CSP Inc. (CSPI) Q4 2017 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to today's CSP Inc. Fourth Quarter Fiscal Year 2017 Conference Call. [Operator Instructions] Please note, this conference is being recorded. [Operator Instructions] It is my pleasure to turn the conference over to Chief Financial Officer, Gary Levine. Please go ahead, 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 the section on Forward-Looking Statements included in the company's filings with the Securities and Exchange Commission. During today's call, after Victor provides an introduction, I'll discuss our fourth quarter financials before Victor comes back for an update on our business segment and on our strategic progress. Then we'll open it up to your questions. With that, I'll turn it over to Victor.

Thanks, Gary. We reported another strong quarter to close our successful year as we continued to expect positive changes across CSP in line with our growth strategy. During the fourth quarter, we achieved solid growth and profitability across both the High Performance and the Technology Solutions segment. In terms of our financial performance, sales were up 39% for the fourth quarter and 8% for the year. EPS was $0.36 in Q4 2017 versus $0.14 in Q4 2016, and was $0.63 for the year versus $0.67 in 2016. We're proud of our financial performance but even more so of the progress we've made in executing on our strategy to position the company for stronger growth and profitability for the long term. Our cross-selling efforts between HPP and TS divisions are gaining traction. Our managed IT service pipeline is growing. And we are advancing the development of our cyber security HPP product to capitalize on a rapidly growing security market. We are in the midst of an exciting period of change at CSPi. And as I'd like to put it, we're a start-up company that just happened to have been in business for nearly 50 years. We are remaking our company with a focus on managed IT services and cyber security market. We made a significant amount of progress in the past few years, but we still have ways to go. After Gary reviews the financial results for the quarter, I'll come back with a review of our progress in Q4 in each segment and where we're going in 2018. Gary?

For the quarter, revenue increased 39% to $35.7 million from $25.6 million a year ago. Our total cost of sales for Q4 was 27.2 million, up 40.6% from the prior year due in large part to the increased revenue. Gross profit for the quarter increased 35.3% to $8.5 million or 23.9% of sales from 6.3 million or 24.6% of sales a year ago. Fourth quarter engineering and development expenses was essentially flat at $615,000 compared to $616,000 a year ago. As a percentage of sales, Q4 engineering and development expenses decreased to 1.7% from 2.4% last year. This is below our expected range of between 2.4% and 3.2% of sales, with the increase in staff to our security products. Q4 SG&A expenses was 5.7 million or 16.1% of sales compared to $5 million or 19.4% of sales in the previous year. Based on our planned investments, we expect SG&A expenses to be in the range of 13.9% to 18.9% for fiscal year 2018. The effective tax rate for the quarter was 34.6% compared to 18.8% in the prior year quarter. We had a large R&D credit due to a carryover of our prior year in FY 2016. The company is undergoing analysis of the tax reform bill and its impact on the company's tax rate. Among other items, the company's deferred tax assets and liabilities will need to be revalued to reflect the new corporate income tax rate. Currently, the U.S. deferred taxes and liabilities are measured at a 34% rate and would be revalued at an active rate of 21%. Additionally, the company has a pool of earnings and profit that will be subject to taxation under the proposed legislation. Net income was $14.4 million or 36% per diluted share compared with the net income of 561,000 or $0.14 per diluted share a year ago. Cash and short-term investments decreased to 13.8 million from 13.1 million at 2016's fiscal year-end, due in large part to the increased profitability in the quarter. Lastly, our Board of Directors voted to pay a quarterly dividend of $0.11 per share to shareholders of record on December 29, 2017, payable January 16, 2018. We aim to improve our bottom line performance by focusing on our growth programs, increasing the level of high-margin products and align our cost containment initiatives across the organization. I'll now turn the call back to Victor.

