CSP Inc. (CSPI) Q2 2021 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to today's CSPi Fiscal Second Quarter 2021 Operating and Financial Results Conference Call. [Operator Instructions] Please note, this call may be recorded [Operator Instructions] It is now my pleasure to turn today's program over to Michael Polyviou. Please go ahead.

Thank you, Britney. Hello, everyone, and thank you for joining us to review CSPi's Fiscal Second Quarter ended March 31, 2021. 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 CSPi'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 future events. All forward-looking statements are qualified in their entirety by this cautionary statement, and CSPi undertakes no obligation to publicly revise or update any forward-looking statements 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. Victor, please go ahead.

Thanks, Michael, and good morning, everyone. Our second quarter performance again highlights the type of success we can achieve even during unprecedented business climate. In addition to maintaining our business and migrating to a higher-margin product and services, we have also had the wherewithal to develop innovative solutions from the ground up to meet today's growing security concerns. This is becoming CSPi's trademark. We continue to advance the primary objective of transforming CSPi into cybersecurity, wireless and managed service company, and I believe the positioning will enable us to execute our long-term operating strategies. For example, our team has remained engaged with customers in the new business prospects and this continuous touch strategy during the pandemic. With a sizable customer base in Florida, I would expect CSPi to emerge from pandemic disruption quicker than most competitors as the state returns to a more normal business climate. Total revenue for the fiscal second quarter was $14.1 million. I am pleased with the overall performance as we experienced some positive indications such as new accounts, new product lines within some existing customers and a growing pipeline of new opportunities. I continue to believe we will emerge from the pandemic in a more formidable company with an expanding complement of offerings to grow top line. And consistent with previous quarters, the revenue mix, in pursuit of higher-margin offerings, allowed us to report our sixth consecutive quarter of year-over-year gross margin improvement with a 4% increase over fiscal Q2 2020. Now let me review a hallmark of CSPi. If you recall, this past December, up to 18,000 organizations were likely exposed by Sunburst, enable cyber attacks, a new major attack as early as a few weeks ago. And a bad actors actively use the network to access many of the vulnerability systems as possible while using techniques to try to hide their actions. Our ability to quickly identify the attacker's action and stop them provides a unique solution for this emerging cybersecurity threat demonstrates our capacity to adopt the overarching commitment to develop compelling solutions to meet modern day threats. We achieved this with ARIA Advanced Detection and Response, or ADR, an out-of-the-box solution that requires no special configuration and is purpose-built to automatically find and stop all forms of attacks, including advanced persistent threats. The ARIA ADS solution was designed to detect such attacks as well as ransomware, malware, which are consistent threats to our organizations. In March, ARIA ADR received a Cybersecurity Excellence Award, an outstanding achievement for recently released solution because it automatically find and stops network borne threats as soon as they become active in the network and, most importantly, before harm occurs. The single platform solution provides an automated AI-driven Security Operations Center, or SOC, that provides organizations with benefits of a transitional SOC at a fraction of the cost. Unlike other solutions, ARIA ADR provides full threat service coverage for on-prem infrastructure, data centers, remote devices and cloud environments. It could be operated anywhere by IT resources with little or no cybersecurity training. Since its introduction, we have already received purchase orders from several customers. And the win for us is that these orders are not only for ADR, they are also for total MSSP Solutions, where we will monitor all their security needs, but also their IT infrastructure, including firewall, switches and routers. With the expanding pipeline, I look forward to sharing the progress with you over the next few quarters. For the quarter, our Technology Solution, or TS division, revenue was $13.2 million. The TS division hit on all cylinders and was truly a strong quarter, exceeding our internal projections as revenue contribution came from our managed service, UCaaS, in selling third-party products and services, which is highly profitable and reflecting in the quarterly gross margin. While budget-related delays due to COVID remain a fact that we have not shifted our strategy, and I believe the performance of the TS division demonstrates a laser-like focus. We are staying close to the customer, often meeting them informally in accordance with social distancing guidelines to remain top of mind when decisions are made. This is already bearing fruit, and I'm confident it will lead to new orders as we slowly emerge from the pandemic. Our managed service practice is performing well and continues to grow as we sign new cloud-based and UCaaS customers. Latin America, which I referred to in Q1 conference call, is a bright spot right now as customers are adding bandwidth to a dozen of their locations throughout their region. Now let me share some thoughts on the cruise ship industry, which remain a vital market for CSPi. We have recently awarded a ship and expect to have them have a team in place this quarter. Further, another 3 ships are budgeted for retrofit by their own, and we believe the implementation can occur in the fiscal 2021 second half. This, along with operators planning to resume cruise in July, is perhaps the clearer sign yet that we are seeing the light at the end of the tunnel. We are also monitoring in other developments such as state of Florida filing suit against the Center for Disease Control and Prevention, or the CDC, to allow cruises to commence immediately. We also continue to expand our UCaaS presence during the quarter as we added several U.S.-based customers. I believe the virtual product demonstrations have helped tremendously, both from an educational and practical perspective. So I believe we will begin to leverage the pipeline and begin converting these into revenue. Remember, this is a multibillion-dollar market opportunity, and we only need to carve out a tiny sliver for it to be quite meaningful to CSPi. Now moving to our high-performance products, or HPP division. Revenue for the quarter was $0.9 million, below internal expectations. A couple of factors are responsible. Myricom sales are historically slowed during the fiscal second quarter, and we did not receive royalty revenue related to the E-2D program, but we believe the E-2D revenue will come in the second half of the year as scheduled. Nevertheless, we remain excited about the long-term potential of the business, especially as ARIA gains customer traction. As I mentioned earlier, we closed a few ARIA deals in the fiscal second quarter. However, because these occurred later in the quarter, we expect the reoccurring monthly revenue to initiate during the current quarter. In addition to ARIA ADR award recognition I mentioned earlier, ARIA Packet Intelligence also received a Cybersecurity Excellence Award. The ARIA PI application enables complete visibility into organizations network, including typical unmonitored lateral traffic patterns. It watches all communication and generates analytics for every packet. Security operation centers using security tools, such as a SIM or the ARIA ADR solution, leverage this enriched data to detect and then stop network-borne threats. So as we wait for movement within a leading cable company, the added OEM opportunities we've created for ARIA and the industry accolades embolden us that even though we are competing against much larger organizations, because our solutions were selected due to the innovative approach to find and stop cyber attacks, including ransomware, malware and zero-day attacks. We currently have over a dozen channel program partners, and we are speaking with several others to ensure a robust channel program, which increases our chances for success. To summarize, our approach since day 1 of the pandemic was to maintain contact with the customer. I believe the multiple touch points has and will continue to create an atmosphere that will allow us to emerge from the pandemic's disruption quicker than most competitors. Our performance highlights, especially over these past 6 quarters include our continued gross margin expansion and reinforcing our strategies to transition to a cybersecurity, wireless and managed service company. The entire CSPi team has done a superb job to get us through the storm and buoyed by a solid balance sheet. We continue to have the resources to execute our operating strategies and the benefit greatly as customers seek to upgrade their critical infrastructure needs. With that, I will now ask Gary to provide a brief overview on the fiscal second quarter financial performance.

