CSP Inc. (CSPI) Q1 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to CSP Inc.’s first-quarter fiscal 2011 conference call. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference call. (OPERATOR INSTRUCTIONS.) I would now like to turn the call over to Mr. Gary Levine, CSP’s chief financial officer. Please proceed, Gary.

Thank you, and good morning, everyone. With me on the call today is our chairman, president and chief executive officer, Alex Lupinetti. I’ll take you through our first-quarter financial results, and then Alex will review our operations before we take your questions. But first, our safe harbor statement. During the call, we will take advantage of the “Safe Harbor” provisions of the Private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward-looking under the Act. The Company cautions that numerous factors could cause actual results to differ materially from forward-looking statements made by the Company. Such risks include general economic conditions, market factors, competitive factors and pricing pressures, and others described in the Company’s filings with the SEC. Please refer to the section on forward-looking statements included in the Company’s filings with the Securities and Exchange Commission. With that, let’s get right into our financial review. We performed well in the first quarter of fiscal 2011 – on the top- and bottom-lines, and in the execution of our growth strategy. Total sales grew 18% to $22.1 million. This included a 3% negative effect from foreign currency due to the strong U.S. dollar in Q1 2011 versus Q1 2010. The year-over-year revenue increase was driven by 11% growth at our Service and Systems Integration business and a triple-digit increase at Systems. CSP’s total cost of sales for Q1 increased year over year to $17.6 million from $16.4 million in Q1 2010, in line with the higher sales volume. Gross profit for the quarter grew 97% to $4.5 million as a result of the sales increase, and higher gross margins at both segments. Overall gross margin climbed 800 basis points to 20% of sales. First-quarter Engineering and Development expense was flat at approximately $500,000, and was down by about 20 basis points as a percentage of sales to 2.3%. This is slightly below our target range for Engineering and Development expenses of 2.4% to 2.6% of sales. SG&A expenses increased by 10% on a real-dollar basis to $3.4 million in the quarter. This primarily reflected commissions and bonus expenses on increased profits. SG&A was 15.3% of sales in Q1 of fiscal 2011, compared with 16.4% of sales in Q1 last year. Our target range for SG&A expense is between 16.1% to 16.6%. Our effective tax rate for the quarter was 37.5%. We expect our effective tax rate will be approximately 38.5% for the second quarter of fiscal 2011. Net income for the first quarter was $400,000, or $0.11 per diluted share, compared with a net loss of 700,000, or $0.21 per share, in the first quarter of fiscal 2010. Let’s now turn to the balance sheet . . . Cash and short-term investments increased by approximately $400,000, from $15.5 million at fiscal year end September 30, 2010 to $16 million as of December 31, 2010. The increase was primarily due to better accounts receivable collections and the contribution from net income, partially offset by [an increase in other assets/prepaid items] and capital expenditures. In addition, CSP purchased approximately $200,000 of common stock during the quarter. As we have talked about in the past, CSP’s cash position can vary significantly from quarter to quarter due to the high working capital requirements needed to fund large projects at both our Systems and our Services and Systems Integration segments. Going forward, our financial priorities remain the same. We will manage the company cautiously with a strict focus on controlling expenses and efficient working capital management, all while driving toward long-term profitable growth. With that, I’ll now turn the call over to Alex.

Thanks Gary. And welcome to our call this morning. We were very pleased with this quarter’s performance, which surpassed our expectations on the top- and bottom-line. I’ll begin by providing some context around the first-quarter results for both our Service and Systems Integration and our Systems segments, and discuss our growth initiatives for each. Then we’ll go right to your questions. Let’s start first with our Systems segment, which consists of our MultiComputer business. This business sells exclusively to the major prime contractors that sell to the U.S. Defense Department. The Systems business reported revenues of $1.8 million, a significant increase over the $0.5 million in the first quarter last year. $1.4 million was from high-margin royalty payments from Lockheed Martin related to the E2D Advanced Hawkeye intelligence, surveillance and reconnaissance aircraft. The payments were for aircraft being built as part of the Low Rate Initial Production Phase, or LRIP. As a result of the high-margin royalty payments, Systems gross margin was 82% for the quarter compared with 14% last year. We anticipate approximately an additional $200,000 in E2D royalty revenues for the remainder of the year, in line with the expectations we discussed on our last conference call. This will complete phases 1 & 2 of the LRIP. At this time, we are in discussion with our customer about phases 3 & 4 of the LRIP. Going forward, we will continue to invest in technology to position CSP to capitalize on the military’s focus on intelligence, surveillance and reconnaissance (or ISR). In addition, we are marketing two products we launched toward the end of last year -- our 3000 SERIES Open VPX and 4000 SERIES ATCA. The 3000 SERIES OpenVPX improves interoperability between computing and communications platforms and reduces customization, testing, cost and risk. The 4000 SERIES gives CSP an entry-level product for the first time, and we plan to leverage the 4000 SERIES to broaden our base of customers focused on ISR. Our Service and Systems Integration segment also began the year with a solid quarter. This segment includes our MODCOMP subsidiary and provides solutions and services for complex IT environments focusing on storage and servers, network security, unified communications and consulting and managed services. Sales were up 11% in this segment to $20.3 million, driven primarily by growth at our U.S.-based Systems and Solutions division (or SSD). The growth at SSD was the result of sales that were previously recorded as deferred revenue. This included revenue from our large hosting customer, as well as revenue from a luxury hotel customer we’ve discussed on prior calls. During the quarter we completed a major unified communication project for the hotel. Another positive sign is that we saw a number of customers that had not placed orders in quite some time, purchase from SSD during the quarter. Our double-digit sales growth in the U.S. offset a small decline in Germany, which was primarily due to unfavorable foreign exchange. Gross margins for the Service and Systems Integration segment grew by 300 basis points to 15%. This was due to a greater number of smaller, higher-margin deals in the U.S., as well as a larger portion of newer products that carry higher-margins and improved utilization at our services business in Germany. Our strategy in this segment is to enhance profitability by attracting a greater percentage of higher-margin consulting, as well as solutions and managed services business. You can see from our gross margin success that this strategy is working. We are particularly pleased with the success that we have had through our partnership with California-based nCircle, a provider of automated IT security and compliance auditing solutions. nCircle was selected to provide the infrastructure platform for MODCOMP’s managed services offering in addition to MODCOMP reselling nCircle’s on-premise solutions to customers in Germany. Right now we’re seeing significant opportunities with telecom operators seeking to upgrade their infrastructure. These companies are looking to us to help them load balance their networks to mitigate the heavy demand generated by the proliferation of smart phones. Last quarter we discussed how our nCircle partnership had resulted in a strategic account with Vodaphone, one of the largest mobile telecommunications network companies in the world. During the first quarter we increased the productivity of our consultants on contract at Vodaphone, and received a follow-on order for nCircle products and services from Swisscom, Switzerland’s leading telecom provider. Before we take your questions, let me leave you with a few thoughts. First, we are pleased with the progress of our strategy at our Service and Systems Integration segment to attract higher-margin consulting, as well as solutions and managed services business. Through this strategy, we expect to incrementally increase our margins over the long-term. Second, at our Systems segment, we are well positioned to capitalize on the military’s network-centric warfare priorities, as well as supporting the next LRIP phases of the E2D program. And third, in addition to organic growth, we are committed to accelerating revenues by executing on our acquisition strategy. With that, Gary and I will take your questions.