CSP Inc. (CSPI) Q3 2020 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the CSPi Fiscal 2020 Third Quarter Conference Call. [Operator Instructions] Please note that this call is being recorded. And now it is my pleasure to turn the conference over to Mr. Doug Sherk with EVC Group. Please go ahead, sir.

Thank you, operator. Hello, everyone, and thank you for joining us to review CSP Inc.'s fiscal third quarter ended June 30, 2020. With me on the call today is Victor Dellovo, CSPi's Chief Executive Officer; and Gary Levine, CSPi's Chief Financial Officer. After Victor and Gary conclude their opening remarks, we will then open the call for questions. Statements made by CSP Inc.'s management on today's call regarding the company's business that are not historical facts may be forward-looking statements as the term is identified in federal securities laws. The words may, will, expect, believe, anticipate, project, plan, intend, estimate and continue as well as similar expressions are intended to identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results. The company cautions you that these statements reflect current expectations about the company's future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond the company's control that may influence the accuracy of the statements and the projections upon which the segment and statements are based. Factors that may affect the company's results include, but are not limited to, the risks and uncertainties discussed in the Risk Factors section of the annual report on Form 10-K and the quarterly report on Form 10-Q filed with the Securities and Exchange Commission. Forward-looking statements are based on the information available at the time those statements are made and management's good faith belief as of the time with respect to the future events. All forward-looking statements are qualified in their entirety by this cautionary statement and CSP Inc. undertakes no obligation to publicly revise or update any forward-looking statements, which is a result of new information, future events or otherwise after the date -- excuse me, whether as a result of new information, future events or otherwise after the date thereof. With that, I'll turn the call over to Victor Dellovo, Chief Executive Officer.

