CSP Inc. (CSPI) Q2 2013 Earnings Report, Transcript and Summary

Good day, and welcome, everyone, to CSP's Second Quarter 2013 Earnings 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. [Operator Instructions] With us today are CSP's President and Chief Executive Officer, Mr. Victor Dellovo; 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.

Good morning, everyone. Thank you for joining us. With me on the call today is the Victor Dellovo, CSP's Chief Executive Officer. Before we begin, I'd like to remind you that during today's call, we'll take advantage of the Safe Harbor provisions of the Private Securities and 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 can 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 filings with the Securities and Exchange Commission. During today's call, I'll start by reviewing our financial performance in the second quarter, then Vic will provide an overview of our 2 operating segments and the progress we made on our growth strategy. Then we'll open it up to your questions. We reported a very strong second quarter, revenues increased 36% year-over-year to $25.8 million, and net income was up 67% to $740,000. The effects from foreign currency was negligible. On a diluted per-share basis, we achieved $0.21 in Q2 of 2013 compared to $0.13 a year ago. All of our top and bottom line growth came from the Service and Systems integration or MODCOMP segment of the business. Our Systems business continues to experience significant market headwinds. CSPI's total cost of sales for Q2 was $20.1 million compared to $14.3 million in Q2 of 2012. Gross profit for the quarter increased to $5.8 million from $4.7 million as a result of the higher revenues. Gross margins declined to 22% from 25% due to a lower mix of products from the Systems segment, which typically carry higher margins. In addition, in the second quarter of 2012, we recognized $2 million in Systems segment royalty revenues compared with no royalty revenues in Q2 of 2013. Second quarter engineering and development expense was $380,000 compared to $474,000 a year ago. As a percentage of sales Q2 2013, engineering and development expense was 1.5% compared with 2.5% last year. The reduction was due to lower consulting and material expenses with the development of next-generation of product for the Systems segment. Going forward, we expect to be in a target range for engineering and development for 2013 between 2.4% to 2.7%. SG&A expenses were $4.2 million, or 16.1% of sales, from $3.6 million, or 18.8% of sales, in the year-ago quarter. The real dollar increase was due to higher commissions and headcounts in the Service and Systems Integration segment. Our second quarter SG&A was within our target range of 14.5% to 16.2%. We're continuing to maintain a vigilant focus on cost control, and we are constantly reviewing every aspect of the business to ensure that we are operating at the most efficient manner possible. I think it's important to point out that the SG&A line includes $286,000, or $0.08 per share, in costs associated with our proxy contest earlier this year. Our income tax rate in the quarter was 38%. Provision for income tax was $457,000 compared to $191,000 in Q2 2012 due to the change in the mix of revenues between Germany and the U.S. We expect our overall tax rate for Q3 to be approximately 40%. Cash and short-term investments decreased from $20.5 million at fiscal year end to $15.3 million at the end of the second quarter due primarily to the increase in accounts receivable. The increase in accounts receivable is the result of a greater mix of revenues from large customers with extended terms and the large sales volume at the end of the second quarter. We also paid out $700,000 in dividends in the first half of the year. We are very pleased to announce that the Board of Directors has voted to enhance the shareholders' value by increasing our quarterly dividend from $0.03 per share to $0.10 per share, beginning with the third quarter dividend payment. This reflects the board's confidence in our long-term prospects and commitment to shareholders. Before I turn the call over to Vic, I'll summarize by saying that we performed very well in the second quarter, with excellent contributions from the Service and Systems Integration segment. We also continue to make progress in the execution of our growth strategy, and some of the earlier progress is evident in our financial results. I'll turn the call over to Vic to provide you with an update on that progress.

