CSP, Inc. (NASDAQ:CSPI)
F3Q10 (Qtr End 06/30/2010) Earnings Call
August 4, 2010, 10:00 AM ET
Gary Levine - Chief Financial Officer
Alex Lupinetti - Chairman, President and Chief Executive Officer,
Good day, ladies and gentlemen, and welcome to CSP Inc.’s third-quarter fiscal year 2010 conference call. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference call. (OPERATOR INSTRUCTIONS.)
I would now like to turn the call over to Mr. Gary Levine, CSP’s chief financial officer. Please proceed, Gary.
Thank you, and good morning, everyone. With me on the call today is our chairman, president and chief executive officer, Alex Lupinetti. I’ll take you through our third-quarter financial results, and 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 review.
We reported another quarter of excellent top- and bottom-line results for the third quarter of fiscal 2010.
Our total third-quarter sales were 28.6 million dollars, an increase of 53% from Q3 of fiscal 2009, and up 19% compared with the sequential second quarter.
The revenue growth for the quarter was primarily driven by increased sales at our Service and Systems Integration’s U.S. subsidiary as well as increased royalty payments in our Systems segment from Lockheed Martin. Our strong sales growth was partially offset by a negative foreign exchange effect of approximately 500,000 dollars due to the strong U.S. dollar in Q3 2010 versus Q3 2009.
CSP’s total cost of sales for Q3 increased year over year to 23.7 million dollars from 15.8 million dollars in Q3 2009 due to higher sales volumes. Gross profit for the quarter increased 73% to 4.9 million dollars as a result of volume leverage and improved gross margins in our Systems segment, which was due to increased high-margin royalty payments. Overall gross margin increased 200 basis points to 17% from 15% a year ago. Our increase in gross profit would have been greater, but was negatively affected by a 306,000 dollar settlement agreement, which was recorded in cost of goods sold. The settlement was the result of a pricing dispute with one of MODCOMP’s largest vendors.
Third-quarter Engineering and Development expense of approximately 500,000 dollars was essentially flat on a real dollar basis year over year, but was down as a percentage of sales from 2.8% last year to 1.7% in fiscal 2010. Our target range for Engineering and Development expenses is 2.4% to 2.6% of sales.
SG&A expenses increased by 12% on a real-dollar basis to 3.7 million dollars in the quarter. This primarily reflected higher commissions paid and bonus expenses on increased profits. SG&A was 13.1% of sales in Q3 of fiscal 2010, compared with 17.9% of sales in Q3 last year. Our target range for SG&A expense is in the range of 18.0% to 18.4%.
Other income in the third quarter of 2010 was an expense of 10,000 dollars compared with an expense of 23,000 dollars in Q3 last year.
Our income tax rate was 15% in the third quarter. The low rate was the result of a reversal of an accrual for a significant FIN 48 item for an uncertain tax position. This decreased our federal tax expense in the quarter. We expect our effective tax rate will be approximately 40% for the fourth quarter.
For the third quarter, we reported net income of 621,000 dollars, or 17 cents per share on a diluted basis, compared with a net loss of 752,000 dollars, or 21 cents per share, in the third quarter of fiscal 2009.
Let’s now turn to the balance sheet . . .
Cash and short-term investments decreased by approximately 1.1 million dollars, from 18.9 million dollars at fiscal year end September 30, 2009 to 17.8 million dollars as of June 30, 2010. The year-over-year decrease was due to changes in working capital as well as the effect of foreign exchange. Cash increased sequentially by 5.5 million dollars from the second quarter as a result of lower receivables. 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 Services and Systems Integration segments.
We are pleased with our financial performance as we head into our fourth quarter of fiscal 2010. Going forward, we will continue to run the company with a cautious approach, tightly managing our expenses and focusing on efficient working capital management, with the goal of driving long-term profitable growth.
With that, I’ll now turn the call over to Alex.
Thanks Gary. And welcome to our call this morning.