Thank you, and good morning, everyone. Before we begin, I want to acknowledge the impact of the coronavirus pandemic and express our heartfelt concern to those that have been affected. Since we last talked with you in May, our team has continued to adjust how we operate the business to maximize our opportunities in a manner that is safe for both our employees and our customers. We have been able to maintain most of our workforce executing for our clients and more than 90% of the team is working remotely. We are now several months into the new normal, and despite limiting our ability to visit our customers and potential customers, we continue to build our pipeline in all lines of our business. Total revenue for the fiscal third quarter was $13.5 million compared to $21.6 million we reported in the same period of fiscal 2019. While the year-over-year revenue decline was primarily related to COVID-19 pandemic, our decision to also transition our business to higher-margin products and services enabled us to significantly improve our gross margin. I believe this achievement demonstrates the soundness of our execution of our profitable growth plan. Further, during this transition, our prospects remain quite high. And if nothing else, the suddenness of the COVID-19 pandemic and unprecedented of remote working environment is helping to highlight network vulnerabilities. Businesses of both large and small remain exposed to increased threats and there have been several well-publicized ransomware attacks. I believe this fear, in addition to providing a secure remote working environment, is a growing concern for many businesses. It is critical that the businesses have a partner that understands the complex challenges. We are positioning CSPi to be that partner as our newest solutions ARIA and our Unified-Communications-as-a-Service, or UCaaS, seem readymade for today's critical network issues. For the quarter, our Technology Solution, or TS, revenue was $11.9 million. While the TS division was impacted by COVID-19, we were able to generate most of our revenue from our large customers. Our managed service practice, or MSP, continues to perform well as we signed new customers during the quarter, which include cloud business and UCaaS. Importantly, we have not lost a single customer as they value the service we are providing. This stickiness demonstrates our importance to our customers even during these unprecedented times. I believe that the 3 lines of recurring revenue business we created continues to bring stability to CSPi. Separately, the cruise ship industry remains one of the most COVID-19 impacted industries. When we spoke in May, many operators were looking to resume cruise during the summer months. However, in June, the Cruise Lines International Association, or CLIA, announced that the association's ocean-going cruise line members will voluntarily extend the suspension of the cruise operations from the U.S. ports until mid-September 2020. However, some cruise operators have plans to restart in the EU ports in the coming weeks. While the continued travel restrictions hampered the ability to gain access to the ships, we continue to communicate with the operators every other week, and we are prepared to move on a moment's notice. On the positive side, these upgrades need to occur, and the operators have already purchased the equipment, so we would expect these ships to be prioritized when business resumes. As we have consistently reported over the past few quarters, our Microsoft practice continues to perform well, and this latest quarter was no exception. We are a month through Q4, so I'm reaffirming our belief that we will achieve a greater growth rate for the business compared to a full year growth rate of 140% we achieved in 2019. Regarding our UCaaS offering, an all-in-one service for hard and soft phones, including 24/7 security and technical support with redundant data centers, both in Florida and Texas. As a reminder, the UCaaS market size is expected to grow from $15.8 billion in 2019 to $24.8 billion by 2024, being driven by growing trends towards mobility and bring your own device, or BYOD, to the workplace. During the quarter, we continued to have success as we added new customers and expanded sites at our current customers, all while continuing to increase the number of virtual product demonstrations we are performing on a weekly basis. The new business pipeline is promising, and the team is engaged with prospects and is maintaining constant communication. Now I will move to our High-Performance Products, or HPP division. Revenue for the quarter was $1.6 million, in line with our estimates and reflects revenue from our legacy business, being offset by the expected decline in the Myricom business. ARIA, our award-winning next-generation cybersecurity platform that helps organizations protect themselves from harmful hidden attacks without human intervention, is continuing to garner tremendous interest and customer success as we recently completed an installation for an international customer. Further, we continue to be well positioned within a leading cable company and other OEMs opportunities for ARIA. I believe the testimony, along with the industry, acknowledgment and robust lead flow we are generating from virtual trade shows will drive future sales in the HPP division. Additionally, we now have 6 partners for our official channel program, and we are speaking with several others to ensure a robust channel program. To summarize, the CSPi team is performing well and remained focused during the unprecedented times. We have made and will continue to make necessary adjustments to our operations to ensure business execution. Specifically, our new ARIA and UCaaS offerings are generating the expected interest as we sign up new customers and broadening our pipeline. We have a diverse customer base, both large and small, and this breadth will allow us to successfully navigate the near-term uncertainty. We are excited about our long-term growth prospects. With that, I will now ask Gary to provide a brief overview on the fiscal third quarter financial performance.

Thanks, Victor. As Victor mentioned in his opening remarks, our third quarter revenues were $13.5 million compared to $21.6 million in the year ago third quarter and reflects our pursuit of higher-margin business. We reported gross profits of $4.2 million compared to last year's third quarter profit of $4.8 million, resulting in a gross profit of 31.2% compared to the year ago gross profit of 22.4%, an improvement of 9%. Our engineering and development expenses for the third quarter was $693,000 compared to $583,000 in the year ago quarter. In the prior year quarter, we received a refund of $150,000 from consulting cost for a project that wasn't completed. Our SG&A expenses in the quarter were $3.9 million, slightly decreased from $4.1 million in last year's fiscal Q3 due to a decrease in variable compensation costs. We repeated -- we reported a loss before income of $200,000 in Q3 compared to income before income taxes of $206,000 in the prior year third quarter. During the quarter, we had income tax expense of $10,000. The prior year quarter had a tax benefit of $326,000. In early April, when it became evident that the COVID-19 would have a severe economic impact, we took several actions to improve our cash flow, including the suspension of our quarterly dividend, stopped our stock buyback program, and applied for and received a PPP loan. These actions at the end of June strengthened our cash position by approximately $3 million. We ended the third quarter with cash and short-term investments of $20 million, which includes cash of $10 million in the U.K., and we have a pension liability of $5.2 million. Our actions are designed to ensure that we continue to drive our bottom line performance and boost sales of our higher-margin products. With that, I will turn it over to the operator to take your questions.

