CSP Inc. (CSPI) Q3 2012 Earnings Report, Transcript and Summary

Good day. And welcome everyone to CSP's Third 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 that 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, operator, and good morning everyone. With me on the call today is our Chairman and President and Chief Executive Officer, Alex Lupinetti. I'll take you through our third quarter financial results, 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, I'll review our third quarter financial results. We reported another excellent quarter with revenues increasing 19% to $22.4 million. On our top line growth was driven by a 120% increase in Systems segment revenue to $3.3 million and a 10% increase in Service and Systems Integration revenue to $19.1 million. Foreign currencies had a $1 million unfavorable efffect on revenue [F&O] on a year-over-year basis. On a constant dollar basis, sales would have been up by $4.6 million or 24%. CSP's total cost of sales for Q3 was up 13% to $17.1 million on the 19% increase in revenue. As a result, gross margins for the quarter grew 44% to $5.2 million and gross margins increased 400 basis points to 23% compared with last year. The increase in gross margin was primarily due to royalty revenues recorded at the Systems segment in Q3 2012. Third quarter engineering and development expense was about flat at $444,000 compared with a year ago. As a percent of sales, engineering and development expense was 2% of sales compared with 2.4% last year. Engineering and development expense was slightly lower than our target range of between 2.2% and 2.6% of sales. SG&A expenses increased slightly to $3.6 million in the quarter from $3.5 million a year ago, due to increased commissions, bonus accruals because of higher gross margins and operating results. SG&A as a percentage of sales declined to 16% from 18.4% on a year-over-year basis. SG&A is slightly lower than our target range of between 17.9% and 18.6%. Income tax expense was $400,000 compared with a benefit of $90,000 last year, as a result of a loss we reported in the prior-year period. We expect our effective tax rate would be approximately 38% for the fourth quarter of fiscal 2012. Net income for the third quarter was $774,000 or $0.22 per diluted share compared with a net loss of $214,000 or $0.06 per share in the third quarter of fiscal 2011. Now let's turn to the balance sheet. Cash and short-term investments increased 13.6% to $18 million from $15.9 million at year-end. The increase was due primarily to higher net income and the increase in accounts payable and accrued expenses, higher deferred revenue, a decrease in inventory and depreciation and amortization. This was offset by an increase in accounts receivable an increase in other assets and prepaid items and the purchase of PP&E, the dividend payment and the negative effect of foreign exchange. We announced this morning that the Company's Board of Directors declared a special cash dividend of $0.12 per share based on CSP's strong balance sheet, financial conditions and concerning the Company's working capital needs and potential investments and strategic growth opportunities. At the close of year-end fiscal 2012, the Board will evaluate CSP's financial performance, balance sheet strength, working capital requirements to determine the amount of an annual cash dividend, if any. Going forward, the Board will regularly evaluate the best use of cash to build long-term shareholder value. We continue to manage the Company with a strict focus on controlling expenses in an efficient working capital management while driving towards 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've turned in a very strong performance in Q3 with solid increases in revenue, margins and net income. Fiscal 2012 is shaping up to be an excellent year. Year-to-date, revenue is up 10% with significant growth from both the Systems and Services and Systems Integration segments. Gross margins are up 240 basis points as a result of higher royalties in our Systems segment. Our operating income is up by 225%, net income by 240% and earnings per share $0.49 is up 277% from last year. We're very pleased with this performance and we look forward to culminating the year with another strong quarter. With that as an introduction, let me give you a quick update on what is driving our