CSP Inc. (CSPI) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Third Quarter Fiscal 2018 Conference Call. My name is Leo, and I'll be your coordinator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference call. [Operator Instructions] I would now like to turn the call over to CSPi Chief Financial Officer, Gary Levine. Please proceed, sir.

Thank you, Leo. 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 sections 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 third quarter financials. Victor will come back for an update on our business segments and on our strategic progress. And then we'll open it up to your questions. With that, I'll turn it over to Victor.

Thanks, Gary. We have closed on interventional third quarter. We announced the sale of Germany operations, providing us with a greater time and resources to invest in higher managed service opportunities and continue to execute on the transformation towards capitalizing on the demand for cyber security products in the proliferation of wireless. Sales are up by 24%, primarily due to a significant product sale, last year by one of our major customers that was not repeated. Lower multi computer sales and the delay of the launch of ARIA Software defined security platform. On the bottom-line, we reported net income of zero, compared to $0.24 a year ago, mainly due to volume leverage. We had a net income per share of $0.11 from continuing operations, that was offset by a net loss of $0.11 per share from discontinues operations. In our High-Performance Product segment, we continue to invest in developing our next generation cyber security products and experienced stronger-than-expected demand for our legacy products. In Technology Solutions our U.S. operation benefit from demand from our managed IT services and wireless security offerings. After Gary reviews our financial results for the quarter, I’ll come back with detail review of our achievements and progress in Q3. Gary?

Thanks, Victor. For the third quarter of fiscal 2018, revenues were $20 million compared to $26.4 million a year ago. Our total costs of sales declined to $14.8 million from $20.3 million in the prior year, in line with the lower sales volume. Gross profit for the quarter was $5.2 million or 26% of sales compared to $6.1 million or 23.3% of sales a year ago. Gross profit was higher due to mix of business in the Technology Solutions segment. Third quarter engineering and development expenses were $895,000, up 54.7% from $578,000 a year ago. As a percentage of sales, Q3’s engineering and development expenses rose to 4.5% from 2.2% last year, as a result of increased engineering staff and consultants, or higher level of investment in our ARIA, Software Defined Security platform. Q3’s SG&A expenses were $4.1 million or 20.4% of sales compared to $4.2 million or 16% of sales in the previous year. We had a third quarter tax liability of $249,000 compared with a tax liability of $393,000 last year. And continuing operations effective tax rate for the quarter was 36.6%, compared with 29.7% in the prior year. Net income from continuing operations was $431,000 or $0.11 per share compared with net income from continuing operations of $932,000 or $0.24 a share a year ago. Net loss from discontinuing operations, which reflects the results of our German operations was a loss of $0.11 per share compared with a 6% loss per year a year ago. Cash and short-term investments was $10.4 million, at the same level as the 2017 fiscal year end. During the fourth quarter, we received $14.1 million in cash from the sale of our German operation. As the divestiture closed in the fourth quarter, we expect a significant gain on the sale of the subsidiary. We are still closing the books, we will disclose the gain on it once it's been determined and reviewed by our auditors. We will disclose this prior to the completion of the audit of our fourth quarter and year-end financial results. Lastly, our Board of Directors voted to increase our quarterly dividend to $0.15 per share to be paid to shareholders of record as of August 31, 2018 payable on September 14, 2018. Our financial priorities for the fourth quarter of 2018 will be to improve our bottom-line performance by increasing the level of high margin products and containing costs from the organization. I'll now turn the call back over to Victor.

