CSP Inc (CSPI) 2009 Q2 法說會逐字稿

Good day and welcome, everyone, to CSP's second-quarter fiscal 2009 conference call. Today's call is being recorded. The financial results' news release is posted on the website at www.CSPI.com for those of you who did not receive it by e-mail. Later, we will be conducting a question-and-answer session. (Operator Instructions). With us today are CSP's President and Chief Executive Officer, Mr. Alex Lupinetti, and Chief Financial Officer, Mr. Gary Levine. At this time, for opening remarks and introductions, I would like to turn the call to Mr. Levine.

Good morning, everyone. With me on the call today is our Chairman, President, and Chief Executive Officer Alex Lupinetti. I will take you through our second-quarter financial results and then Alex will provide a brief overview of our operation before we take your questions.

But first, our Safe Harbor passage. During the call, we will be taking 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 be different materially from forward-looking statements made by the Company. Such risks include general economic conditions, market factors, competitive factors, pricing pressures, and others described in the Company's filings with the SEC. Please refer to the section on the forward-looking statements included in the Company's filings with the Securities and Exchange Commission.

With that, let's get right into the numbers. We grew sales by 4% year over year, or 10% adjusted for currency in the second quarter, to $22.5 million. The first six-months' sales were 18%, or 23% adjusted for currency, and $46.6 million.

Higher sales at both Systems and our Service and Systems Integration business contributed to the three- and six-month increases. We were able to leverage this sales growth into an even stronger bottom-line performance.

For the second quarter of fiscal 2009, net income grew 48% to $279,000, or $0.08 per share -- $0.08 per diluted share, from $189,000, or $0.05 per diluted share, in the second quarter last year.

For the first half of the year, net income grew to $659,000, or $0.18 per diluted share, compared to a loss of $70,000, or $0.02 per share for the same period last year. The quarter and year-to-date increases were driven by sales volume as well as high-margin royalty payments at our Systems business.

Cost of sales increased 5% to $18.4 million, and gross profit for the quarter was essentially flat at $4.1 million.

Engineering and development expense decreased 11% on a real-dollar basis to $479,000. As a percentage of sales, engineering and development was 2.1% of sales compared to 2.5% of sales a year ago.

Engineering expense was lower for the prior year due to less engineering work on our new 3000 series MultiComputerss. We expect engineering and development expense to be in a range of 2.2% to 2.5% of sales going forward.

SG&A expenses decreased by 7% on a real-dollar basis to $3.2 million in the quarter, due primarily to a reduction in consulting services expenses, as well as a reversal of a bonus accrual. As a percentage of sales, SG&A was 14.4% of sales, compared with 16.5 -- 16.2% of sales a year ago.

We expect SG&A to be in a range of 15.8% to 17.6% of sales going forward.

Other income was an expense of $25,000, compared to income of $211,000, due to the effects of foreign currency and lower interest income.

Our income tax rate was 29% in the quarter and we expect the income tax rate to be approximately 36% going forward.

Let's turn to the balance sheet, which continues to be a key strength for CSP. Cash and short-term investments were $14.3 million as of March 31, 2009, compared to $18.5 million at fiscal year-end September 30, 2008. The decrease in cash was due to the negative effects of foreign exchange, as well as an increase in receivables.

We also repaid a short-term note payable of 1 million -- of $1.5 million, and bought $886,000 of CSPI stock as part of our repurchase plan.

Receivables increased $3 million to $14.5 million as a result of large orders in the last few weeks of the quarter in Germany and at our Systems and Solutions division. Inventories decreased by $2.8 million to $5.4 million as a result of shipments made during the quarter.

Now let me turn the call over to Alex to review the operations.

Welcome, everyone, to our call this morning. We reported another solid quarter in Q2. As Gary mentioned, sales were up 4% in an increasingly difficult economic environment, and net income grew 48%.

At the time of our last call, we have yet to see the effects of the economy on our Service and Systems Integration business, although we certainly entered the fiscal year quite cautious. During the quarter, we did start to see macroeconomic effects on our business. Customers in both Europe and the United States are delaying orders and we are seeing definite pricing pressure.

The resulting lower margins on our Service and Systems Integration side of the business was somewhat offset by $200,000 in royalty payments at our Systems business. This was related to product production for the E2D Advanced Hawkeye intelligence, surveillance, and reconnaissance airplane that we have previously discussed.

