CSP Inc. (CSPI) Q2 2012 Earnings Report, Transcript and Summary

Good day, and welcome everyone, to CSP's Second 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 email. 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 is today is our Chairman, President and Chief Executive Officer, Alex Lupinetti. I'll take you through our second 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 the 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 filing with the Securities and Exchange Commission. With that, I'll review our second quarter financial results. We followed up a strong start to the year in Q1, with another solid quarter in Q2. Total second quarter sales increased 8% to $19 million from $17.6 million in Q2 fiscal 2011. This growth was driven by a 9% increase in Service and Systems Integration revenue to $16.7 million, while Systems segment revenue was flat year-over-year at $2.3 million. Foreign currency had a 2% unfavorable effect on revenue on a year-over-year basis. CSPI's total cost of sales for Q2 was up 7%, to $14.3 million on the 8% increase in revenue. As a result, gross margins for the quarter grew 11% to $4.7 million, and gross margins increased 67 basis points to 24.8%, compared with Q2 of 2011. The increase in gross margin was primarily due to higher royalty revenues recorded at the Systems segment. The second quarter engineering and development expense…

Thanks, Gary, and welcome to our call this morning. With another strong quarter in the books, we're increasingly optimistic that fiscal 2012 will shape up to be a great year. Our gross margins for the first half of the year are up year-over-year by about 90 basis points to 23.8%. This was due to higher systems royalty revenue and our focus on consulting, as well as solutions and managed services in the Services and Systems Integration segment. As a result, we've leveraged 5% sales growth year-to-date, into a 34% increase in net income. With that as an introduction, let me give you a quick update on what is driving our top and bottom line growth with our 2 segments before taking your questions. Let's talk first about our Systems segment, which consists of our multicomputer business. This segment sells primarily to the major plant contractors that sells to the U.S. Defense Department. During the quarter, we recorded $2 million in royalty revenue from Lockheed Martin with 3 E2D Advanced Hawkeye intelligence, surveillance and reconnaissance aircraft, as part of Phases 3 and 4 with a Low Rate Initial Production Phase, or LRIP. We've now received royalty revenue for 4 planes thus far, under the purchase order for 10 planes. On prior calls, we have discussed our expectation to receive a royalty revenue from the 10 planes, about evenly split between fiscal 2012 and fiscal 2013. However, we now expect that we could receive royalty revenue for at least 6, and possibly up to the entire 10 planes in fiscal 2012. Products and technology innovation are critical success factors for the Systems segment. Shortly after the close of the quarter, we introduced CSP's latest next-generation multicomputer. The TeraXP Embedded Server for OpenVPX with Intel Xeon processors. Essentially, this exciting new product future-proofs…

[Operator Instructions] Our first question is coming from Sheldon Grodsky of Grodsky Associates.

I'm relatively new in following the company. And this is -- well, one thing that's been confusing me a bit or bothering me a bit as the case maybe, I think you said on previous calls that the royalty income that you're getting from Lockheed Martin is essentially all pretax income. And then it looks to me that aside from that, that you're losing money. So just try to explain, if there's any confusion on my part, as whether that is all basically pretax profits, because that succeeds everything else, that you'll be losing money on everything else?

Well that's basically it's -- we have to look at the whole company. We can't segment that one piece. If you pulled that out, certainly it would have a dramatic effect. But this is a program that we've been built-in for years and we're looking for it to support the whole company, and its based on products that we build. And from that assumption, it's just part of our sales mix.

It doesn't come without the support of the company to get the business. You can't separate it out and say it will -- it's only a sure profit.

Why wouldn't Lockheed just buy you? It seems that the course of that royalty, that they're going to be paying, especially if this contract is extended to become a full-blown program, it would be cheaper to just buy all of CSP than pay the royalties?

That's an interesting question. We -- yes, it's interesting. I don't know the answer to that.

Our next question is coming from Brett Davidson of Investletter.

I just got a couple of questions here. Did both segments have positive operating income?

Yes.

So both of them, then during the quarter?

Yes.

Let's see, so maybe you can just clarify, the E2D shipments, there's been 4 so far this year, and the purchase order for 10, or LRIP 3 and 4, and the remaining 6, possibly could be billed for the remainder of this fiscal year?

Yes, the reason we've upped that is, we've been working with them, as you know for about 7 or 8 years and we've gone through the SD&D Phase and LRIP 1 and 2, and we based our forecast on their ability to produce this equipment. And up until now, their maximum production rate has been about 5 systems a year. Right now, they're producing at a higher rate. And if they continue on that path, it could well be maybe between 6 -- we're estimating, between 6 and 10. No guarantee of course, because that -- the production rate could change between now and October 1. But...

Have you guys received any indication yet that they're going to be putting out the purchase order for, I think it's LRIP 5?

It's actually -- no the full rate production, FRP will be next. Discussion have started on that. We expect an RFP by the end of the year, but we don't have it yet, and we've looked carefully at the President's budget to see what's included in there. And it looks like there's -- the full rate production is in there, and it could be up to 24 planes over the next 5 years, down from 31. But that's obviously all in the flux when you're looking at a 5-year budget at this point. And it does not include sequestration which is another cloud that's hanging out there. So all that aside, and these are the factors we deal with, we expect that we will be seeing an RFP, hopefully before the end of the year for the first part of the full rate production.

And maybe one more thing. Has any consideration been given to -- maybe dropping another dividend payment sometime this summer?

