U.S. Markets close in 5 hrs 27 mins

Edited Transcript of CSPI earnings conference call or presentation 13-Aug-18 2:00pm GMT

Q3 2018 CSP Inc Earnings Call

BILLERICA Aug 29, 2018 (Thomson StreetEvents) -- Edited Transcript of CSP Inc earnings conference call or presentation Monday, August 13, 2018 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Gary W. Levine

CSP Inc. - VP of Finance, CFO. Treasurer & Secretary

* Victor J. Dellovo

CSP Inc. - CEO, President & Director

================================================================================

Conference Call Participants

================================================================================

* Joseph Nerges

* Brett Davidson

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to CSPi's Third Quarter Fiscal 2018 Conference Call. My name is Leo, and I'll be your coordinator for today. (Operator Instructions) I would now like to turn the call over to CSPi Chief Financial Officer, Gary Levine. Please proceed, sir.

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [2]

--------------------------------------------------------------------------------

Thank you, Leo. 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'd 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 third 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.

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [3]

--------------------------------------------------------------------------------

Thanks, Gary. We have closed out an eventful third quarter. We announced the sale of Germany operations, providing us with greater time and resources to invest and hire managed service opportunities and continue to execute on the transformation towards capitalizing on the demand for cybersecurity products and the proliferation of wireless.

Sales were off by 24%, primarily due to a significant product sale last year by one of our major customers that was not repeated. Lower MultiComputer sales and the delay of the launch of ARIA Software Defined Security platform. On the bottom line, we reported net income of 0 compared to $0.24 a year ago, mainly due to volume leverage. We had a net income per share of $0.11 from continuing operations that was offset by a net loss of $0.11 per share from discontinued operations. In our High Performance Products segment, we continued to invest in developing our next-generation cybersecurity product and experienced stronger-than-expected demand for our legacy products. In Technology Solutions, our U.S. operation benefited from demand from our managed IT services and wireless security offerings.

After Gary reviews our financial results for the quarter, I'll come back with detailed review of our achievement and progress in Q3. Gary?

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [4]

--------------------------------------------------------------------------------

Thanks, Victor. For the third quarter of fiscal 2018, revenues were $20 million compared to $26.4 million a year ago. Our total cost of sales declined to $14.8 million from $20.3 million in the prior year, in line with the lower sales volume. Gross profit for the quarter was $5.2 million or 26% of sales compared to $6.1 million or 23.3% of sales a year ago. Gross profit was higher due to mix of business in the Technology Solutions segment.

Third quarter engineering and development expenses were $895,000, up 54.7% from $578,000 a year ago. As a percentage of sales, Q3's engineering and development expenses rose to 4.5% from 2.2% last year as a result of increased engineering staff and consultants or a higher level of investment in our ARIA Software Defined Security platform. Q3 SG&A expenses were $4.1 million or 20.4% of sales compared to $4.2 million or 16% of sales in the previous year. We had a third quarter tax liability of $249,000 compared with a tax liability of $393,000 last year. In continuing operations, effective tax rate for the quarter was 36.6% compared with 29.7% in the prior year.

Net income from continuing operations was $431,000 or $0.11 per share compared with net income from continuing operations of $932,000 or $0.24 a share a year ago. Net loss from discontinued operations, which results from the -- which reflects the results of our German operations, was a loss of $0.11 per share compared with a 6% loss per year a year ago.

Cash and short-term investment was $10.4 million, at the same level as the 2017 fiscal year-end. During the fourth quarter, we received $14.1 million of cash from the sale of our German operation. As the divestiture closed in the fourth quarter, we expect a significant gain on the sale of the subsidiary. We are still closing the books. We will disclose the gain on it once it's been determined and reviewed by our auditors. We will disclose this prior to the completion of the audit of our fourth quarter and year-end financial results. Lastly, our Board of Directors voted to increase our quarterly dividend to $0.15 per share to be paid to shareholders of record as of August 31, 2018, payable on September 14, 2018. Our financial priorities for the fourth quarter of 2018 will be to improve our bottom line performance by increasing the level of high-margin products and containing costs from the organization.

