CSP Inc (CSPI) 2011 Q3 法說會逐字稿

Good day and welcome, everyone, to CSP's third-quarter fiscal 2011 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 did not do 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 over to Mr. Levine. Please go ahead, sir.

Thank you, Jackie, and 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 third-quarter financial results. Then Alex will review our operations before we take your questions.

But first our Safe Harbor statement. During the 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.

With that let's get right into our financial results.

Our financial results this quarter reflect difficult comparisons in both systems and service and systems integration business. Total sales were $19.7 million compared to $28.6 million in the third quarter a year ago. The revenue decline is primarily attributable to a 31% decrease at Services and Systems Integration segment.

This was the result of significant reduction sales to a major hosting customer. As we have discussed on the past few calls, that customer had acquired one of our largest competitors in 2010. I should note that there was a slight offset by an increase in revenues at our German subsidiary.

We reported a 28% decrease in revenues at our systems segment, primarily due to $1.6 million in royalty revenues in the year-ago quarter from Lockheed Martin related to the E2D Advanced Hawkeye aircraft. We only reported $0.5 million from Lockheed Martin in the third quarter of 2011 for low-margin parts.

The effects of foreign currency was $0.9 million favorable on our year-over-year basis.

For the nine-month period consolidated sales were down by about 14% to $61 million due to the relative strength we saw in the first half of the fiscal year. CSPI's total cost of sales for Q3 declined to $16.1 million from $23.7 million in Q3 2010 due to the lower year-over-year volume. Gross profit for the quarter was $3.6 million compared with $4.9 million as a result of the lower sales. Gross margin was 18% compared to 17% in Q3 2010 as a result of better product mix and smaller average deal size.

Third-quarter engineering and development expense was approximately $400,000 compared to $500,000 a year ago. As a percentage of sales Q3's 2011 engineering and development was at 2.2% of sales compared with 1.7% of sales last year. Our target range for engineering and development expense is 2.4% to 2.6% of sales.

SG&A expenses decreased on a real dollar basis to $3.5 million in the quarter from $3.7 million a year ago as a result of lower commissions. SG&A was 17.5% of sales in Q3 of fiscal 2011 compared to 13.1% of sales in Q3 last year. Our target range for SG&A expenses is between 16.1% to 16.6%.

Our effective tax rate for the quarter was 30%. This compares with an effective tax rate of 4% in the third quarter of 2010 due to the reversal of an accrual for a significant FIN 48 item for an uncertain tax position. We expect our effective tax rate would be approximately 34% for the fourth quarter of fiscal 2011.

Net loss for the third quarter was $214,000 or $0.06 per share compared with a net income of $621,000 or $0.17 per diluted share in the third quarter of fiscal 2010.

Let's now turn to the balance sheet. Cash and short-term investments increased by approximately $2 million from fiscal year-end September 30, 2010, to $17.5 million as of June 30, 2011. The increase was primarily due to a decrease in accounts receivable.

We purchased approximately $60,000 in CSPI stock during the quarter. As we have discussed in the past, CSPI's cash position can vary significantly from quarter to quarter due to the high working capital requirements needed to fund large projects at both our systems and our service and systems integration segment. Going forward our financial priorities remain the same, we will manage the Company cautiously with strict focus on controlling expenses and efficient working capital management, all while driving towards long-term profitable growth.

With that I will turn the call over to Alex.

Thanks, Gary, and welcome to our call this morning. With Gary's financial review as background, I would like to talk for a few minutes about the opportunities we see in each of the business segments and then turn the call over to you for questions.

Let's start first with our Systems segment which consists of our MultiComputer business. This business sells exclusively to the major prime contractors that sell to the US Defense Department.

The Systems business reported revenues of $1.5 million compared with $2.1 million in the third quarter last year in which we benefited from $1.6 million in royalty revenue. On last quarter's call we discussed the budget approval of 10 new E2D Advanced Hawkeye intelligence, surveillance, and reconnaissance aircraft. These aircraft are part of the phases 3 and 4 of the low rate initial production phase or LRIPP. We expect to begin benefiting from the production of these aircraft in 2012.

E2D is the Navy's aircraft for early warning and battle management, control -- command and control. The E2D analyzes information from internal and external sensors, disseminates this information to joint forces, and enables tactical decision making. Our MultiComputer is an important component of the intelligence, surveillance, and reconnaissance, or ISR, taking place onboard the E2D. Going forward, we will continue to invest in technology to position CSP to capitalize on the military's focus on ISR.

Let's turn now to our Service and Systems Integration segment, which includes our MODCOMP subsidiary. This segment provides solutions and services for complex IT environments, focusing on storage and servers, network security, unified communications, and consulting and managed services.

As Gary mentioned, while sales were down 31% in this segment, the lower sales actually obscure the progress we are making on our strategy to attract higher-margin consulting as well as solutions in managed services business. In fact, while our US business was down as a result of the one large hosting customer, our German subsidiary reported a 34% increase in sales.

