CSP Inc. (CSPI) Q4 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and Welcome to CSPi's Fiscal Fourth Quarter and Full Year 2019 Conference Call. My name is Keith, and I'll be your coordinator for today. [Operator Instructions] I'd now like to turn the call over to Michael Polyviou. Please go ahead, sir.

Thank you, Keith. Hello, everyone, and thank you for joining us to review CSPi's Fiscal Fourth Quarter and Full Year Ended September 30, 2019, Results Conference Call. With me on the call is Victor Dellovo, CSPi's Chief Executive Officer; and Gary Levine, CSPi's Chief Financial 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, 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 Securities and Exchange Commission. Please refer to the section on forward-looking statements included in the company's filings with the SEC. After Victor and Gary conclude their opening remarks, we'll then open the call for questions. With that, I'll turn the call over to Victor Dellovo, Chief Executive Officer. Victor, please go ahead.

Thanks, Michael, and good morning, everyone. Gary will be reviewing the Q4 financial results in a few minutes, so I will focus my remarks on our full year performance. To begin, total revenue for fiscal 2019 increased 8% to slightly over $79 million. I am pleased with our results, and I also believe the investments we made over the past couple of years positions us for even greater success in fiscal 2020 and beyond, as we transform CSPI into a cybersecurity, wireless and managed service company. Specifically, our new and exciting revenue opportunities for Unified Communication as a service and ARIA. I do expect these to begin generating revenue during the second half of our fiscal 2020, and I'll discuss these in greater detail. But first, let me begin with a review of our Technology Solutions business. For the full year, TS revenues increased to $71.1 million, representing a [ 14% ] increase over fiscal 2018. This reflects a healthy increase in the product and service revenue, which grew at 13% and 18%, respectively. Our managed service practice, or MSP, exceeded our expectations and for a business that did not exist 3 years ago, we already had a significant number of new customers, and the list keeps growing each quarter. In fact, in the first few weeks of our fiscal 2020 first quarter, we signed several new customers, so we are bullish onf the full year results. However, what I'm most proud of is the high customer satisfaction. And I believe the continued positive customer experience is going to help us secure new customers. Kudos to the entire team. They're doing an amazing job, and I'm confident that they will continue to perform at a very high level. We also continued our work within the cruise industry, which, if you recall, initially started with 1 operator and increased to include a second. Both are well regarded and among the largest global operators. In fiscal 2019, we have completed a total of 17 ships, and we currently have commitments for the next 7 months or through fiscal third quarter. Finally, our Microsoft practice is performing well and is benefiting from the actions to recruit the right talent. While we still have open positions, filling these together with our marketing spend will continue to strengthen our Office 365 business. We also continue to pursue our Unified Communication as a service business or UCaaS, which is an all-in-one service for hard and soft phones, including 24/7 security and technical support, with redundant data centers located in Florida and Texas. This is a fast-growing and dynamic market, which is controlled by just a few large players and according to published reports, is expected to have a 29.4% compounded average growth rate through 2024, when it's anticipated to reach a $79 billion market. As you would imagine, with these market's characteristics, we are -- have allocated significant resources to develop an offering, which I believe is distinct and offers competitive differentiation. Currently, we have 2 customers performing testing. And since they have over 1,000 users being tested in multiple locations. The feedback is positive, and we maintain our timeline to officially launch in January. There is a tremendous amount of interest in the UCaaS and the pipeline is getting deeper. I'll now move to our High Performance Product division. Full year revenue was $7.9 million. And while the $2.6 million decrease was not entirely unexpected, it's primarily due to $1.7 million decline in royalty revenue related to the E-2D program. Plus another $3.5 million in lower multicomputer service and Myricom revenue. However, this was partially offset with nearly $1 million increase from multi-computer products and services. We remain confident we can secure additional purchases for both parts and royalties for fiscal 2020 of foreign military E-2D planes. In addition to our HP -- legacy HPP revenue, we are very excited about the future revenue opportunities. As I mentioned earlier, ARIA, our award-winning next-generation cybersecurity platform is why we are cautiously optimistic about the growth potential for our HPP business segment. As a reminder, ARIA provides advanced protection for critical data assets that need to be assessed by end users and applications, both in the cloud and on site. I want to review the progress that we made since we last spoke and the initiatives that we are currently underway to ensure the successful launch of ARIA during the second half of current fiscal year. With the supplier issue successfully resolved, we commenced shipments as we have officially transitioned from beta stage to rollout stage. This increased level of confidence has allowed us to build a sales team. In the last 3 months, we have hired 3 trained direct salespeople with each, a minimum of 15 year's experience. I believe it's worth pointing out that each was fully employed at the other organizations that they made a conscious decision to join the CSPi team. As many of you know, this is a historically tight labor market, so I believe that the decision is a game-changer because they recognize ARIA's advantage in how we can potentially reshape the competitive landscape. Let me remind you, CSPi is a relatively newcomer in the cybersecurity space, an unknown entity, so it's a big moral boost when they joined. And I can say with our hesitation, their energy and enthusiasm is already permeating through CSPi. While we continue to downplay a rapid initial ramp-up given the typical long sales cycle required when dealing with OEMs and MSSPs, the pace of sales meetings has increased and our sales funnel has risen exponentially. We are continuing to vet potential partners for our official channel program, which is part of our two-pronged strategy to expand to include resells with security expertise in order to improve the sales funnel of our cybersecurity products. We have signed 3 partners in the past 3 months, and we are expecting more as we progress over the next coming months and since the robust channel program together with the expanding direct sales team, will give us a strong platform for revenue growth. As anticipated, the customer feedback remains positive, primarily regarding ARIA's ease of deployment and ease of use. So it's now just a matter of time before we get the first significant order. Actually, every potential customer has looked at ARIA is still in the sales funnel of more than 2 dozen or so. So I'm pleased to report that not a single one has walked away. Each one is progressing throughout the sales process with a few approaching the more advanced stages. Also, the recent acknowledgment we received from Cyber Defense magazine, the premier source of IT security information, validates our vision and is a key in the third-party endorsement that will drive further customers' interest and demand. I can't underestimate the points of this reference and its combination with our sales and development efforts, we will remain -- maintain our plans to further educate the market. I also believe due to the momentum we are generating and the positive customer experience, the timing will benefit us as customers are finalizing budgets for the new year. Certainly, the larger ones. In summary, we made significant progress in fiscal 2019, and we carried this momentum into the new fiscal year. As we enter the new year, we have a solid existing business and exciting new offerings in each of our business segments, UCaaS in our TS business and ARIA in our HPP business, and believe we are positioned to succeed in the coming year and cement our migration to a cybersecurity, wireless and managed service market company. I believe we now have the pieces in place to significantly improve our top line and achieve profitability in fiscal 2020. With that, I'll now ask Gary to provide a brief overview of our fiscal fourth quarter financial performance. Gary?