Thanks, Victor. As Victor mentioned in his opening remarks, our fiscal second quarter revenue was $14.1 million. While the year-over-year decline is primarily related to COVID-19, the 24% increase compared to fiscal 2021 first quarter, as the company demonstrates our success, continues to navigate the impact of COVID-19. We reported gross profit margin of $4.4 million or 31% of sales compared to $4.5 million or 27% of sales in the year ago fiscal second quarter, reflecting improved product gross margin percentage plus a mix of higher margin services business. This is an improvement of 4%. Our engineering and development expenses for the second quarter was $762,000 compared to $716,000 a year ago -- in the year ago period. The increase is due to a higher headcount of 2, which was offset by a reduction in consulting services. Our SG&A expenses in Q2 was $3.7 million compared to $3.9 million in last year's fiscal Q2 due to a decrease in payroll, benefits, travel and stock compensation. The $723,000 of income tax expense was primarily driven by an increase in valuation allowance for our deferred tax asset, which is a noncash item, offset by a benefit for the effects of a change in the tax law, allowing immediate deductions of the covered expenses through the PPP loan. We reported a net loss of $847,000 in the second fiscal quarter or $0.20 per share compared to a net loss of $732,000 or $0.18 per share for the second quarter of fiscal 2020. Excluding income tax expense, the negative impact of currency exchange of $154,000, we would have recorded a slight income of $30,000 for the quarter. We ended the second quarter with cash and cash equivalents of $20.4 million as of March 31, 2021, an increase of $500,000 compared to cash and cash equivalents on December 31, 2020. We believe the measures we implemented during fiscal 2020, including the suspension of the quarterly dividend, stopping our stock buyback program in addition to the PPP loan proceeds, enabled us to preserve our cash and maintain a robust balance sheet throughout these past 12 months. We will maintain a similar proven cash preservation posture for the foreseeable future or until such time that the economy and businesses resume normal operations. We made a significant investment in our business prior to the pandemic such as the development of the UCaaS and the ARIA offerings, and our goal is to monetize them. So we have the resources to fulfill -- commercializing these is vital to our executing our business plan. With that, I'll turn it over to the operator to take your questions.