Thanks, Gary. I'll get right into the segment review, starting with the High Performance Products division. HPP revenues were down 2.2% year-over-year in the fourth quarter, but we had higher royalties from the domestic E-2D contract. Sales of our Myricom ARC Series network adapters and multicomputer products were down for the quarter. Looking closer at the sales for our multicomputer products, we received orders for three E-2D planes as expected, as well as additional spares. Looking ahead, we haven't been given any indication as to the order levels of the E-2D next year as it's highly dependent on the budget approval and prioritization. Right now, we're receiving orders for boards for the project within the E-2D program and anticipate sales for the E-2D foreign military program. On our Myricom ARC Series side, we continue to see expected decline in the legacy 10-gig network adapters for packet capture in media and entertainment market. To counter this decline, in 2017, we began aggressive investment and development in our next-generation cybersecurity products. These next-generation products include Myricom nVoy Series, which is focused on helping companies to not only identify potential data breaches, but also determine the exact records or files that were compromised. Our nVoy solution notifies information security teams at the early stages of the breach, enabling the investigation process to begin immediately and forensic activities to be wrapped up much sooner in weeks than typically it takes today. This is a new category of products on the market. Right now, we have an increase in sales pipeline for the nVoy due in part to the increased regulatory scrutiny, such as GDPR in Europe. During the current first quarter 2018, we announced our newest line of security products, our ARIA software-defined security platform. This software platform provides advanced cybersecurity protection capabilities for critical data asset, which need to be accessed by end users and applications in both the cloud and on premise. For customers that require more advanced security features that are CPU-intensive, ARIA can be augmented by the newest Myricom ARC security intelligence adapter that will provide offloading capability to these CPU-intensive security functions, allowing for improved performance of applications running on currently deployed service in VM environments. Organizations will find ARIA particularly compelling because it allows application developers to quickly implement security features for those applications without having to become cybersecurity experts. This is especially important as companies continue to move to an agile DevOp model where the development and launch of applications need to happen quickly but securely. We're moving to beta with ARIA in the next few months and expect initial shipments to occur later in 2018. Customers are excited about brand new approach to enterprise-wide security and anxious to get beta versions in their hands to see how ARIA could reduce potential security vulnerabilities across the environment. We've come a long way from a purely defensive, independent provider of multicomputers to a company poised to benefit from significant demand in advanced cybersecurity products. It's a change that has been long in the making, and we have a lot more work to do. We're excited about the prospects to continue progress in 2018, resulting in long-term growth and profitability benefits. Turning now to our Technology Solutions business. Quarterly revenues were up 48% year-over-year, driven by strong performance in each of the geographies, particularly in the U.S. In Germany, fourth quarter revenues were up year-over-year, driven by product revenues. We continue to have good managed service pipeline, and we've closed two large MSP contracts in Germany at the end of the fourth quarter. We also continue to focus on acquiring engineering talent to support our growth in Germany, particularly around cyber security. In the U.K., we had a strong fourth quarter as a result of a major hardware deal for worldwide distribution with a major customer. I'd like to note that the deal originated in the U.S., demonstrating the continued success of our strategy to cross-sell between geographies. We're also seeing improved profitability out of this business, demonstrating that our cost savings and efficiency initiatives are having their intended effect. In the U.S., sales were very strong in the quarter. Our managed service pipeline remains robust, and we continue to close deals at a greater frequency and the reoccurring revenue stream is increasing. In fact, at the beginning of last year, our MSP business for the overall company was about 1% of revenue. And right now, MSP stands around 3% of revenue. As long as we continue to close one or two deals every quarter, we'd position our company very well for the future as a high-margin, recurring revenue growth. We also continue to have success in wireless security, which is an area that has been very consistent and especially strong for us. Last quarter, we mentioned that we had won a large contract with two major cruise -- with a major cruise line for installation of wireless security in two of their cruise ships and with the potential for future business. We now expect to be working on between eight to 14 cruise ships in both Europe and in the U.S., and our service will range from site maps to full installation of wireless. Overall, our performance in the Technology Solutions is demonstrating the initial success of our strategy. Our new products are doing well. Our managed service offerings are gaining traction, and our cross-selling initiative is bringing in new revenue across all geographies. Before we go to questions, let me leave you with a few key thoughts. First, we performed well in fiscal 2017, generating growth both on the -- on bottom line and on the -- on the top line and bottom line as we're returning $1.7 million to shareholders in dividend payment. Second, we are still very much a company in the middle of a great and exciting change. We are moving from a company focused on defense-related multicomputers to one that has significant growth opportunity from cutting-edge technology that is capitalizing on major trends like cybersecurity and the proliferation of wireless to grow managed service business that did not exist 24 months ago. Such change takes time but we're well on our way. With that, I'll turn it over to the operator to take questions.