Thanks, Victor. As Victor mentioned, our fourth -- fiscal fourth quarter revenues increased to $22.2 million from $19.6 million a year ago. We generated a gross profit increase of $0.3 million to $5.1 million compared to gross profit of $4.8 million in last year's fiscal fourth quarter. While the gross margin was 23% and was lower compared to the year-ago gross margin of 24.7%. This is primarily attributable to a higher amount of royalties in last year's fourth -- Q4. Additionally, this year, the results include revenue from a sizable customer, while at lower margins, was strategically important for CSPi and allows us to foster closer working relationship, which will yield benefits for many years. Our first quarter engineering and development expense was significantly lower at $691,000 compared to $925,000 a year ago, which is attributed to a [ reduction in ] contract labor required last year to help in building out the foundation of the ARIA software platform and a recovery of consulting expenses where the services were not completed. Our SG&A expenses in Q4 were $4.6 million compared to $5 million in last year's fiscal fourth quarter. The decrease in expenses was primarily related to variable compensation and expenses related to the sale of our German subsidiary. The company had a tax expense of $395,000 for the quarter. This was a result of a change in the fourth quarter tax provision which includes the annual adjustment of the deferred taxes, which resulted in an effective tax rate of 16.1%. In the third quarter, we had a tax benefit of $327,000 with an effective tax rate of 158%. The changes in the provision and the rates resulted in the large tax expense in the fourth quarter. We reported a fourth quarter net loss of $334,000 or $0.09 per share compared with net income of $16.2 million or $3.95 per diluted share for the fourth quarter of fiscal 2018. As a reminder, the year-ago net income included a gain of discontinued observations related to the German sale of $16.8 million. However, excluding the gain, we would have reported a net loss of $0.7 million or $0.18 per share, a significant year-over-year improvement. We ended the fiscal year, September 30, with cash and short-term investments of $18.1 million. Lastly, our Board of Directors has voted to pay a quarterly dividend of $0.15 per share to shareholders of record on December 31, 2019, and payable on January 15, 2020. Looking to fiscal 2020, we will continue to focus on bottom-line performance and to boost sales of our higher-margin products while managing costs around the company. With that, I'll turn it over to the operator to take your questions.