I'll now turn the call back over to Victor.

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [5]

--------------------------------------------------------------------------------

Thanks, Gary. Let's jump into our segment review, starting with the High Performance Products division. HPP revenues were $3.1 million, down 7% from last year, primarily due to E-2D revenue as well as delay in the launch of our ARIA SDS cybersecurity products.

Last year, we reported royalty revenues from 2.5 planes where MultiComputer sales this quarter were primarily for boards, for projects within the E-2D and E-2D foreign military programs. We did see an increase in MultiComputer orders in Q3 compared with the first half of the year as expected and expect this level of activity to continue in Q4. Due to the nature of the E-2D program, we have limited order visibility beyond Q4 at this time.

We continue to see stronger-than-expected demand for our legacy Myricom network adapters, including our ARC Series 10-gig adapters. Our focus with these products has been to work with equipment manufacturers to integrate our Myricom technology into their own. We've seen good demand for these applications, which has helped us stem the long-anticipated decline in this product line. During the quarter, we continued to invest in the development of our next-generation cybersecurity products, including our new ARIA SDS platform. The ARIA software solution provides advanced security protection capabilities for the critical data assets that need to be accessed by end users and applications in both the cloud and on premise.

As we discussed last quarter, we extended our development work to meet the needs of our managed security service providers or MSSPs, which are a large new target market for ARIA offerings. This required more time and investment that opens up exciting new markets for us. We've experienced additional delays due to supplier issues and now expect to launch the beta version of the product in late Q4. We are encouraged by the significant and diverse market opportunities for ARIA and expect to begin to realize revenue from the product early fiscal 2019 and building throughout the year.

Turning now to our Technology Solutions business. Quarterly revenues were down 27% year-over-year, mainly due to the decrease in shipments to a major customer, which was partially offset by shipments in the U.K. In Germany, we reported an operating loss due to softness in product sales and service margins, which were down due to a lot of vacation time taken by our service engineers.

At the end of the quarter, we announced the sale of Germany's operations to a European IT service provider and media conglomerate Reply for EUR 10 million in cash. We closed on the deal on July 31. The purchase price represents about $11.4 million at the time of closing. In addition, we received EUR 2.3 million or approximately $2.7 million from cash on the balance sheet at the end of the time of closing. Reply purchased all its assets and liability, including a pension obligation of approximately $5 million. While we were optimistic about the future of Germany's business, it was not as profitable as we had hoped. When we weighted the positive financial effect on the sale of the business against the increasingly difficult competitive environment in Germany, we were compelled to divest the business.

We have seen many small security companies like CSPi be acquired by large organizations. The effect was extreme pressure on our margins from competing with these large companies and our customers wanting a discount on services every year. This ultimately resulted in the lack of profitability in Germany. We will now be able to devote greater time and resources towards higher-margin managed service opportunities. We're excited about the prospects for growth in -- this action provides us. On behalf of our team, I would like to thank all of our employees in Germany for their contribution to CSPi over the years.

In the U.K., revenues were up for the third quarter as a result of increased activity with international customers. We continue to work on building a pipeline of new business in larger contracts and expect continued profitability for this business in Q4. With the sale of the German business, the U.K. operations will service all multinational customers.

In the U.S., the decrease in sales was driven by lower product sales in the U.S. In Q4, we expect to start realizing revenues for the $1.9 million contract we won with Broward College in South Florida to deploy, design and integrate and manage their private cloud to support enterprise applications.

In the wireless security, we continue to grow our business with major cruise lines. A year ago, we won a contract to install and manage the wireless systems for 2 ships of 1 cruise line. We are now working on ships across multiple brands of cruise lines, and we have completed 8 installations and are servicing a total of 3 vessels as far as China and Australia. As part of these contracts, we conduct site surveys to access wireless coverage, install controllers and access points and configure networks. We are increasing our hiring rate to meet the growth across this business.

In closing, we continued to execute on our strategy to transform CSPi from a company focused on defense-related MultiComputer business to a growing managed service business that can capitalize on the demand for cybersecurity products and the proliferation of wireless. Through the sale of Germany -- German's operations, we now have greater financial resources and have freed management time to better capitalize on managed service opportunities. We look forward to keeping you up-to-date on our progress.