Our Systems business consists primarily of CSP's MultiComputer division. This division designs and manufactures high-performance digital signal processing systems for the defense market. It continued to perform well from a top and bottomline perspective in the second quarter, and expect it to report year-over-year growth at our Systems business for fiscal 2009.

We continue to believe that our revenues in the Systems business should approximate levels we reported in the years prior to fiscal 2007. As a reminder, in '07 we recorded revenue from an unusually large contract from Raytheon for our FastCluster 20-R MultiComputers.

Looking at the second half of the year, we're expecting a shift in revenues toward follow-on system orders with no royalty revenue. Of course, we will continue to compete for new programs, although there are currently little visibility for such programs.

Looking longer term, we are confident that our MultiComputer technology gives us a competitive advantage in the market. Our key differentiator is the open systems nature of our technology. We were first to embrace Linux when we developed our 2000 series, and we are proud of the fact we have the largest Linux deployment in the high end of the embedded computer market in the military.

Now let's turn to our Service and Systems Integration business, which consists primarily of MODCOMP's solutions and services for complex IT environments that include storage and servers, network security, unified communications, and information lifecycle management consulting services.

As I mentioned, although we are seeing some customer delays and pricing pressure, this business continues to report year-over-year growth. We are especially pleased with performance of our U.S.-based Systems solutions division and we continue to seek additional salespeople to capitalize on the opportunities we see for this business.

In recent quarters, we have developed a particular niche in selling servers of storage through web hosting companies. Since these companies install tens of thousands of servers, this market represents a very large opportunity for us. Year to date, we have realized approximately $7 million in revenue from these companies.

Gary mentioned in his remarks how our balance sheet is a key strength for CSP. During the quarter, our balance sheet helped us win a new web hosting company as a customer.

The financial strength that our balance sheet provides was a deciding factor when this company determined which vendor they could put their trust in. Some of our competitors just do not have the liquidity to support the large hardware purchases that are required for these large infrastructure solutions.

At our German subsidiary, our utilization rates are still running about 100% for our service professionals. The clients are dependent upon our expertise, especially in the security consulting practice.

We are expanding our high-margin professional service business to other practice areas this year, like application delivery infrastructure based on Citrix technology.

I mentioned on our last call we expected to report large installation deals of fiscal 2009. We saw none of these deals in fiscal 2008, after recording three in the prior year. As a result of the economic downturn, we are less certain about the timing of these deals.

We are still hopeful that we will record one or two in fiscal 2009, but these deals could slip into fiscal 2010 at this point. And margins could be less than they have been with large deals in the past.

Looking at our UK business, our service professional subsidiary also continued to be at about 100% utilization rate for the quarter.

So what does this all mean going forward? Looking at both the Systems business, as well as our Service and Systems Integration business, we expect to report revenue and net income growth for full fiscal 2009. However, we do not expect our performance for the second half of 2009 to be as robust as it was in the first half, for a few reasons.

First, pricing pressure and order delays caused by general slowdowns at our customers will negatively affect our revenues and margins at MODCOMP. Additionally, we do not expect to report royalty revenue related to the E2D program for the remainder of the fiscal year.

Even with the recession and the strong dollar affecting our Service and Systems Integration business, we are encouraged that we should still report a year-over-year growth in both revenue and net income.

We continue to add salespeople to capitalize on opportunities in our markets. Our service professionals remained at about 100% utilized, due to our depth of expertise and the continued demand for these services. And we believe that our Service and Systems Integration business is well-positioned for robust growth when the IT market rebounds.

At the same time, we are continuing our focus on a disciplined approach to cost and expense management to maintain our strong financial position.

With that, Gary and I will take your questions.

(Operator Instructions). Gary Siperstein, Eliot Rose Asset Management LLC.

Good morning. Congratulations on a solid quarter. Alex, can you give us a little more color on the Hawkeye and -- with all the machinations in Washington and all the changes Gates is making with -- there's been some product cancellations recently, or deferments. Is there any color on that at this point?

Sure. First off, on the recommendations that Gates has made, we are not involved in any of the programs that he is recommending to scale back or cancel, which included the F-22 fighter plane; the Zumwalt destroyer; FCS, which is a program for the Army; and I forgot -- there might have been one more, but we are not involved in any of those programs. So that will not affect us.

What he did say, also, was that he recommended by cutting back in some of these programs that more money be spent on surveillance and reconnaissance, which is where we have been quite successful. So we may benefit from those cuts, but we will have to see when it happens.

