CSP Inc. (CSPI) Q1 2012 Earnings Report, Transcript and Summary

Good day, and welcome, everyone, to CSP's First Quarter Fiscal 2012 Conference Call. Today's call is being recorded. The financial results news release is posted on the website at www.cspi.com, for those of you who did not receive it by e-mail. Later, we will be conducting a question-and-answer session. [Operator Instructions] With us today are CSP's President and Chief Executive Officer, Mr. Alex Lupinetti; and Chief Financial Officer, Mr. Gary Levine. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Levine. Please go ahead, sir.

Thank you, Jackie, 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 we -- may be deemed to be forward-looking under the Act. 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, 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 filing with the Securities and Exchange Commission. With that, I'll review our first quarter results. We started the year off on solid footing with a strong margin and net profit performance on a slight year-over-year increase in revenues. The total sales were $21.1 million compared with $20.6 million in the first quarter a year ago. The 2% increase in revenue was driven by a 29% increase in Systems segment revenue to $2.3 million, while our Service and Systems Integration was flat over year at $18.8 million. Foreign currency did not have a meaningful effect on revenue on a year-over-year basis. CSP's total cost of sales for Q1 increased 1% to $16.3 million from $16.1 million in Q1 2011. As a result, gross margins for the quarter grew 7% to $4.8 million and gross margins rose 100 basis points to 23% compared with Q1 of 2011. The increase in gross margin was due to a higher service revenue mix at our Service and Systems Integration segment. For Services were 26% of revenue in Q1 2012 versus only 20% in Q1 of 2011. This was partially offset by a $400,000 decline in Systems segment royalty revenue compared with the year ago quarter. First quarter engineering and development expense decreased to approximately $383,000 compared to $510,000 a year ago. As a percentage of sales, Q1 2012 engineering and development was 1.8% of sales compared to 2.5% last year. Our target range for engineering and development expenses is 2.2% to 2.5% of sales. SG&A expenses increased to $3.7 million in the quarter from $3.4 million a year ago, as a result of increased commissions, bonus accruals because of higher gross margin and operating results. SG&A was 17.4% of sales in Q1 of fiscal 2012 compared with 16.4% of sales in Q1 last year. Our target range for SG&A expenses is between 16.3% to 18.4% of sales. Income tax expense was $269,000 compared to $233,000 last year, as a result of higher net income. We expect our effective tax rate will be approximately 35% for the second quarter of fiscal 2012. Net income for the first quarter grew 19% to $461,000 or $0.13 per diluted share compared with net income of $389,000 or $0.11 per diluted share in the first quarter of fiscal 2011. Now let's turn to the balance sheet. Cash and short-term investments decreased to $14.6 million from $15.9 million at year end. The decrease was primarily the result of an increase in accounts receivable offset by net income, a decrease in inventory, an increase in deferred revenue and an increase in accounts payable and accrued expenses. I should note that in the current second quarter, we'll be paying out approximately $342,000 in an annual dividend. Going forward, we plan to manage the company with a strict focus on controlling expenses and efficient working capital management while driving towards a long-term profitable growth. With that, I will now turn the call over to Alex.

Thanks, Gary, and welcome to our call this morning. We reported a strong quarter with 17% growth in net income, on a 2% increase in revenues. We're particularly pleased with our margin and bottom line performance, given that we actually reported significant less in Systems royalty revenues in Q1 2012 than we did last year. This demonstrates that our strategy to generate more high-margin Services revenues that our Service and Systems Integration segment is working. With that as an introduction, let me give you a quick update on our 2 segments before taking your questions. Let's first talk about our Systems segment, which consists of our multicomputer business. This business sells primarily to the prime contractors that sells to the U.S. Defense Department. During the quarter, we shipped a $700,000 order for our FastCluster 3000 SERIES multicomputers for an international sonar customer. FastCluster 3000 SERIES multicomputers are designed for deployment in harsh environments, where performance and processing density are critical. We also received a $1 million in royalty revenue from Lockheed Martin for the first E2D Advanced Hawkeye intelligence, surveillance and reconnaissance aircraft, as well as spare parts, as part of Phases 3 and 4 of the Low Rate Initial Production Phase or LRIP. We received a purchase order for 10 planes and we expect revenue for this deal to be recognized during fiscals 2012 and 2013. As we have discussed on prior calls, the E2D is a perfect example of the military's focus on intelligence, surveillance and reconnaissance or ISR. There's been much discussion about potential military cuts, we are certainly watching that carefully, but all indications are that ISR is exactly the type of technology that the military will be spending more on in years to come, not less. We continue to invest in technology to position CSP to capitalize on this trend. For example, I mentioned on last quarter's call that we had introduced our next-generation FastCluster 3000 SERIES OpenVPX multicomputer with converged fabric. This product was designed for military high-performance embedded computing platforms that require high bandwidth and scalability across boards and systems. One ideal ISR platform with converged fabric multicomputer is the unmanned aerial vehicle or UAV. We're optimistic about the prospects of this product based on the positive response from customers we've been receiving since the introduction. Turning now to the Service and Systems Integration segment, which includes our MILCOM subsidiary. This segment provides solutions and services for complex IT environments focusing on storage and servers, network security, unified communications in consulting and managed services. I mentioned at the outset of the call that our results this quarter demonstrate the success that we are having thus far in our strategy to grow the higher-margin segments of our business, such as consulting, as well as solutions and managed services. The 600-basis-point increase in Services revenue from Q1 of last year that Gary mentioned, is a real testament to that success. At our U.S. subsidiary, we reported significant revenue from our large hosting customer that we have been discussing on the last few calls. Sales to this customer have proven to be rather lumpy from quarter-to-quarter. In Germany, revenues were primarily driven by sales to Vodafone, one of the largest mobile telecommunications network companies in the world. Right now, we are providing consulting services on the buildout of the infrastructure for their global services operations center or GSOC. The GSOC provides network security for Vodafone's 30 operating companies around the world. We expect significant revenue from this project as deployment continues through Q2. Our sales to Vodafone underscores the success we have had with our partnership with nCircle, which provides automated IT security compliance auditing solutions. nCircle provides the infrastructure platform for MODCOMP's managed services offering in addition to MODCOMP reselling nCircle's on-premise solutions. MODCOMP is also providing both intrusion detection and intrusion prevention solutions to Vodafone with technology from both Sourcefire and Imperva. So to summarize before we go to Q&A. We began fiscal 2012 with a strong Q1 performance. We are particularly pleased with the success of our Services strategy, it enabled us to report strong margin and net income growth this quarter. While we started the year off well, we are still relatively cautious about fiscal 2012. Given the uncertainty surrounding macroeconomic factors particularly in Europe, and the unpredictability of sales from our large hosting customer. At the same time, we are encouraged by the continued growth in higher-margin services at our Services and Systems Integration segment, and the expectation of royalty payments relating to E2D throughout the year and beyond at our System segment. Finally, as Gary mentioned, we are pleased to pay out the annual dividend for the current second quarter fiscal 2012 in order to reward and generate value for our shareholders for their commitment to the company. With that, let's go to your questions.

