CSP Inc. (CSPI) Q2 2017 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the CSP Inc. Second Quarter Fiscal 2017 Conference Call. [Operator Instructions] Please note, this call is being recorded. It's now my pleasure to turn the conference over to Mr. Gary Levine. Please go ahead, 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 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 Securities and Exchange Commission. Please refer to the section on forward-looking statements included in the company's filings with the SEC. During today's call, Victor will provide an update on our business segments and on our strategic progress. And then I'll discuss the second quarter financials. Then we'll open it up to your questions. Victor?

Thanks, Gary. During the quarter, we continued to make good progress on our growth strategy across our High Performance Products and Technology Solutions segments. Cross-selling efforts between our Technology Solutions geographies as well as across HPP and Technology Solutions continue to gain traction. Our managed service pipeline is growing. We made great strides in product development and we saw adjustment in order to strengthen our HPP Division to capitalize on the rapid growth security space. In terms of our financial performance, second quarter sales were down 6.7%, primarily due to the timing of shipments at our U.S. business in the TS Solution division. Backlog is healthy with our managed service opportunities, we expect strong growth in the back half of the year. On the bottom line, volume, deleveraging and expense to implement restructuring initiatives offset the positive effect of prior cost-reduction actions. EPS was $0.11 per diluted share versus $0.13 a year ago. With that, I'll get right into our segment review starting with the High Performance Product division. HPP revenues were down 1% in the second quarter while profitability is up, driven by the E-2D royalty revenue for 2 planes compared with a small amount in miscellaneous E-2D revenue in a comparable quarter last year. Looking ahead, our expectation is to receive royalties from 2 planes in Q3 and 1 additional plane in the fourth quarter. Sales of the Myricom ARC Series 10-gig network adapter for packet capture market has softened. To offset the decline, we have been developing new next-generation products focused on security, which have the potential to expand the commercial market reach of the division. We are focused on expanding the scope of the new Myricom Series nVoy Series Solution, comprised of a packet broker and packet reporter, which used in combination, a design to assist organizations in the validation and analysis of cyber threats against the most critical business data, and thus improve rapid incident response capabilities. This is especially appealing to companies in high-regulated industries in order to fully meet compliance rules of the numerous and growing data privacy regulations. We are partnering with established leaders in the security markets to incorporate this special activity of band's output into our nVoy Series Solution to automatically trigger our data capture recording capabilities. This will allow the continuous recording of data files that are directly tied with the event that they are investigating. We believe that this is -- this will be critical advantage over other solutions when a suspected breach occurs. We will be able to provide our customers with the ability to investigate and respond to breaches, much faster, meeting reporting and auditing requirements of the P2 data privacy regulations. On the marketing side, we have strengthened our position in the security market. CSPi has been featured in publications, discussing the pending European Union's impending GDPR and data privacy regulations. Our nVoy solutions are particularly well suited to help meeting the GDPR 72-hour notification. In addition, our articulation of the security product strategy is already receiving industry accolades with the Leading Lights award, mentioned in our opening comments. On the engineering side, we have begun to research our HPP group to focus more on software development to improve the ability to deliver these new sophisticated security products. On the sell side, we are expanding upon our existing distribution channels through which we can sell our security products in the growing market. In addition, we will be introducing our growing list of security solutions to our distinct distribution partners, which they can sell alongside the security optimized ARC network adapters. Turning now to our TS Solution business. Quarterly revenues were down 8% year-over-year by weakness in the U.S., particularly offset by strong performance in the Germany, in the U.K. In Germany, revenues were higher year-over-year due to increased activity from a large multinational telecommunication provider as well as additions of new customers. Overall, we experienced strong product revenue during the quarter. However, as part of our efforts to realign our engineering team to focus on security services versus legacy offerings, we record additional restructuring charges and recruiting fees, which negatively impacted the bottom line. Looking forward, our backlog remains strong and our outlook is positive for Q3, both on the top and bottom lines in Germany. In addition, we do not anticipate additional restructuring or recruiting costs in the near term. Looking at the U.K., we had a very strong quarter on the top line due to new orders that were received in Q1 that were able to be shipped in the second quarter. Our new salespeople are generating larger, higher-margin opportunities, which we expect will be positively affected in the second half of the year. Looking ahead, we expect another good quarter from revenue standpoint as new customer sales continue to ramp up. At the same time, we remain focused on cost savings and improved efficiencies to drive better profitability out of the business. In the U.S., sales were down year-over-year, primarily due to shipping timing issues. Our managed service pipeline remains robust. We are closing managed service deals at a greater frequency and the recurring revenue stream is increasing. We should see some of the deals in our pipeline close in the second half of the year. We are continuing to hire engineers in the U.S. to support this growth. During the quarter, we also hired a new enterprise sales rep with solid book of business and we are actively recruiting additional salespeople. We continue to have success in the vertical markets such as hospitals and school systems. In fact, we recently secured a $2.5 million IT-managed service contract with Broward College in South Florida. This managed service contract is designed to not only move the IT infrastructure of the college to a cloud environment, but also provide around the clock monitoring and management to ensure the healthy, security and performance of its multiple campuses. We are very excited to continue our partnership with Broward College and assist with their strategic initiatives. Wireless security is an area that has been very consistent and especially strong for us. We continue to make investments in this space to keep pace with the growing demand. During the quarter, we also closed deals for the installation and services around Microsoft Office 365. We've capitalized on the growing trend towards cloud-based computing as large enterprise rely on us to move Microsoft Office applications from their internal exchange server to the cloud. With that overview of our divisions, I'll turn it over to Gary for the financial review.

