CSP Inc. (CSPI) Q2 2015 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to today’s program. At this time, all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Mr. Gary Levine. You may begin, sir.

Thank you. Good morning, everyone, and thank you for joining us. With me on the call today is Victor Dellovo, CSPI’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 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 this section on forward-looking statements included in the company's filings with the Securities and Exchange Commission. During today’s call, I’ll discuss our second quarter financials. Then Victor will provide an update on our business segments and on our strategic progress. Then we’ll open it up to your questions. Revenues declined 9.7% to $18.9 million from $20.9 million a year ago, reflecting lower sales in both the Technology Solutions and the High-Performance products. Foreign exchange had a negative year-over-year effect of $1.3 million. Our total cost of sales for Q2 was $14.8 million, down 6.2% with the prior year. Gross profit for the quarter was $4 million, compared to $4.1 million a year ago. Gross margins for the quarter were 21.4%, compared to 24.3% in the prior year. The decrease was primarily the result of recording $771,000 in royalty revenues last year and no plane royalty revenues this year, as well as lower Technology Solutions revenue. In the High-Performance Products division we recorded higher revenues from the current Myricom products, which offset the lack of revenue from E-2D royalties but obviously did not offset the margin effect. Second quarter engineering and development expense increased to $826,000 from $792,000 a year ago, primarily as a result of additional spending to develop new Myricom products. As a percentage of sales, Q2 engineering and development were 4.4% compared to 3.8% last year. We expect that our engineering and development expenses will range between 4% to 5% as a result of ongoing product development and initiatives to capitalize on the Myricom opportunity. SG&A expenses were $3.9 or 20.4% of sales, compared with $4 million or 18.9% of sales in the previous year. We expect that our SG&A expense will range between -- range 16.5% to 17.6% going forward. The effective tax rate for the quarter was 12.1% which was lower than the estimated rate due to higher tax rate in Q1, no tax benefit for the losses we recorded in the U.K. due to the fact that we have full valuation allowance against our deferred asset. The prior year tax expense was higher due to higher income in Germany. We expect that our tax rate going forward will be approximately 44% for the year. We reported a net loss of $675,000, or $0.19 per share, compared with net income of $676,000 [sic] [$167,000], or $0.05 per diluted share a year ago. Cash and short term investments decreased to $9 million from $16.4 million a year ago at year end. The decrease was primarily due to the change in working capital which includes accounts receivable, payable, inventory and other current assets, loss for the six months, payment of dividends and foreign exchange. Lastly, our board of directors voted to pay a quarterly dividend of $0.11 per share to shareholders of record on May 29, 2015 payable on June 10, 2015. We aim to improve our bottomline performance by focusing on our growth initiatives, increasing the level of high margin products and aligning cost containment across the organizations. I’ll now turn the call over to Victor.