top and bottom line growth with our two segments before taking your questions. Let's talk first about our Systems segment, which consists of our MultiComputer business. This segment is sold primarily to the major plant contractors that sell to the US defense department. As Gary mentioned, Systems segment revenue was up 120% to $3.3 million in the quarter. During the quarter, we recorded $2 million in royalty revenue from Lockheed Martin for three E2D Advanced Hawkeye intelligence, surveillance and reconnaissance aircraft as part of the phases 3 and 4 of the Low Rate Initial Production Phase or LRIP. We have now received royalty revenues for seven planes thus far under the purchase order for a total of 10 planes. As a result, we now expect to receive royalties for between eight and ten planes by the end of the fiscal year. You may remember that based on the DOD schedule and Lockheed Martin's production rate during LRIP one and two, we set our expectations to recognize royalties for five planes in fiscal 2012 and five in fiscal 2013. However, it now appears that Lockheed Martin has significantly increased their production capability and will complete LRIP 3 and 4 in one year instead of two years. In addition, we recorded revenue in Q3 for shipments of 3000 Series multicomputers to an international sonar customer. FastCluster 3000 Series multicomputers are designed for deployment in harsh environments where performance and processing density are critical. Turning now to our Services and Systems Integration business, which includes our MODCOMP subsidiary. This segment provides solutions and services for complex IT environments focusing on storage and servers, network security, unified communications and consulting and managed services. We also had another great quarter in Services and Systems Integration. The 10% growth in this segment was driven primarily by our German subsidiary with a contribution from the UK as well. With a non-favorable foreign exchange effect of $1 million, the increase would have actually been 17% on a constant dollar basis. This growth was partially offset by a sales decline in the US, primarily as a result of lower sales to our large hosting customer. As we've previously discussed, sales to this customer are project based, so revenue is inherently lumpy. The overall demand environment continues to be good in the US. We discussed our recent successes in winning large university networking contracts and this success continued in Q3 with yet another win. We have additional universities and other large institutions in the pipeline and we expect this to be a good growth area for our US business. We also continue to be successful in finding new hosting customers. And two such companies contributed to revenue in Q3. In Germany, we began working with a new specialized network integrator and sales for this company significantly contributed to our growth in the quarter. We also continued to grow sales on a year-over-year basis to Vodafone, one of the large mobile telecommunication network companies in the world. As we have discussed, we are consulting on the build-out of the infrastructure for the Global Security Operation Center or GSOC. We expect this to continue through the end of the fiscal year. Our focus on winning higher margin consulting as well as solutions and managed services business also continues to be successful. We expect better leverage out of this business going forward as newly hired service engineers get up to speed and are billable. Looking at the Services and Systems Integration segment overall, sales for our large customers continue to be robust and we expect strong demand for the end of the fiscal year. We're also continuing to build a good pipeline of new university hosting and other commercial businesses. To summarize before we go to Q&A. First, I'd like to say how pleased we are to be able to declare a $0.12 special dividend to CSP shareholders as a result of our excellent performance thus far in fiscal 2012 and our strong balance sheet. Second, Q3 was another strong quarter for CSP both for Systems and our Services and Systems Integration segments. And finally, going forward while we are watching the global economy closely for any potential effects on our business, we expect to end the year with a strong Q4 performance. With that, let's go to your questions.