[Operator Instructions] And we will take our first question from Joseph Nerges.

By the way, great report. Finally, we seem to be moving forward with ARIA, and this has been a long time coming, but that makes me very happy about this, the long-term nature of this possibilities we have. Maybe a couple of quick questions off your press release. You mentioned that quite a few purchase orders for -- have come in, I guess, on the ARIA product line in the last 30 days. So that was subsequent to the end of the quarter. So most or all of that revenue would be going forward. Is that correct? We're talking third and fourth quarter revenue.

Actually, over the next -- it's on a monthly basis, Joe, because they're -- it did -- there are 3-year deals. So we recognize over 36 months because they're managed, right? So not only are we selling product, we're doing managed services. So that's built on a monthly basis.

So we're talking about purchase orders in Technology Solutions division in that department, not in high-performance products?

No, it's a combination of both, Joe. So we sold ARIA, but the goal was to build up the recurring revenue business, and that was both in the MSP. So we tie the 2 divisions together to where, when ARIA is sold, we sell it as a managed service. So not only are we getting the product, we're getting the maintenance, the support and then we're tying it into the managed service. It won't always occur like that, Joe. But in the last couple of deals that we have sold, we sold it as a complete managed service on the both umbrellas, the HPP and on the TSI. So revenue will be -- some revenue will be on both sides of the house.

All right. Well, it has been offering areas of managed service and Technology Solutions division. So that's what you're saying that through that division, you're getting the area sold as well as the managed services attached.

Correct.

Okay. On the next question, on the 2 large or leading manufacturing organizations, are we talking Fortune 500 type companies here? Or are we talking to somebody very large?

No, not that large, not Fortune 500. But they're tied into large organizations as subcontractors. I can't -- we can't mention who they are, Joe.

No, I understand that. I'm just trying to understand, are we talking about ARIA here? Or are we talking about managed services here or a combination of both?

Both, Joe. Both.

Okay.

In a perfect world, Joe, there will never be an ARIA sale with our managed services in a perfect world.

But the managed services would be coming out of Florida, not out of Massachusetts?

Correct.

Correct. Yes.

What type of...

But we will be selling the product out of Boston, and the support and maintenance out of Boston. But the support will come out of Florida managed service piece of it, yes.

What are we talking about? Because you said multiple facilities, are we -- what are we talking about time of implementation on this. So is that pretty quickly? Or is this over the next -- over the course of the next couple of months, 6 months, whatever on these large...

No. It could be as fast as the customer allows us to get into their setup.

Okay. A couple of quick things. So you mentioned about the 2 awards that you got for -- the Gold awards you got for both the ADR as well as the Pack Intelligence in the quarter. Who votes on these awards? Because they're both gold awards. How large a voting group was involved with that? Do we know?

No, I have -- I don't know exactly.

Okay. No problem there. But this is more than once now that we've been recognized for both ADR and the Pack Intelligence operations.

Yes. Every year, you have to apply for them -- for the awards. And I guess, there's industry experts that vote on this.

Okay. And another one, which I consider a major announcement this quarter, and that is the NVIDIA release of their Morpheus platform in April, which supposedly expand various capabilities in identifying cybersecurity attacks. Am I correct in that?

Yes. We partner with NVIDIA because they make some of the boards we use when we port over our software, and we work hand in hand. And the nice part about that announcement is if you look at the CA, they had an NVIDIA conference or asset, I think, just about a week, and they mentioned some of the security partners they work closely with. The CEO announced, there was a few other major brands that are out there in the security space, but they mentioned CSPi, ARIA as one of their key partners of integrating their platform with ours.

Well, beyond that, not only did they mention us, they provided a link area on their press release, their press release. They didn't provide a link to anybody else except us, which at least, from my standpoint, says that the narrative that we've been trying to say for the next couple of years is a narrative that they're buying into wholeheartedly with this platform.