[Operator Instructions] We'll take our first question from Jay Hill, private investor.

Wanted to ask you a bit about the stock, which despite a lot of high-growth industries remains really undervalued relative to its peers. Any plans -- or I should say, what are your plans to generate some more interest in the stock to hopefully not only just help liquidity but valuation as well?

Well, I think our plan right now is with some continued success in the area, we will start attending some conferences as well as meet with respective investors. We have recently changed our IR firm and are working with them to put a program together to talk to other potential shareholders in such things as families, business -- I mean, family trusts and fiduciaries. So we're going to concentrate more on some of that as we get more success coming out during the year.

We'll take our next question from Joseph Nerges with Segren Investments. Joseph Nerges;Segren Investments;Managing Director: Great job last year. It looks like we're moving forward very good here. Just a couple of quick questions. You did say that the E-2D revenue royalties were about $1.7 million less this last fiscal year. Is that correct? Did I hear that correctly?

Yes, between the royalties and -- right, there are some parts in there, too, Joe. Joseph Nerges;Segren Investments;Managing Director: But it's a fair amount of fiscal '19 versus '18, right?

Yes. Joseph Nerges;Segren Investments;Managing Director: I was right. They are about $1.7 million in that area.

Yes. Joseph Nerges;Segren Investments;Managing Director: Okay. On the -- and you said you have some visibility. You don't have a lot of visibility, I know, on E-2D planes. But going forward, you're anticipating an increase this year coming? Or we don't know that yet?

No. We don't see it really increasing. We probably believe it will be closer to sort of the level we had this year. Joseph Nerges;Segren Investments;Managing Director: Okay. I don't know if you guys did notice, but beyond Japan ordering an additional line of 9 planes. Of course, the U.S. ordered 24 of those. And France is now ordering 3 E-2D planes. So as to when the orders are fulfilled, that's another story, but it seems like the book is increasing in that respect anyway. Last -- on the last call, you basically detailed -- or Victor detailed 3 areas that we're pursuing with the ARIA marketing. And that's the first one you came up with was the carrier -- a large carrier that might be rolling out a 5G network and then they might be using it both internally and externally with their customers. Is that still moving forward with that carrier?

The conversations are actually taking place as we speak right now. There's multiple meetings that have been going on over the last quarter with them. Joseph Nerges;Segren Investments;Managing Director: Okay. Great. And then, of course, the integration was a second area, and we announced, of course, Medisto (sic) [ Demisto ] press release on that just recently, and I'm assuming we have other integrations that we're working on at the current time with other securities?