[Operator Instructions] Our first question comes from William Kidston with North & Webster. Please proceed with your question.

Good morning, gentlemen. Just a quick question regarding the special dividend here. How did you guys settle at $0.12 a share? I know previously you had been declaring an annual dividend of $0.10 a share. Can you give us some color on the Board's stock process there? And also that dividend is $410,000 due to the last share count and you guys are reporting 18 million on the balance sheet. Just a little color around the special dividend thought process? Thanks guys.

Well, I think we looked at the strength of our balance sheet, working capital requirements the same thought process we use on the annual dividend and we wanted to make it special, so we discussed what the right amount would be and we still have about $0.12 that wasn't -- we don't have any special algorithm we use. We just look at all the factors we look at when we are making the decision on a dividend. -

Okay. And just one quick follow-up. You recorded revenues for three planes this quarter. And you guys are, I guess, expecting one to three planes next quarter. What's the outlook for fiscal 2013, if you can give that to us?

We don't really have a firm handle on that at this point. I mean there's a lot of things up in the air with potential sequestration and other factors affecting the defense department. But next year we'll defend them. Whether or not those one to three come in this year, if they don't they would be -- whatever doesn't come in this year, we hopefully have next year assuming everything stays fairly status quo relative to the budget. Otherwise, the next thing we're looking forward to is the production phase to start. With the current phases we have been in for the last couple of years was the Low Rate Initial Production phase. And then if everything goes forward, then we'll go into the production phase and build up to 75 planes. We don't expect that could be a big piece of revenue next year. Again, if things stays on schedule from what we've seen, and it's very early at this point, then it would start kicking in again fairly strong in '14. But, that's way too preliminary to make any forecast or even estimate what kind of revenues it's going to be.

All right. Well, thanks guys and I'll back out for other people to ask some questions.

[Operator Instructions]Our next question comes from Vincent Staunton with Wedbush. Please proceed with your question.

Can you give a breakdown of what the operating profit was for each segment for the quarter?

For the quarter, the profit in the Systems segment, we had profit of $874,000 for the Systems segment and $331,000 for the Service and Systems Integration segment.

What would profit have been in the Systems Integration business if you exclude the effect of foreign exchange?

I haven't calculated that, Vincent. I don't have that right off hand. I can get that and get in touch with you.

Okay. And can you give like some color on what you see going forward in the Systems Integration business?

Sure. I think that we have a very good strategy right now. We've got very strong partnerships, particularly in our security -- network security in the practice. And our biggest challenge is hiring up engineers to drive the business. To give you a feel for that, in Germany which is our biggest operation from a professional service perspective, we've just hired eight new people but we're getting them up to speed, as I said in the script, and we expect to get a lot more leverage out of them going into the next year as they become billable. So it's a tough market for people and that's what drives this market right now. But, we have an attractive Company that people want to work for and we're successful in getting them. It just takes a little time. But right now, the demand for our services is very strong. We're in the right segments of the markets; virtualization, consolidation, network security, unified communications and we're just driving forward on that. And like I said, the big challenge is getting enough qualified people both in the US and Germany, in the UK to be able to grow faster.

Okay, great. Thanks guys.

Our next question comes from Brett Davidson with Investletter. Please proceed with your question.

Good morning. It was a very welcome sign this morning to see the announcement of the dividend and I was also looking to have a little color added to that. In a similar quarter with similar earnings, would it be reasonable to expect, and let me qualify this, in a quarter where there's no perceived better use for the cash but would it be reasonable to expect the dividend somewhere similar size?

I think we call it special because each one would be unique to me. I'm not going to give you the idea that this is going to be a standard thing. I mean each one will be looked at individually and discussed and we'd come up with a Board decision for it. That's where I'd leave it I mean at this point. I mean it would depend on whatever potential uses of the cash there is at the time.

And I got just one other question. The pension liability drop, have we -- has that number peaked and it's going to start showing a steady decline now?

From that standpoint, we got to go through the valuation, Brett, and take a look at it. I really can't answer that, because we've just -- we've got an accrual that we're putting an end and payments are going out and some of it is related to the currency adjustments. So it's really the year-end is the one to look at and see where we are when we go through the actuarial reports valuations.

Would that sort of fit with changes in the workforce and are the folks that are under that frozen benefit, are they beginning to leave the workforce and starting to collect benefits and…?

Yeah, there are increasing each year, Brett, but the plans are frozen. So there is no more people going into it. So it's just accruing on the interest side of the thing. There's no service numbers going into the calculation.

Do you have a feel for how many of those participants in that plan are active and how many have left the workforce?

We have the numbers but I couldn't give it to you off the top of my head. But I can give you a percentage if you'd like me to contact you with that.

Yeah, I'll give you a buzz that'll work good. Thank you very much.

At this time, we have reached the end of the Q&A session. I would turn the conference back over to Mr. Alex Lupinetti for any closing or additional comments.

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

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