Thanks, Gary. Our Q2 results were soft as expected. Given that we do not foresee any royalty revenue from the E-2D until the second half of fiscal 2015. That said, we continue to execute against each aspect of our long-term growth strategy. Myricom is performing better than expected and has a good potential to help us smooth out the lumpiness inherent in the High-Performance Product division. In the Technology Solution division, we made good progress in growing our managed service pipeline. We expect it will enable us to increase our margins in recurring revenue based on the long term. With that, I’ll get right into the segment review, starting with our High-Performance Product division. Revenue decreased 17.9% in the quarter compared to last year, driven by a decline in multicomputer revenue as a result of the lack of royalties compared with a year ago. Once again, we posted a stronger quarter for Myricom’s current product suite, which we initially had expected to decline over time. Sales of these products have surpassed our expectations and our sales force is being very aggressive in continuing to drive demand. The real opportunity for Myricom, however, is with our next-generation products. We made significant investment in developing of these new products to capitalize on opportunities in the new commercial market. As we have stated before, we see Myricom as an opportunity to expand our commercial market reach and help strengthened a high-performance product division. Keep in mind that these new products are focused on entirely new market for us. So there will be no cannibalism with our current products. The fourth generation of Myricom network adapters we introduced last week are focused on financial service market where they will used in high-frequency trading and packet capture market, which will enable customers to monitor what is happening in their network at very high speeds. Our new Adapter Technology delivers new and unique domain specific functions and provide a quick path to 100-gig solutions. We expect sales of these products to ramp up as we flow products through the channel. We anticipate recording meaningful revenue from the next-generation products in the fourth quarter of this fiscal year. Regarding the E-2D, we continue to expect revenues for five planes this fiscal year. We anticipate recording revenues for three planes in Q3, with one of those having already shipped in April and two planes in Q4. The revenue we recorded in Q2 was primarily from large international defense customer. Again we are confident that Myricom provides us with an excellent opportunity to reduce the topline volatility in the division. Let’s turn now to our Technology Solution. TS revenue in the quarter were down 8.2% year-over-year due to lower sales at our German subsidiary in U.S. In Germany, our pipeline of managed services offering continued to grow. Demand is very strong and we are encouraged by the fact that we are in the running for increasingly larger deals. At the same time, our managed service deals are not closing as definitely expected or would like. Managed services has a much longer sales cycle than our legacy business, but the payoff will be well worth it. When these deals begin to close, we’ll have an increasingly larger recurring revenue stream and higher margins add our traditional sales in the business. Two years ago, we had virtually no managed service revenue. Last year, we invested in backend systems and software to manage our customer’s infrastructure as well as enhancing our engineering talent. So, we are looking forward to capitalizing on those investments. We’ve had recent success in closing deals for our installation and service around Microsoft Office 365. We are capitalizing on the growth trend towards cloud-based computing as large enterprises rely on us to move the Microsoft Office applications from the internal exchange server to the cloud. We have an excellent staff of engineers on board in Germany with particular expertise in security, where we expect the demand flow will be the greatest for the foreseeable future. In that area, we are analyzing our customers’ networks and helping them to prevent hackers from getting in. We are looking forward to continue to build our pipeline, closing and increasing the number of deals and improving the productivity of our new engineers. We expect that managed services will continue to be a key revenue in earnings generated for us in the back half of the fiscal 2000 and on. Our U.S. business marries our Germany operations in many ways. We have incredible talented engineers and excellent opportunities in the market. We are well positioned to capitalize on these opportunities and increase the productivity of our engineering team. And as we have mentioned before, we are leveraging our engineer resources across all of our locations. Before we go to questions, let me sum up a few things. First, from a financial perspective, we are glad to have the first half of 2015 behind us. We had expected the first two quarters to be soft on a year-over-year basis due to the timing of the E2-D revenue, the ramp-up of our managed service pipeline and the launch of a schedule for the new Myricom products. Second, while our financial results were not impressive, we accomplished a great deal from a strategic and operational perspective that sets us up for the second half of the year and on. In the second half of the year, we expect to receive royalty revenue for five E2-D planes, providing a significant benefit to both the top and bottom line. In addition, with the launch of our new Myricom products, we expect to see revenue from the business incrementally ramp up through the year. And finally, we have significant upside at our Technology Solution division, once the deal in our strong managed service pipelines starts closing at a faster rate. So, we are very enthusiastic about our prospects going forward. In addition, we remain committed to enhancing shareholder value through the continuation of our dividend policy. With that, Gary and I would be happy to take your questions.

[Operator Instructions] Our first question is from William Kidston from North & Webster. Your line is open.

Good morning, gentlemen. Just a few questions this morning. Can you guys break out operating income for the two segments, Technology Solutions and High Performance Products?

Sure. For the three months period, the operating income for the High Performance or loss was $647,000. For the Technology Solutions group, it was a profit of $8,000. For the year-to-date, the income was a loss of $1.5 million for the High Performance Products and $56,000 for the Technology Solutions group.

A loss of $65,000 for the Technology Solutions?

$56,000.

$56,000. Okay. Thank you. And can you guys just break out the revenue for those two divisions and then can you also break out the Myricom revenue from the High Performance Product segment?

