CSP Inc (CSPI) 2017 Q3 法說會逐字稿

Good day, and welcome to the CSP Inc. Third Quarter Fiscal 2017 Conference Call. (Operator Instructions) Please note, today's call may be recorded. (Operator Instructions) It is now my pleasure to turn the conference over to Mr. Gary Levine. Please go ahead, sir.

Thank you. 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, Victor will provide you with an update on our business segments and on our strategic progress and then I'll discuss our third quarter financials. Then we'll open it up to your questions. Victor?

Thanks, Gary. We had a solid third quarter as we executed on our growth strategy across the High Performance Products and Technology Solutions segments. Our cross-selling efforts are gaining traction. Our managed service pipeline is growing. We are advancing the development of our HPP product to capitalize on the rapidly growing security space.

In terms of our financial performance, third quarter sales were up 13%, primarily due to the shipments of our U.S. business in the Technology Solutions division. Backlog is strong, and we expect another good quarter in Q4. On the bottom line, we had a

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due to the greater mix of high-margin products in Q3 last year. EPS was $0.17 per diluted share versus $0.32 a year ago.

With that, I'll get right into the segment review starting with the High Performance Products Division. HPP revenues were down 41% in the third quarter driven by a tough comparison versus the prior year in the multicomputer and Myricom sales -- product sales. We received each of the royalty revenue for 2.5 planes compared with royalties with 3.5 planes plus an additional revenue from large product shipments in the comparable quarter last year. Looking ahead, our expectation is to receive royalties from 2 planes in Q4.

Sales from the Myricom ARC Series 10G network adapter for packet capture in media and entertainment market continued to soften in Q3

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trends have stabilized to steady the gradual decline. To offset this factor, we remain committed to our product development strategy, focusing efforts on the next-generation security products, which have the potential to expand the commercial market reach of the division. During the quarter, we launched an enhancement to the Myricom nVoy solutions that enabled the automatic detection of data breach to critical databases or file stores. The newly announced Myricom nVoy AIR application when paired with the nVoy packet recorder automates not only the ability to verify a data breach but also triggers the start of the breach investigation. Having this data at the earliest stages of the breach means that the investigation response activities can typically be wrapped up within hours of the total duration instead of the weeks that it normally takes.

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Cisco's technical alliance ecosystem, offering an integration with Cisco FirePOWER and Myricom nVoy AIR. As we incorporate additional software and applications into our security portfolio, the engineering team will continue to assess our ability to deliver these new sophisticated security products. We are also realigning our cost structure as we develop the new products. In short, we are making good progress all in line with our growth strategy to become a data security organization. In addition to ramping up our Myricom security product offerings, we are making excellent progress with our strategy to cross-sell between our High Performance Products Division and our Technology Solutions division.

Turning now to our Technology Solutions business. Quarterly revenues were up 28% year-over-year driven by a strong performance in the U.S. In Germany, revenues were up

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thousand. We shipped several large orders at the end of the quarter, for which we will be recording the associated revenue in Q4. Our outlook for the next quarter is positive given our strong backlog. We are seeing both product and service revenue increase, and we expect this strength to continue moving forward.

In the U.K., we had a solid third quarter, in which we reported slightly down revenues year-over-year. I'm happy to announce that the U.K. received its

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quarter. All 3 of our geographic locations now record MSP deals. It is important to note that a good portion of the revenue in the U.K. this quarter is primarily from business that originated in the U.S., demonstrating the success of our strategy to cross-sell between geographies is working.

Looking forward, we expect another good quarter on the top line in the U.K. as customer sales continue to ramp up. At the same time, we remain focused on cost savings, improved efficiencies to drive better profitability out of the business.

In the U.S., sales were up year-over-year driven by strong product sales and several new contract wins, including a deal with a large multinational financial service firm.

During the quarter, we reallocated our network operation center in Deerfield, forwarded it to a larger facility and we continue to make investment in additional engineering staff to support the

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We also continued to make investment in sales capacity to focus on managed services.

