitors include Accurate Computers, Queue Systems, Protostar, and Electronic Visions.

Competitors for both Company proprietary and open systems product lines also include systems integrators with process control skills in markets such as primary metals, oil and gas, power, rubber and plastics, pharmaceuticals, chemicals, pulp and paper, and food and beverages. These competitors offer open systems hardware platforms and industry-specific tailored application software packages.

Direct competitors of MODCOMP’s real-time UNIX operating system used in legacy systems include VxWorks, HP-UX, PowerMAX, Windows NT, Lynx, QNX, and Linux. As performance in microprocessor technology rapidly advances, real-time capabilities of competing operating systems narrows. Competing products are differentiated by hardware platform support and operating system robustness.

Service and System Integration

In the network management and storage systems integration services business, MODCOMP competitors are extensive and are different in each of the geographical markets but they include such competitors as EDS, IBM, and Sun Microsystems.

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Systems and Solutions

In the network management and storage systems integration services business, MODCOMP competitors are extensive and are different in each of the geographical markets but they include such competitors as HP, IBM, and Sun Microsystems.

Competitors range from catalog houses such as CDW, PC Connection, Insite, More Direct, and MicroWarehouse, to customers buying directly from the distributor, to distributors with solutions services such as IBM, Unisys, iData, Foresyth, Dell, and HP. Nearly all of the products MODCOMP Systems and Solutions resell are available through other channels. For this reason the combination of personalized attention, expertise, add-on services and competitive pricing have been the key to the Company’s current sales.

ViewMax^®

The Company’s principal, direct competitors to ViewMax in the Legacy Extension market space are IBM, Jacada, Attachmate, Clientsoft, Intelligent Environments, and Micro Focus. Companies such as Jacada, Attachmate and IBM have greater technical and marketing resources that could adversely affect our position. Additionally, in the Internet Security Services area, the principal direct competitors are ISS, Enterasys, VeriSign, Computer Associates, IBM, HP and TruSecure. Again, these companies have greater financial, technical and marketing resources that could adversely affect our position.

Competitors for the Company’s AIM66 transaction server software, in this new wireless market segment, range from small, single product companies to large multinational companies with much greater resources like Oracle, IBM, and Microsoft.

Other Software

In the Digital Microscopy market, the Company’s major competitors are Media Cybernetics, Universal Imaging, and ImproVision. Other competitors include Compact, Carl Zeiss, Intelligent Imaging, and QED Imaging. In the Genomics market, major competitors include Genomic Solutions, Media Cybernetics, BioRad, and Alpha Innotech. In the High Throughput Screening market, the only other software company that competes directly with the Company is BioDiscovery. Competitors in all of these markets range from small, single product companies to large, multinational instrument companies. The Company maintains its competitive advantage by offering high-value solutions.

Manufacturing, Assembly and Testing

All of the Company’s MultiComputer systems manufacturing is performed at its plant in Billerica, Massachusetts. The primary manufacturing process is the assembly and test of printed circuit boards and systems, designed by the Company and fabricated by other vendors. The Company endeavors to build for inventory and offers products in a variety of standard formats. A small percentage of sales reflect products customized to a particular customer’s specification, and even these products are easily reconfigurable should the customer cancel the order for any reason.

Upon receipt of material by the Company from outside suppliers, the Company’s QC/QA technicians inspect products and components. During manufacture and assembly, both subassemblies and completed systems are subjected to extensive testing, including burn-in and Environmental Stress Screening designed to minimize equipment failure at delivery and over it’s useful service life. The Company also uses diagnostic programs to detect and isolate potential component failures. A comprehensive log is maintained of all past failures to monitor quality procedures and improve design standards.

SuperCard products were designed using the Intel i860 RISC microprocessor. Intel discontinued production of the i860 at the end of the 1998 calendar year. CSPI has made provisions to accommodate the future needs of all its SuperCard customers for this product. No new application development programs will be initiated

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incorporating SuperCard products. However, SuperCard products will continue to be shipped into existing programs that have committed to the SuperCard end-of-life plan.

The MultiComputer Division does not consider the risk of interruption of supply to be significant to meet its projected revenue requirements for the immediate future.

The Company provides a warranty covering defects arising from products sold and service performed, which varies from 90 days to one year, depending upon the particular unit. However, warranties of substantially greater scope have been extended to certain major customers for financial and other considerations.

All “other software” products and manuals are shipped from the Fairfax, Virginia facility. The Company performs system integration of computer equipment with various image capture devices, such as microscopes or digital cameras, at their facilities in Virginia before installation at the customer site.