Correct. Absolutely. That's correct. And as we get further down and the integration becomes finalized, I will announce those as we go. Joseph Nerges;Segren Investments;Managing Director: Okay. Very good. And then, of course, the last one is of course, in the press release yesterday, it's indicative that's your channel partners, MSP resellers and as you indicated, you're moving forward there too and added, what, 3 new people in the last couple of months or so on that program?

Well, yes, 3 new buyers or resellers that specialize in the security space. And then we -- I mentioned that we hired 3 direct sales reps also that are targeting their own direct accounts. That will work through the channel ultimately, but we're trying to prospect on our own and drive up some business and they're all large companies, whether it's financial or insurance, medical, those manufacturing, we're targeting those on our own also. Joseph Nerges;Segren Investments;Managing Director: So basically, the direct sales people are not necessarily soliciting channel partners. They're out there soliciting legal accounts or both?

If they have some relationships that they've worked with in the past, that they know that the companies would be interested in ARIA. Then, of course, we're engaging with those resellers also and they're passing some of that relationship over to the channel people, that are running our channel division. But they'll continue to work with them to drive joint sales calls together, at the same time. Joseph Nerges;Segren Investments;Managing Director: So last -- quickly, last quick question, that is the -- you said you noticed an increased inbound traffic, let's put it that way. Well, the question, after the Cyber Defense magazine nominated you guys for the best network security management product is that -- and that's been fairly recent. That's something that came out in October, at least the press release on that. So you're seeing something in the -- you're tying the -- that particular award acknowledgment and the increased traffic, possibly, from that?

I think it's a combination of that. We're pushing out that announcement, through social media, through press releases through -- via e-mail. We're trying to get that out not only to explain what the product does, but to validate that it's not just CSPi saying it, it's an independent party that looked at the product and determined its validity in the market space. Joseph Nerges;Segren Investments;Managing Director: Okay. Great. That's all I have. You guys are moving -- it sounds good to me. And I'm pretty excited about the next year and the following year.

We'll take our next question from Terry Keratsopoulos with Upstream Investment Partners.

Your company has about 1/3 of its market cap in cash, trades at less than 1x sales, which is very unusual for a technology company. I was just wondering what advantage does the ARIA product line brings to the market, who would be direct competitors? And lastly, what do you think the market potential of your ARIA's cybersecurity product line could potentially be?

Well, to your first question, there's a lot of products that are out there. You can name some of the big players are out there, some of the smaller ones. But I think taking some of the technology that we developed with packet inspection that we've been doing on the Myricom side for 20-plus years. With the latency that it has and the accuracy of basically no package drops, using that to analyze east to west traffic because a lot of the products that are out there are looking in north to south. I think that's, kind of, where we separate our advantage to do that. And then we also -- we could be an individual product by itself or we could team up with companies that -- maybe, customers that have bought like Splunk and a few other products that are out there that gets costly on ingesting -- the more you ingest more of the Splunk. We can look at a lot of those packets before it hits back and ingested and only pushed through the packets that have issues. So we get rid of a lot of the false positives that a lot of these products look at. But yet, pay for, even on the false positives based on ingestion alone. So I think those are the few areas that I think we really separate ourselves from some of the other products that are out there. And we're looking at -- Demisto is 1 of the companies that Palo Alto ended up purchasing not too long ago. So we were already talking to them prior to that purchase. And looking at the dashboard and us being able to quickly look at the data and send it through accurately, of only truly what the problems are, not just massive flows of data that has to be looked at. And sometimes that completely inspected accurately and things get through. So we will be teaming up with all the third parties that we look at that are -- they inspect package, but I think we can inspect it and add to that value and make it a lot more accurate compared to the way these other companies are doing it. And I said -- like I said, east to west traffic is not looked at by most products, it's north to south, and I think that's where we really separate ourselves from the other third parties out there. And what was your other question?

What do you think the market potential of the ARIA's cybersecurity product line could potentially be?