Thank you, Gary. We see significant growth potential for CSP and are confident that we have the right strategy to unlock the value in our company. As Gary mentioned, we have made progress and are starting to see some results evident in our financials. However, while we have taken steps in the right direction, we have much work to do and significant opportunities to pursue. Let's begin our discussion of operations with our Systems segment, which consist of our MultiComputer business. This business sells primarily to major prime contractors that sells to the U.S. Defense Department. Systems segment revenue was flat at $2.4 million. As expected, we reported a sequential increase in Systems revenue due to a strong sales to international customers in our second quarter. However, the sales in Q2 of a year ago included $2 million of royalty revenue from the E2D Hawkeye intelligence, surveillance, reconnaissance aircraft, while we recorded no royalty revenue this year. Therefore, our gross margin was down significantly year-over-year. The sequential continuing resolution is having a negative effect on our Systems segment performance as we expect it will continue in the near term. On our last call, I mentioned that we had started to see activity related to Lot 1 of full rate production for E2D. At that time, we were responding to customer calls, and I'm very pleased to report that parts are on order for Lot 1, which is now in full rate production as expected. These parts should be shipped in this fiscal year, and we will receive royalties on these parts in fiscal 2014. We expect Lot 1 to include production of 5 planes. Lot 2 through 6 have not yet been approved, but we expect those lots to evolve 32 to 37 planes through fiscal 2018. We're continuing to develop our system sales capabilities to implement our cross-selling strategy. As you may recall, we plan to cross-sell our Systems segment MultiComputers with our Service and Systems Integration software and services to become a more of an end-to-end supplier to our legacy customers, as well as to new customers and new markets. Our segments have historically operated through mutually exclusive businesses with completely separate products and customers, but we're now leveraging the capabilities in our Services Systems segment to enable our Systems segment to become a single source solution for defense, government and commercial customers. We've had excellent feedback from our customers and expect to see results from this initiative when our sales force is fully trained, and we'll see some decisions on sequestration and continuing resolution. Now turning to our Services and Systems Integration segment, which includes our MODCOMP subsidiary. This segment provides solutions for -- and services for complex IT environments focusing on storage and service, network security, unified communication and consulting and managed services. As Gary mentioned at the outset of the call, we continue to perform very well in this segment. Service and Systems Integration business revenue in the quarter increased 40% year-over-year to $23.4 million. Sales were primarily driven by very strong demand in our U.S. subsidiary, as well as a solid growth in Germany. As we've discussed, we've been ramping up our marketing efforts and working with manufacturers to obtain sales leads. We've also been adding to our sales force during the past few quarters. We are starting to see those activities come to fruition, and a good part of the growth this quarter came from new customers. Looking at our vertical markets, we're seeing excellent demand coming from our traditional hosting customers, which we expect will continue. Additionally, we're generating increasing sales from the health care verticals, which mainly include hospitals and medical diagnostics and medical billing company and from academic institutions. For example, we recently announced that we have been selected by Broward College for a multimillion dollar project to provide a total network solution for all its campuses and learning center environments across Broward County, Florida. We replaced Broward's old network infrastructure to support today's complex needs and to enable the college's staff to properly manage and control every aspect of the environment serving 65,000 students and faculty. The project includes equipment installation, training and ongoing support for the college's IT staff. We're also starting to get some traction from new customers to our Network Operations Center, or NOC. Having a NOC is a competitive advantage for us because it enables us to monitor their networks and proactively take care of any issues. Sales from the NOC are not material, but we expect the recurring sales would begin to escalate quickly. Our gross margin performance at our Service and Systems Integration was also strong, increasing 200 basis points to 18%. Across the segment, virtually all our sales are project-based and now have some service component. This includes either project management, presell services and integration services. While our gross margins can be lumpy from quarter-to-quarter in this segment, our strategy to sell more higher-margin services is working and is evident in our results. Another component of our strategy is to become a global partner to our customers by cross-selling between MODCOMP geographic locations. We have global customers with various network, security, unified communications and storage and server needs in different parts of the world. We've already seen results from this strategy as our U.S., Germany and U.K. subsidiaries leverage their customer relationships to cross sell. Before we take your questions, let me provide you with a brief summary. We performed very well in the second quarter and in the first half. As we've discussed previously, we expect a challenging year-over-year comparison in our Systems segment due to royalty revenue we recorded in fiscal 2012 from E2D and the headwinds we faced in the fiscal 2013 selling our end-to-end solutions to government customers as the result of sequestration and continuing resolution. At the same time, we're seeing strong demand from commercial customers from the MODCOMP end-to-end solution, and that business has been able to essentially fill the performance gap from the Systems side of the business. We remain enthusiastic about our new growth strategy, and we are making the necessary investment and changes across organization to execute on the strategy effectively. And with that, Gary and I would be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Brett Davidson with BCIA.

