CSP Inc. (CSPI) Q4 2014 Earnings Report, Transcript and Summary

Good day, and welcome, everyone, to CSP's Fourth Quarter 2014 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 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. Victor Dellovo; and Chief Financial Officer, Mr. Gary Levine. At this time, for opening remarks and introductions, I would like to turn the call to Mr. Levine. Please go ahead, sir.

Thank you. Good morning, everyone. Thank you for joining us. With me on the call today is Victor Dellovo, CSPI's Chief Executive Officer. Before we begin, I would like to remind you that during today's 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. During today's call, I will discuss our fourth quarter financials. Then Victor will provide an update on our business segments and on our strategic progress. Then, we will open it up to your questions. As a reminder, early in 2014, we renamed our reporting segments to more accurately and clearly reflect the operating businesses in those segments. Our Systems segment is now called the High Performance Products & Solutions segment. This segment includes our MultiComputer business, as well as our new Myricom acquisition. Our Service and Systems Integration segment, which includes our Myricom business is now called Information Technology Solutions. Let's take a look at the financials for the quarter, starting with the income statement. Revenues were 19.7 million compared to $21.9 million a year ago, reflecting lower sales in the Information Technology Solutions segment. Foreign-exchange had a negative year-over-year effect of about $42,000. Our total cost of sales for Q4 was $14.6 million, down from $17.1 million in the prior year, as a result of the lower volume. Gross profit for the quarter was $5.1 million compared to $4.8 million. Gross margins increased 26% from 22% in the prior year, as a result of a greater mix of high Performance Products & Solutions segment revenues and $0.6 million in royalty revenues versus no royalty revenues last year. Fourth quarter engineering and development expenses increased to $1.1 million from point $0.6 million a year ago, primarily as a result of the Myricom acquisition. As a percentage of sales, Q4 engineering expense was 5.6% compared to 2.7% last year. We expect that our engineering and development expenses will remain in a range of 3.1% to 4.3% as a result of ongoing product development and initiatives to capitalize on our Myricom opportunities. SG&A expenses were $3.9 million or 20% of sales compared to $4.2 million or 19.3% of sales in the year ago quarter. On a dollars basis, the lower SG&A expense was due to lower commissions and bonuses expenses in the Information Technology segment, primarily offset by higher expenses in High-Performance Products & Solutions segments due to the Myricom acquisition. Going forward, we expect that our SG&A expenses will be in a range of 10.7% to 11.9%. The tax expense for the quarter was $71,000, due to the changes in the deferred taxes and the year-end adjustments. The prior year fourth quarter had a tax benefit of $66,000 for the years adjustments in the deferred taxes. We expect that our overall tax rate going forward to be approximately 41%. We reported a net loss of $78,000 or $0.02 per share compared with a loss of $8,000 and a breakeven per share a year ago. Cash and short-term investments decreased by $2.2 million from the year-end. Key factors included payment of dividends of $1.5 million, a $0.6 million for capital equipment and $0.5 million for the acquisition of Myricom. We will continue to focus our growth initiatives while improving our bottom-line performance by increasing our level of high-margin products and maintaining a focus on cost containment across the organization. I will now turn the call over to Victor.