Our managed service pipeline remains robust. We are closing managed service deals at a greater frequency, and the reoccurring revenue stream is increasing. We are also hiring engineers in the U.S. to support this growth. We continue to have success in the vertical markets such as hospitals, school systems and wireless security. Wireless security is the area that has been very consistent and especially strong for us. We recently hired an additional 2 wireless engineers to support the growth in this area. And in fact, we are in the process of negotiating large contracts for wireless deployments with several large enterprise accounts. As an example, we recently won a large contract with a major cruise line for the installation of wireless security in 2 of their cruise ships with the potential for future business.

With that overview of our 2 divisions, I'll turn

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financial review.

Thanks, Victor. For the quarters, revenue increased 13.5% to $30.5 million from 29 -- $26.9 million a year ago. Our total cost of sales for Q3 was $23.7 million, up 20.4% from the prior year due in large part to the increased revenue. Gross profit for the quarter decreased to $6.8 million or 22.3% of sales compared to $7.2 million or 26.8% of sales a year ago due to product mix. Third quarter engineering and development expense decreased to $578,000 from $779,000 a year ago due to lower consulting and outside service costs. As a percentage of sales, Q3 engineering and development expenses were 1.9% compared with 2.9% last year. This was below our expected range of between 2.4% and 3% of sales with the increase in staff for the security products.

Q3 SG&A expenses were $5.2 million or 16.9% of sales compared with $4.6 million or 17% of sales in the previous year. Based on our planned investments, we expect SG&A expenses in the range of 17.8% to 18.1% for the fourth quarter of fiscal 2017.

The effective tax rate for the quarter was 32.7% compared to 29.3% in the prior year. We expect our overall tax rate going forward to be approximately 39%.

Net income was $695,000 or $0.17 per diluted share compared with net income of $1.3 million or $0.32 per diluted share a year ago due to a greater mix of higher-margin product sales in Q3 2016. Cash and short-term investments increased to $16 million from $13.1 million at 2016's fiscal year-end due in part to the changes in working capital.

Lastly, our Board of Directors voted to pay a quarterly dividend of $0.11 per share to shareholders of record on August 21, 2017, payable on September 5, 2017.

We aim to improve our bottom line performance by focusing on our growth programs, increasing the level of high-margin products and align our cost containment initiatives across the organization.

I'll now turn the call back to Victor.

Thanks, Gary. Looking ahead, in the High Performance Products division, we anticipate royalty revenues from 2 E-2D.

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We are working to develop and enhance our products in the security marketplace and continue to take action in the engineering, product development, marketing and sales to position HPP as a security solutions provider.

In the Technology Solutions division, we remain focused on executing against our MSP strategy, which we expect to be an excellent driver of growth and recurring revenue for the long term. Our pipeline is strong. We have hired several engineers and sales people to support this growth. In addition, we expect to see continued progress on our cross-selling strategy between Technology Solutions locations as well as between Technology Solutions and High Performance Products.

In total, we're expecting a solid performance in Q4 on both top and bottom lines given our backlog in both divisions and our cost controlling efforts. Long term, we're making good progress against our strategic initiatives, and we're positioning CSP

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growth opportunities.

And now we'll take your questions.

(Operator Instructions) And we'll go first to Joseph Nerges from [Sergin Investments].

By the way, Victor, some of your -- you're breaking up on your phone line. I don't know if -- parts of your -- I don't think -- I didn't hear everything you said. I don't know what it is, whether it was the connection or what, but not everything was clear. So I don't know whether you're coming off a cell phone or what, but just wanted to let you know. Are you aware of that? Were you aware of that?

No, not at all. I'm on the conference room phone. So I'm not sure exactly what happened.

There were some breaks, not dramatic, but there were a few breaks that words would be dropped. Let me ask...

We'll have to check into it.

Yes. We're talking about the High Performance Products. And then, of course, just recently, you announced about the cyber -- the security products division. Now are they separate divisions? Going to be measurably separate divisions? Or are we talking about cybersecurity a part of HPP? I mean...

No, it's all part of HPP.

Okay. But the recent press release sort of indicated there's a separate -- you're enhancing it or you're making a separate unit with R&D, with the software engineering group that you want to add in Lowell. I'm trying to understand that last press release on the cybersecurity enhanced -- cybersecurity products division?

