CSP Inc. (CSPI) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the CSPi Second Quarter Fiscal 2019 Conference Call. My name is Aaron, and I'll be your coordinator for today. [Operator Instructions] Please be advised today's program may be recorded. 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'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 security and exchange commission. During today's call, after Victor provides an introduction, I'll discuss our second 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. During the second quarter, we advanced our transformation to become a cybersecurity, wireless and managed services company. Financially, strong demand for our managed IT services was offset by softer multi-computer sales and resulted in slightly lower year-over-year revenue. In High-Performance Products segments, we advanced the customer evaluation stage for ARIA SDS cybersecurity solution and experienced good demand for our legacy Myricom network adaptors. In the Technology Solution, our U.K. operations delivered a strong quarter and our U.S. operation benefited from the growing base of customers for our managed IT services. After Gary reviews our financial results for the quarter, I'll come back with a detailed review of our achievements and our progress in Q2 by segment. Gary?

Thanks, Victor. For the second quarter, revenues were essentially flat at $16.4 million compared to $16.6 million a year ago. Our total cost of sales was flat versus the prior year at $12.6 million. Gross profit for the quarter was $3.7 million, down from $4 million a year ago, in line with the slightly lower sales volume. Gross margin was 22.9% compared to 24% a year ago. Second quarter engineering and development expenses were $781,000, up slightly from $759,000 a year ago, reflecting our continued investment in the development of our next-generation cybersecurity solutions. As a percentage of sales, Q2 engineering and development expenses was 4.8%, up from 4.6% last year. Q2's SG&A expenses were $3.7 million or 22.9% of sales compared to $4.1 million or 24.6% of sales in the previous year. This reflects our focus on cost reductions initiatives. We had a second quarter tax benefit of $142,000 compared to a tax benefit of $160,000 last year. The effective tax rate for the quarter was 18.7% compared to 17.7% in the prior year. Net loss from continuing operation was $695,000 (sic) [ $619,000 ] or $0.15 per share compared to a net loss of $742,000 or $0.20 per share a year ago. Net loss in the second quarter of 2018 was $594,000 or $0.16 per share, which included a profit of $148,000 from discontinued operations related to the German business, which was sold in July of 2018. Cash and short-term investments were $18.2 million at the end of the second quarter, down from $25.1 million at the close of fiscal 2018. The decrease was due to $3.3 million increase in accounts receivable due to a [ 43% of the quarter sales ] we recorded in March of 2019. We also had a reduction of $3.2 million in accounts payable and accrued expenses and $1.2 million was for payment of our quarterly dividends. Lastly, our Board of Directors voted to pay a quarterly dividend of $0.15 per share to shareholders of record on May 31, 2019, payable June 14, 2019. Our financial priorities in the third quarter of 2019 continue to improve our bottom line performance by increasing the sales level of our 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 Products division. HPP revenues were $1.6 million, down 10.2% from last year, mainly due to the delay of the launch of the ARIA SDS cybersecurity platform, which was partially offset by solid demand for our legacy Myricom products. We delivered better-than-expected results in this segment driven by a favorable product mix and continued cost control initiatives. In our multicomputer product business, we received a small amount of royalty revenues during the quarter. As we have stated on prior calls, we have limited visibility into the E-2D order levels this fiscal year, but continue to expect the bulk of the multicomputer revenues in FY 2019 to be in the back half of the year, and we expect those royalties to be [ for ] the E-2D foreign military program. During the quarter, we saw strong demand for our legacy Myricom ARC Series products. Sales are primarily coming from [ last ] customers who used it for packet capture off the wire at line rate to feed internal applications. We're also seeing interest from companies with security operations and as a staff of people who are looking for threats in their network environments. These companies have found that our cybersecurity products helped their teams enhance their detection abilities and produced the data needed for the investigation up to 10 times faster. Moving on to our award-winning next-generation cybersecurity platform ARIA. ARIA provides advanced protection capabilities for critical data assets that need to be accessed by the end user and applications, both on the cloud and on-prem. We recently formally announced ARIA SDS Packet Intelligence application at the RSA 2019 conference in San Francisco. This application ensures security resources have complete network visibility and automated capabilities for threat detection, disruption in network policy enforcement without impacting application performance. At the conference, we received positive feedback from customers and saw increased interests from both firewall and SIM vendors in our ability to augment this solution with our cybersecurity products. We also identified more specific opportunities for the original equipment manufacturers to incorporate ARIA into their product. We are excited about the prospects in growing revenues from this segment, but it's important to note that sales cycles with OEMs are quite a bit longer than with a typical client. It is full steam ahead from the development perspective with ARIA. We continue to work on the next product sets, including adding our Sniffer applications to complement ARIA's Packet Intelligence. This would enable ARIA to capture packets off the wire and feed them to host-based applications at a greater than 10-gig line rate. As we shared last quarter, we received the first batch of ARIA secured intelligent adapter boards from our suppliers and are now conducting evaluations with customers. As we advance through this process during Q3, we are working with our suppliers to ensure that ARIA can support all of our developed applications. To move -- to more quickly advance our cybersecurity products in the market, we have hired a channel account manager with responsibility for expanding our portfolio of security resellers. With this addition, the existing sale team can focus on existing partners direct opportunities, including OEMs and security service providers. Several new resale candidates have been identified, which are now in the process of vetting as well as exploring additional opportunities with existing partners. We are confident that with the reinforced sales team and focused channel engagement, we will have a strong platform to grow revenues from our cybersecurity products. Turning now to our Technology Solution business. Revenues in the quarter were down slightly by 0.5% of 1% year-over-year driven by strong sales in the U.K. Our U.K. office delivered one of the best quarters they've had in several years. We have rightsized the staffing in the office and reduced fixed costs, while focusing on new projects serving multinational customers. As a result, our U.K. office has now been profitable for 2 consecutive quarters. Looking ahead, we expect continued stability for this part of our business. In the U.S., sales were driven mainly by the growth of our managed IT service and some large hardware purchase from new accounts. During the second quarter, we continue to expand our managed service customer base, while increasing the overall size and scope of existing customer contracts. We're doing particularly well with our Microsoft practice after having built up our engineering talent and made increased investments in marketing. We have grown the number of our end users by 7 times since the beginning of 2019. More recently, we've built a new session initial protocol or SIP practice, which will develop opportunities in the VoIP phone space. We are encouraged by its potential based on early response from our customers. Our pipeline has grown faster than we initially expected, and we will see net new revenues in Q3. We also continue to work with cruise lines around the world on our wireless installations for their ships. Our expertise in the area and excellent customer service continue to yield positive results in the market. Before I close, I would like to thank our team for their contribution to make CSPi a great place to work. For the second year in a row, our Deerfield Beach office in Florida was named top workspace -- place by the Sun Sentinel. This ranking is based solely on employee feedback measuring several aspects of workplace culture, including alignment, execution and connection. In closing, we are full steam ahead in transforming CSP from a company focused on defense-related multi-computers to one of -- with significant growth opportunities in the cybersecurity space, wireless and managed service markets. With solid execution on the cost control and confidence in our ability to deliver our next-generation cybersecurity products, we are well positioned to deliver future growth for CSPi. We look forward to keep you up-to-date on our transformation and our progress. With that, I'll turn it over the call to the operator to take your questions.

