Alexander R. Lupinetti - Chairman and Chief Executive Officer
Gary W. Levine - Chief Financial Officer
CSP Inc. (CSPI) F2Q11 Earnings Conference Call May 4, 2011 10:00 AM ET
Good day, ladies and gentlemen, and welcome to CSP Inc.’s second-quarter fiscal 2011 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 W. 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 second-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 are pleased with our financial performance this quarter, given the difficult comparison we had with the second quarter of 2010. For the year-to-date, we are running significantly ahead of where we thought we would be, especially on the bottom line. Let’s walk through the income statement and I can provide you with more perspective.
Total sales were $19.2 million, compared with $23.9 million in the second quarter a year ago. The effect of foreign currency was not significant on a year-over-year basis.
The year-over-year revenue decrease was the result of two factors. First, sales at our Systems business declined by 50% as result of a difficult comparison with the second quarter of 2010 when we recorded a 3.7 million dollar follow-on order to Raytheon for the shipment of two FastCluster MultiComputer systems and related services. In addition, we had a 13% decrease in Service and Systems Integration sales due primarily to reduced sales to a major hosting customer. As we discussed previously, that customer acquired one of our largest competitors in 2010. In addition, the hosting company also had expected a downturn in business from one of its own customers that had previously created significant demand for CSP’s products.
For the first half of the year, despite the difficult comparisons in both businesses, sales are only down by 3% to $41.3 million.
CSP’s total cost of sales for Q2 decreased to $15.0 million from $18.4 million in Q2 2010 due to the lower year-over-year volume. Gross profit for the quarter was $4.2 million compared with $5.5 million as a result of the lower sales. Gross margin was 22% compared with 23% in Q2 2010. For the first half of the year, gross margins are 21% compared with 18% for the first half of 2010 as a result of the inclusion of $1.6 million of royalty revenue in the Systems business.
Second-quarter Engineering and Development expense was approximately $500,000 compared with $400,000 a year ago. As a percentage of sales, Q2 2011 Engineering and Development was at about 2.6% of sales compared with 1.8% last year. Our target range for Engineering and Development expenses is 2.4% to 2.6% of sales.
SG&A expenses decreased on a real-dollar basis to $3.3 million in the quarter from $3.4 million a year ago as a result of lower commissions in the Systems business. SG&A was 17.2% of sales in Q2 of fiscal 2011, compared with 14.2% of sales in Q2 last year. Our target range for SG&A expense is between 16.1% to 16.6%.
Our effective tax rate for the quarter was 33%. We expect our effective tax rate will be approximately 37% for the third quarter of fiscal 2011.
Net income for the second quarter was $300,000, or $0.08 per diluted share, compared with net income of $1 million, or $0.28 per share, in the second quarter of fiscal 2010.
Let’s now turn to the balance sheet . . .
Cash and short-term investments decreased by approximately $1.1 million from fiscal year end September 30, 2010 to $14.4 million as of March 31, 2011. The decrease was primarily due to an increase in inventory of $2.3 million to support sales to our large hosting customer, and the purchase of $395,000 in CSP stock.
As we have discussed 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. This was the case this quarter with the significant increase in our inventory.
Going forward, our financial priorities remain the same. We will manage the company cautiously with a strict focus on controlling expenses and efficient working capital management, all while driving toward long-term profitable growth.
With that, I’ll now turn the call over to Alex.
Alexander R. Lupinetti
Thanks Gary. And welcome to our call this morning.
We are quite pleased with how our year is unfolding. After reporting a stellar Q1, notwithstanding unusually difficult year-over-year comparisons in both our Systems and our Service and Systems Integration businesses in Q2. Nonetheless, we delivered another quarter that surpassed our expectations on both the top and bottom lines.
With that said, I’ll begin by providing some context around our second-quarter results for both our Service and Systems Integration and our Systems segments, and then we’ll take your 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 U.S. Defense Department.
The Systems business reported revenues of $2.3 million compared with $4.6 million in the second quarter last year. As Gary mentioned, the year-ago quarter benefited from $3.7 million in revenue from follow-on orders from Raytheon.
The highlight of the quarter was the budget approval of 10 new E2D Advanced Hawkeye intelligence, surveillance and reconnaissance aircraft. You might remember that on last quarter’s call we mentioned that we were in discussions with Lockheed Martin regarding phases 3 and 4 of the Low Rate Initial Production Phase, or LRIP. These 10 aircraft, which we expect will be built over the next few years, are part of phases 3 and 4 of the LRIP. This is very exciting news.
The E2D is a perfect example of the military’s focus on intelligence, surveillance and reconnaissance, and we will continue to invest in technology to position CSP to capitalize on this trend.
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.
Sales were down 13% in this segment to $16.9 million, as a result of lower sales to our large hosting customer. Despite the year-over-year decline, overall we are pleased with the performance of the Service and Systems Integration segment.
The business was able to overcome much of the year-over-year revenue deficit caused by the reduced hosting customer sales, as well as improve gross margin for the quarter. In fact, even though sales were down 13%, gross profit actually increased 4% and gross margin grew 300 basis points to 16%. The increase was due to a greater mix of higher margin products as well as a greater number of smaller, higher-margin deals in the U.S.
One factor that led to the higher margins this quarter is the success that we have had in leveraging our R2 Technologies acquisition to win business in the unified communications market. Unified communications holds significant growth potential for us, and our strengthening relationship with Cisco is important to our success in this area.
Looking at this business segment geographically, double-digit growth in Germany partially offset the year-over-year decline in the U.S. caused by the lower hosting customer sales. Strength in Germany was driven by sales to Vodaphone, one of the largest mobile telecommunications network companies in the world. Productivity levels in Germany also remained high for the quarter.
Our sales to Vodaphone underscores the success we have had with our partnership with nCircle, a California-based 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’re, also seeing significant demand from telecom operators who need to upgrade their infrastructure and load balance their networks to mitigate the heavy demand generated by the proliferation of smart phones.
As we have discussed previously, 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. Based on the fact that our gross margins in the Services and Systems Integration Segment have increased even as revenues have decreased, shows this strategy is working.
Before we take your questions, let me leave you with a few thoughts.
First, we are pleased with how the year is progressing. Our earnings for the first six months of the year at $0.19 per share are up significantly over the same period last year.
Second, demand is strong across our Service and Systems Integration segment, with the exception of the reduced sales to our large hosting customer. And as I just mentioned, we’re also pleased with the progress we’re making to attract higher-margin consulting, as well as solutions and managed services business. The demand environment in this segment and our margin performance gives us good reason for optimism about the remainder of the year.
And third, we are excited that funding for 10 additional E2D Advanced Hawkeye ISR aircraft has been authorized and we expect to benefit from sales to Lockheed Martin for these planes over the next few years.
And 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.
Alexander R. Lupinetti
Thank you for joining us today. We look forward to speaking with you on our Q3 call this summer.
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