Strength in Germany was driven in part by sales to Vodafone, one of the largest mobile telecommunications network companies in the world. As we discussed previously, our work with Vodafone is in part the result of our partnership with nCircle, a provider of automated IT security and compliance auditing solutions. nCircle provides the infrastructure for MODCOMP's managed service offerings in addition to selling nCircle's on-premise solutions to customers in Germany.

We continue to see significant demand in the security market.

Another trend that we have been seeing relates to the proliferation of smartphones. As a result of the tremendous amount of data traffic generated by these ubiquitous phones worldwide, telecom operators need to upgrade their infrastructure and load balance their networks. This has been a boon to sales for MODCOMP.

Our strategic success also was reflected in our gross margin, which was up 400 basis points to 16%. This was due to a better product mix with more higher-margin solutions in managed services, as well as fewer larger deals which typically carry lower margins.

Before we go to your questions, let me leave you with a few parting thoughts. First, we are pleased with the progress of our strategy in our Services and Systems Integration segment to attract higher-margin consulting as well as solutions and managed service business. With this strategy we expect to incrementally increase our margins over the long term.

Second, with the exception of the reduced sales to our large hosting customer, demand continues to be strong across our service and systems integration segment. Third, we are well-positioned to capitalize on the military's network-centric warfare priorities as well as supporting LRIPP phases 3 and 4 for the E2D program. Finally, in addition to organic growth, we are committed to accelerating revenues by executing on our acquisition strategy.

With that, Gary and I will take your questions.

(Operator Instructions) Will Lauber, Sterling Capital Management.

With the Advanced Hawkeye at some point do you guys have to rebid or how secure are you in keeping that contract?

It's always possible that there could be a rebid to refresh the technology. We know of no plans at this point for a refresh bid, but that always looms out in the future. But right now we are focused on working with Lockheed Martin through the next phases of LRIPP to build these next 10 aircraft.

Okay. And then have you guys gotten any feedback as to where the advanced Hawkeye sits in the pecking order there? There has been a lot of talk about defense cuts. And I guess in that new deal that Congress made I saw some quote from Harry Reid that Republicans would either have to raise taxes or cut defense spending, because I guess if they couldn't come to a deal that -- across the board cuts come in.

If you could just give us any kind of -- your thinking on where it fits in on the pecking order of defense spending.

We think that the E2D is an integral part of the early warning command and control systems, and the success of the aircraft has been heralded. So we are encouraged by the fact that these 10 aircraft have been budgeted and funded.

We are going to watch what happens, like everyone else. Of course, no one knows exactly what is going to come from this commission and how we are going to address this debt ceiling problem in the future. So we are going to watch it closely, but like I say, we are positive at this point that this is a very important part of the DOD strategy.

And for the Advanced Hawkeye, am I correct that five have been delivered to the Navy so far?

I think that is the number, yes.

And I guess -- I had a newspaper report recently that said it was going to be 11 new Advanced Hawkeye but you are saying it's 10?

Everything we have seen is 10 on our purchase orders.

Okay. And if you could give me a better idea of how this will affect CSPI. You say 2012; I know you can't pick out by quarter because it's not really up to you, but how many orders you will get in 2012? And then these two LRIPPS go through 2015, am I correct?

I don't know that. No, we don't see a 2015. It could be; we don't know that they go through 2015. From our planning perspective we thought it would take them approximately two years to build these planes at the rate they have built them in the past.

We have not seen a production schedule yet, so we will let you know as soon as we see a production schedule. (multiple speakers) seems to be in the five aircraft realm per year. We don't know that to be fact at this point.

Okay. And then if you would refresh my memory on the benefits to you guys on the revenue line, how much you get for each plane. And then if I recall, do you guys get I guess two different -- you get parts and the royalties is that correct?

Correct, yes. The parts are a little lower margin; obviously the royalties are 100% margin. Most of the parts orders have been processed this year, the vast majority of them. That is about $170,000 per plane. Then once the planes are built and the processors are shipped and put in the planes we get approximately $670,000 in royalty payments per plane.

And that is after it shipped to the Navy?

After the processors are shipped to the Navy, yes, and put in the plane.

And when you said the parts, the parts for these new planes you have already -- have booked that revenue?

Yes, the majority of it.

Okay. So now it's basically just waiting to see when the planes are shipped to the Navy and then that is when you are going to get the royalties of the $670,000 per plane? Hello?

Yes, we are here.

Okay. So the royalties, the $670,000 per plane and that is when they are shipped. And you are expecting five in 2012 and five in 2013?

I would say that for planning purposes you could use those numbers. They are -- we have not seen a production schedule yet, but I know you are looking for something so that is a good approximation at this point. But we will confirm it as we see the production schedule.

And then I guess will there be an LRIPP 5 or does it go into full production after this?

We are totally -- we don't know that. I guess it could go either way at this point.

All right. Thank you very much.

Vincent Staunton, Wedbush.

I have a question about the system integration business. I guess the large hosting customer for the most recent quarter, how much revenue did that account for?