[Operator Instructions] And we will take our first question from Joseph Nerges with Segren.

Just a couple. You did say there was a slight amount of revenues on the E-2D that were incorporated in this quarter, a slight amount of [ revenues ] ?

Yes, very small.

Okay. So it's almost immaterial. And did you also say that, that you're expecting something in the latter half of this fiscal year from the 4 military sales of E-2D?

Yes.

Okay. Now you do -- just recently, of course, the government issued another order for 2 -- north of [indiscernible] for 24 more of these E-2D planes. And assuming -- it also looks like the Japanese are ordering 9 more of these additional planes. But I think you had indicated that we have no idea on the delivery schedule for that either of those tranches coming forward?

Correct.

Okay. On your area applications, I think, the last time -- the last conference call, you said that there was, I guess, 4 different evaluations going on. Initially, the boards were delivered -- do we have any more evaluations currently going on beyond that? You said there more boards were delivered. Are we still in the -- still adding some different clients for the evaluation?

Yes, we are doing -- we're continuing with the initial ones plus we've added a few more.

And I'm assuming in the different areas, whether they'll be OEMs, managed security service providers, that type of thing and then individual customers -- individual competitors, I put it that way.

That's correct.

And just one more point on that -- on your area. It would seem that from my standpoint that the encryption applications are somewhat less involved from an evaluation standpoint. Getting into the Packet Intelligence, that might be more complex application. Am I correct in that? In other words, both the KMS and microHSM applications should be less intense evaluations or...

I would say, less intense. You're just got to make sure that the time line with the customers is set up so they have the bandwidth to actually do the evaluations. But overall, I would agree with you.

All right. So basically, the loss for the quarter almost totally is involved with the R&D. R&D is well in excess of the $600,000 [ plus that ] we lost for the quarter?

Yes, the rest of the business is doing really well, Joe, actually. The TSI, the U.K., that's been doing well and showing profits. It's just the -- basically the start-up of the new product line is still in -- as like I had mentioned last time, it's really a start-up company on that side of it, just trying to develop the product and get it into customers' hands and getting it through the eval process. But besides that, the rest of it is going well.

And essentially in the press release, you had indicated that you thought that there might be some ARIA SDS solution revenue this fiscal year or 2019 fiscal year...

Yes.

And of course, ARIA ends in September, not December?

Correct, yes.

[Operator Instructions] We will take over next question from Brett Davidson, private investor.

I'm hoping you can add a little color for me to the link between the Myricom, the hardware and the ARIA products. From a revenue standpoint, how does it look like those are going to sift out. All of it is going to be linked? Or are they going to be moving to different customer bases?

Different customer basis and hopefully overlap also.

Do you have any view as to what their breakout is going to look like, is it going to be like a 50-50 split? Or is there going to be tilted more one way or the other?

I would say, as it continues in the future, the ARIA should outpace the legacy products, but it's all in the Myricom name, right? It's just the brand of the initial boards that are called ARIA, but we're still keeping all the Myricom name for the product as developed by Myricom CSPi. But all that will be linked together on the 1 number. We're not separating it.

So it's just like a split between the legacy stuff and the newer products and the Myricom and the ARIA?

It's just a different product line under the Myricom name. All under the High-Performance piece of it.

Is the software side of it always going to be linked to the hardware sales? Or is there going to be a chance that that's going to be split?

You can have both.

Yes, you can have both. On the software side of it, you can run it on their -- your own service. So we'll have the opportunity to just sell the software as a stand-alone piece also as a 2 -- 1-, 2- or 3-year renewal type of -- with maintenance and support.

So the product will be licensed? Or is it going to be sold more as like as a Software-as-a-Service-type sale?

As a license. And then if the option of [indiscernible] there in the future.

At this time, there are no additional questions. I'd like to turn the program back over to Victor Dellovo for any closing remarks.

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.