Thanks, Gary. We made excellent progress on our growth strategy in fiscal 2014. We are excited by the promise of growth and customer diversity from Myricom, which we acquired and integrated into the High-Performance Products & Solutions segment during the year. We also took great strides in positioning CSP to increase margins and recurring revenue by growing our managed service business. From a financial perspective, we grew net income by 263% in fiscal 2014 to $1.3 million and a 3% decrease in revenue. We are pleased with the bottom-line accomplishments, especially given the significant investment we are making in the business for future growth. With that, I will get right to segment review, starting with the High-Performance Products & Solutions segment. Revenue in the segment was up $1.5 million to $4.2 million in the quarter. As Gary mentioned, this growth was driven by revenue contribution from Myricom, which we acquired in first fiscal quarter. Our Myricom acquisition is performing well as a result of continued success of its legacy products. We are seeing greater potential from Myricom, and we are making significant investments to capitalize on these opportunities. For example, we have established a product roadmap based on extensive market research and we are developing next-generation products to target new vertical segments. We expect to begin shipping beta products around the mid-fiscal 2015, with the products really beginning to get into the channel as we proceed during the year. Meaningful revenue should begin in fiscal fourth quarter, in line of this effort, we hire an additional High-Performance Products and Solutions sales person to cover New York area, where we see potential opportunities in the high-frequency trading market. As Gary mentioned, we expect that our continued investment in Myricom will result in greater penetration of the commercial space and will help us significantly smooth out the lumpiness we have historically seen in a High-Performance Products and Solutions segment. Myricom has the potential to be a real homerun on for us in the long-term. We recorded royalty revenue from one E-2D plane in Q4, which represents six for the year, exceeding our expectations. We started discussion with our customer related to production for 2015. At this point, we expect to receive revenue for five planes next year, all in the second half of our fiscal year. Longer-term, we expect significant opportunities as the production of the E-2D continues through fiscal 2018. Let's turn now to our IT segment. Segment revenue in the quarter were down $3.6 million year-over-year to $15.6 million. The year-over-year reduction in sales was primarily due to lower shipments to our hosting customers at our U.S. subsidiary. We have been focused on acquiring engineering talent to enable us to capitalize on managed service opportunities. During the quarter, we added a total of eight engineers who were immediately put to work on opportunities in our pipeline. We expect that the managed service will be a key revenue and earnings generated for fiscal 2015. In the U.S., we have changed the commission structure for sales force to provide incentives to capture managed service opportunities. In addition, we have enhanced and expanded our sales force with specific managed service expertise. In addition, to keying in our managed service opportunities, we are also focused on cross-selling between our businesses around the world. Some of our success in the year in the U.K. has come from client accounts in the U.S. and Germany. We are gaining increased traction from cross-selling and revenues are becoming more consistent from this effort. Before Gary and I go to your questions, let me summarize by saying that we are confident that we on the right course for long-term profitability and growth. We have excellent opportunities to build a recurring revenue model at IT Solutions and we are seeing the initial success of our efforts to focus on high margin managed service business. We are also gaining traction on our efforts to increase revenue by cross-selling between our businesses. At our High-Performance Products and Solutions segment, we are growing and diversifying revenue by increasing our percentage of commercial customers. To do this, we are investing in product development at our Myricom business, where we see excellent growth opportunities in a number of vertical markets. We expect the growth of this business will help smooth out our revenue in those quarters that had softer sales from the military side of the business, which inherently lumpy. For example, as we discussed, we expect that all of the E-2D royalty revenue for fiscal 2015 will be in the second half of the year. To make all this happen, we have also upgraded our management, sales and engineering talent across CSP. As a result of this investment we are when making in the business and the execution of the strategy, we expect to have stronger growth and greater profitability over the long-term. In the meantime, we are remaining committed to driving shareholder value, including the continuation of the dividend policy. With that, Gary and I will take your questions.

Yes. Thank you. We will now be conducting a question and answer session. [Operator Instructions] We can take our first question from Brett Davidson with Investletter. Please go ahead. Your line is open.

Good morning, gentlemen. I have a couple of quick questions for you. The first one is, Mr. Dellovo, maybe you could add some color to the R&D spending. I will just throw out my second question. The second is regarding the E-2Ds. Do you guys have any kind of color whatsoever as to whether the Japanese plane orders are going to filter down to CSP?

No. On the second question, we have no insight on that. On your first question, the R&D increases as we a acquired Myricom, the product that we acquired along with the inventory was a legacy product, has it been checked there had been no changes of the last two to three years, so with that being said the market space for that is in the tens of millions, so we are investing on the next-generation and trying to capture that with the customer that we currently have an opening up to new ones both, here in the U.S. and overseas.

Thank you very much.

[Operator Instructions] We can take our next question from Joseph [indiscernible]. Please go ahead. Your line is open.

Hello? Joe

[Operator Instructions] We can go next to Joseph [indiscernible]. Please go ahead. Your line is open.

Yes. Let me follow-up on that first question. I am assuming that Brett meant, there are some orders for Japanese planes E-2D planes. Is that correct? Do you know anything about that?

No. We don't have any information on that at all.

