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CSP Inc. (NASDAQ:CSPI)

F4Q10 Earnings Call

December 14, 2010, 10:00 AM ET

Executives

Gary Levine - Chief Financial Officer

Alex Lupinetti - Chairman, President and Chief Executive Officer

Operator

Good day, ladies and gentlemen, and welcome to CSP Inc.’s fourth-quarter and fiscal year 2010 conference call. My name is [Operator name], and I will be your coordinator for today.

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.

Gary Levine

Thank you, [Operator name], 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 fourth-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.

Our fourth-quarter results capped an excellent year of financial performance.

During the quarter, total sales were 23.9 million dollars, an increase of 31% from Q4 of fiscal 2009. The year over year increase was driven by 42% growth at our Service and Systems Integration business, while Systems revenues were down 45% year over year. Our strong overall year-over-year sales growth was partially offset by a negative foreign exchange effect of approximately 600,000 dollars due to the strong U.S. dollar in Q4 2010 versus Q4 2009.

For the year, revenue grew 14% to 95 million dollars as a result of a 4% increase at Systems and 15% growth at Service and Systems Integration.

CSP’s total cost of sales for Q4 increased year over year to 19.3 million dollars from 14.7 million dollars in Q4 2009 due to higher sales volume. Gross profit for the quarter grew 23% to 4.6 million dollars as a result of the sales increase. Overall gross margin was flat at 19%.

Fourth-quarter Engineering and Development expense of approximately 600,000 dollars increased from 400,000 dollars in Q4 2009, and was up by about 100 basis points as a percentage of sales to 2.3%. This was still slightly below our target range for Engineering and Development expenses of 2.4% to 2.6% of sales.

SG&A expenses increased by 5% on a real-dollar basis to 3.9 million dollars in the quarter. This primarily reflected bonus expenses on increased profits. SG&A was 16.3% of sales in Q4 of fiscal 2010, compared with 20.4% of sales in Q4 last year. Our target range for SG&A expense is in the range of 18.0% to 18.4%.

Other income in the fourth quarter of 2010 was 53,000 dollars compared with an expense of 144,000 dollars in Q4 last year.

Our effective tax rate was XX%. We expect our effective tax rate will be approximately XX% for the first quarter of fiscal 2011.

The net profit for the fourth quarter was $4,000, or $0.00 per share, compared with a net loss of $3.6 million, or $1.03 per share, in the fourth quarter of fiscal 2009.

For full year fiscal 2010, net income was $763,000, or $0.21 per diluted share, compared with a net loss of $3.8 million, or $1.05 per share, for fiscal 2009. Last year’s net loss in Q4 and the year included a goodwill impairment charge of 3.9 million dollars.

Let’s now turn to the balance sheet . . .

Cash and short-term investments decreased by approximately 3.4 million dollars, from 18.9 million dollars at fiscal year end September 30, 2009 to 15.5 million dollars as of September 30, 2010. The decrease was primarily due to an increase in accounts receivables in line with higher year-over-year sales volume, as well as the effect of foreign exchange, and purchases of property, plant and equipment. In addition, CSP purchased approximately $400,000 of common stock during the year.

Cash decreased sequentially by 2.3 million dollars from the third quarter as a result of higher receivables.

As we have talked about in the past, CSP’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.

As we enter fiscal 2011, 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.

Alex Lupinetti

Thanks Gary. And welcome to our call this morning.

As Gary mentioned, we performed well in the fourth quarter, ending what has been a successful year – on the top and bottom lines, as well as in terms of our strategic execution.

I’ll provide you with some color about the performance of our operating segments in the fourth quarter and the year, and what we see going forward for each. Let’s start first with our Systems segment, which consists of our MultiComputer business. Our Systems segment sells exclusively to the major prime contractors that sell to the U.S. Defense Department.

The Systems business had a good year, with revenues up 4%. Sales benefited from a follow-on order for FastCluster MultiComputer systems and related services as part of our contract with Raytheon. The Systems segment contributed even more significantly to the bottom-line in fiscal 2010 as a result of high-margin royalty payments from Lockheed Martin related to the E2D Advanced Hawkeye intelligence, surveillance and reconnaissance aircraft. The payments were for aircraft being built as part of the Low Rate Initial Production Phase, or LRIP. Systems gross margin was up about 800 basis points for the year.