Now on the E2D, as you know that program is a large program that we won about three or four years ago. Maybe it's five years ago now. And the first phase is called the SD&D phase, for systems design and development. At that time, we sold about $5 million worth of systems and received royalties during that period, while they developed the software and built two prototype planes.

Then we didn't see any business from that for about a year or so. And now, this year, we were involved in their pilot production, which is another three planes, and we have recorded over $2 million in royalties and parts during the first six months of this year.

Next year, we expect that they will move into the next phase, which is called [L rip], the low-volume production, and we expect that to be about five planes, and to be about $3 million or $4 million again worth of royalties and parts.

Beyond that would be the deployment for up to 70 more planes. So that's the steps that can be taken. Sometimes they don't take all these steps in these programs, but right now, we are doing fine with the pilot program, and if the L rip stays on schedule, that will bode well for 2010.

Super. In terms of what are you seeing in that business on the competitive side from Mercury, Curtiss Wright, or some of the others?

It's formidable competition. The companies are all much larger than us. We tend to compete mostly with Mercury at the high end of the market, and they are rebounding. So they are going to be more formidable. They've been involved in a turnaround kind of program.

But our technology is very competitive. We still have significant differentiators and advantages, when we get engaged in a competitive bid for a new program or an upgrade to a program.

Moving over to the MODCOMP side, you mentioned some new hires over the last three months, six months. Can you give us any color on that? Did they come from good competitors? Were they good salespeople? Did they have some good client relationships they brought over?

It varies. The majority of the hiring is done in Florida. And it's kind of a treadmill where we are constantly hiring, trying to get and find people to become productive.

We have a fairly high turnover rate. We are up to 22 people in the original business there, with another four in the R2 business we bought. So we are at a high with 26 people.

Yes, our hiring has picked up over the last year or so, since the recession really took hold. There's more people who are willing to take on a higher leverage sales position. Some come with -- from our competitors who aren't doing as well. Others come from our suppliers, in some cases. They just want a different kind of situation.

So we are getting people from different venues, and I would say that we are more confident in the people we have been hiring lately that might be able to make it and become productive, based on their experience.

I think you mentioned in the last conference call, or perhaps it was in the news release prior, about some valuable Cisco certification that the Company possessed. Has anything materialized from that?

Let me put it this way. The integration -- that came with the acquisition from R2. They had several engineers who possessed the highest levels of certification on Cisco technology, which is a real valuable thing to have in a growing market for unified communications.

The integration between R2 and our MODCOMP division has gone as good as we could expect it over the last six months. Those engineers are working with those other 24 -- 22 salespeople that were on the MODCOMP side. It's a little early to report any results yet from that, but we think there's truly going to be some synergy from the acquisition.

That's always a bonus. We bought it on the basis it would be accretive on its own, but this one had -- really has the potential for synergy, including more customers being added to our network operations center that came with that acquisition. So everything is positive on that. But it's a little early for results at this point.

Two more questions, and I'll let someone else ask. Anything on the docket over the next 60 to 90 days on the IR front?

On the IR front, we are doing these conference calls. We had an investor day in Boston in early April, and we are scheduling another one in June before the summertime. So we've got activity going there.

Super. Last question. More high-level and strategic, talking about capital allocation. Gary, you mentioned the $800,000-plus spent on the buybacks since the start of the fiscal year. And I guess that goes hand-in-hand with the buyback program.

But if we are on a clip to spend $1 million, $1.5 million on the buyback, I just think you guys should think about perhaps -- let's say, going forward, you have in mind $1 million, $1.5 million a year. Instead of doing that all in the buyback, maybe spend 750 on the buyback and stop paying a cash dividend of 750.

You know, the buyback has been great, but we are generally an [illiquid] company for any institutions. And the buyback didn't stop the stock declining, even though it was a good buy for the Company.

But I think you will find, and I've seen it with a lot of the other micro caps I am involved in, if you're going to spend $1.5 million a year on stock buybacks, if you pay 750 on the buyback and 750 on the dividend, that would be almost, roughly, a $0.20 dividend, which at $3 would give this thing an 8% yield.

I think you'd see the stock spike up to -- we've got $4 in cash and you've got a 640 book. I think if you look real hard at your capital allocation and divide the money two ways, with alternative investments yielding 1% or less, you'll see the stock move higher and at least be trading, presumably, somewhere between cash and book, if not better.