[Operator Instructions] Our first question comes from Brett Davidson as a private investor. Your line is open.

I'd like to congratulate you on this pivot that has been going on over the past couple of years. It looks like it's really finally picking up some momentum and gaining some serious traction here. I do have a couple of questions. I think, Victor, I think you mentioned that your content is going in on the international E-2D planes, is that correct?

Yes. We have some opportunities there. It's not as robust as what we're selling in the U.S., but there's definitely opportunities for the next couple of years at least with some foreign military planes.

Oh, wow. That's pretty exciting. I know you had mentioned the tax reform, Gary. And do you guys kick in at all to the corporate AMT?

Not usually, no.

Okay. So you guys are pretty much is going being a straight cut from the 35-ish down to the 21% rate?

Right. We just have to go through the deferreds and see what happens as it goes, yes.

Got it. Yes. And have you guys taken a look? I'm not entirely sure where the R&D tax credit stands. Have you seen any other provisions that may impact?

Yes. It's cut back, I think by 80%. But yes, I mean, it would still be there for a few years. There's sort of a talk about phasing some of those out. But I haven't seen the final. I'm just reading the blurbs you get from the big accounting firms.

Yes. You indicated that SG&A is going to be in a range between 13.9% and 18.9% next year. Is there some -- or as a percentage of sales? Is there some reason for that broad range? Does that account for onboarding new employees?

Yes. There's new employees. And I think we're going to have -- with the launch of the new products, there's going to be some significant marketing and sales effort going on. We're going to be participating in a large number of shows in the security areas. So there's expanded activities in that as the new product gets launched. And we've worked a lot over the last year getting our name out there in the security industry. We've won some awards and some things because we're not known in the security areas. So it's been an uphill battle, but these shows have been productive, and there's been a great deal of interest in the new products. So we think that's a great avenue for us to get out there.

And it's just a little unclear as to what the cost of all that is going to be?

Yes. I mean, it's expensive to get these things. We're watching it and monitoring it because we got to find what's the success formula. And Victor and Gary Southwell are working together on seeing what makes the most sense with this. But you've got to get out, in front of the larger organizations and other places and get our name known in the area, especially in cybersecurity.

Now there was also mention in your comments that the Myricom sales were down this past quarter. I didn't quite catch whether it was compared to Q4 last year. Does that just have to do with the switchover away from the legacy products to the new stuff, like this...

Correct.

Okay. Yes, just a little slow on the uptake.

Right, because we're switching. The 10 gig is now they're moving into 25 and higher. And we haven't done -- we've moved into the cyber area away from that. We've got some partners we're working with some of those products. But right now, it's the legacy stuff that is being impacted.

So everybody's getting ready to make the transition then.

Well, there's some, yes. It takes time, but yes, it's coming.

Thank you. [Operator Instructions] Our next question comes from Joseph Nerges with Segren Investments. Please go ahead, your line is open.

One quick question on the taxes that Gary brought up. Who knows? The thing hasn't been signed yet, but it looks like it's going to be a 21% rate. But if you -- how much of our cash is overseas? In other words, if we have to repatriate that money, isn't there a 15 point -- 15.5% is transferred on...

Yes, 15.5%, right. I mean, that's something we'll look at. We've got about 35% to 40% of our cash is in Europe.

And theoretically, there's really no reason to repatriate that because you're using it over there in Germany and Great Britain. Is that correct? Pretty much you -- it would be a board decision whether...

At this point, yes. I mean, we're using it as per growth and items like that as we grow the business, yes.

If you want to factor in up in Lowell or whatever for more input, whatever. If you want to advance it from the standpoint. Okay, let's go on to some of -- a few other questions. I know you hired a new man to advance our channel partner network. How is that progressing? I mean, are we adding channel partners?

We've added a few. Part of that is educating them, not only just onboarding. It's easy to sign them up, but it's a process of educating them also on the products. So the bandwidth that we have here, we're not huge with 10 channel people internally, so it's been slow and methodical but we've added people on.

And of course, primarily, right now, it's the nVoy products that they would be marketing for us. Since the ARIA is still in baseline.