MODCOMP’s refurbished system configurations can include a wide selection of peripheral subsystems built or purchased under the original equipment manufacturer agreements. The Legacy system manufacturing facility is located in Fort Lauderdale, Florida. The process is controlled by various quality steps throughout the process. The assembly cycle of an individual system generally takes between 30 and 45 days, depending on its complexity.

Customer Support

The CSPI MultiComputer Division and Scanalytics (other software) support its customers with telephone assistance, on-site service, system installation, and training and education. The Company provides product support service during the warranty period. Customers may purchase extended software and hardware maintenance and on-site service contracts for support beyond the warranty period. An analyst who researches the issue and assists the customer to resolve the problem reviews each problem reported by a customer.

The Company offers training courses at either corporate headquarters or the customer site. Field and customer service support is provided through its headquarters in Billerica, Massachusetts for systems customers. Scanalytics (other software) provides support service through its Fairfax, Virginia headquarters.

Support for “legacy systems” is delivered in a number of ways including telephone assistance, on-site service, installation of systems, training and education. Service and parts warranty, generally of 90 days duration is provided on all products. In addition, the Company sells maintenance service contracts to customers. The Company also conducts customer training courses of one to three weeks’ duration on a fee basis either at their or the customer’s location.

Field and customer service support is provided through offices strategically located throughout the world.

Research and Development

During fiscal year 2003, CSPI’s expenses (including depreciation) for engineering and development were approximately $3,543,000 (11% of sales) compared to approximately $3,737,000 (13% of sales) and $3,823,000 (9% of sales) in fiscal years 2002 and 2001, respectively. Expenditures for engineering and development are expensed as they are incurred. CSPI MultiComputer systems Division expects to continue substantial expenditures, both in additional applications software development and development of hardware and software. Other software will continue to expand its product offering in software with its various products in gel and cell analysis for life sciences and complete new releases of the PC version of the IP Lab software product. The MultiComputer systems products and development currently in process are intended to extend the usefulness and marketability of existing products and introduce new products into existing market segments. E-business will continue development of the ViewMax and OpenXport products, as well as Linux and ScadaBase for SCADA solutions.

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CSPI MultiComputer Systems

In 2003, two new CSPI MultiComputer products were deployed in military surveillance and communications applications.

The first of these products—our 2842 MultiComputers—are high-performance processing modules for the 2000 Series and FastCluster product lines, and we completed our initial 2842 deliveries in fiscal year 2003. The second our new products—the Jumpgate-I MultiComputer—was acquired by the U.S. military for advanced software-defined radio platforms.

Early in fiscal year 2004, CSPI MultiComputers introduced the StarGate I/O Blade, which bolsters CSP’s offerings in software-defined radio, radar, sonar and surveillance DSP by providing the high-speed data acquisition capabilities and rapid execution times necessary for the complex signal processing demands of these applications. The StarGate I/O blade is the initial product in a new generation of CSP MultiComputers that will benefit from the exceptional performance provided by the 1GHz Motorola 7457 PowerPC microprocessors and related technologies. Customers purchasing this new line of products will have the option of selecting either an open-source Linux operating system and GNU toolkit or the industry standard VxWorks real-time operating system, coupled with the Tornado II development tools suite.

MODCOMP

MODCOMP’s strategic investments in R&D in fiscal year 2003 included OpenXport, the next generation of its successful Xport software platform. Xport currently is used by some of the major players in the financial services industry, including J.P. Morgan Chase and Barclays. In developing OpenXport, we leveraged our expertise in building customized communication software solutions using message-oriented middleware with Dresdner Kleinwort Wassersteins’ open source messaging adaptor technology for the rigorous performance and reliability requirements of the financial services industry. OpenXport is a Java/XML-based enterprise level server that allows for rapid business systems integration with little or no custom programming and seamlessly interfaces a wide range of major software platforms.

Scanalytics

Scanalytics extended its record of innovation in fiscal year 2003, introducing 1Dscan EX for Windows, a new gel analysis product designed for use by investigators in biomedical and molecular biology research labs within universities, pharmaceutical companies and government. Scanalytics also forged a distribution agreement for 1Dscan EX with Ultra-Lum, Inc., of Claremont, California. 1Dscan EX will be integral in providing capture and analysis capabilities in Ultra-Lum’s new line of gel imaging systems.

CSPI “systems and other software” has 39 employees, of which 16 professional and staff employees were engaged in software and hardware engineering and development activities as of September 30, 2003.

The “legacy System and service and system integration” engineering and development staff has developed various computers, computer peripherals and software since 1970, which it continues to maintain and enhance.

CSPI’s principal products are the CLASSIC hardware and software system line, Linux and ScadaBase application software and special one-of-a-kind products requested by customers.