That's something Brett that we will review at the board meetings. We've talk about it every board meetings and we will take it under consideration.

Our next question is coming from William Gibson of North & Webster.

Just a couple of questions regarding the MODCOMP division. Can you guys breakout gross margin from that division for me?

Okay, it was 17% or 18%.

For the quarter it was 16%.

16% for the quarter, and what's the year-to-date? Okay, so that's the range though, it runs at between 16% and 18% on average, varies a little bit. 17% for the year, so far to-date.

Perfect. And can you guys comment on any M&A activity you guys are involved in right now? I know you guys had mentioned that you guys are always looking at acquisitions, can you mention that one, for now?

Not really, we don't have anything to report at this point. We are active in the market. We have people who we work with -- it's, to find the right thing for us. It's a tough search and it has to be strategic, it has to be accretive. It has to fit with what dealing with. We're not going to diversify anymore. So it is a needle in a haystack kind of exploration we're on. And when we got something that we think is -- we can talk about we'll let you know. But we're active, but obviously we haven't done anything in a few years. So, it takes time.

Our next question is coming from Vincent Staunton of Wedbush.

I'm just wondering if I can get operating profit for both the Systems segment and the Service and Systems Integration segment for the quarter?

Okay, Gary will dig it out.

And while he's looking for that, my another question is, the large hosting customer, what percent of revenue was it for the quarter? And do you have any outlook going forward on that?

I don't know the percentage for the quarter, but our outlook is improved, because we had such a big first quarter with them. At this point, we expect that we will, do at least as much as we did with them last year instead of -- our original thought process was that we might see a continuing decline in there because of the large competitor they acquired. But at this point, there's enough projects that we're working on, that we feel that, right now we will do as much as we did last year, which is roughly around $10 million.

So you might not have K&E [ph] reduction?

Yes, that's -- right now, we're expecting not too.

Okay.

It's $230,000 for the Service and Systems Integration, and $438,000 for the -- I mean the Systems operating profit.

[Operator Instructions] Our next question is coming from Will Lauber of Sterling Capital Management.

Yes, I guess I'm -- on those profits that you're giving out, that's not fully allocated with the SG&A, is that correct?

Yes, this is operating.

Yes, its operating. Yes, that's operating with SG&A.

Okay, but when you guys -- do you guys break it out -- the SG&A allocated to the 2 different businesses?

Correct.

Okay, what is that total for each of the businesses?

For the SG&A?

Yes, or the final bottom line on each side?

Well, the final -- you mean, at the net income level?

Yes.

Well the net income level is -- for the quarter was at -- one of the things I have Will is the tax allocation. I haven't found it on this sheet right now. We do it on a gross basis, the -- with the U.S. basis, going back and spread that back. So it's not a true reflection of -- what the tax number is. Consolidated U.S.

FFor Systems and MODCOMP.

For Systems and MODCOMP, included.

Okay, and how much of bonuses are you accruing for currently?

We don't give that out.

We don't really give that out right now. It's on a projected basis.

Okay, so is the bonus based off of the actuals versus whatever your plan was?

Right.

Okay, in the plan you have put in about 5 planes in there?

Sure.

Okay, will that be adjusted for next year? Because obviously, your going to beat that plan this year because of this -- the quarter orders are going to be accelerated and that's really at no doing of the management, would that be a factored into next year's budget, as well?

I don't understand what do you mean by next year's budget. I don't understand that process.

I mean, well for your bonuses, if you were budgeting 5 and you get 10, instead of 5 this year and 5 next year, you're going to get bonuses on 10. And that is really no doing of yourself and -- it was just basically, taking from next year. Would you -- next year in the plan will you put 5 planes in there, to make up for that?

We'll put what's ever in there that's going to be reasonably in the forecast. I mean it's -- we wouldn't load 5 in there unless there were 5 -- we had a purchase order for 5, or close to getting one for that.

I mean. I guess you understand what I'm saying is that, if you're going to get bonuses on 10 for this year, even though that you've -- you're management has nothing to do with that, that's something that you cannot control.

It goes both ways Will. There are years when we planned for 5 and get 3.

Well, I mean, there's no...

So it's -- this is -- you're into a theoretical situation here that -- I don't see where you're going with it.

Well I assume there is never any crawl backs.

Crawl backs?

Or that -- you don't ever have that give any money back if the plans go the other way, do you?

No.

They are 1-year plans, Will.

Our next question is coming from Daniel Zeff of Zeff Capital.

Thanks for a good quarter and for paying that dividend and buying back some stock. I appreciate it, as a shareholder. Have you -- first of all, do you expect to be profitable? And do you expect cash to increase on a year-over-year fiscal 2012 basis?

Yes. So cash is variable. Profitably definitely, it depends on how the accounts receivable hit at the end of the year. I mean I...

You should be cash positive.

It will. We were very -- yes, we're cash positive but we got very large customers, as you can see cause our accounts receivable over the last year or 2 to be quite large.

So it's timing of orders, to some extent.

Okay and have you considered a more aggressive shareholder actions in terms of seeking strategic alternatives, pursuing perhaps a Dutch [ph] tender offer, looking to sell the company, looking to sell parts of the company, based on your extremely low valuation?

Well, at least I'll have -- Dan these are always the things that we review. We reviewed them again at this board meeting, so we'll constantly looking for ways to create shareholder value.

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 third quarter call.

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