[Operator Instructions] We'll take our first question from Joseph Nerges with Segren Investments. Joseph Nerges;Segren Investments;Analyst: Just a couple of quick questions. From the last conference call, we were talking about proof-of-concept demos that you were, at least, attempting to do with the customers on this ARIA product line. What's the status of that? Have we been able to get access at all to some of these customer sites?

Not yet, Joe. Joseph Nerges;Segren Investments;Analyst: Not yet?

Not yet. Joseph Nerges;Segren Investments;Analyst: Okay. So we have a backlog of -- we should have a backlog of proof-of-concept demos out there. I assume that we've been -- have you been doing virtual demo...

We've been doing the virtual ones, and we've been trying to do like a try-and-buy, where they actually give us a purchase order, stuff like that. That's what we're offering. They want to see it working... Joseph Nerges;Segren Investments;Analyst: They want to see it work.

Yes, exactly. And we haven't been able to get on site. Most of our customers still have -- unless you work there, you're not allowed to be on the facilities. Joseph Nerges;Segren Investments;Analyst: Okay. But the last -- again, in the last conference call, you were saying you were doing demos. So I assume you were able to do some sort of a demo absent the proof-of-concept...

We're doing demos. We're doing 3 to 5 demos a week consistently. But getting it to the next level of the proof-of-concept is what's kind of slowing things down at this stage. Joseph Nerges;Segren Investments;Analyst: Okay. And so I have to assume that in the last 3 months, you've had quite a few virtual demos, if you want to call it that. And it's a matter of getting -- and so we have not been able to get to most customer sites at all, is that what you're saying? Okay. On the UCaaS offering, I see we've signed a couple of customers up with UCaaS. Have we -- are most of the customers that we're getting here, are they taking the standard product? Or are we do modifications, like you had indicated some conference calls ago? Are we modifying it to the customer specification, the Cisco?

I would say 50-50, Joe. Joseph Nerges;Segren Investments;Analyst: Okay. And I guess my question is, are we competitive versus, let's say, the RingCentrals of the world because they're out there doing the same thing, right? Pretty much. Is that Cisco product line, with the platform that we're utilizing, very competitive in the market?

I would say, Joe, if you go look on this like 3 buckets that they sell into like a higher end line where you get the WebEx and everything that goes along with that. And then there's the middle -- the 2 middle tiers, we're very competitive. Not a problem. If it's just ring tone, it's probably not our bag of -- they're not customers that we're really interested in. They're trying to do like $4 a month or something very, very inexpensive per user. That's not where we are trying to go after. Joseph Nerges;Segren Investments;Analyst: Okay. And so you did indicate again that we still are in contact with the cable company. I'm assuming we haven't been able to do much because of the whole COVID situation...

A lot of communications, just things have been just slowing down. Yes. We do have, if not weekly, every-other-week conversations. But things got pushed out a few months due to their uncertainty of how they want to move forward. Joseph Nerges;Segren Investments;Analyst: Okay. And one other thing. On the -- we're finally -- well, Technology Solutions is finally offering our vital MDR advantage, which we incorporated into ARIA platform. And I'm just wondering, this is a perfect platform to -- obviously, for any of the managed security service providers. Have we been able to garner some interest in that through Technology Solutions group?

Well, the Technology Solutions here is offering a part of the managed service now. So that has been integrated and the sales force is working diligently to provide opportunities for that. And then we're also talking to other MSPs on the ARIA side that they're discussing direct that they may want to use our platform as their SIEM. Joseph Nerges;Segren Investments;Analyst: But I'm assuming the same problem exists with Technology Solutions group that is that they don't have -- they can't get access to the customer sites either, if they're interested in following through on -- with this platform.

Exactly. We just have some stronger and long-term relationships that we could kind of -- we're trying to push them to just say, "hey, believe in us." You trusted us for the last 10 years. We know this is going to work. So those are the conversations that we're trying to push on the TS side a little bit faster than we would normally on a brand-new customer that may not know CSPi or ARIA. Joseph Nerges;Segren Investments;Analyst: Okay. How about -- any E-2D royalties in this particular quarter or expected in the next quarter?