In the quarter? (multiple speakers) Year-to-date they have done $9.5 million. Last year they did $22.5 million, so that will give you the scale on how we are tracking against last year.

$9.5 million versus how much?

$22.5 million last year.

Okay. And I guess do you expect that to continue to decline?

Yes.

And excluding the large hosting customer, how much did your revenue increase or decrease in that segment for the quarter?

For the quarter -- for the year we are about $0.5 million down.

Excluding that?

Excluding that, yes.

And I guess you said you are optimistic about the systems integration business going forward.

Yes.

Can you elaborate on what is driving your optimistic outlook?

Well, one of the things is we talked about smartphones, but in general mobile devices -- if you have seen some of Fidelity's ads recently, they are talking about 10 billion mobile devices being sold over the next 10 years, between now and 2020.

Every time a mobile device is sold it generates network traffic, which causes telecom operators that need to buy more switches and more security products. It causes more transactions on servers so it creates server business, and then it causes more need for storage. So it's just this ripple effect that we believe we will continue to allow the IT business to keep growing.

The IT business worldwide right now is approximately $1.8 trillion. And the advent of smartphones and mobile devices, iPads, etc., is going to continue to drive this to continue to make it a growth market. We are well-positioned in that market, particularly on the unified communications front and in the security business.

We have invested heavily over the last several years and we feel that we can continue to grow our consulting and managed service business, which have higher margins than the traditional hardware businesses had. Although we think the hardware business will continue to grow because of the factors we just talked about.

I am going to give you a relative number; 10 billion devices is more than one per person on the planet right now. There is slightly under 7 billion people on the planet, so it's a tremendous amount of computing power going out in mobile devices if the forecast is accurate.

Okay. And in terms of the cash balance, are there any significant plans in the future? Are you looking at acquisitions, increased stock buyback, dividend?

All of the above. We have said in the past that our businesses, both businesses, require a large amount of working capital to fund large orders. We have -- are as aggressive as we can be, given the restraints we have in buybacks, and we will continue to pursue that program.

And, yes, we have been quite active in the last quarter and quarter before that on the acquisition front. We don't have anything to report right now but we have a lot of activity going on in that arena.

Okay. Thanks, guys.

[Brett Davidson], [BCIA].

Good morning, gentlemen. I just have a quick question for you. Is there going to be any further consideration of offering a dividend going forward?

The large cash balance on the balance sheet hasn't done any appreciable benefit to shareholders. Just looking to see if you guys have reconsidered and still may put a dividend in place.

Brett, as you know we have discussed this in the past and we brought a third-party consultant in last year to give us some advice on this. We are still in the position we have been in and we are not considering a dividend at this point. Again, we believe it's highly uncommon for small-cap companies and for the reasons I just stated.

The use of our cash, particularly on the acquisition front -- we use our cash -- we only use cash to buy companies and we put it to good use.

Thank you.

(Operator Instructions) Daniel Zeff, Zeff Capital.

Can you discuss profitability? In past calls you have mentioned that you expect to be profitable for fiscal 2011. Do you expect profits in the fourth quarter of this year, do you expect profits for the full year, and do you expect profits for 2012?

We don't discuss quarterly forecasts, as you know. We are sticking to our original comments about being profitable for the year. And, yes, right now 2012 looks good on the profit side. In terms of -- we are not planning phases for that, but we are optimistic about 2012.

What has gone wrong at the MODCOMP business that you are actually shrinking revenues outside of your large lost customer, while despite the 10 billion devices and most other IT businesses sort of in recovery phases here?

Well, I wouldn't say, quite say it that way about going wrong. We are in a transition, particularly in Germany, where we are transitioning to more services from our traditional hardware business.

Going through that transition the volume, sales volume, is flat or can actually decrease, but you can make more money because you are going from margins that can be doubled on the service side. So we are in that transition, particularly in Germany, that is where we are seeing that phenomenon.

And how much was the large hosting customer in the quarter? I heard year-to-date but not for the quarter.

$4.7 million last quarter.

And is that going to zero in subsequent quarters and how fast?

We don't believe it's going to zero and we don't know the slope of the line at this point.

Finally, I would like to add that we strongly advise against any type of acquisition as you have been unsuccessful at those kind of activities in the past. It would be an ill-advised use of the cash on our balance sheet.

Thank you for your input.

Will Lauber, Sterling Capital Management.

I just wanted to follow up on some of those previous calls about the acquisitions. Can you tell us -- I mean are you looking for an acquisition in one of your two current categories, are you looking in another category?

I guess the last caller there, looking back on it, the MODCOMP acquisition certainly hasn't turned out well. I guess your defense business is very loppy, but I think that is where the real value in this company is and encourage you to, if you are going to make an acquisition, to be maybe doing something in that category where I think your core competence is.

Okay, we will take that into consideration.

Thank you. There are no further questions at this time. I would like to hand the floor over to management for any closing comments.

Thank you for joining us today. We look forward to speaking with you on our Q4 call.

Thank you. That concludes our conference call. Thank you for joining us today.