So just food for thought. Thank you for your time.

(Operator Instructions). Will Lauber, Sterling Capital Management.

You had touched on the programs that Gates was cutting. I guess kind of more of a big-picture issue, do you see any kind of more favorable environment on your side of the defense spending? Kind of longer term? I'm kind of guessing that if they put more resources into Afghanistan, that that is kind of pretty much the same thing as the Iraq war for you guys. It doesn't really help you.

It could go either way. We have had programs that have been funded from what's called the GWOT, the global war on terror, budget, which is a supplemental. And that will continue to go on for some time.

And we anticipate more business coming from some of our existing programs that will be funded from the GWOT. If that's what you're getting at. That's part of the overall funding at this point.

Yes, I was just -- I know there for a while, you guys -- I think quite rightly so, were blaming some of the weakness in your defense business on the Iraq war. And it was more --

It works both ways. Last year, I think there was a lot of shuffling going on, and we have three programs specifically that were scheduled to happen last year that rolled into this year, and actually one rolled into FY '10. So sometimes -- it depends on what happens, but we anticipate that actually that supplemental will fund some of the programs that we are (multiple speakers)

I think it was sometime this week, one of the major defense officials, I guess, in testimony to the Congress, had talked about the buildup of -- the Chinese were building up their naval capacities. Do you think that would have any -- kind of positive wind at the back at the Hawkeye?

Possibly. The Hawkeye's original mission was surveillance for aircraft carrier groups. It's been expanded with this new plane to include ground theaters. That possibly could do it, but that will definitely help us -- one of our most successful programs is sonar programs in Japan. So any pick-up in activity by the Chinese will potentially cause the Japanese to be more aggressive with their programs.

That's the only questions I had. Thank you.

Pierce Lord, Lord Capital Management LLC.

Good morning. I just wanted to know what's the reason for your tax rate moving up from 29% to, I think you said, 36%.

It's based primarily from foreign income, and some of the changes in their law over there. We're right now evaluating because there's a bunch of proposals in Europe as to, under the stimulus plan, to change some of their rates.

So we've gone under our assumptions from the beginning of the year, since none of these things had passed, and there are a number of what you call nondeductible tax items that do affect it on the European side.

But it's being driven out of our international market rather than the U.S. side.

So this isn't necessarily a seasonal thing? Is this 36% something we should maybe consider for 2010?

We are in the throes of evaluating what's going to happen going forward, because a number of both the state, the federal government, and the foreign governments are talking about all sorts of changes within the taxes going forward. And a number of the states are going to have lower rates.

So I believe, going forward, we will probably have a lower tax rate. But at this point, we are working with our advisers to take a look at it.

Regarding your stock buyback, I think this has been the case before, I just want to see if it's still the case now. Are all your purchases of shares still being done on the public market?

Yes.

Do you guys ever actively seek to buy back shares from people privately, if they are looking to do so?

Yes.

I guess you haven't really had any takers, then, I take it.

We've had a couple.

Great. I just wanted to reiterate, from what the first caller said. I do think the buyback is great, that you guys are doing it. I kind of wish you could be a little aggressive, but I know you're a little bit limited in how many shares you are allowed to take in on a daily basis.

But I would reiterate that a dividend would certainly be very interesting to consider, and I do think you certainly will get a stock price that is more reasonable, given a dividend. Because once people look at your financials and realize you actually have the cash to continue to pay the dividend for a very long period of time, they're going to -- put simply, they're going to have to push your stock up to a level that makes a little bit more sense. Because as you said, an 8% yield probably would be too high, therefore that stock will probably pushed up to a more reasonable level. But thanks for the call.

(Operator Instructions). Vincent Staunton, Wedbush.

Good morning. Just one question. Could you provide a breakdown for the quarter between sales and operating profits for the Systems and Systems Integration business?

Sure. The sales for the quarter, for the Systems group, was $2.6 million, and the sales for the Service and Systems Integration was $19.9 million. For $22.5 million total.

Operating profit -- the operating profit for the Systems was $131,000, and for the Service and Systems Integration, it was $285,000. For $416,000.

Okay. Thanks, guys.

At this time, we have reached the end of the Q&A session. I will now turn the conference back to Mr. Alex Lupinetti for any closing or additional remarks.

Thank you for joining us today. We look forward to speaking with you next quarter.

That concludes our conference call. Ladies and gentlemen, thank you for joining us today.