This was a very good quarter for CSP. We performed well financially and continued to execute our strategic plan. While our 53% year-over-year sales growth compares to a weak Q3 a year ago, we are pleased to have reported a 19% sequential increase in revenues – the third-straight quarter of sequential growth.
Both of our operating segments performed very well during the quarter. The growth in our Systems segment, which consists of our MultiComputer business, was primarily driven by an increase in royalties from Lockheed Martin. Our MultiComputer business focuses on very high speed digital signal processing for defense electronics applications, including advanced radar in the intelligence, surveillance and reconnaissance, or ISR, space. During the quarter, we received about 1.6 million dollars in royalty payments for radar processing systems from Lockheed Martin for the E2D Advanced Hawkeye ISR aircraft. The payments are for aircraft being built as part of the Low Rate Initial Production Phase or LRIP. We expect to receive another 1.6 million dollars in royalty payments before year end, based on the current production schedule.
Our Systems segment sells exclusively to the major prime contractors that sell to the U.S. Defense Department. Due to the ongoing global war on terror and the wars in Afghanistan and Iraq, there is reason to believe that the Defense Department will continue to invest in intelligence, surveillance and reconnaissance strategic programs to maintain our Nation’s military leadership. The E2D aircraft project is a great example of the DOD’s focus on ISR. We believe that our ongoing investments in technology positions CSP to capitalize on future ISR opportunities.
CSP’s Service and Systems Integration segment also reported an excellent quarter. This segment includes our MODCOMP subsidiary, which provides solutions and services for complex IT environments that include storage and servers, network security, unified communications and consulting and managed services. The IT demand environment has improved and we have capitalized on our superb technical expertise and the ability to solve our customers’ complex IT problems.
As Gary mentioned, our 54% year-over-year revenue growth was the result of increased sales at our U.S. Systems and Solutions division. SSD sales growth was primarily driven by two major projects in the quarter: first, we provided systems and services to a hosting company that is seeing demand from their social networking customers. Second, we delivered a comprehensive Cisco-based unified communication hospitality solution for a luxury hotel.
The unified communication project for the luxury hotel is a multi-million dollar contract and is a great example of how our R2 Technologies acquisition has helped us to win business in the unified communications market through their market expertise in this space and their relationship with Cisco. The hotel project included managing the development and installation of the VOIP telephones, wireless network, network security, and digital media signage. We also began another major project during the quarter with a new large banking customer to provide unified communications and consulting services.
During the quarter, the German division of MODCOMP continued to face a challenging pricing and demand environment. As a result, sales were down in that geography both on a year-over-year and sequential basis. As we have been discussing on recent conference calls, we are executing our strategy to increase sales of higher-margin consulting and managed services offerings through channel partnerships. In May, we announced a partnership with California-based nCircle, a provider of automated IT security and compliance auditing solutions. nCircle was selected to provide the infrastructure platform for MODCOMP’s managed services offering in addition to MODCOMP reselling nCircle’s on-premise solutions to customers in Germany. We have already been able to leverage this relationship to win two new large customers - a telecom company and a software company. This strategy should produce higher margins that will help off set the lower volume we are seeing in the short term in Germany.
Looking forward, the demand picture remains positive at our Service and Systems Integration segment, and our U.S. sales team has done an excellent job at targeting prospects for our solutions as demand has picked up. We have increased the number of our sales reps at this division to 20, and are pleased with this staffing level. We should note, the largest MODCOMP customer in the U.S., recently acquired a major competitor to MODCOMP. At this point, it is too early to tell how the acquisition might impact our business with this customer next year.
We are quite pleased with the momentum we have experienced during the first nine months of fiscal 2010 and we are expecting to finish fiscal 2010 with solid Q4 results. Longer term, we are encouraged by progress at our Service and Systems Integration segment in attracting a greater percentage of higher-margin consulting and managed services business. At our Systems segment, we continue to invest in new technologies to position us to capitalize on strategic ISR opportunities.
Over the next few years, our goal is to exceed $100 million in revenues, and grow the bottom line on an average annualized basis of 10 percent per year.
With that, Gary and I will take your questions.