With that, I'll turn it over to the operator to take questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) We'll take a question from Brett Davidson.

--------------------------------------------------------------------------------

Brett Davidson, [2]

--------------------------------------------------------------------------------

I got a couple of questions. The first one relates to the E-2D. I know you indicate you have limited visibility. But are there orders for any of the content for individual planes or is it still bits and pieces? Maybe you can give me a little light on that.

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [3]

--------------------------------------------------------------------------------

Well, it's been primarily -- we've had some aircraft earlier in the year and most of it's been bits and pieces at this point. We probably are going to get more information getting into -- once the fiscal year-end is over for the government. But we don't have any insight into what the orders are going to look like for next year right now, Brett.

--------------------------------------------------------------------------------

Brett Davidson, [4]

--------------------------------------------------------------------------------

Got it. Gary, maybe you can give me a little idea, the changes on the balance sheet. From the looks, it looks like there's going to be a net like $15.5 million increase in shareholders' equity. Does that sound about right?

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [5]

--------------------------------------------------------------------------------

Well, they have to work it out. But yes, I see from what you're saying, yes, there's going to be a definite improvement on the balance sheet.

--------------------------------------------------------------------------------

Brett Davidson, [6]

--------------------------------------------------------------------------------

And the pension -- the remaining pension liability, is that related to the U.K.?

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [7]

--------------------------------------------------------------------------------

Well, there's also a U.S. piece that we have a deferred retirement plan assert with the life insurance offsetting it. We've done that to fund it, but it's not part of it, so it doesn't offset the liability. So the liability still sits in that number.

--------------------------------------------------------------------------------

Brett Davidson, [8]

--------------------------------------------------------------------------------

Yes, that life insurance piece, do know what that is offhand, the dollar value?

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [9]

--------------------------------------------------------------------------------

The cash surrender value is like $3.6 million. Well, it's between that and -- yes, we've got a few SERP policies, about $3.6 million.

--------------------------------------------------------------------------------

Brett Davidson, [10]

--------------------------------------------------------------------------------

Got it. And the last thing is maybe give me a little light on what the board was thinking with the increase on the dividend. Just maybe if you can add a little color to that.

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [11]

--------------------------------------------------------------------------------

Vic, do you want to take that?

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [12]

--------------------------------------------------------------------------------

Yes, yes. When we sat down just last week, we talked about it, we have a lot of cash on hand. So we figured we try to give some of it back to the shareholders. And also, we like where we're going for the future. So between the 2, we felt that a small increase was -- made sense.

--------------------------------------------------------------------------------

Brett Davidson, [13]

--------------------------------------------------------------------------------

Well, you call it a small increase. I'll call it a really big one, but yes, we're...

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [14]

--------------------------------------------------------------------------------

Are you happy, Brett?

--------------------------------------------------------------------------------

Brett Davidson, [15]

--------------------------------------------------------------------------------

Yes, I'm really happy. Yes. And I'm encouraged to have seen that R&D expense keep rising. To me, it looks like a really good sign. So yes, thanks a bunch, guys and keep up the good work.

--------------------------------------------------------------------------------

Operator [16]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question is from Joseph Nerges of Segren Investments.

--------------------------------------------------------------------------------

Joseph Nerges, [17]

--------------------------------------------------------------------------------

Well, if Brett was happy about the dividend, I'm really happy about the dividend.

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [18]

--------------------------------------------------------------------------------

I bet.

--------------------------------------------------------------------------------

Joseph Nerges, [19]

--------------------------------------------------------------------------------

A couple of quick questions and I'll let you go. We're -- beta testing the SDS platform, are we testing it in multiple locations or just one primary customer?

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [20]

--------------------------------------------------------------------------------

Right now, Joe, we're just trying to -- I had mentioned that the chipset that -- we're developing the software, which we're on target where we need to be. But the chipset that we needed from the manufacturer was delayed. So that's what's causing the overall delay. So once -- we literally just got them. So now we're putting it all together and we'll be putting into various different customers. But right now, we're targeting one large customer to get it out to them within the next basically 10 days.