There will be -- in this current quarter, Joe, we're going to have royalties, and we had a few in the last quarter. Going into next year, we just have to see how they fall out because what's happened over the last few years is they don't get the products out and it trickles into the first quarter of the next fiscal year. So we just have to see how they roll out when they build the boards. Joseph Nerges;Segren Investments;Analyst: So basically, we had a little bit this quarter, you're saying? The current quarter, we just...

Yes, Q3. Yes, it was small amount. Joseph Nerges;Segren Investments;Analyst: And we are expecting a little bit more in the fourth quarter?

Correct. Joseph Nerges;Segren Investments;Analyst: And then we just don't know how it's going fall next year?

Correct.

Well, we know we're going to have royalties. We just don't know the timetable for the royalties coming in the next year. Joseph Nerges;Segren Investments;Analyst: Okay. All right. Very good. That's about all I have. R&D expenses, you said around $693,000 for the quarter. So again, we would have been -- obviously, absent the R&D, we would have been profitable essentially. All right. Thank you very much. Appreciate it, guys. Hopefully, we can get over the pandemic and move forward with certainly some of the new offerings.

Yes. Thank you.

Thanks, Joe.

And we'll take our next question from [indiscernible] with [ Compound Partners ].

You know I represent an individual and a group, which is, I believe, the largest shareholder in the company. And we're extremely bullish about what you're doing. The technology is there. The innovation is there. The management is there. And the story is -- and we believe the valuation to be really compelling, especially compared to so many names in your group. How can the story be best put out to let people know what potential is here, especially given the market? Could you speak to the size of the market for CSPi? And how we can kind of help people understand that this isn't a sleepy value opportunity, this is a growth company in the cybersecurity space that is trading at a massive discount, in my opinion?

Well, I think that there's a few things that we're doing behind the scenes. We've got a new IR firm that we've hired and working with them so that we're trying to get in front of more potential shareholders to get our message out. We're also continuing to at least trying to put the word out about the product itself. We're still competing in certain issues so that we get notified -- I mean, noticed by different people in the media and trying to get more there as well as we're being very proactive on the channel to get people there from the customer standpoint. But we really have to look at getting our message out more and more. We think you're correct in that. And I know Victor is trying to get more things going on, on the IR front.

Yes. And I completely agree with you in the segment that we're competing with some of the competitors. They've been doing it maybe a little longer than we have. But if you really look at the technology, they do piece points where we feel that we're covering 70% to 80% of the overall security we can cover with both the ARIA products that we currently have. So we -- I definitely think we're undervalued. We need a few more customers to build up a little bit more of a reputation that you could go to some of the players that covered Gartner, the Forresters and try to get them to cover it. But I put our product against any of the other products that are out there that you see on national TVs, commercials and stuff like that, that are out there. But they've been doing it a little bit longer and definitely a lot bigger at this stage. So -- but product-wise, I definitely put us against their product any day.

Thank you, Victor, and thank you for the relationships that I know you're building. I don't want to dominate the call, but I'll ask very briefly too. Can you speak a little bit to that? Because I think CSPi is undervalued small cap that has relationships with some of the largest large caps. Can you briefly speak to a couple of the companies that you're working with that you hope to work with that are among the well-known -- most well-known in their spaces?

I can tell you we're in the financial institutions. I'd rather not specifically mention the customers' names without their permission. But we're in the largest -- the large financial institutions we currently talk to. The verticals are all over. Banking and health care are the 2 verticals we really started focusing on. I think even in this pandemic type of environment, they do have money that they have to spend in security to protect whether it's client information, both on the financial or on the HIPAA and health care. So those are 2 verticals that we've concentrated on. And we're talking to, like I said, the largest cable companies that are out there also that we're talking to right now. So of course, there's always competition, but I think once we were able to get the product in there and show how it works, we'll have a good chance of earning their business.