The CLASSIC hardware and software line is a proprietary line of mini-computers and related software especially designed for the hard real-time market and has been in existence since 1970.

“Legacy, service and systems integration” and “E-business” groups have 120 employees, of which 2 professional and staff employees are engaged in software and hardware engineering and development.

CSPI does not have any patents that are material to its business.

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Backlog

The Company’s backlog of customer orders and contracts was approximately $3,790,000 at September 30, 2003 as compared to $3,343,000 at September 30, 2002. The backlog of the Company can fluctuate greatly. These fluctuations can be due to the timing of receiving large orders for integration services and OEM purchases.

Employees

On September 30, 2003, the Company had 159 employees. None of the Company’s employees is represented by a labor union and the Company had no work stoppages. The Company considers relations with its employees to be good.

(c)  Financial Information about Foreign and Domestic Operations and Export Sales

The Company’s sales and percentage of sales by geographic area based on the location of the customers are as follows:

Risk Factors

This document contains forward-looking statements based on current expectations that involve a number of risks and uncertainties. Further, any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made. As it is not possible to predict every new factor that may emerge, forward-looking statements should not be relied upon as a prediction of actual future financial condition or results. In response to competitive pressures or new product introductions, the Company may take certain pricing or marketing actions that could adversely affect the Company’s operating results. In addition, changes in the products and services mix may cause fluctuations in the Company’s gross margin. Due to the potential quarterly fluctuations in operating results, the Company believes that quarter-to-quarter comparisons of its results of operations are not necessarily an indicator of future performance.

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

Dependence on Key Customers

The Company is dependent on a small number of customers for a large portion of its revenues. E-Plus, a wireless telecommunications company in Germany, accounted for 32%, 20% and 40% of sales in fiscal years ended September 30, 2003 and 2002 and August 31, 2001. A significant diminution in the sales to or loss of any of the Company’s major customers would have a material adverse effect on the Company’s business, financial condition and results of operations. In addition, the Company’s revenues are largely dependent upon the ability

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of its customers to continue growth or need for services or to develop and sell products that incorporate the Company’s products. No assurance can be given that the Company’s customers will not experience financial or other difficulties that could adversely affect their operations and, in turn, the results of operations of the Company.

Competition

The markets for the Company’s products are highly competitive and are characterized by rapidly changing technology, frequent product performance improvements and evolving industry standards. Due to the rapidly changing nature of technology, new competitors may emerge of which the Company has no current awareness. Such competitors could have a negative impact on the Company’s ability to win future business opportunities. There can be no assurance that or a new competitor will not attempt to penetrate the various markets for our products and services. Their entry into markets historically targeted by CSPI may have a material adverse effect on the Company’s business, financial condition and results of operations.

Slowdown in the Economy

The Company’s business has been negatively impacted by the slowdown in the economies of the United States, Europe and elsewhere that began during fiscal year 2001. The uncertainty regarding the growth rate of the worldwide economies has caused companies to reduce capital investment and may cause further reduction of such investments. These reductions have been particularly severe in the electronics and technology industry. The Company cannot predict if or when the growth rate of worldwide economies will rebound, whether the growth rate of its business will rebound when the worldwide economies begin to grow, or if or when the Company’s growth rate will return to historical numbers.

Change in Operating Results

The Company has experienced fluctuations in its results of operations in large part due to the sale by the Company of its systems and services integration and servers, E-business software and other software in relatively large dollar amounts to a relatively small number of customers. Operating results also have fluctuated due to the competitive pricing programs and volume discounts, the loss of customers, market acceptance of the Company’s products, product obsolescence and general economic conditions. The Company’s gross margins from third-party products are typically lower than the Company’s gross margins from standard product revenues. The Company expects research and development expenses to continue as the Company continues to develop products and services to serve its markets, all of which are subject to rapidly changing technology, frequent product performance improvements and evolving industry standards. The ability to deliver peak performance on a timely and cost-effective basis is a critical factor in wins for future generations of defense business. Significant research and development spending by the Company does not ensure its systems will be designed into a customer’s system. Because future production orders are usually contingent upon securing a design win, the Company’s operating results may fluctuate due to either obtaining or failing to obtain design wins for significant customer systems.