Yes. No, it's all the same. We just kind of -- as I said in the last couple of calls, we (technical difficulty)

other engineers that were developing some legacy products, and we rehired a bunch of new ones who's concentrating on the new security products we're bringing to market. And all that falls under HPP. Yes.

Yes. So you didn't change the name HPP? You're still -- we still have an HPP division?

No, everything's the same.

Okay. So let me understand. In your press release today versus what the press release you made just recently on the AIR application, which is the basic -- the automated investigative response capabilities. In that press release, you indicated that the nVoy AIR application is compatible with all firewalls, IDS/IPS and SIEMs via their APIs. That was part of the press release. Then today, you said our first integration is the nVoy application with Cisco FirePOWER firewall. Is there something different between the integration and -- first of all, you kind of indicated that it works with everything, anyway, in the first press release and then today you're saying there was the first integration.

That's the one that we worked with first, was Cisco. They hold a big part of the market share, and they've been a great partner. They're our top vendor on the TS side. So we went to market with Cisco to help win our first development between their FirePOWER and our product line.

Well, does that mean that we have to work with others to get it integrated with their firewalls other than Cisco firewalls?

We have to work with everyone's APIs, correct.

Okay. But we were saying in the initial press release that we work -- it works, but now we need to work with them to further integrate it. Is that what you're saying?

It's been in the works. We're just kind of promoting

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because that was the first to market that we work with.

I understand. Okay. On your channel part of the program that you announced several months ago that you're going to expand, has -- have we made progress there in adding some channel partners? What's the status there?

Yes, we're making progress working with the channels and other resellers also in the marketplace that focus on security. It's a slow process because you have to bring on a new product, you have to educate them, but we are making progress.

Okay. So we had -- of course, we had existing channel partners, not all of which were security related previously. And now we're adding hopefully channel partners that have security bias in their work progress. We're adding now -- we have added some since we talked about it. Is that what you're saying?

That's correct.

Okay. How about the demo? We have demo units in the field now with the -- both the recorder and the broker?

Yes, sir.

And have we sold any yet?

We're still talking to customers.

Okay. In your -- what are we planning on doing in Lowell as far as software? You sort of indicated that it's going to be a -- you're looking for additional software people with the cybersecurity unit. Is there a number that we're looking at? I mean, how many people do we have now in that -- involved with that in software in Lowell?

We have -- I can tell you, we have 1 open rack, we filled a rack, and it was like 8 or 9 total.

Okay. So we have 8 or 9?

Yes, we just have 1 open left.

Oh 1 open. So we have filled -- we've done pretty well in filling the requirements up there.

Yes.

In your -- going back to your blog. You came out with a -- by the way, is the AIR application, is that a software addition? Or is that a part of the license that they sign when they buy the product? Is that another -- is that just an upgrade to the software?

It's an add-on.

It's an add-on. So it's an additional buy, let's put it that way.

Yes.

Are we going to license the software? Or is that -- do they purchase the software upfront alone and then we add additional costs along the line? It's not a perpetual license, is it?

Every box that we sell, they will need a license to go along with it if they want the full spectrum of capabilities.

Okay. But what -- we have add-on capabilities potential down the road? And I think you sort of indicated that in your conversation now about some software additions?

Yes. We're constantly developing, right? We went to market, but there's other features that we'll be adding over time.

And are they all going to be tied to either the recorder or the broker.

There'll be some features for the recorder. There'll be some features for the broker.

Okay, very good. Another question I have is on the -- you announced on the blog several weeks ago on a -- I don't know if I can pronounce this right, deobfuscation algorithm that was developed in Germany for malware. Do you recall...

Yes, yes.

Is that a -- are we selling that as a software add-on to different systems? Is that what -- is that [sale] on that respect?

It's separate. It has nothing to do -- the AIR is the only software that goes along with the nVoy right now.

No, I understand that. I'm talking about this malware detection algorithm that was developed in Germany. Is that something that can be sold as a software?

Oh, yes. I thought you, I thought you mentioned

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with nVoy.

No, no I'm talking about...

Oh, yes. No, absolutely.

