CSP Inc. (CSPI) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to CSPi's First Quarter Fiscal 2019 Conference Call. My name is Aaron, and I will be your conference coordinator today. [Operator Instructions] I would now like to turn the call over to CSPi Chief Financial Officer, Gary Levine. Please proceed, 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 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 first quarter financials. Victor will come back on for an update on the 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 delivered a solid start to the fiscal year 2019 with revenues up 14%. Strong demand for managed IT services in the U.S. offset softer multicomputer sales and development delays for our next-generation cybersecurity products. On the bottom line, we reported net income of $50,000 or $0.01 per diluted share. In our High-Performance Products segment, we continued to develop value-added capabilities for our legacy Myricom network adapters and have now advanced our next-generation ARIA SDS cybersecurity solutions to the customer evaluation stage. In Technology Solution, our U.S. operations benefited from new and larger projects for our managed IT services and wireless practice. After Gary reviews our financial results for the quarter, I'll come back with detailed review of our achievements and our progress in Q1 by segment. Gary?

Thank you, Victor. For the first quarter of fiscal 2019, revenues increased to $19 million compared to $16.6 million a year ago. Our total cost of sales increased to $14.6 million from $12.3 million in the prior year quarter, in line with the higher sales volume. Gross profit for the quarter was $4.3 million, flat from a year ago. Gross margin of 22.8% decreased from 26.2% a year ago, primarily due to the higher royalty revenue from multicomputer sales in Q1 of 2018. First quarter engineering and development expenses were $745,000, up from $698,000 a year ago, reflecting our continued investment in the development of our next-generation cybersecurity solutions. As a percentage of sales, Q1 engineering and development expenses was 3.9%, down from 4.2% last year. Q1 SG&A expenses were $3.6 million or 18.9% of sales compared to $3.5 million or 21% of sales in the previous year. We had a first quarter tax liability of $2,000 compared with a tax liability of $1.1 million last year due to the effects of the new tax law. The effective tax rate for the quarter was 3.8% compared with 730% from the prior year. Net income was $50,000 or $0.01 per share compared to a net loss of $1.2 million or $0.32 per share a year ago. Cash and short-term investments was $20.7 million at the end of the first quarter, down from $25.1 million at the close of the fiscal year 2018. The decrease was due to the timing of orders and the result of increase in accounts receivable to $17.2 million at the end of Q1 from $12 million at year-end of the fiscal 2018. Lastly, our Board of Directors voted to pay a quarterly dividend of $0.15 per share to shareholders of record on February 28, 2019, payable March 14, 2019. Our financial priorities in the second quarter of 2019 continue to be to improve our bottom line performance by increasing the level of high-margin products and containing costs across the organization. I'll now turn the call back to Victor.

Thanks, Gary. Let's move into our segment review, starting with the High-Performance Product division. HPP revenues were $2 million, down 18.1% from last year due to softer sales of our multicomputer and legacy Myricom products and the delay in the launch of our ARIA SDS cybersecurity platform. Multicomputer revenues were mainly for spare parts and boards for each of the U.S. and foreign military programs. We continue to have limited visibility related to the order levels for 2019, but we are expecting most of our royalties to be related to the E-2D foreign military program, which will be recorded in the back half of fiscal year. There were 3 factors that negatively affected our legacy Myricom ARC Series product sales in Q1. First, we had a very strong sales quarter in Q4, and we believe that there was some pull-in from the sales from Q1. The government shutdown also slightly affected sales as orders ceased from the government sector in the second half of December. And finally, we had some timing issues on the repair side of the business as some larger repair projects extended into Q2. Looking at Q2, we expect stabilized revenues from the repair business, but we are optimistic that our Myricom business will get back to normal levels. During the quarter, we continued to develop new software features for our legacy ARC Series 10-gig network adapters and worked with equipment manufacturers to integrate our technology into their own. As part of the effort, we launched our Myricom Secure Intelligent Adapter, or SIA, which allows manufacturers to offload advanced security capabilities onto a card, reduce equipment costs and accelerate security functions like data encryption, compression, packet capture and classifications. We believe this will generate demand from application developers and expand the customer base for our Myricom products. Let's move on to the update about our award-winning next-generation cybersecurity platform, ARIA. ARIA provides advanced cybersecurity protection capabilities for critical data assets that need to be accessed by end users in applications, both in the cloud and on-prem. During the quarter, we continued to invest heavily to develop a software platform to support different security applications. As a result, we recently announced ARIA Packet Intelligence application, which enhances ARIA's ability to detect network-born threats. With this software, ARIA can monitor data feeds, packet streams and conversations, improve data detection tools' capabilities and even block infiltrating of data from a network. This new capability can prevent as much as 80% of the threats occurring in the network environments. By developing these capabilities, we continue to take radically different approach to enterprise-wide data security by focusing on enhancing network security and ensuring application data impenetrability. We recently received the first batch of ARIA boards from our suppliers and are in the middle of evaluations with 4 customers. We expect to continue conducting testing and evaluations in Q2 and early Q3, and we should see sales beginning to ramp up in the second half of fiscal 2019. Turning now to our Technology Solution business. Quarterly revenues were up 19.7% year-over-year, mainly due to strong sales in the U.S. As we discussed in the past, we rightsized the U.K. business by adjusting headcount and reducing fixed costs. As a result, this business was profitable in Q1 as we served our long-term multinational customers. Our team continues to work on booking new projects, and we expect a positive contribution from the U.K. office during 2019. In the U.S., we had an excellent quarter driven by the growth of our managed IT services and the wireless practice. We are adding new and larger clients and establishing higher bill rates across our customer base. During the quarter, we also benefited from the announcement of tariffs on electronics, which prompted several of our customers to book contracts in advance of the new year. We completed wireless installments on 6 cruise ships and leveraged our capabilities in the area to sign a new, large international retail customer. In closing, we are working hard to transform CSPi from a company-focused on defense-related multicomputers to one with significant growth opportunities in the cybersecurity and wireless and managed service markets. We have executed well in controlling costs and positioning our business for growth. We are developing new cybersecurity applications for our legacy products, and we are encouraged that we are getting closer to the launch of our next-generation platform for cybersecurity products. In the coming quarters, we will continue to invest in engineering talent while managing costs to deliver profitability. We look forward to keeping you up-to-date on our transformation progress. With that, I'll turn it over to the operator to take your questions.

