CSP Inc. (CSPI) Q4 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.

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 would 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 risk includes 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'll discuss our fourth quarter and year-end financials and Victor will provide an update on our business segments and our strategic progress. Then we'll open it up to your questions. For the year, revenues increased 5.5% to $89.3 million, with unfavorable foreign exchange rates having a negative effect of 5.4% or $4.5 million. For the year, we generated a loss of $210,000 or $0.06 per share. For the quarter, revenues increased 40% to $28 million. Foreign exchange had a negative year-over-year effect of 6.6% or 1.3 million. Our total cost of sales for Q4 was $21.8 million, up 48.3% compared with the prior year. Gross profit for the quarter was 5.9 million compared to $5.1 million a year ago. Gross margins for the quarter were 21.3% compared to 25.8% in the prior year. The decrease was primarily the result of an increase in lower margin business in the U.S. and Germany, and we also had lower services revenues in the U.S. We take an action in both the U.S. and Germany to expand and enhance our managed service offering in order to improve the performance of those businesses. Fourth quarter engineering and development expenses decreased to $521,000 from 1.1 million a year ago, primarily as a result of planned turnover of our engineering personnel as we hire talent that is in line with our strategic initiatives. As a percentage of sales Q4 engineering and development expenses were 1.9% compared to 5.6% last year. We expect that our engineering and development expenses will range between 3.5 to 4% of sales as a result of ongoing product development initiatives to capitalize on the Myricom product opportunities. SG&A expenses were $4.3 million or 15.6% of sales in the fourth quarter, compared to 3.9 million or 20% of sales for the same period in the previous year. Based on our planned investments over the next 12 months, we expect SG&A expenses in the range of 17.8% to 18.2% for fiscal 2016. The effective tax rate for the quarter was 43.5%, due to higher income in the quarter with no tax benefit for the loss recorded for the UK due to the fact that we have a full valuation allowance for our deferred tax asset. We expect that our overall tax rate going forward will be approximately 40%. We reported net income of $653,000 or $0.19 per diluted share compared with a net loss of 78,000 or $0.02 per share a year ago. Cash in short-term investments decreased to $11.2 million at year-end 2015 from 16.4 million a year ago at year-end 2014. The decrease was primarily due to a $8.2 million increase in accounts receivable as a result of high levels of sales received late in the quarter at the U.S. Technology Solutions division, as well as a strong Q4 in Germany compare with a year ago, which was partially offset by an increase in accounts payable of $4.5 million. Lastly, our Board of Directors voted to pay a quarterly dividend of $0.11 per share to shareholders record on December 31, 2015, payable on January 11, 2016. Altogether, we have returned $1.6 million to shareholders during fiscal 2015 by the way of dividends. We're aiming to improve our bottom-line performance by focusing on growth initiative, increasing the level of high margin products and aligning cost containment across the organization. I'll now turn the call over to Victor.