That's awesome. I mean, before the pandemic, interestingly, CSPi traded very closely with the Cybersecurity ETF. It has recovered quite dramatically. CSPi, obviously, to a lesser extent. So we're bullish, and we really believe in what you're doing. And that's why we think the company is undervalued and continue to hold. Thank you again.

Well, thanks for your support.

Thank you, [ Jonathan ].

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

I'm following up to Joe here. Joe had some fast questions. I got some slow ones. So you guys made a reference -- in your comments, you made reference to growth, and I didn't catch all of it. I was wondering if you could just touch on that again?

In relation to?

The prior year. I was not sure if -- where we're going to end up this year.

I was saying the growth was just on the Microsoft piece of it, the Office 365. We had a good growth rate on the cloud business. That's what I was referring to.

Got it. All right. There was a new customer installation you had mentioned. And I believe it was the UCaaS, and did that revenue -- did any of that drop in the last quarter? Or is that all going forward?

Well, we've had new customers in both UCaaS, MSP over the quarter. We also had an installation of the ARIA product. It was an international customer that was installed. And it wasn't large, but we did book it last quarter, so...

And the UCaaS, I mean, was that throughout the quarter last quarter or was that end of the quarter?

Well, the UCaaS is recurring. Everything we're doing right now, and I don't know if you caught it, there's 3 business lines that we're trying to do has a recurring revenue model. So whether it's -- even ARIA can be as a recurring revenue model on a monthly basis. You have the UCaaS on a recurring revenue model basis, usually, they're 3-year contracts. And then -- so between UCaaS, potentially ARIA can be sold just bought or month -- recurring revenue. And then you have the MSP, the managed service practice, which are all recurring revenue models. So we would recognize revenue as we -- over the period of 3 years.

So I mean, the prior quarter was such a disruption. I'm just having a hard time figuring out exactly what's going on inside the business. I'm just trying to get an idea whether that was late in the quarter or during the course of the quarter. Or how that's going to impact revenues going forward? So, I mean, if it was the last week of the quarter and you guys booked some revenue, obviously, it's not representative of what this quarter will look like. I mean, can you comment on that at all or if it is...

Well, I think throughout the quarter, we had some ups and downs as many other companies did. We didn't -- and certain months were stronger than other, but the trends were that the customers were purchasing. So at some times when buying product, you're getting the whole product more, but the reoccurring revenue is the ones that we're getting the new stuff. And that's where's the sort of spread throughout the quarter that different things came on board.

So it's difficult to answer your question because what happens is, you could have a $400,000 contract that's spread out over 3 years. You've got a $1 million contract. So you are not going to see huge swings every month you're hoping you just keep increasing it. But then there's been a lot -- some large purchases, some of our financial institutions that towards -- throughout the whole quarter, spend millions of dollars at a time. So there's a combination of what Gary is saying is you got just purchase orders of just selling product, delivering it and you're done, and then you have the recurring revenue, which it happens throughout the whole quarter. And if it's at the end of the -- towards the quarter, you're not going to get any of it until more than likely if we sign in the last week, we're not going to bill until the following month.

Yes. And that's just what I'm trying to get a handle on is, how is this distributed? So if this was distributed evenly over the quarter, you'd have about 1.5 months total [ representation ] in the quarter. So I mean if all this activity was spread out evenly, it's going to be a little different than if the majority of it was in the final month of the quarter.

As soon as we can gain the business, Brett, we book it.

Yes. But I'm just trying to get a handle on when this is coming, how it's going to impact this coming quarter now that's going to be recognized for 3 months' worth instead of 1 month or 1.5 or whatever.

Yes.

So you guys did book revenue from the UCaaS in the quarter?

Yes.

Press releases. I know in a prior call, you had talked about issuing press releases and looks like that's been dislocated by the COVID thing to some extent. How do you see that going forward in the next quarter or 2? I mean, do you anticipate a flurry of press releases coming or nothing that you can really put your finger on at this point?