The revenue for the first quarter, for the High Performance was $2.6 million and the revenue for the Technology Solutions was $16.2 million. And for the six months period, the revenue was $5.3 million. And for the technology solutions division, it was approximately $34 million. And the question, the Myricom for the six months period was $4.3 million and for the quarter, it was $1.8 million.

What kind of margins is Myricom driving for you guys?

About 47%, 48%.

47%, 48%. And you guys have been investing heavily in that segment, hiring more engineers, sales people, etcetera since you made the acquisition.

Yes, we have. Yes, both on sales, engineering people, internal and external outsourcing, and we also -- in management also in that area.

Perfect. And so you guys are -- I guess a higher level questionnaire, you’re projecting positive net income for the next two quarters at least because of the royalty revenues?

That in the -- improvement in the segments themselves to see that both the business segments will do better in addition to the growth.

Sure. All right. Well, that’s all I have, right now. I will back out. I do have a couple more questions if no one else is on the line.

Okay. You go ahead.

Perfect. So engineering and development expense two years ago was $380,000. This quarter I think it was north of $800,000. Is that all directly related to the Myricom acquisition? Has E&D expense and the legacy portion of the HPP segment gone down and Myricom has grown even more? Can you just discuss that a little bit for me?

You are correct. Really we are focusing on the Myricom products. We are supporting our existing products in the MultiComputer division, but developing new products in that area we see that the real growth is the potential with the Myricom products. And that’s our strategy and tactically, that’s what we are rolling out. So we expect to have a much more future benefit from that division.

Yes. And that our R&D expense we believe will continue only because we are looking to have a lifecycle of products not just one. So that’s the first of many we hope as time goes on here.

Can you guys just comment a little bit about the cash balance? A couple of years ago we were pushing $20 million, now it’s down to $9 million. Equity during that time has also fallen. Can you comment a little bit about the confluence of events here? The company has lost money the last two years. And we’re really hoping that you guys can write the shipping. Can you provide some color around kind of what strategic initiatives you guys are undertaking to kind of drive topline and focus less on the royalty stream from the legacy defense contract?

Yes. I think that’s -- Bill I think that’s basically the direction we are, right. And then with the investment in the Myricom which is a higher margin business, we’re going towards the heavy service content within the technology solution to get the margins up. Obviously the cash has been affected with the foreign exchange, the drop within the euro and the pounds, and that has affected us to some degree, as well as we will be making money which will start to get monies back into the profits. It’s been just a difficult six months for us. So when you are losing, you got losses, that has certainly affected us but the foreign exchange too has also hurt us.

But the last two years we’re on losses. We made money in both of those years. Just to clarify, I think you said we had lost last two years. So the first half of this year, we said early just because of the playing the second half would be better. And then also we need to invest in the company for the future. So that’s what we’re doing now with the Myricom acquisition, year ago, November and we will continue to do that.

Sure. That’s very helpful. So equity is falling by close to $4 million. You guys just attribute that to the high dividend payout ratio?

Well, I think the dividends, we’ve had some large -- with the pension adjustment because of the discount rates have effected that, so that you get other things flowing through at least, the equity from other comprehensive income. So, we've had some of those effects and obviously looking at those so yes. But dividends certainly is part of that. But we're trying to be return something to the shareholders.

Sure. Sure. And that’s understandable. All right. Well, I don’t have anything else. I appreciate the time as always, gentlemen and good luck next quarter.

Thank you.

Thank you.

[Operator Instructions] Our next question is from Joseph Nerges from [Segrum Investment] [ph]. Your line is open.

Good morning, gentlemen. Good morning. How are you today?

Good morning, Joe.

First one is a quick accounting question. Do we know how many E-2D planes have been delivered to this point? How many planes have we received royalties on?

One.

So, I’m talking about….

Year-to-date.

No, no. I’m talking about from beginning of the program to now. Do you remember how many, have we actually had royalties of what, 10, 15 planes?

No. More than that. Curtail it, Joe, I don't know off the top of my head. We have it but I just don’t have…

20 plus, right.

Yes.

I would say 20 plus.