[Operator Instructions] Your first question is coming from Vincent Staunton of WEDBUSH.

In terms of the large hosting customer, what was the revenue from the large hosting customer this quarter as compared to the prior year quarter?

It was $5.2 million this quarter. We're going to look that up, it was up over last -- the first quarter of last year, I got it here somewhere.

And what are your expectations going forward on the large hosting customer revenue?

It's very difficult to forecast that because their customers change all the time. I mean the downsizing that we saw over last year was because they've lost a very large customer, it was a social networking company that decided to build their own infrastructure, they had used them to build up to a certain point, so they were reusing a lot of the equipment that was bought for that 1 social networking company. And since it's hard to predict, we don't have insight, a view of their customer pipeline. So this first quarter was very good and our view for the year is positive -- is more positive than might have been before the first quarter, but it's just very difficult to give you a specific answer, because they don't tell us.

Okay. But this is the same company that bought your competitor, right?

Yes it is. Yes, and we haven't seen the total effect of that at this point. Maybe what we're seeing now is what's going to be, but we are prepared for the worst than that, and it's obviously, we're doing pretty good. Well, Gary?

Yes. Sales were $2.5 million compared to last year.

Our next question is coming from Brett Davidson of Investletter.

I have a couple of questions I'm looking for a little clarity on. First one is, has there been any revenue received for the E2D Hawkeye that relates to LRIP 3 or 4?

Yes. It was a -- just a little under $1 million in the quarter.

So that was for 3 or 4? It wasn't for any...

Yes 3 and 4, it's [indiscernible].

Now I think in the past, you guys have announced that the royalties amount to about $650,000 per plane?

Yes.

And this quarter, $1 million was reported. Maybe you can provide a little color on that?

Yes this quarter included a 1 planes worth of royalty as well as some spare parts that they built, and we actually get the royalty on some spare parts. So that was the differential.

Oh, okay. So it was just 1 plane then?

Yes, 1 plane.

Got you. And recently it's been reported that Northrop received the contract for long lead materials and related support for Lot 1 of the full-rate production of E2D, and I'm just trying to get a handle on when you guys would normally receive a purchase order? Would it be during this portion of the contract or is it some later portion that you guys will get a purchase order, Gary?

It will trickle down. We saw that same announcement. We're still trying to get clarity on it, talked about 31 planes by 2019 and we don't know that's 31 in that lot or 31 including the LRIPs, so we'll keep you posted on that as we learn more.

Yes, my understanding is that, that's going to be 7 in the first lot of full-rate production. I'm not quite sure why they funded for 5 of it, but like I said, my understanding is there's going to be 7 total.

Okay. We'll let you know when we hear with our -- when we're going to get turned on for that.

Our next question is coming from Sheldon Grodsky of Grodsky Associates.

I want to know if I can get additional information on royalties. You said you're getting about $650,000 per plane. What did you provide -- what technology I assume did you provide that you get the royalty for?

We provide a license, it was based on license agreement, it goes back several years now, where we partnered with Lockheed Martin for them to take our design and build, it was quality inflection [ph], cooled version of it, which is a much more rugged version than we were providing at the time. And for that, every time they build a processor board or a chassis, all the parts that go into making up a system, we receive royalties for that. And the complete shift set as it's called, for 1 plane equals about $670,000 of royalty.

How long is that program likely to continue?

Well we -- it hasn't gone into full production yet. We've been through the systems design phase, the pilot phase, and now we're into the third and fourth phase, of what's called a Low Rate Initial Production. And then full production is scheduled to follow for up to 75 planes, and the details will come forth as they get budget approval for certain lots of those planes.

And that sounds like it's a pretty big item for you in the future, if they actually take 75 planes?

Yes, it's very large.

[Operator Instructions] There are no further questions at this time. I'd like to hand the floor back over to management for any closing remarks.

Thank you for joining us today. We look forward to speaking with you on our Q2 call.

Thank you.

And that concludes our conference. Thank you all for joining us today.