Thanks, Victor. For the quarter, revenues decreased 6.7% to $25.3 million from $27.1 million a year ago. Our total cost of sales for Q2 was $19.6 million, down 5.7% from the prior year. Gross profit for the quarter decreased to $5.6 million or 22.5% of sales compared with $6.3 million or 23.3% of sales a year ago on the lower sales volume. Second quarter engineering and development expenses decreased to $573,000 from $790,000 a year ago, due to lower consulting and outside service costs. As a percentage of sales, Q2 engineering and development expenses were 2.3% compared to 2.9% last year. This is below our expected range of between 3.5% and 4% of sales with the increase in the staff for the security products. Q2 SG&A expenses were [ $4.5 ] million or 17.8% of sales compared to $4.7 million or 17.2% of sales in the previous year. Based on our planned investment, we expect SG&A expenses to be in the range of 18.1% to 18.5% for the rest of the fiscal year. The effective tax rate for the quarter was 33.7% (sic) [ 33.1% ] compared to 33.9% in the prior year. We expect our overall tax rate going forward to be approximately 39%. Net income was $428,000 or $0.11 per diluted share compared to net income of $503,000 or $0.13 per diluted share a year ago. Cash in short-term investments decreased to $11 million from $13.1 million at 2016 fiscal year-end, due in part to the increase in accounts receivable with the increase in sales in the last month of the quarter and the working capital requirements. We delayed the filing of our quarterly report, Form 10-Q, which is due to expanded testing of revenue transactions for the company's European operations. As a result of the expanded testing, our independent auditors had not completed their review of our company's financial statements for the quarterly report. They had completed their review and we filed our Form 10-Q yesterday. We've made personnel changes, utilized third-party consultants and made system changes. We are reviewing the result of these efforts with our Board of Directors and the auditors. The company will be taking additional actions to ensure that the revenue transactions in our European operation are reported properly and timely. Lastly, our Board of Directors voted to pay a quarterly dividend of $0.11 per share to shareholders of record on June 1, 2017, payable June 15, 2017. We aim to improve our bottom line performance by focusing on our growth programs, increasing the level of high-margin products and aligning our cost-containment initiatives across the organization. I'll now turn the call over to Victor.

Thanks, Gary. Looking ahead, in the High Performance Product division, we anticipate royalty revenue for our 2 E-2D planes in Q3 and another 1 plane in Q4. We are working to develop products in the security market space and we are taking actions in engineering, product development, marketing and sales to position HPP as a security solution provider. In our Technology Solutions division, we remain focused on executing against our MSP strategy, which we expect to be an excellent driver of growth and recurring revenue for the long term. Our pipeline is strong and we have hired several engineers and salespeople to support this growth. In addition, we expect to see continued progress in our cross-selling strategy between Technology Solutions location as well as between Technology Solutions and High Performance Products. In total, we're expecting a solid performance in Q3 on both the top and bottom lines giving our backlog in both divisions and our cost control efforts. Longer term, we're making very good progress against our strategic initiatives, and we're positioning CSPi to capitalize on many growth opportunities. And now we'll take your questions.

[Operator Instructions] And we can take our first question from Joseph Nerges with Segrum Investments.

Let me start off on some of the comments you made right off the cuff. You said that the second quarter here we had some additional charges, some restructuring charges as well as recruiting charges. What was that amount approximately? How much of the cost basis is that?

About $148,000.

Okay. And also you mentioned in the comments about the Managed Services that you're expecting some positive announcements on that front in the second half of the year. Is that correct? Did I hear that right?