At this point, we’ve got 20 plus, not counting the five year. You’re not counting into five that we didn’t get yet.

Correct.

Correct. Yeah.

Okay. And you are -- the remainder of the contract that was signed last year with the government was for, I believe what 25 planes through fiscal year 2018.

18. That’s correct.

That’s correct.

And of that 25, how many have been delivered, do we know? How many that we’ve received royalty? Let’s put it that way.

I think that of that -- I think we've got -- but they were 5 -- 5, I think.

Five last year and one this year. Okay.

I think there are six total. Five last year and then the one that we got in April.

One that we got that we didn’t -- it’s not in this…

Not in this quarter.

No. Not in this quarter.

Not in this quarterly before

Yeah.

Okay. And of course, I’m assuming you realize that the government adjusted that contract in March of this year for an additional plane.

Right.

And you were that, right?

Yeah.

So, I guess you had a total of 26 planes, 25 planes.

Correct.

25 planes.

Yeah.

Okay. That’s a good question on that accounting area. Let’s go to Myricom. Let’s call it Myricom.

Yeah. Myricom.

The adapter that was announced last week, are you saying that adapter was specifically designed for both the financial services as well as the packet capture market?

Yes.

So, additional adapters will be released over the course of -- I assume the next three to six months.

Yes. And we are hoping to get another version out. If everything goes well with beta testing, it’s hard to exact but we are looking at the July timeframe give or take.

Okay.

And it will continue with the 10-gig release now and our goal is to get to -- as I mentioned earlier, to get to the 100 gig into the market space, which we believe the market starting to accept that type of technology. So we’re hoping to get our product in a timely manner out to meet that need.

Yeah. The card released last week was for the 10 gigabit card.

Right.

That’s correct.

And you’re looking to release 100 gigabits down the road.

Yeah.

To accept that market.

Yeah.

So if you mentioned and this is in past conference call is we’re developing next-generation products to target new specific vertical markets. So you are -- some of these cards are -- some of these adapters are going to market that we haven’t had addressed in the past? Is that what you’re saying?

Yes. These cards the way we develop software that we are hoping to get most of that software on each and every one and then we tweak it to the different verticals. We are hoping 75% to 80% of the investment we’ve made on the previous cards, we could take that to the newer generation to fit all the verticals.

I see. What are we -- do we have idea on the kind of the type of market volume that we are shooting at in this market? How big market is this adapter? What you are -- is it a $50 million year market, is it $100 million year market or do you have any idea what you are -- what we are looking at down the road?

I think each one is a little different. I think the packet capture is probably the largest market and probably, I'm guessing it’s in hundreds of millions and we are looking to capture a percentage of that. Hopefully, if we could enter that market space and get into 10% to 50% of that initially we would be happy with that. I think the high frequency trading space is a little bit smaller. There’s only a few players that play in that space and we are one of them. It’s smaller but Myricom has a great reputation over the years. So customers are willing to talk and beta our product. So with that being said, it would be basically taking it from the competition which is our ultimate goal.

Very good. And one more for you, your newest hire that you announced about a week or two ago…

Yeah. Yeah.

… I think like he has got a terrific background in this segment, anyway.

Yeah.

And I am assuming he has got some pretty good context that we are -- at the market that we are particularly shooting for and as well as we are hoping to shoot more in the future?

Absolutely. That's why he is on Board. Not for only his knowledge of the market but also his contacts and his aggressive nature, let’s put it that way.

Very good. Thank you very much. I appreciate the time and good luck. It sounds like this could be a real winner for us down the road.

That’s what we are counting on, yes.

Thanks for your support Joe.

Thank you.

[Operator instructions] Our next question is from Brett Davidson for Investletter. Your line is open.

Good morning Gary, Victor.

Morning Brett.

Hey Brett, how have you been?

Not too bad. I got a question regarding E-2D. Has any of the foreign contracts on the E-2D, any hint that might filter down? Any discussions?

Yeah from -- its only -- it’s going to be a variation and I don't think the variation of those planes they are going to include us from my understanding.