[Operator Instructions] And we will take our first question from Joseph Nerges with Sergen Investments -- excuse me, Segren Investments.

I think you already answered my first question, and that is there were very little to no revenues on the E-2D program in the first quarter. That was just announced, right? Just boards. Is that what you said? Very small revenue?

A few boards and some spare parts.

Okay. In the 10-K, I see where you had about $9 million in cash and equivalents are remaining in the U.K. At least that's what -- I thought I read. And that's, I assume, from the sale of the German operations, and some of the cash was shifted over to the U.K. So do we have -- are we subject to, obviously, a repatriation of that cash back to the United States and the taxes associated with it?

Well, first, the U.K. is the one that -- they owned the German company so that all of the cash went into the U.K.

Okay.

And so we did repatriate some of the cash into the U.S. during fiscal 2018. And that cash came back because of the new tax law that we had already under the guilt tax taken the expense. So that came back tax-free.

And the remaining cash that's over there, I assume are still subject...

Due to the liability that we have with the pension, we have to keep a certain portion of that there, Joe, because of the regulators. And so we will be bringing more of that back, but we haven't really -- we've got a filing we have to do with the U.K. regulatory to a statutory requirement. And that's in March. And so after that, we'll have some -- a detailed review with our advisers to see what -- how much more we'll bring back.

Okay. All right. Very good. On the conference call in December, you indicated you were working on several wireless managed service contracts. I'm assuming none, of course -- firstly, none of that was recorded in the first quarter because the conference call was on the 27th. So if there's any closure, it's going to be subsequent quarters with any income associated with that. Am I correct?

That's correct, Joe.

And when it comes to recognition of revenue on managed service, you're doing it on a monthly basis, right? If you have a 1-year contract for $120,000, then you're applying $10,000 per month. Is that how you do it normally?

Under the new revenue requirements, we have to look at what the obligations are under the new 606 standards, so some of those differ from that. So it depends on what the performance obligation under that contract is, Joe. But...

Okay.

Portions of that, so if you read in the filing at the 10-K, we'll have a full description of the new revenue policies.

Okay. All right. Very good. So you never know quite sure how much of a -- on the quarter you sell it or the subsequent quarters, depending on what you have to do from an operations standpoint under the contract.

Right. We have to look at each one individually.

Sure. Of the 4 boards, this is the new board that was finally released, which is good. Thank you. And I'm sure everybody -- all our shareholders are grateful for that. You announced in the 10-K several categories that would be applicable for the ARIA product line, I'm talking about managed security, OEMs, value-added resellers. Am I correct in assuming that of the 4 boards that are out there in beta testing now, they're on -- I'm not asking for companies' names or whatever, but they're sorted out into different categories. We have some people with managed security and resellers or OEMs involved?

That's correct. There are -- some are looking at the key management piece of it. Some of them are looking at packet inspection. So multiple customers are looking at multiple application, and some customers are looking just for one in particular, which we'll start there and let them know what the other capabilities are at that point.

Are we expecting more boards to be shipped for beta testing?

Yes. The next batch is going out in the next week or so. That's correct.

And the numbers -- any approximate number on that?

We'll see Joe.

Number of batch?

So the reason we're doing the way -- we're rolling out slowly is it's easy to ship boards to customers, but then do they have the bandwidth or the time to actually truly evaluate. So what we do with each customer in the questionnaire of giving them what they expect to accomplish with it -- and kind of work all the way through, making sure they have the time and energy to look at the boards and not just have them sit on a shelf. So we're a little bit more cautious of how we're just shipping them out on the evaluation.

You're shipping it out to people that can utilize them and to receive it rather than...

Correct. And they have the bandwidth to evaluate them, not just take them and then sit on a shelf for 2 to 3 weeks or a month or longer, which happens a lot of times at some of these large organizations. So we're making sure that they have the cycles to go through it.

So that -- then I would assume that you have a number of people that are quite interested in evaluating this. That -- they're either are in the queue or we haven't shipped out to yet. Am I correct?

That's correct.

[Operator Instructions] At this time, there are no additional questions. I'd like to turn the program back over to Mr. Victor Dellovo.

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

Thank you.

Thank you for your participation. This does conclude today's program. You may disconnect at any time.