Thank you, Gary. We ended fiscal 2015 with a solid fourth quarter, with the exception of the UK all of the divisions performed well. The UK geography is still a work in progress with new leadership and a strategic plan in place we're confident it's heading in the right direction. The keywords for the recent concluded year was most certain change. During the year we entered to a positive change in both products and services we provide our customers, most is related to more robust managed service portfolio and new products in the high performance products division to take us into a new commercial market. We also significantly upgraded a high percentage of our personnel across the globe in sales, engineering and management in order to better capitalize on the growth potential in front of us. With that, I'll get ready to our quarterly segment review starting with the High Performance Products or HPP division. We decreased revenue by 12% for the quarter as we received royalty revenues for two E-2D planes as expected, compared with one plane in Q4 of last year. We also recorded revenue in Q4 from a large international defense customer. Looking ahead to next year, our expectations is to receive royalties from five planes in fiscal 2016. Myricom’s historic product suite also continues to perform very well and ahead of our initial expectations. As you may remember, we had expected these products to do client overtime, which has not been the case. The Myricom acquisition has been arousing successful financially and strategically. The strategic opportunity for Myricom is with our next-generation of products, which have the potential to expand the commercial markets and be a primary growth driver for the HPP in the coming years. As we mentioned last quarter, we began to ship Alpha versions of our new 10 gig packet capture products at the end of Q3 and expect to ship Alpha version of the 100 gig packet capture products in the second quarter of 2016. Everything is proceeding according to plan with the launch of the products which offers more functionality than the competition at a significantly lower price. Market traction is very positive and we're excited about the potential of this product. Our second generation suite of HPP products are network adaptors for the financial service markets, primarily used in high frequency trading. Potential customers are providing positive feedback about the product characteristics and its value proposition. As we have mentioned last quarter, the sales cycles would be lining up with these products as customers using Linux service are waiting for their next sever refresh cycle to install the network adaptors. Additionally, a transformational product such as this takes time with the amount of testing necessary, so meaningful revenue from the financial service products will take a little bit more time than packet capture products. Turning now to our technology solution division, quarterly revenues are up 48% year-over-year. This includes a negative foreign currency impact of 1.3 million or 8.3%. Let’s walk through the TS geographies businesses starting with Germany. We have a particularly strong expertise in penetration testing which is where we analyze our customers’ networks and help them to identify weakness and prevent intersection from hackers. A large piece of our German revenue comes from penetration testing and this continues to be a very strong market for us. We continue to seek more engineers in penetration testers to support the growth that we are seeing in the business, while growing the penetration testing market our core strategy continues to be to increase high margin revenues from managed services. During the second quarter of fiscal 2015, we announced a multimillion dollar managed service contract with an international IT service company, a large to-date, this engagement is to provide end-to-end managed service and managed security service is going very well we are now speaking them about contract renewals. Our managed service sales pipeline continues to grow and we are very encouraged by our future prospects. When these deals begin to close at a greater frequency we will have increasing larger recurring revenue stream and higher margins than our traditional sales in the business. In addition to managed services we are also focused on increasing product revenue with higher margins. Our overall margins in Q4 were negatively affected by large volume, low margin product sales to major customers. We believe cross-selling services across geographies will also help generate growth in our German TS division. We made significant progress on this initiative during the past year and our revenues generate from cross-selling as well dramatically off of a relatively small base, but more importantly we have established a strategic foundation from which to accelerate the progress of this initiative in 2016. A critical change we made in the past year was to consolidate management of the German and UK offices. Frank Puetz is now overseeing the UK business as well as Germany and as a result we will be better able to identify opportunities in direct engineering resources in a more efficient manner across geographies. In the U.S. our MSP pipeline has grown significantly and we are continuing to add new customers particularly for installation and services around Microsoft Office 365. We are capitalizing on growing trends towards cloud-based computing as large enterprise are large enough to move their Microsoft Office applications from internal sync service to the cloud. Overall our backlog of closable order is the highest in more than any year and our engineering team is exceptionally well qualified and highly billable. We are also hiring a second full time sales person to focus exclusively on MSP opportunities in the U.S. In terms of products we've released two new add-on MSP software products that appear to be changing the game and our ability to attract customers. Before we go to questions let me sum up. As I mentioned at the outset, we instituted dramatic changes in fiscal 2016 to position CSPI for growth. As we proceed in fiscal 2016, we now have to execute on the strategic plan and build on the solid foundation we established. In the high performance product division we are making progress with our next generation products for Myricom and expect to see meaningful revenue from our packet capture products as we proceed through the year. And as I mentioned we anticipate royalty revenue from 5 E2-D claims this year. In our technology solution division we plan to increase revenue on a global basis from our managed service offerings which we expect to be an excellent driver of growth in recurring sales for the long-term. And of course we remain committed to enhancing shareholder value through the continuation of our dividend policy. Fiscal 2016 promises to be an exciting year for CSP and we look forward to reporting our achievement to you as the year progresses. With that Gary and I would be happy to take your questions.

[Operator Instructions] We'll take our first question from private investor Brett Davidson, your line is open.

I am hoping you can maybe hone down the revenue changes for me, so is there any indication that this increased revenue rate has carried over to Q1?