Looking specifically at Q4, while Systems revenues were down 45% from Q4 of fiscal 2009, we recorded 1.1 million dollars in high-margin royalty payments from Lockheed Martin. If you remember from last quarter’s call, we had expected 1.6 million dollars in royalty payments for radar processing systems by fiscal year end. About a half million dollars of those payments were pushed out by just a few days into the first quarter of fiscal 2011.

During the year we continued to invest in technology to position CSP to capitalize on opportunities in intelligence, surveillance and reconnaissance (or ISR), which we believe is a U.S. military priority. This investment has led to two recent product launches – including our 3000 SERIES Open VPX and new 4000 SERIES ATCA.

Our new 3000 SERIES OpenVPX is the architecture framework that defines system-level interoperability for multivendor, multimode, integrated system environments. OpenVPX improves interoperability between computing and communications platforms and reduces customization, testing, cost and risk.

The new 4000 SERIES ATCA products deliver affordability, sustainability and high availability to manned and unmanned large mobile platforms on land, air and sea. ATCA provides built-in high reliability features and other capabilities that are ideal for the U.S. military’s network-centric warfare initiative. The 4000 SERIES gives CSP an entry-level product for the first time, and we plan to leverage the 4000 SERIES to broaden our base of customers focused on ISR.

Looking to fiscal 2011, we believe that our product mix will be different than in 2010. While we expect to record a total of 1.8 million dollars in E2D royalty revenues (including the half million dollars that were pushed out into Q1), we expect a lower percentage of royalties in our revenue mix than this past fiscal year.

Let’s turn now to our Service and Systems Integration segment, which includes our MODCOMP subsidiary -- providing 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.

Our strategy in this segment is to enhance profitability by attracting a greater percentage of higher-margin consulting, as well as solutions and managed services business. We executed well on this strategy in fiscal 2010 and reported excellent financial results for the year. Sales were up 15%, while gross margin was down about 100 basis points as a result of higher volume from low margin hardware sales, as well as the impact of a settlement agreement from a vendor pricing dispute.

CSP’s Service and Systems Integration segment also reported an excellent quarter, with a 42% increase in revenue due to strength at both our U.S. Systems and Solutions division (or SSD) and our Germany subsidiary. In the U.S., sales growth was primarily driven by services to a hosting company that provides outsourcing of computer infrastructure, storage and communications resources. We also were successful in attracting other unified communications and consulting services projects.

We have established a good base of sales professionals in the U.S. and have recently reorganized the sales team into pre- and post-sales to enhance sales effectiveness and better track and increase utilization.

Before I turn to our Germany subsidiary, I’d like to note that the hosting customer I just mentioned – which is also MODCOMP’s largest customer –acquired one of our largest competitors several months ago. In addition, the hosting company also expects a downturn in business from one of its own customers that was creating significant demand for CSP’s products. We expect that these events could result in a significant reduction in sales volume from this customer for fiscal 2011 and beyond.

At our Germany subsidiary, our revenue increase was primarily related to sales to a large telecom company as well as other large customers through our 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. For example, our partnership with nCircle resulted in a strategic account with Vodafone, one of the largest mobile telecommunications network companies in the world with operations or partner networks in 67 countries. Our expertise in security and ability to quickly staff up to meet changing customer needs, provides an excellent solution for companies like Vodafone.

In addition to Vodafone, we have won two other very large customers through our partnership with nCircle that should contribute to revenue in fiscal 2011. Due to the nature of our consulting services, this revenue could be lumpy from quarter to quarter. We expect that our partnership with nCircle should result in additional high-margin work in 2011. As with our U.S. division, we’re focused on tracking utilization to maximize effectiveness and enhance our margin performance.

Before we take your questions, let me provide you with our thoughts on fiscal 2011.  First, we’re seeing positive signs from both sides of our business.  That said, we believe that reduced sales from our large Service and Systems Integration hosting customer is the key factor that most likely will prevent us from reporting year over year growth in fiscal 2011. We anticipate that we will be profitable for full year fiscal 2011, primarily due to continuing Systems segment royalty revenues.

Longer term, we are bullish about our prospects in both Segments.  We expect to continue to make progress at our Service and Systems Integration segment in attracting a greater percentage of higher-margin consulting, as well as solutions and managed services business.  And we are well positioned in our Systems segment -- especially with our newly announced products -- to capitalize on the military’s network-centric warfare priorities, as well as supporting the next LRIP phases of the E2D program.

With that, Gary and I will take your questions.

Question-and-Answer Session

[Q&A]

Alex Lupinetti

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

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