The Company’s quarterly results may be subject to fluctuations resulting from the foregoing factors as well as from a number of other factors, including the timing of significant orders, delays in completion of internal product development projects, delays in shipping the Company’s computer systems and software programs, delays in acceptance testing by customers, a change in the mix of products sold to the defense and other markets, production delays due to quality programs with outsourced components, shortages of components, the timing of product line transitions and declines in quarterly revenues from previous generations of products following announcement of replacement products containing more advanced technology. Another factor contributing to fluctuations in quarterly results is the fixed nature of the Company’s expenditures on personnel, facilities and marketing programs. The Company’s expense levels for personnel, facilities and marketing programs are based, in significant part, on the Company’s expectations of future revenues. If actual quarterly revenues are below

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management’s expectations, results of operations likely will be adversely affected. As a result of the foregoing factors, the Company’s operating results, from time to time, may be below the expectations of public market analysts and investors, which could have a material adverse effect on the price of the Company’s Common Stock.

Dependence on Suppliers

Several components used in the Company’s products are currently obtained from sole-source suppliers. CSPI is dependent on key vendors like Myricom as well as Motorola for many of its PowerPC line of processors. Generally, suppliers may terminate their contract with the Company without cause upon 30-days notice and may cease offering products to the Company upon 180-days notice. If Motorola was to limit or reduce the sale of such components to the Company, or if these or other component suppliers to the Company, some of which are small companies, were to experience financial difficulties or other problems which prevented them from supplying the Company with the necessary components, such events could have a material adverse effect on the Company’s business, financial condition and results of operations. These sole source and other suppliers are each subject to quality and performance issues, materials shortages, excess demand, reduction in capacity and other factors that may disrupt the flow of goods to the Company or its customers; thereby adversely affect the Company’s business and customer relationships. The Company has no guaranteed supply arrangements with its suppliers and there can be no assurance that its suppliers will continue to meet the Company’s requirements. If the Company’s supply arrangements are interrupted, there can be no assurance that the Company would be able to find another supplier on a timely or satisfactory basis. Any shortage or interruption in the supply of any of the components used in the Company’s products, or the inability of the Company to procure these components from alternate sources on acceptable terms could have a material adverse effect on the Company’s business, financial condition and results of operations. There can be no assurance that severe shortages of components will not occur in the future. Such shortages could increase the cost or delay the shipment of the Company’s products, which could have a material adverse effect on the Company’s business, financial condition and results of operations. Significant increases in the prices of these components would also materially adversely affect the Company’s financial performance since the Company may not be able to adjust product pricing to reflect the increase in component costs. The Company could incur set-up costs and delays in manufacturing should it become necessary to replace any key vendors due to work stoppages, shipping delays, financial difficulties or other factors and, under certain circumstances, these costs and delays could have a material adverse effect on the Company’s business, financial condition and results of operations.

Dependence on Defense Business

Sales of the Company’s systems to the defense market accounted for approximately 16%, 16% and 17% of the Company’s revenues in fiscal year ended September 30, 2003 and 2002 and August 31, 2001, respectively. Reductions in government spending on programs that incorporate the Company’s products could have a material adverse effect on the Company’s business, financial condition and results of operations. Moreover, the Company’s subcontracts are subject to special risks, such as: delays in funding; ability of the government agency to unilaterally terminate the prime contract; reduction or modification in the event of changes in government policies or as the result of budgetary constraints or political changes; increased or unexpected costs under fixed price contracts; and other factors that are not under the control of the Company. In addition, consolidation among defense industry contractors has resulted in fewer contractors with increased bargaining power relative to the Company. No assurance can be given that such increased bargaining power will not adversely affect the Company’s business, financial condition or results of operations in the future.

Changes in government administration, as well as changes in the geo-political environment such as the current “War on Terrorism,” can have significant impact on defense spending priorities and the efficient handling of routine contractual matters. Such changes could have a negative impact on the Company’s business, financial condition, or results of operations in the future.

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Dependence on Key Personnel and Skilled Employees

The Company is largely dependent upon the skills and efforts of its senior management, managerial, sales and technical employees. None of the senior management or other key employees of the Company are subject to any employment contract which require services for a period of time. The loss of services of any of its executives or other key personnel could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s future success will depend to a significant extent on its ability to attract, train, motivate and retain highly skilled technical professionals. The Company’s ability to maintain and renew existing engagements and obtain new business depends, in large part, on its ability to hire and retain technical personnel with the skills that keep pace with continuing changes in industry standards and technologies. The inability to hire additional qualified personnel could impair the Company’s ability to satisfy its growing client base, requiring an increase in the level of responsibility for both existing and new personnel. There can be no assurance that the Company will be successful in retaining current or future employees.

Risk of International Operations

The Company markets and sells its products in certain international markets, and the Company has established subsidiaries in the United Kingdom, and Germany. Foreign-based revenue is determined based on the country in which the legal subsidiary is domiciled, and represented 57%, 59% and 67% of the Company’s total revenue for the fiscal years ended September 30, 2003 and 2002 and August 31, 2001, respectively. If revenues generated by