I'd like to say that the results this morning were nothing less than shocking. What have you guys been eating for breakfast? And don't change it. Can I assume that things have changed a little and that we expect to end the year with positive net income?

I think we expect to end this second half of the year is going to be challenging.

Maybe you could expand a little bit on the Broward College deal. Can you give me an idea how that fits in with the normal margins for that division? I mean, is this a little bit higher margin? Is there going to be revenues coming in on a yearly basis for management of that system?

At this particular point, that hasn't been addressed. We will integrate it into the new campuses, get it all laid out and then that will be a different conversation. So moving on, year-after-year [indiscernible] show you, to be honest with you.

But there's an opportunity that it's a possibility?

It's an opportunity, absolutely.

And the margins on that, is that somewhat higher than what would normally be seen because of the nature of installation? Or is that...

It might be somewhere in the -- a little bit higher but pretty much in line only because there's a lot of products driven there. It's millions of dollars of products, and there are services involved. But the ratio isn't as high, of course.

Got you. And maybe -- Gary, maybe you could comment on the operating leverage. And is this an indication in this quarter -- what could be seen as far as operating leverage with revenues in this range?

Well, as I said, I think there are some challenges. I think that, obviously, the Systems side is going to be more difficult. The results we're experiencing certainly in the Service and Systems Integration has been very good. And I think that as the new sales people start to ramp up, those things will continue. We just have to see what's going to happen on the government side. I mean, that's still very, very slow.

Got you. And I'd also -- I know that some of the board members are probably on. I'd like to congratulate them. I think the increase of the dividend, the $0.40 a share is an excellent decision and going to reward and make a lot of shareholders very pleased. So I'd like to thank you for that, and congratulations again on a great job. And I'm sure there was a lot of support people behind you guys, and they deserve a healthy congratulations also. So thank you very much and talk to you guys.

[Operator Instructions] We do have a question coming from the line of Michael Hess [ph], a private investor.

I was just wondering if you guys can give us any guidance. I'm sure the answer is no, but I would love it if you could give us some guidance either on how things are going into the next quarter or for the rest of the year in terms of backlog or earnings or revenues or however you'd feel comfortable.

Well, I think we're having some discussions on those things, and I think we'll be commenting on that sometime in the future. But we're having some discussions and taking a look at that, and we'll try to get out there and give you some more information relative to that. I think at this point, we're looking at a lot of different things, and there's a number of balls in the air. So I don't think we're in a position today to offer really much guidance, I think, because the challenges within this quarter since the Systems group were not going to have any royalty income. And right now, we're just getting a number of things ramped up in the Service and Systems Integration with some new opportunities. So we will probably have something for you in the future.

Wonderful. And what form would that take? Would you come out with a press release or maybe the next quarterly call or...

It will probably be in the form of a press release, that we would release it and then we would be available to comment to shareholders who would call in and try to just give some more information. We've heard what the shareholders are saying, and we try to give our best efforts to give them some more information. Obviously, we've listened to you, and I think that's one thing the board is taking action relative to the dividends and things like that. So we're very open to comments from shareholders.

Thank you. At this time, we have reached the end of our Q&A session. I would now turn the conference back over to Mr. Dellovo for any additional remarks.

Thank you very much for today, and I look forward to speaking with you again on Q3 call.

Thank you.

Thank you, ladies and gentlemen, and that concludes our conference call. Thank you for joining us today.