If we get into some of the bigger MSSPs, we target this, it could be hundreds of millions of dollars. Some of the stuff that we're looking at now is tens of millions. It's based on server base and the more servers these data centers have, the more boards you need, the more software licensing, the maintenance, the support. It's -- it could be huge. That's what we're counting on.

[Operator Instructions] We'll go next to Brett Davidson, private investor.

Couple of questions. I'm looking to back up a little bit. Back up to the balance sheet. And there's so much going on, but it's hard for me to keep this all straight here. But nonetheless, there was a $2 million increase in current assets, I wonder if you guys can give a little color on that? And a $5 million in other assets.

So let me look at it quickly. Well, obviously, we had increases within the receivable area and as well as the inventory. Because there's a lot of different pieces in there that we're doing now and have really focused more on the long-term side of it for us.

So would it be easier if I give you a call later, Gary?

Yes. Because then we can go through it right now and just, then we can talk through that.

Got it. That sounds good. So the E-2D, do you guys have an idea how many planes that you ended up billing for this year?

Well, we don't -- we do it based on it's really boards, Brett, that we're dealing with. We've sort of gotten away because the footprint of the foreign military stuff, there's different sizes depending on the radars and they're not compared to what the U.S. has. So we really just look at it from a board standpoint and the revenue comes in on a board basis, not really on a plane.

So how many were linked to the U.S. versions of the plane?

I'd have to check. I can't answer that because it's difficult for us to say because it's -- there's some that comes in as spares that go to the U.S. military, and then there's others that are going to the foreign. And they don't really [ hit ] a market to us. So we don't really know. We know based on the number of boards, they're smaller numbers that they're taking would be for the foreign military, but they don't really say it is U.S., and this is foreign to us. It's really -- we track as much information, but Lockheed doesn't really disclose a lot of that.

Makes it fun trying to...

Well, yes, difficult from that side. Yes.

Yes. So I know you guys used to include in your release like how many planes that the content was for, it become a little tougher to get that pinned down.

Right. Now...

We weren't giving foreign before. It was just U.S. based.

And Lockheed was more forthcoming with that, which related to more of the public information that was coming out.

Got it. So in the press release that came out yesterday. Can you guys just give me an idea how long it took to develop those relationships with those 2 partners?

They vary because we're targeting -- so what -- we're not just signing everyone up, right? Because if we just want to sign a piece of paper and say, "Hey, you want to be partner? Great", that would be one thing. What we're doing is when we're looking at the resellers, it's kind of they're interviewing us, we're interviewing them. There's a relationship there because like our channel person came from 1 of the larger networking companies out there. So he knows -- they sign up everybody and whether they sell $50 or $50 million. They just signed them up. That wasn't our -- our goal was to have security partners that focus around that and had the bandwidth to bring on ARIA and not only bring it on as a product but get trained, have access to our lab. So that interview was talking to the owner of the business. Their CIO or Business Product development person to make sure that they understood the technology, and they were, a, they bought in on what we were selling; and two, they understood the value of that. So we didn't just blow it out. So it was a process of probably 2 or 3, 4 months. Just getting together and making sure that you're talking to their engineers, where Orange is and then with doing evals. The whole thing went through it. So it does take a little longer than just signing up a resell partner. But we have a pipeline of probably another dozen or so that we're doing that with right now. So you should see a little bit more -- bring on a few more, but we're trying not to boil the ocean, because we will -- just because of the size of our organization, we won't be able to give them the attention they need on the sales side, if we sign up 50 partners overnight. So my goal is to have somewhere between 15 and 20 by end of next year, that can generate significant revenue.

Got it. So you guys want a manageable amount. So then with that, then there must be others -- like you said, you got others in the pipeline here at various stages. So is it reasonable that we could expect to see more press releases in the near future, similar to what we saw yesterday?

I'm going to put as much press out there that I possibly can, to keep you guys informed of what we're trying to do and how we're moving forward. Whether it's with awards, bringing our partners. I may not be able to mention customers, but if we get significantly wins, I'm not going to let them -- if they're $100,000, $200,000, I'm not going to announce that. But if it's a long-term significant win, that's tens of millions, we're going to try to get you that information as soon as possible when we can.