Nothing like the second. We have to just see how things roll out. There's still a lot of uncertainty, as you know, in the whole industry. So right now, we've just got to heads down, trying to focus on the new products and just trying to prospect with customers in a time where customers are just trying to figure out what their business looks like. So it's one of those balance and acts to push as hard as you can without upsetting the potential customers. So as soon as we have some press releases that are worthy, we'll get them back out.

So do you guys -- do you have any internal metrics that you guys use to give you an idea of what revenues might possibly look at? I don't believe you have any backlog that -- you guys don't track anything like backlog, do you?

Yes, we do.

Oh, you do that?

Yes.

We do that and we monitor the pipeline. We do all the metrics. But obviously, we don't report that, but we have a lot of internal data that we do monitor and we keep a pulse of what our business is doing and how we're doing. So we have many meetings going through those within all the operations of the company.

Can you just give an idea of what some of those things that you guys are actively monitoring?

Well, obviously, pipeline, backlog and items related to the sales metrics as well as the engineering schedules and those kind of things are what we monitor very closely and watch that as well as we're always maintaining and watching the quality of our products going out the door.

And I mean, how do you guys -- how do you quantify pipeline? Are you looking at the number of customers you contacted, the potential contract size? I mean, what is it exactly that you're monitoring?

No. You look at -- when you're prospecting, you start off at 20%, 40%, 60%, 80% and in close rate. And then you see as you move through the pipeline, of what's moving ahead or behind, what you lost, and that's kind of how you manage against it. And then you view it with your sales individuals and based on communication with vendors or customers, you figure out how you move it up or down. And then you always -- things move, right? Things that were 80%, we thought close ratio, got put on hold. Not canceled, just on hold. So you bring that back down to 40% or 60% or however you want to do it, and that's how we manage it. And then we have sales meetings and reviews with the salespeople every week. And they go over their pipeline and net new opportunities, and then we have other meetings where we have our project managers on the phone with the lead and head of engineering. And we go through all the business that's either new SOWs that went out the door to customers or current SOWs that have already been signed and rollouts and where we are in the projects. And when we expect to close them, so we can actually recognize revenue and that's -- those are things -- that's everyday business that we do.

And I'd imagine in March that might not have been a real favorable looking thing, but has that generally recovered during the course of the summer here?

No. It's up and down. Some customers are better than others, and it's a mix-match of -- it's just constant communication. May, honestly, was the one month that hit us the toughest. I think we had enough backlog for -- March, everybody just got shocked, but business was already there. April, I think there was enough backlog. And for us, May was the month that the brakes went on and then June kind of picked back up. So we're -- there was at least some normality, but not back to where it was, but at least people are talking now.

So you guys kind of like touched bottom in May and things are kind of pushing back in the other direction now?

Yes. They're significantly better than they were in May.

Got it. So -- and last thing on my slow questions here is, maybe you can just give a little color on what the current thinking is on the dividend.

Well, I think one of the important things for us is to get profitability first as a company and then take a good close look at it because the cash requirements, if we're losing money and such that we just can't really do it. But we're certainly looking at that and discussing it every quarter with our Board.

And I just think the economy is just still too uncertain to even make that. If this is something that you read -- something this morning that they have a vaccine, and then what does that actually mean to everybody when they get how it rolls out, the confidence levels until we have some type of normality that we can count on, then -- but we are having -- we do review at every Board meeting and talk about it and -- what the options are. But right now, I think we're just -- like I said, we're still cautiously optimistic right now.

So that's how we can think about it once we cross that divide back to profitability than the dividends kind of back on the table?

Yes. That's certainly and that's what to look at.

And there does appear to be no further questions at this time. I'll turn the call back over to management team for any closing remarks.

Thank you, operator. As always, I want to thank our shareholders for your continued interest and support. Our strategy of pursuing higher-margin business is generating the desired results. And as we continue to transition the business, we are encouraged by the strong and growing interest in ARIA and UCaaS offering. We do have a bright future. Have a great day.

Thank you. Bye.

Thank you. And this does conclude your program. Thank you for your participation. You may disconnect at any time.