Yes, absolutely. We're working -- that's a lot of the stuff we're working with them is with the cable companies that we have mentioned in the past and there's some other 5G providers on the OEM side of the house. Nothing that we've -- it just takes a long time to get integrated with some of these large organizations. But once you do, it's opportunity that lasts for years. So it's -- no, we were very happy with the progression we're making with NVIDIA as such one of the large key players that are out there.

But one last point I'll make on this, and you've mentioned this on several conference calls, and that is because CSPi is basically fairly unknown in the cybersecurity industry by a lot of major players, the idea that NVIDIA would link to your website should take a lot of the -- who you are out of the equation, but that's how I'm looking at it anyway. It's very positive to have a big company tie-in CSPi's ARIA platform.

Yes. I agree with you, Joe.

[Operator Instructions] And we will take our next question from Brett Davidson.

Well, I'm glad to be here this morning. I got a couple of questions for you guys. I'm looking at that press release yesterday, the HP ProLiant servers, and I'm not entirely sure what that means. Let me just run this past you. So if I were to go on HPE site and look to order a ProLiant server, there'd be a drop-down offering ARIA equipment. Is it -- am I somewhere on the right track?

No.

Okay.

Yes. So what we've done is we're working with their OEM team to help integrate the ARIA technology. So when we're selling an appliance, we were using Supermicro, and also, now we're using the HP platform. That's a possibility because some of the major brand -- companies, they don't want to use a third-party OEM like maybe a Supermicro. So we teamed up with HP. They will be promoting our product along with it to some of the OEMs, but it's more that we were able to get them to work with us on the design and the pricing model that makes it attractive for us. So when we do sell it, it will be profitable for CSPi.

So is this kind of like a seal of approval that says that your stuff works with the HP equipment? Or...

Correct.

Okay. Got it.

Yes, yes. And the next step potentially could be what you're saying, but we're not at that point yet. We're at step 1 of the relationship.

Got it.

In a perfect world, it would be what you suggested if we could do that on the cybersecurity on the HP, but we're not at that stage yet. Not that it's out of the question, we're just not there yet.

Is it kind of like the proven type phase where you guys had to get new stuff on some of their equipment in the...

Yes. We're still dating. We're still dating, Brett. We're not in the marriage stage yet.

Well, it comes with a lot of pits. So I'm okay with that. So on those purchase orders, can you add a little color as to -- I know I got from Joe, the 3-year deals and the size of these. I mean, are we talking like tens of thousands of dollars? Are we talking 6 figures? Or...

With the German contract, they're hundreds of thousands.

Nice. That's -- yes, that's exactly the type of color I was looking for. So that works good. I do have a question that's probably more pointed to Gary here. And there is a big jump in a long-term receivable and likewise similar increase in noncurrent liabilities. Can you add some color as to what that represents?

Yes. Some long-term purchases with one of our customers, and we've done these over the years. So that -- and there are 3- and 5-year deals. So that's what we're doing, is putting that on the balance sheet.

And that's equipment software installed, that type of deal?

Yes. So those kind of items, right.

Yes. And that also is the noncurrent liability?

Right.

Got it. Okay. That's both sides of it. All right, I got it. Yes, I think that's about all I got. So yes, I don't -- so this isn't going to be like a huge splash. This isn't going to be where all of a sudden, $5 million in revenue shows up on the income statement. This is all going to be incremental because, like you said, in a perfect world, you're going to capture both the hardware and the management side of this. Correct?

Correct. That's correct. Yes, we're trying to build our recurring revenue model, as I've been saying. And it's -- it took a few years with the MSP to build up a decent-sized percentage of the overall revenue. And we're hoping, if we could stay on the same track that we did with the MSP in UCaaS, it would be in another 12 to 18 months that will be significant revenue that you can count on quarter-over-quarter for years to come.

Yes. And it's not as sexy as a big $5 million increase in revenues, but it sure probably has a lot more value to it. So I'm all...

Well, the multiple on recurring revenue is definitely -- the onetime hits, it's worth something. But the recurring revenue, you get a 10 to 15x factor on top line. So you definitely...

Are you guys going to start breaking that out in the quarterly, the amount that is from recurring revenues?

When it gets to be a significant portion of it, we will.

And there are no further questions at this time. I will now turn the program back over to Victor Dellovo.

Thank you. As always, I want to thank our shareholders for the continued interest and support. We have maintained our focus throughout the current climate. We have the resources and product and service portfolio to grow the business. Gary and I look forward to sharing our progress in the fiscal third quarter operating results in August. Until then, stay safe.

Yes. Thank you.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.