Got it. The 25 plane order runs out to 18 or whatever the year that it runs out. Has there been any movement and the next order for planes out past that point in time yet or is that way too early?

Way too early.

Way too early.

Damn.

Yeah. We know we are hoping it will go longer, but no indication one way or the other.

Well, I think the indication you’ve been on -- I think its not to upside this -- the initial production of these planes are going to be 75 units. So I take it with the 25 order and the planes that are shipped before that were up somewhere in the 45, 50 range.

Yeah.

On about right?

Yes, correct.

All right. So yeah…

We are hoping -- your evaluation is the same but we can’t guarantee that. We are hoping that it’s going to go longer for the next five or six years past that. But just based on when they are starting a new plane, it would take so long but there’s still no guarantee. I can’t comment to that but we are hoping. And our analysis is sometime we’ve looked at the same way.

Everything that comes across the internet regarding E-2D, it’s getting great reviews so.

Yeah, very positive.

Quite full of. The normal lifecycle of these planes is -- I got a pretty long lifespan. So I would expect that we are going to see more orders down the road but I guess we’ll see that when we get there.

Exactly.

And regarding Myricom, you guys had indicated that you are expecting significantly more revenues later in the year. Could you add just a little color to that?

Well, with the new product we just released that, as you know. We were hoping to get out a little bit earlier but through beta testing it was delayed a little bit. So we have some inventory in hand and we are hoping to flush out that inventory by the end of the year. And the legacy Myricom product, we thought there would be somewhat of a decline over -- considering the product was developed in 2005. But we haven't really seen any of that at this particular point. It’s going to happen sooner or later but we haven't seen that decline in the legacy product yet. So we are hoping if both continue, the new product does what it’s suppose do, which we are confident. And we’ve already got a couple of orders for the new product. So if that continues through the rest of Q3 and Q4 and the legacy stays where it’s at, we should have a good quarter again in the rest of the next five or six months.

I mean, are you looking at the gains of 50%, 100% over the revenues of the past quarter. I mean is that just way too optimistic at this point for some like the fourth quarter?

Yes, way to optimistic. It’s too early still.

And some of the sales cycles Brett on this product take a while. There is some of the customers are OEMs and those kinds of things. So you get accepted in the product, but it's not going to be released for a while. So they're not instantaneous.

So you're dealing with OEMs and not necessarily with…

Some of them. We are trying to look at both market segments where we're selling direct in some cases. But the big opportunities are in the OEMs. If we can get our products spect in, then every time they sell their product our boards are part of that. So we are looking at -- Vijay has a lot of, which is a new hire has a lot of experience with the OEM. So that’s’ what we are targeting to get developed in the OEMs product, which as Gary said. So a little longer sales cycle, but you're in there for a long time. And like I said every time they sell their product, we’re part of that.

Okay. I was looking more towards the lines of the high-frequency traders where money for something like that has literally no object.

Right.

Right. And that’s what we see the quicker increase in sales in that marketplace and that’s kind of why we came to market with their product first.

Got it.

All right. Thank you very much.

Thank you, Brett.

Have a good day, Brett.

You too. Bye-bye.

And next we do have a follow-up question from Joseph Nerges from [Segrum Investment] [ph]. Your line is open.

Just one more follow-up, guys. A number of years ago Myricom said it had a partnership agreement with Emulex, is that still in place? And Emulex of course is just bought out the last couple of weeks, do we know if that’s still in place at the agreement?

No, it’s not. It’s hasn’t been in place since the acquisition.

Yes, right. So, was that a considerable amount of business or something we lost now or?

We never had it. Joe, we were never part of that, that relationship was gone before the acquisition a year ago, November.

I know it was back in 2012 let’s put it that way. That’s one of the announcement on that. I didn’t know they were still dealing with Emulex?

Yes.

Thank you very much. I appreciate the time, guys.

No problem.

Good luck. Go forward.

Thank you.

Thank you.

And we have no further questions at this time.

Thank you for joining us today and for all your support of CSPI. We look forward to speaking with you all again in our Q3 call.

This does conclude today’s program. You may now disconnect at anytime.