Do you want to take that Victor or?

Right, we're still -- our strategic plans are put in place, we're working diligently to get the new products release for Myricom to increase that revenue. Our goal is to keep that growing and our MSP practice our pipeline is strong, those take a little time, we're hoping that that will continue so that recurring revenue model we don’t start at ground zero every quarter in the TS side of that division. Our customers that are being buying us for a long time are continuing to support us and we're adding new customers on, so with that product division is a timing issue too. We do more professional services around product so we could be -- we're closing business consistently but when the timing of when that was actually we can record that revenue sometimes moves depending on sign up from customers. So -- but things look pretty good right now for across, the UK needs some help but that's why as I mentioned we put Frank which has done a good job, taking Germany and making it a positive year and rolling that complete UK practice right into Germany not only on the engineering side but on the financial side also.

Were those late orders in Q4, I mean is that a one-off thing or has that volume kept up into Q1?

The timing of when customers purchase orders we have no control of we do a lot of coding, we do a lot of specking in with our engineering services. As when they are willing to pull the trigger, we don't have any control but the pipeline for those large customers is still as strong as it was prior. But some of those projects that we closed were eight months in the marking just to give an idea how long we were working on those.

Yes, the other thing that I think Victor did mention too Brett is that, under the revenue recognition rules and it's difficult sometimes for us to say because we've got a lot of things that are in the queue but we have to just see whether we've got the ability to take that revenue, so it's difficult at this point because we got a number of very large projects but we really have to go through and assess those and that does take us a little time.

So the revenue isn't -- we've finished the sale and sent out an invoice, this is.

Right now.

And realize whether you can recognize it. [Multiple Speakers] Yes, if you look the project is completed and all the professional services are done, we can't take all the revenue.

So is this something that normally happens after the close of the quarter then?

Well, I guess when you get notification so you're going through and in the evaluation, yes, that's a portion of what we do in our closes. If we know they're done and so on that's easy, but usually as you get to things as you know with things being done in service timing we just have to go through and evaluate because you have got a lot of multi-elements within these pieces.

Do you guys have any outlook as to whether I mean this is the revenue for Q4 is going to be something representative of a new level going forward or just too hard to tell us at this point?

Too hard to tell.

Too hard to tell, yes.

And the last thing that I want to broach is the E-2D which has been in the news just continuously, I mean, you got the Japanese order in the plane, you got talk about retrofit to the radar systems and I believe 11 of the planes have been delivered, you got talk about increases in the number of planes that are going to be ordered on the program, you got the Secretary of Defense asking for more E-2D planes and fewer ships in the navy, has any of this at all filtered down to your level?

Not yet, not yet no we just know on that because we're dealing -- we work with Lockheed and we see all the information out there, but there is nothing that is filtered down to us.

I mean the orders that are supported to be coming down the pipeline should make for some very enjoyable earnings years in the near future?

That's what we're counting on.

[Operator Instructions] Our next question is from Joseph Nerges from Segrum Investments, your line is open.

Just one follow-up on the E2-D, do we have any idea on the delivery schedule for that this year there were three, I know we have come the first quarter, second quarter, third quarter, fourth quarter?

Now that's, it's very difficult for us, I mean they give us a sort of a timeframe but you know it’s within three months and that's where things flip over. We don't really get noticed Joe until after they have delivered the products to the prime contractor.

I know last year you were pretty confident it was all going to be in the last half of the year, because of the planes that were going to…

Well that's what we got told by Lockheed. This year they're not, right now it's sort of moving around, they seem to be moving things, we thought we have something definitive and it isn't at this point. We will get five units but knowing exactly what quarter's they're going to go in, they're not really giving us a lot of visibility.

Okay. Another question would be, let me just follow-up on the Myricom product line, and if I understand reading the press release you're saying that some of the -- in the financial trading market there some of these customers are waiting for the next generation release of -- am I correct on that is that what you're inferring in that press release?