Yes. We just announced that big deal we won with Broward College and our pipeline. We work on that deal for over a year. So as the pipeline continues to grow, we don't know exactly when that falls, but based on our pipeline, if a certain percentage of those deals do come in, it will continue with the expected growth in that MSP area that we've been talking about for a while.

So you're saying our pipeline is pretty large in that area, is it a fair amount?

Yes, it can. Yes, absolutely, absolutely. We're working hard to continue with that strategic initiative of growing that MSP process, which gives us the recurring revenue model that we all would like to see.

Now I've got quite a few questions on the nVoy series for obvious reasons, for the emphasis that has been placed there. Did we receive the nVoy products in the March month and that you were expecting on last conference call? Did we finally get them in-house in March or did -- were they delayed beyond that, the appliances?

In what way do we...

Well, now you were saying that, we announced and we were talking in February saying you're expecting actually to have the hardware in-house in March. So you could, I assume, demo it or whatever. Did that take place in a time -- at the time frame you're expecting?

A little behind to be honest with you, Joe, but nothing. We got the hardware in and we're continuing to test it in different environments and continue with that effort, yes.

Are we -- do we have a contract manufacturer putting those things together for us or are we doing that in-house?

We do it in-house, yes.

So we're building both the broker and the recorder in-house, we have the capability.

That's correct.

And do we have the capabilities of where our current facility to accelerate that. If the volume starts coming, kicking in here, like, I assume you're hoping that does go over the next couple of quarters. Do we have that capability and room in Lowell for this?

Yes. We do.

Okay. That's good. What is the list price for the recorder and the broker?

$50,000.

For both?

Yes.

Okay. Now -- and then along with that we have a software license, right, the Sniffer and the disk software license? And what does that cost about?

It depends on what license it is. There's various licenses that can be. So that's a hard -- and that one has a little difficult coming on.

Okay. It depends on the setup basically.

Yes, the setup, exactly.

Okay. Is there any other software because I'm looking at some comments that Gary Southwell mentioned about the product line. He talks about the appeal of our unique software approach to satisfying security of critical data when he's talking about the nVoy series. What software is there beyond the license for the Sniffer? Is there any software we're missing, is there anything else beyond that?

So the recorder and the broker both have specialized software that kind of analyzes the data that comes in. So as you know, there's lot of data that gets put through the line that needs to be analyzed. So the broker is able to sift through what should go through and what doesn't, and that what needs to be analyzed. That gets a snapshot and then if you have the recorder, it can actually record all that information so you can go back and look at it to see what type of security policies may need to be changed or added or moved in that. So that's -- those are 2 separate licenses, one for the recorder and one for the broker also.

Okay. So that's the point I was getting at. There are 2 separate licenses for that.

Yes.

And it's beyond the Sniffer entry disk license?

Sure, yes.

Okay. So we're talking about a license for the Sniffer entry disk license and then the possible license for the broker and the possible license for the recorder?

That's correct. You could sell -- the broker and the recorder could be sold separately. We'd like to sell them in pairs. So you can get the full capability of both, but they can be sold separately. So it won't have a separate license.

Well, but I guess, the point I did realize about the additional licenses. I saw where the -- where you -- there was and initially talking about the Sniffer entry disk license, but I didn't see any reference to the additional licenses for the broker and the thing, but that's fine. The training. I am assuming, we have some of these appliances at our Technology Solutions divisions, both in Florida and then in Germany. Are they testing it in both locations or at least taking it out to customers in both of those areas?

We have the broker and recorder in Germany and in the U.K. -- I am sorry, in the U.S. here in Deerfield Beach Florida. And we're all -- we're testing it with other product manufacturers like Cisco, Juniper and other. So that gets the feeds off of their products and feeds into our nVoy. So we're teaming up with some of the major security manufacturers out there to -- for testing and trying to put our full solution together with different manufacturers.

Well. Is there possibility of the manufacturer encompassing our product with their sales force as an OEM type thing or is it not?

Too early to tell right now, but we are going as where I'd like to be, let's put it that way.

Okay. Of course, you just announced, looking for a channel partnership, expanding the channel partnership you have now with Myricom. And -- so I guess, my question is, how much training is necessary to sell these products. You talk about it, being easy to install and easy to deploy. So I am wondering how much of a training, is there a seminar up there? And or a couple of training session up in Lowell? Or do you -- what's the -- what does it take?