Okay. So that's a software salable to anybody that's involved with security applications, any place?

That's correct.

Not necessarily connected to nVoy.

Correct.

Okay. One more, and that is the radar services announcement that you announced a couple -- several weeks ago, tying in with the U.K. They seem to be -- and looking from my standpoint, they seem to be a competitor in managed services as opposed -- and I'm trying to understand the connection of adding RadarServices in the U.K. and why we went that way.

I don't understand your question.

Well, the RadarServices announcement that was, what, about 1 month, 1.5 month ago that the U.K. is now going to be -- you're in a joint partnership with RadarServices and our U.K. group of salespeople.

Yes.

And I'm just saying that -- but RadarServices throughout Europe, I see they seem to be selling a managed services application themselves, and we're selling a managed services within our organization. Are they not a competitor of ours in one respect...

The managed services that we're selling has nothing to do with that. It's just -- we're monitoring networks on the MSP side of it. Networks, whether you're managing and looking at desktops or servers or firewalls, that's kind of what the MSP that we

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And what does RadarServices add to the picture? What are they doing differently?

That, I'm not sure what exactly that's (inaudible) on the MSP side of it, our competitor on the RadarServices. I'm not sure what their offering is.

Okay. All I know is they're...

They -- it has nothing to do with what we're offering. I do know that.

Okay, okay, very good. It seems like you're -- we're making progress. The key thing here is to -- obviously, from my perspective, is to see if we can get these nVoy products in the mix because that seems where the great potential is from my standpoint. Am I correct in that assumption?

Yes.

(Operator Instructions) We'll go next to the line of Brett Davidson.

I've got a couple of questions for you guys. Maybe we can start off with the accounting. This was the first quarter that was timely in a couple of quarters, and I know you guys had indicated that it was due to additional testing overseas. Has that changed? Are we still doing the additional testing and just now got a better handle on it, or maybe you can give me some color to that?

Yes. We have continued -- I mean, we've changed some of the internal control system as well as some of the staff. So we've got a better staff organization now, and we've got added internal controls that we're still doing, Brett, to manage this. So it has improved. And we're -- that's one of the reasons that we're filing on time. And so we've been able to get a little of this behind us. So we're moving towards trying to remediate the material weakness now.

Well, that's great because, I'll tell you, it was really stressful on my side. I'm sure it was even more so on your side. Good thing.

There was an indication that there were sales that had occurred. I'm assuming the expenses have been recognized. Does that explain the increase in current liabilities? And correct me if I'm wrong.

No. The expenses would have been deferred, because we'd have to match it up with the revenues. So they were either included in deferred costs or in the inventory, depending on what those items. Some of them could have been product that were in shipment as well as some of them you didn't have acceptance from the items, so that costs would have been deferred.

Got it. So I mean, inventories, I believe, dropped. So -- and there was a huge increase in current liabilities. Is that just payables?

Yes.

Got it. And is that related to that order?

That's -- part of that's related to those orders as well as some in the U.S.

I mean, is there some reason that it was such a large dollar amount?

No. Customer bought -- it was a large purchase by one of our customers.

And that is the one that we're talking about that's going to be booked in the fourth quarter?

Yes.

Got it. So the Myricom stuff, it's kind of tough to follow along. Are you guys thinking about breaking that out as a segment in the earnings releases? Or is just not to the size were it would be worthy to break that out at all?

It's not to the size. Just part of the whole thing, because as we're migrating now, as Victor talked about with the security. So we're getting a different mix of product. As things get larger and need to be broken out, we'll do that within the Q and the Ks.

Got it. And has that -- the mix between the legacy products and the new versions, has that like -- has that changed over the past couple of quarters? Are we pretty much burned out on the legacy sales or is that stuff still selling?

It's still selling.

Oh, nice.

I mean, they've declined, but they're -- we're still getting orders and we have existing customers and that's going to go on for a while.

(Operator Instructions) And it does not appear that we have any further questions at this time, so I'd like to turn it back over to our presenters for any closing comments.

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

Thank you.

We'd like to thank everybody for their participation on today's conference call. Please feel free to disconnect your line at any time.