The other one, but we're still previewing the concept of the ARIA to all the existing customers there we're also talking to nVoy about. So when we -- because we're looking at it to sell it as a complete platform. So when we talk about nVoy, we also bring up ARIA. If ARIA comes up, we also talk about nVoy.

Yes, that was my next question. That is, would we be able to utilize the same partners for both of these products, the nVoy and the ARIA? And you pretty much answered that. Now in the nVoy product line, you introduced the Automated Investigative Response, the AIR response, for the nVoy's recorder a couple of months back. I guess, initially, we tied that product into the Cisco firewall. And then subsequent to that, to the 40 net, right?

The 40 net, yes. And then there's a few other manufacturers we've completed testing on and we'll be announcing soon.

Well, that's what I was going to say next. Well, I'm assuming that's a lot of what's going on in Lowell right now, they're tying those automatic response into other firewalls, other manufacturers?

That's correct. Correct.

Both of these guys, both Cisco and the Fortinet group, have large kind of partner networks. And I would have -- I assume that we would attempt to utilize some of their existing channel partners in advance from our channel market?

Yes. We've been -- we -- Cisco has given us about a half a dozen of some of their key partners to talk directly with. So that's kind of -- Fortinet, we haven't gone down on that path yet, but I'm -- there's overlap there. It's just about bandwidth at this stage. The Cisco partners usually sell Fortinet and vice versa. So...

Okay. It's not -- so just like we do in Germany and other. We have both.

In the U.S. also, right. We sell both.

Cisco and Fortinet are both our partners for us, okay.

Correct.

In -- now I realize Germany was our key security group from marketing security products. How have we done in the U.S.? Have we added any people? Obviously, now with our products in-house, have we been able to add people to the R&D group in Florida?

We have. We've actually hired an engineer, a couple of engineers actually and a couple -- the sales people are not dedicated to security, but they have security backgrounds that we've hired over the last, I don't know, three, four months.

Okay. So I am assuming some of these -- the new people would be able to co-sell with their existing sales group, too, and helping...

Correct. We have one opportunity just came up last week that was a legacy salesperson that just talked into a customer, just brought it up and we've done a demo. And now we're doing pricing down in the Florida area. So we've cross-trained the salespeople, phase one and two. It just takes a little time for them to understand the concept and adapt to selling some of these higher-level security products. So -- but we are in the process of trying to cross-train all the existing salespeople in the Florida area.

Okay. I was -- I assume so. What -- in that territory, Florida, we also have Miami to the Tampa area, Tampa-Orlando area. Do we go much beyond that? Is that our -- pretty much our coverage area for our Florida group?

It covers most of Florida. But we do -- they can sell anywhere. So we've -- if you look at some of the sales of last -- just last quarter alone, heavily in Virginia area, Alabama. It kind of goes all over California. So they sell anywhere and everywhere. But if you looked at the majority of the revenue is, a lot of it's based in Florida.

But we don't have any presence in those states. Do we? Virginia?

Air flights are cheap. They just jump -- they jump on planes, engineers can go. Like I said, some of the projects we're working on, they'll be in Europe doing wireless on ships, in Australia, in different areas of the world. So as long as you can get the engineers in the location on a timely basis, that's all the customers really care about. Ordering product on the phone is not the biggest. That's easy.

Okay, very good. you did mention that Germany signed a couple of pretty good-sized managed service contracts was it late in the quarter or late in the fourth quarter or early this quarter?

Yes, late in the fourth quarter.

Do we have a sized number on those? Don't you want to disclose that?

I don't want to disclose it.

Okay. But there's two contracts, you said.

Yes. There's two different customers.

Two different customers. Okay. Do we have a count on our E-2D planes royalties over the edges? Do we keep count of how many we actually have received to date from the inception of the contracts? Do we have a running total on this? Do we know offhand?

To answer, right now, we do, but I don't have the answer right on the tip of my tongue. Because a lot of the stuff we're doing, Joe, there's a lot of spares, there's centers that they're opening up. So there's a lot more royalty than just the planes themselves that we're doing and that's happened over the last couple of years.