Got it. Yes. That's good.

I think, Brett, you've seen the difference between how we try to share information as we get it compared to keeping things behind closed doors?

Yes. Yes. And like I said, there's just so many moving parts right now. It's tough for me to keep it all straight. So the last quarter, when you talked about the ARIA platform, it was high-growth potential. This quarter, the company is positioned to deliver strong revenue growth. So how much of that 13% revenue growth was in the ARIA side? Was that anything significant yet, or we're still just in the early stages of ramping up?

Oh, it's early stages. It's early stages. And that's the thing that I've been trying to highlight also is that some of the investment we made, not just on ARIA. But on the other side of the business, that building an MSP practice with a recurring revenue model, the third year out is delivering positive results that are putting true earnings to the bottom line. UCaaS is just another piece of it. And then we built the Microsoft 365 practice. All that is our recurring revenue model. So it just keeps giving month in and month out. And that's, kind of, what we're trying to focus the other TS side of the business. Which at this point is really generating all the profits of the organization at this stage. So that side of the business, we continue to invest in heavily, because I said they've been successful over the last 3, 4 years of generating $2 to the bottom line. And as we build the ARIA and the new products moving forward.

So that's generating all the revenue growth right now.

Correct.

Got it. So have you seen any shift yet from the legacy Myricom stuff to the ARIA? Has any of that occurred? Or is this like -- we talked last quarter that, that legacy stuff just keeps plugging away and it's going to continue to generate revenues from the people that aren't looking for the new shiny object and separate distinct set of customers.

Yes. It works. And we have -- keep the value on for like the new Apple software that came out, we did all the drivers. So we are doing some development and investment in the legacy Myricom product just to make sure it continues to work inside the servers and stuff like that, that are out there. So it's not just we're just watching it die, all right? There is some development and maintenance on it, and that we continue to do to keep the product moving forward. And in certain areas, it's above and beyond what they need. In some areas, it's not. So where it's not, we start looking at the new platform and try to move customers to that.

So they've been just plugging away, still generating sales revenues and that hasn't like fallen off a cliff or nothing and just...

It slowed down, but it hasn't fallen off a cliff. It's -- some months are better than others. But consistently, we still get sales every week from that business. And like I said, some months better than others, but it's still there. It has shrunk since we bought it but considering it's been 5 or 6 years at that, it's still going pretty strong.

Yes, I think you got a pretty good return on the price?

Yes. If I could find 5 more of those, then I'd probably hit the lottery at the same time.

So just maybe add a little color -- and I'm just looking for qualitative not quantitative here, and that, kind of, backs up to that question earlier on improving the share price. My take is generate sales, we don't have to worry about the share price. So the revenue growth over the year, you're projecting to see more of that in the second half? And does that directly tie into the ramp-up of the ARIA products? Or are there other factors that are playing into that?

The majority is the ARIA. And then whatever our foreign military planes are more in the second half of the year also.

Got it. And do you have any feel for -- I mean, what that's going to look like over the course of the year? Or just no visibility whatsoever.

No visibility right now. No visibility.

So no surprise there. But the last thing I'd like to touch on, I'd just like to say that I strongly support the new governance policy. And agree wholeheartedly that directors should be held accountable. That's a necessary thing. But I think that was a great move. Loved seeing the press release and enjoy your holiday season.

Thank you. You too.

And it does appear we have no further questions. I'll return the floor to Victor Dellovo for closing comments.

I want to thank everyone for your continued interest and support. We wish everyone a happy and safe holiday season and a joyous New Year. I believe we are successfully repositioning the business. And Gary and I look forward to sharing our progress with you on the fiscal Q1 conference call in February.

Thank you.

Thank you. And this does conclude today's program. Thanks for your participation. You may now disconnect.