Yes, because we have one of our products that we kind of alpha and beta tested which we have in front of some customers that they're testing right now and giving us feedback making sure all the bugs are kind of worked out of it and then we're awaiting for the next release of the DBL products which will be the lending conversion of the current product that we have in alpha beta right now, and that's a big market segment in that financial market it's more a Linux based, you know most customers are running that. Myricom historically did try out from -- before we purchased Myricom they heavily concentrated in the Window space and now we're kind of opening up towards Linux platform also.

Do we have any idea on how quickly that release may come about or?

Not exactly because you know with the new release of a brand new product there's a lot of testing that has to go on, so as you know we're developing products, if it all comes down, there's very little bugs we can release it a lot faster if not you know we're trying to make sure that we get a product that customers are happy with right out of the bat with it initially and then you know it’s our reputation that they've had Myricom for a lot of years and we're trying to keep that intact, we're getting a product that you know we can be proud of.

I have no problem with that and I agree with that strategy, another, you mentioned both the financial trading and the packet capture market. Are we doing anything with the storage networking in the machine vision markets, anything new there or on any releases or is that just working up the legacy product?

That's so just -- you know right now we're just kind of -- we can't boil the ocean right now Joe so we're kind of concentrating on a few market spaces that we want to get out and then we'll start adding you know a little bit out of time, so.

Are we expecting to announce any new Myricom adapters over the course of this year or the -- the software aspects that you would…?

We have a timeline of some new products but just depending on how successfully we can release these initial ones then that'll give us some you know more time to work on the new stuff but we do have some new products that will be coming out over the next 12 to 18 to -- you know we're never going to stop releasing with new products and different things -- our goal is to not be a one trick pony in the Myricom space.

Okay. And managed services we're talking, we have a managed service center in the U.S. and do we have a managed service center in Germany too?

Yes correct, there's the one in Germany is more focused on security.

Yes.

We’re here in the states customers really want one person to do it all whether it's monitoring or whether it's full MSP or the case is sometime it's just a phone system, but you have to be able to do have the capability to do it all that what customers seem to be more in the state where in Germany we're known to be one of the top security providers out there, so that's kind of where our focus is right now and we've been leaning here instead of reinventing the wheel here in the states. We have leaned on Germany when we find opportunities here in states we just let them run a lot of it there because they already have a lot of engineers that are completely capable of helping us here in the state to do that. And with the UK now falling under Germany will be able to talk at the UK customers also and try to open up that a little bit more, so it's a big focus right now. We moved a lot of personnel around in Germany to really focus on MSPs. One of lead engineers actually head of engineering has really been moved over to focus exclusively on MSP and this is a stock that security has cracked to help them. And we find some more sales people out there and we've changed compensations across the whole company to compensate on this recurring revenue model across the whole company.

Well obviously the security market is huge, every day we hear somebody breaching somebody's database and you're saying that if we come across a client in the U.S. we can utilize the German managed survive center to monitor that?

Yes, we can.

And we have, do we have a competent sales people to address that in the U.S. to be able to sell that idea?

Yes, what we've done is we've done some cross training and here in the states we've always sold security, but it's never been a complete focus. We have a storage practice. We have a security practice, networking, so we've done more here in the states with Germany has been very-very focused they do some of everything we've talked about but the majority of the revenue has been in the security market space. So we've done some cross training, we're actually taking all the marketing material the Germany had and we translated it over to U.S. so we're as you know we did a name change now a few months six months ago, so all the marketing material now as global marketing material. So we have multiple calls every month and what we do now in those locations we're doing as one company instead of like a couple of years back where everybody was running pretty much independently. So now we have one sale one messaging to all our customers no matter where they're located.

Very good, I am pretty excited about it looks like the potential there I mean, currently the market for many services seem to be there. There should be no problem with security paramount more and more people should be looking at the alternatives to beyond their own internal security to look for some external help in that matter, so I am pretty encouraged I think the possibilities here are great for the future. Thank you very much.

And we have no additional questions at this time. I would like to turn the call back over to our speakers for any closing remarks.

Thank you for joining us today and for the support of CSPI during the fiscal 2015. We look forward to speaking with all of you again on our Q1 call.

Thank you, happy holidays.

Thank you.