But we get a royalty per plane and then we also sell boards. Is there a…

For both, no. We get a royalty per board, that's what's goes on the plane. The royalties on the boards. So it depends on how the systems in the U.S. has been pretty constant on the sizing. As we go into the foreign military, they're going to be different sizes and they're much smaller than the U.S.

I got you. As far as I know, the only foreign sales that were reported by Northrop, anyway, has been four planes in Japan. Are we suggesting that there are other planes beyond that, that we don't know -- that we know is coming for foreign sales? Or we're...

Substantially, there's going to be more. We just don't know how -- I mean, we've been given -- not that -- we haven't yet given the information at this point, Joe.

Okay. But we're anticipating, obviously, additional.

That's correct.

Well, the initial contract, the reason I'm asking about that, initial contract, I believe, from the U.S. was something like 35 planes. And they're looking for an additional add-on contract that supports that because I think this contract ends midyear next year, but they're looking for another 35 to 40 planes beyond that. At least that's what they wanted, 75. I'm just wondering if we've got any kind of input on that or not as of yet?

No, we don't have any input on that.

Okay. All right. Well, very good. Everything sounds great. One quick question on the ARIA software and the security adapter. Primarily, we're going after the DevOps market with the containers and the VMs that the people are utilizing that in their operations. But will this software will work even with people not utilizing the VMs and container-type operations?

They don't work on any server of any type that's used in any CPU. If they need more CPU power, then they can use one of our Myricom adapters that we're developing right now. They were released through the middle or the end of the year also. Or they can a software alone inside their environment.

So we are still working on new adapters, tying them in specifically to the security market. Is that what you're saying?

Correct. Yes.

I guess I'll be seeing you guys at the annual meeting. I assume that is still expected in February of next year?

Yes, it is.

And it will be in Florida? Or...

Yes, it will.

Thank you. Our next question comes from Lewis Moser with Mafax Investors. Please go ahead, your line is open.

Our group of investors, which is pretty extensive, specializes in looking at companies that we feel are considerably undervalued and under the radar in the marketplace. Reading over your materials and listening to your call today, we find that your stock price is so undervalued versus other high-tech companies on the market. So the question would be, is the company interested in doing anything to promote the company by looking or talking to analysts that may come aboard and do some credibility in terms of projections? And your stock is over $10, which is key for investments from most of the major companies. So the question is, is that of interest to you?

Yes. I mean, we're always interested in that and talking to people. It's a -- we have a small number of shares and not a lot of flow. And it's one of the things that we're always interested in hearing what the investment community or individuals will offer. And we're analyzing that, obviously. As we're going forward, we're considering more and more of the IR function that we'll be doing as we get our product come into market.

The history of the companies we follow is very similar. What happens is, initially, the companies are not noticeable and the trading volume is very low, which scares away a lot of people. However, it doesn't take too much to get the people to notice you. In fact, if you look at your trading today and the stock alone, it's already $25,000 -- 25,000 shares volume, and you're probably doing 4,000 or 5,000 shares a day. So today's report did generate interest. I think that if you can get an analyst or two on board, you'd really establish a basis of credibility and work the time you have or whatever to solicit that opportunity for IRS would be key. So in addition to that, can you give me which product you feel is the most exciting and has the most potential of all the various products that you have at this point going forward?

The new ARIA software-defined security products, the new cutting edge. I think we have a concept that no one else is doing right now, and we're excited. We're talking to a lot of large organizations that have a lot of DevOp, and the concept to them was if we could do this real time, it's something that's game-changing. So we're excited with that. And on the other side of the business, we're trying to grow on our MSP, managed service business, also, which is the recurring revenue model at a much higher margin that just a buyer would normally undertake. So those are the two areas which we're trying to grow as fast as possible and that we're putting engineering dollars, marketing dollars behind it to change the company and grow it in those areas in particular.

Well, I have to tell you, this is one of the most exciting opportunities that I've found over the past few years. Your infancy, I suspect that big things are going to happen to your company's stock if you continue to do this kind of performance, and I wish you a lot of luck.

Thank you very much.

Thank you very much. Appreciate it.

Thank you, gentlemen. We have no further questions at this time. I would like to turn the conference back over to Mr. Dellovo for any closing or additional remarks.

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

Thank you. Happy holidays.

This does conclude today's program. You may disconnect your lines at any time, and have a wonderful day.