CSP Inc. (NASDAQ:CSPI) reported second quarter earnings yesterday, and the results were well below expectations. After reporting just over $21 million in income and EPS of 25 cents per share in the prior quarter, second quarter revenues amounted to $18.8 million and EPS came in at just 7 cents per share. The stock is currently being hammered on the news, and is down more than 12 percent.
However, if we take a closer look at the results, it appears that all is in fact well at CSPI. The entire earnings miss can be accounted for by the fact that the company did not ship any product to Raytheon in the quarter. However, the company has commented that it would resume shipping to Raytheon next quarter and they expect to fulfill the remaining $12 million on the Raytheon contract by the end of the fiscal year. In fact, Raytheon has even added a small follow-on to the contract, so we can be confident that the delay in shipments to Raytheon is only temporary.
In order to understand just how important the Raytheon shipments were to earnings, it is useful to take a look at CSPI’s first quarter as a benchmark. The Raytheon shipments in the first quarter accounted for essentially all of the revenue in the company’s Systems segment of the business, which accounted for about $5.1 million in revenue in the first quarter. However, the Raytheon shipments were even more important to the bottom line, accounting for $1.3 million in gross profits for the Systems segment, or 75% of the company’s total gross profits.
Given these numbers, we can see that the lack of shipments to Raytheon accounted for the entire drop in EPS for the quarter. The second quarter EPS of 7 cents per share is 28 percent of first quarter EPS of 25 cents per share. Given that the Raytheon contract accounted for 75 percent of profits last quarter, the lack of shipments this quarter means we should have seen a decline in net income by at least 75 percent (and probably more given that SG&A would be larger as a % of revenues due to lower total revenues).
The fact that revenues decline by less than $3million and that EPS declined by less than 75 percent means that in spite of the failure to ship to Raytheon, CSPI’s other business segments managed to show respectable growth that somewhat helped to offset the decreased revenue from Raytheon. However, because the Raytheon contract has so much higher margins than the rest of the company’s business, it accounts for a disproportionate amount of the profits, and CSPI’s quarterly results suffered accordingly from the failure to ship to Raytheon.
Given the temporary nature of the stalled shipments to Raytheon, yesterday’s dip in the stock appears to be a large overreaction. When the 10Q is filed for the second quarter, it should become obvious to everyone that the rest of CSPI’s business is performing well, and that the Raytheon shipments account for the entire earnings shortfall. Therefore, I am doubling my position and averaging down my basis to $9.33. I still only have a medium-sized position in the stock, so if we see further weakness, I may look to add again over the coming days.
CSPI 1-yr chart