Well, okay. A follow-up to this then, if - because I do know they are trying to solicit foreign orders for the E-2D planes…

Yes.

I am assuming that any E-2D plane that is delivered, we would be in line for the royalties, whether it is a foreign or U.S. order. Is that correct?

That would be correct.

Conceptually, yes, but have not been - our customer has not told us anything.

Well, I understand, but I do know they are soliciting orders from foreign countries.

Yes.

All I want to know if we are in the mix for sure. Let me just ask one other follow-up question. That is - weakness in your IT group in the U.S., maybe I am mistaken, but are you not - with all hacking that has been going around and the problems with the major corporations being hacked by from wherever in the world, are you not being solicited at all to help a lot of these companies and maybe securing their data centers? Why are we not getting more activity from that or are we pursuing that at all?

We are developing more in that security area, where Germany in that location has been security-centric for years. Hiring talent in building their practice is something that we have been doing over the last six to nine months. As you know, those sales cycles are not short by any means. The pipeline is good. Right now, our strongest practice has been in the wireless area, which we continue to invest in and also the recurring revenue model and the managed service piece of it. We had a staff up for that, but those sales cycles are not short either. You know, it can take anywhere from three to nine months - an opportunity there, but the good thing is once you close those deals, they are usually multi-year deals and you have that recurring revenue model.

Okay. Just one more follow-up, the eight engineers that are employed, are they all U.S. are they all over the world, the eight new engineers that you said you just added.

Both places, both in the U.S. and Germany.

All right. Thank you very much.

You are welcome.

Thank you.

[Operator Instructions] We can take our next question from William Kidston with North & Webster LLC. Please go ahead your line is open.

Good morning, gentlemen. Just a couple of quick questions regarding Myricom. Can you break out the revenue from that acquisition of the last quarter as well as the gross profit dollars that he has realized?

Yes. Well, the revenue for the year was $6.7 million and the margin was approximately 47% on that. In the fourth quarter, the revenue was $2.1 million.

What is the operating profit in that segment, if you have it for the year as well and for the quarter that would be great?

Well, we don't break it. I mean, we keep. It is a product group and it is part of the High-Performance group. We don't really break it out at as a segment from that side. It is included. We are now running as a separate company, so it is basically just a product on that the CSPI name.

Okay. Can you then an break what the operating profit for both segments would be for High-Performance and for the IT Solutions?

Yes. The operating for, what, the fourth quarter or.

Yes. That would be great.

Okay. For the IT segment, the operating profit loss was the $26,000 and for the High-Performance group that was $69,000 in the fourth quarter operating.

Yes. Thank you. Can you just talk a little bit about - I know you don't provide guidance at all, but can you discuss a little bit about what you are seeing for both segments kind of three to six months here. I know you guys are not going to realize any royalty revenue set for the next two quarters it sounds like related to E-2D for the HPPS segment, but if you would just a little color on kind of the industry outlooks for both of those.

Myricom side of the business, the pipeline is good. We are making a big shift to where it is more service-driven. We have been doing that. We see that in the numbers. With that being said, the sales cycles are a little longer and the revenue recognition pieces of it are coming more into play now, where until the projects are completely signed off. We can't recognize that revenue, but the pipeline overall is strong. We brought us some sales people that have been targeting the managed service piece of the business. On the Myricom side, our customers are currently still sending us purchase orders and they are waiting the new generation of products for beta, so we are optimistic that once the beta goes out, that it will keep the revenue that Myricom has been driving, you know, it will continue in the future.

Yes, but there will be some run-off in the legacy business over the period of time, so there is going to be a be a ramp up period, so there could be a little bit of the degradation within the High-Performance group. Most of the MultiComputer business is backhanded as we said.

Right. All right, so the elephant in the room, are you guys going to make money next quarter and the quarter after that, because you are not realizing any royalty revenues?

We are going to do our damnedest, but it is going to be difficult.

All right, I will back out. Thanks guys.

Have a good one.

It appears, we have no further questions at this time, so I will turn the program back over to our presenters for any additional or closing remarks.

Thank you for joining us today and for your support of CSPI. We look forward to speaking with you again in the New Year.

This does conclude today program. Thanks for your participation. You may now disconnect.