Thanks, Gary. Let's jump into our segment review starting with the High-Performance Product division. HPP revenues were $3.1 million, down 7% from last year primarily due to E-2D revenue as well as delay in the launch of our ARIA SDS cybersecurity products. Last year, we've reported royalty revenues from 2.5 planes [ph] where multicomputer sales this quarter were primarily for boards for projects within the E-2D and E-2D foreign military programs. We did see an increase in multicomputer orders in Q3 compared with the first half of the year as expected. And expect this level of activity to continue in Q4 due to the nature of the E-2D program, we have limited order visibility beyond Q4 at this time. We continue to see stronger than expected demand for our legacy Myricom network adapters, including our ARC Series 10 gig adapters. Our focus with these products has been to work with the equipment manufacturers to integrate our Myricom technology into their own. We've seen good demand for these applications, which has helped us stem the long anticipated decline in this product line. During the quarter, we continue to invest in the development of our next-generation cybersecurity products, including our new ARIA SDS platform. The ARIA software solution provides advanced security protection capabilities for the critical data assets that need to be accessed by end-users and applications in both the cloud and on premise. As we’ve discussed last quarter, we extended our development work to meet the needs of our Managed Security Service Provider or MSSP, which are a large new target market ARIA offerings. This required more time in investment that opens up exciting new markets for us. We've experienced additional delays due to supplier issues and now expect to launch the beta versions of the product in late Q4. We are encouraged by the significant and diverse market opportunities for ARIA and expect to begin to realize revenue from the product early fiscal 2019 and building throughout the year. Turning now to our Technology Solution business. Quarterly revenues were down 27% year-over-year mainly due to the decrease in shipments to a major customer, which was partially offset by shipments in the UK. In Germany, we reported an operating loss due to softness in product sales and service margins, which were down due to a lot of vacation time taken by our service engineers. At the end of the quarter, we announced the sale of Germany's operations to a European IT service provider in media conglomerate Reply for €10.0 million in cash. We closed on the deal on July 31st. The purchase price represents about €11.4 million at the time of closing. In addition, we've received €2.3 million or approximately $2.7 million from cash on the balance sheet at the time of closing. Applied purchase of all its assets and liability including a pension obligation of approximately $5 million. While, we were optimistic about the future of Germany's business, it was not as profitable as we have hoped. When we weighted the positive financial effect on the sale of the business against the increasingly difficult competitive environment in Germany, we were compelled to divest the business. We have seen many small security companies like CSPi be acquired by large organizations. The effect was extreme pressure on our margins from competing with these large companies and our customers wanting a discount on services every year. This ultimately resulted in the lack of profitability in Germany, we will now be able to devote greater time and resources towards higher margin managed service opportunities. We're excited about the prospects for growth this action provides us. On behalf of our team, I would like to thank all of our employees in Germany for their contribution to CSPi over the years. In the UK, revenues were up for the third quarter as a result of increased activity with international customers. We continue to work on building a pipeline of new business and larger contracts and expect continued profitability for this business in Q4. With the sale of the German business the UK operations will service all multinational customers. In the U.S. the decrease in sales was driven by lower product sales in the U.S. In Q4, we expect to start realizing revenues for the $1.9 million contract we won what Broward College in South Florida to deploy, design, integrate and manage their private cloud to support enterprise applications. In the wireless security, we continue to grow our business with major cruise lines. A year ago, we won a contract to install and manage the wireless systems for two ships of one cruise line. We are now working on ships across multiple brands of cruise lines, and we have completed eight installations and are servicing a total of three vessels as far as China and Australia. As part of these contracts, we conduct site surveys to access wireless coverage, install controls and access points and configure networks. We are increasing our hiring rate to meet the growth across this business. In closing, we continue to execute on that strategy to transform CSPi from a company focused on defense related multicomputer business to a growing manage service business that can capitalize on the demand for cybersecurity products in the proliferation of wireless. Through the sale of Germans operations we now have greater financial resources and have freed management time to better capitalized on managed service opportunities. We look forward to keeping you up to-date on our progress. With that, I'll turn it over to the operator to take questions.

[Operator Instructions]. We’ll take a question from Brett Davidson. Your line is open.

Good morning gentlemen. I got a couple of questions. The first one relates to the E-2D, I know you indicate, you have limited visibility, but are there orders for any content for individual planes or is there still bits and pieces. Maybe you can give me a little light on that.

Well, it’s been primarily, we had some aircraft earlier in the year and most of it’s been bits and pieces at this point. We probably are going to get more information getting into once the fiscal year-end is over for the government. But any insight into what the orders are going to look like for next year right now, Brett.

Got it. Gary maybe, if you give me a little idea of the changes on the balance sheet. From the looks, it looks like there’s going to be a net like $15.5 million increase in shareholders’ equity. Is that sound about right?

Well, we’ll have to work it out. But yes, I see from what you’re saying, yes. There’s going to be definite improvement on the balance sheet.