--------------------------------------------------------------------------------

Joseph Nerges, [21]

--------------------------------------------------------------------------------

Okay. So we're talking multiple customers, but one -- including one large customer? Was that...

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [22]

--------------------------------------------------------------------------------

Yes, absolutely. It's just getting a hold of the chipset right now. We've kind of had to strong arm the manufacturer just to get us something so we could do the testing and get it to beta.

--------------------------------------------------------------------------------

Joseph Nerges, [23]

--------------------------------------------------------------------------------

Okay, very good. Employees, I assumed most -- all our employees in Germany has switched over to -- down the sale of the asset -- or sale of that division.

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [24]

--------------------------------------------------------------------------------

That's correct.

--------------------------------------------------------------------------------

Joseph Nerges, [25]

--------------------------------------------------------------------------------

Is Frank Puetz no longer with the company, is he with (inaudible)?

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [26]

--------------------------------------------------------------------------------

Yes, he was the German manager, so he's over with Reply now.

--------------------------------------------------------------------------------

Joseph Nerges, [27]

--------------------------------------------------------------------------------

Okay. And I'm assuming the – he also oversaw U.K. operations, so I'm assuming that -- is that being handled out of Florida now or...

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [28]

--------------------------------------------------------------------------------

Yes, that will be handled where originally started a few years back, back here in Florida. Yes, that's correct.

--------------------------------------------------------------------------------

Joseph Nerges, [29]

--------------------------------------------------------------------------------

And how many employees -- just curious, how many employees do we have in the U.K.? I know there's a small amount...

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [30]

--------------------------------------------------------------------------------

Seven.

--------------------------------------------------------------------------------

Joseph Nerges, [31]

--------------------------------------------------------------------------------

Seven employees? And that'll be sufficient to handle what you think as far as the demand -- the large customers that you're going to be -- growing to there.

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [32]

--------------------------------------------------------------------------------

Yes. The majority -- just to let you know, the majority of international customers were all run out of the U.K. Anyway, it's been going our way for pretty much forever. So nothing's really going to change on that side, as they've been doing most -- 99% of all the work over the last couple of years.

--------------------------------------------------------------------------------

Joseph Nerges, [33]

--------------------------------------------------------------------------------

All right. And just really one more question and that is on the loss on the discontinued operations with the Germany, that -- so the loss was $0.11 in Germany for the quarter?

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [34]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [35]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

Joseph Nerges, [36]

--------------------------------------------------------------------------------

And we made $0.11 outside of the German operations, we would've made $0.11 a share on continuing operations?

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [37]

--------------------------------------------------------------------------------

Correct.

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [38]

--------------------------------------------------------------------------------

That's correct.

--------------------------------------------------------------------------------

Joseph Nerges, [39]

--------------------------------------------------------------------------------

Okay. I said one more, but I'm sure I'm going to add one more here. And I'm assuming, on the beta testing, you're going -- primarily managed security service providers, is that what we're primarily going to do beta testing with the SDS platform?

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [40]

--------------------------------------------------------------------------------

The first couple customers, correct. But there are other ones that don't fit into that category.

--------------------------------------------------------------------------------

Joseph Nerges, [41]

--------------------------------------------------------------------------------

All right. Well, very good. And so let's put it this way. I'm looking at the increase in the dividend that you see, the visibility with the new platforms going out there has been being pretty encouraging for the company going forward. So appreciate it and good luck going forward.

--------------------------------------------------------------------------------

Operator [42]

--------------------------------------------------------------------------------

This does conclude our question-and-answer session. I would be happy to return the call back to Victor Dellovo for any concluding remarks.

--------------------------------------------------------------------------------

Victor J. Dellovo, CSP Inc. - CEO, President & Director [43]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [44]

--------------------------------------------------------------------------------

All right. Thank you. Bye.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

This does conclude today's CSPi's Third Quarter Fiscal 2018 Conference Call. You may now disconnect your lines, and everyone, have a great day.