A lot of that can be web-based, Gary Southwell, as you mentioned before, has set up an online WebEx training that we can go through. So if it's in the U.K. or in Germany or anywhere else in the world, we can do a WebEx training for sales people and then one for engineering. We're trying to focus on resellers that have a security background. So it's not completely foreign to them. And we're going to start that just with a bandwidth that we have, being a small company we're trying to focus on companies that really look at security as their primary focus area for their business.

Well, and basically, we're looking for channel partners like our German people.

Correct, correct.

They've been security focused for the last decade and if we can get that type of coverage worldwide, well, that's what we want. I am assuming that we're looking for?

Correct, correct.

Let me see. I'm going here, rambling. On the managed service contracts, I assume both of those are in force right now, the $2.5 million and the $6 million, did announce this year, both in force currently?

That's, yes, signed and moving forward, yes.

Is that something where the revenue is pretty well evened out over the course of the year? In other words, let's say, on the $6 million contract we're looking for $2 million a year.

Yes.

Is that like $500,000 per quarter put evenly or is there ups and downs with that?

It's exactly divided by 36 months. It's evenly spread over 36 months on both contracts.

And the same thing would go with the Broward County $2.5 million contract.

Right.

That's correct, yes.

Okay. That's pretty much my questions. And now it sounds like you've got -- this nVoy Series is really, really dynamic and you got a lot of recognition, especially since you introduced it so recently and then, and to be even considered by the Leading Lights inc for Innovative Product of the year. So it just goes to show what the potential is there in that product line. So thanks a lot. Sounds good. And hopefully, we get these accounting things squared away, so we can get these numbers out in time.

[Operator Instructions] It looks like we have a follow up from Joe Nerges.

Give me a long enough time like we're following up here. On the recorder, I noticed that we're really only selling the 2U unit, right the 2 -- We don't have a -- an ID for the -- we were going to sell both the 1 rack-mount unit or 1U and the 2U. So right now, we're just selling the 2U unit?

The 1U is -- that will be available soon, by the end of June, I believe, it'll be available ready to be shipped out, yes.

But the 2U is available now. If somebody wants it now. And one other thing, you did mention in there looking at your website that there's additional capacity -- memory capacity option available. So how does that work? I mean, I see in the 2U, you got, it looks like, 28.8 terabytes of data is just back.

You could put bigger drive and.

We can expand that unit?

Yes, you can expand it. You put a chassis to a NAS if you have to or just put another whole chassis, just forward drive if you have to.

What's the -- I think I had a follow-up here, right? What's the disadvantage or advantage? I understand going to the NAS, why wouldn't -- what's the advantage of having multiple recorders as opposed to just going to the NAS with 1 recorder?

You'd want to do it per location per network setup. So if you had multiple locations, then you would want -- if everything wasn't coming to the corporate, which nowadays everything is kind of separated then you would have a broker and a recorder in each and every location.

Is there a possibility to have multiple recorders with the broker in one location?

You would -- I don't -- you wouldn't really need that.

You would go to the NAS for additional...

Yes. You just need the additional storage space, but that's -- part of what we're trying to emphasize compared to some of the other products that are out there is that we're able to, through our groovy and through our software, it truly analyze the data that looks suspicious and not just -- there's other product out there that actually records everything and then you have to sift through it where it's very costly because a lot of these other competitors, you pay for the amount of data being stored, which, of course, it could be very effective for some of these large organizations where our sales pitches that. We're able to analyze truly the security issues that look suspicious and then only record those pieces of it to save on the amount of space you need on the data side.

I understand that. I was just trying to -- the question was really, would multiple recorders be needed at one site and it sounds like that's not necessarily the case, a broker and recorder and then of course, transferring the storage to something else for archiving purposes if that need be the case?

That's correct, yes.

All right. I think that's it. I appreciate it. And good luck. It sounds like -- it's a very exciting product line. One more before I go, I think I've got one more. You're talking about R&D and, obviously, we're -- much of what we're doing is building off of the nVoy Series. Is that at the software. You sort of emphasized at the -- worth looking for some software upgrades and that's where we're going with this product line? Is there also additional appliances, or are we talking about just additional software?

Additional software, which I will talk about more as it gets developed.

Okay. Which enhances the product line, in effect.

Yes, I think it does some other stuff there like I said, out of box, as it comes along a little bit more.

Yes, I want -- I don't want yet to disclose ahead of time.

Yes, yes, exactly.

And it does appear we have no further questions, gentleman. I'll return the floor to you for any final remarks.

Thank you all for joining us this morning. We look forward to speaking with you, again, on our next call.

Thank you.

And this will conclude today's program. Thanks for your participation. You may now disconnect and have a great day.