And the pension -- the remaining pension liability. Is that related to the UK?

Well, there’s also a U.S. piece that we have a deferred retirement plan serve with the life insurance offsetting it, there, we’ve done that to fund it, but it’s not part of it. So it doesn’t offset the liability. So the liability still sits in that number.

Yes, that life insurance piece. Do you know what it is off again. The dollar value.

The cash remember value like $3.6 million.

Got it.

Well, it’s between that, and yes we’ve got a few serve security policies, but $3.6 million.

Got it. And the last thing is, maybe you can give me a little light on what the Board was thinking with the increase in the dividend. Just maybe if you can add a little color to that.

Vic, you want to take that?

Yes, when we set on just last week, we talked about it, we have a lot of cash on hand, so we think we try to give some of it back to the shareholders. And also we like where we’re going for the future. So between the two we felt that small increase would make sense.

Well, you call the small increase, I’ll call it a really big one, but, yes we are excited…

Are you happy, Brett.

Yes, I am really happy.

Okay.

Yes, and I am encouraged to seeing that R&D expense keep rising, so for me it looks like a really good sign. So, thanks so much guys and keep up the good work.

Thanks, Brett.

[Operator instructions]. Our next question is from Joseph Nerges of Segren Investments.

Good morning guys, how are you today?

Good morning, Joe.

Well, if Brett was happy about the dividend, I am really happy about that.

I bet.

A couple of quick questions and I’ll let you go, were beta testing the SDS platform, are we testing it in multiple locations, or just one primary customer.

Right now Joe, we’re just trying to -- I had mentioned that the chip set that we -- we are developing the software, which we’re on target where we need to be, but the chipset that we needed from the manufacturer was delayed. So that’s what causing the overall delay. So once we literally just got them, so now we’re putting it all together and we’ll be putting into various different customers. But right now we’re targeting one large customer to get it off to them within the next basically 10 days.

Okay. So we’re talking multiple customers, but including one large customer, let’s put it that way.

Yes, absolutely, it’s just getting a hold of the chip set right now. We’ve kind of had a strong on the manufacture just to get something, so we could do the testing and get it to beta.

Okay, very good, thanks. Employees -- I assume most all our employees from Germany has switched over to -- on the sale of the asset -- sales of that division.

That’s correct.

Is Frank Puetz no longer with the company, is he with…

Yes, he was the Germany Manager, so he is over replying now.

Okay. And I am assuming he also oversaw the UK operation, so I assuming that -- is that being handle out of Florida now or…

Yes, that will be hand of where originally started a few years back, back here in Florida. Yes, that’s correct.

And how many employee, just curious how many employees we have in the UK, now I know they are a small number.

Seven.

Seven employees. And that will be sufficient to handle what you think as far as the managed -- the multiple -- the large customers that you’re going to be running through there.

The majority -- just to let you know the majority of international customers were all run out of the UK, anyway it’s being going on our way pretty forever. So nothing is really going to change on that side, they have been doing most -- 99% of all the work over the last couple of years.

All right. Just really one more question and that sounds the loss on the discontinued operations was the German, so is we lost $0.11 in Germany for the quarter?

Yes.

And we made $0.11 outside of the German operations, we would have made $0.11 a share on continuing operations.

Correct.

Okay, I said one more, but I am sure, I have one more here. And I am assuming on the beta testing, you’re going -- primarily managed security service providers is that what we’re primarily going to do beta testing with the SDS platform.

The first couple customers, correct. But there were other ones that don’t fit into that category.

Okay. All right, well very good. Thank you very much. That’s my questions and let’s put it this way, I am looking at the increasing the dividend that you see the visibility with the new platforms going out there has been pretty encouraging for the company going forward. So thanks a lot, appreciate it and good luck going forward.

Thanks Joe.

Thanks, Joe.

This does conclude our question-and-answer session. I’d be happy to return the call to Victor Dellovo, for any concluding remarks.

Thank you all for joining us this morning, we look forward to speaking with you again on our next call. Thank you. Gary Levine: All right. Thank you. Bye.

This does conclude today's CSPi’s third quarter fiscal 2018 conference call. You may now disconnect your lines. And everyone have a great day.