CSP Inc. (CSPI) Q3 2021 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to today's CSPi Third Quarter Fiscal Earnings Conference Call. [Operator Instructions] Please note, today's call is being recorded. And it is now my pleasure to turn the conference over to Michael Polyviou. Please go ahead.

Thank you, Keith. Hello, everyone, and thank you for joining us to review CSPi's fiscal third quarter ended June 30, 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 the 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 by CSPi, 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. Vic, please go ahead.

Thanks, Michael, and good morning, everyone. For the first time since the emergence of the COVID-19 pandemic, our sales and engineering teams were fully engaged as we achieved several positive developments. For example, the performance of the TS Solution -- Technology Solutions division had another stellar quarter and had one of its best quarters ever. And it had not been for a well chronical supply chain issue delaying certain sizable orders, we would have likely reported considerable higher revenue, which would have given us a year-over-year increase in our total company revenue. Additionally, we grew service revenue, including a net revenue of third-party maintenance by 25% year-over-year as larger and newer customers continued their purchasing habits while simultaneously converting smaller customers to multiyear MSP agreements. And our continued migration to higher-margin products and services enabled us to report our seventh consecutive quarter of year-over-year gross margin growth. Today, these high-margin offerings represent approximately 25% of our revenue compared with 21% in the year-ago third quarter. To continue to believe we will emerge from this pandemic a stronger and more formable company with a full complement of products and services to grow on the top and bottom lines, in fact, I believe, the recent industry accolades across the two businesses will be contributing factors to our success. In May, CRN, a brand of The Channel Company, named CSPi Tech to its 2021 Managed Service Provider 500 list in the Security 100 category. The list, which is announced annually, recognized the leading North America solution providers that have demonstrated innovative and forward-thinking approach to managed services. Also in May, two ARIA SDS applications for automated cyberattack detection and response won the awards from Cyber Defense Magazine, the industry's leading electronic information security magazine. The first is for our award-winning ARIA ADR solution, which automatically finds and stops all types of threats, including cybercriminal launching zero-day attacks, the moment they become active on the network; and most importantly, before harm occurs. In a single platform, organizations gain AI-driven security operation centers without the people and typical equipment costs. As a result, the ARIA ADR solution stops attacks 10x faster and at a fraction of the cost. Unlike other security tools, ARIA ADR provides full threat service coverage for on-premise infrastructure data centers, remote devices and cloud environments, and can be operated anywhere by IT resources with little or no cybersecurity training. The second award, working in conjunction with the ADR solution, is the ARIA Packet Intelligence application, which enables complete visibility into an organization's network traffic, including typical unmonitored lateral patents, and it watches all communications generating analytic organization network traffic, including typical or monitor lateral performance. It watches our communications for every packet. [indiscernible] have deployed ARIA ADR or used security tools such as SIEM, leveraging this enriched data to detect -- to stop network-born threats. For the quarter, our TS revenue was $12.8 million, a phenomenal achievement as the team continues to achieve our objectives. This result reflects another solid quarter as our managed service practice continues to perform well. We also signed a new multimillion-dollar customer with potential up to 10,000-plus users, further positioning us for continued positive performance in this business. Of note, we did not record any revenue from this contract during Q3. It will commence in the fiscal fourth quarter and run into 2022. This just underscores our optimism and demonstrates the progress we are making, penetrating the market for cloud-based solutions. And perhaps in sign of further economic improvements, we closed a piece of business in Mexico with a new customer that we had been pursuing for well over a year. And despite a tighter market for skilled engineers to date, we have not had any issues recruiting engineers to CSPi because we offer them a chance to succeed and make a difference. They want to be a part of a winning culture. And with the amount of business we have been winning and could conceivably win over the next coming months, I believe this will be a competitive differentiator as we compete with other companies for these engineers. Now let me pivot to the cruise line. As you are aware, the industry has estimated by the pandemic, and it directly impacted our ability to gain access to cruise ships and complete our task. However, the Q3 activity level was encouraging, and the outlook today is far better than a year ago. Our pipeline has increased, which validates our decision to maintain our staffing levels throughout the deal as it would enable us to scale quickly when the need arises. However, because this remains a fluid situation, it requires careful monitoring. So we will adjust assignments, if necessary, to ensure the team's safety. We also continued to expand our UCaaS revenue, mostly from smaller transactions as larger deals are taking longer to close due to the longer sales cycle and timing of customers' existing contracts expiring. However, I believe it's only a matter of time before we land a big customer because we have a superior and award-winning product, which allows us to cut out a niche in this multibillion-dollar market opportunity. I am pleased with the performance of TS. This was offset by a slower-than-expected performance of the High Performance Products, or HPP division. Revenue for the quarter was $1 million as Myricom performed as expected, while royalty revenue related to the E-2D program did not materialize as we had anticipated, as we now expect to record royalty revenue in the current fiscal fourth quarter. However, our outlook for HPP is considerable because the activity level of our award-winning ARIA platform is high. It continues to garner tremendous interest during the quarter. It gives us greater comfort as we move forward as it will surely become a star award for the HPP business, and contributes heavily to the success of CSPi. As you know, we have spent considerable resources developing ARIA, and I believe the time we devoted to refine our messaging and educate the market is yielding positive momentum. For example, we currently have over 3 dozen opportunities in the sales funnel, including several from our TS based client with over 30% of these in the later or advanced negotiating stages. Let me also share with you an important development during the quarter. We have fine-tuned the process for onboarding our ARIA ADR customers between HPP and TS MSP. The recurring monthly revenue from this will commence in the current fiscal fourth quarter. Moreover, it will represent the integration of ARIA ADR with MSP business, and with several of the pipeline leads originating from the TS business is clearly demonstrating the synergies possibilities of the TS and HPP business. Additionally, during Q2, we signed three additional ARIA ADR customers, two of which we plan to install this quarter, and the third during fiscal Q1 of 2022, with recurring revenue commencing in fiscal 2022 first and second quarters, respectively. As a reminder, each of these are 3-year arrangements are generating monthly revenues. So it's just a tip of the iceberg as we expect to scale quite rapidly and could achieve an annualized revenue in the millions. This validates everything we have done up to this point and strengthens our conviction that ARIA will be a game changer and will be a dynamic growth driver for HPP business. Broadly speaking, it gives CSPi two best-in-breed businesses with superior products and services. To summarize, we continue to capitalize on those business opportunities at strengthening our long-term growth ambitions, while managing the issues posed by COVID-19, supply chain and talent acquisition. I believe we have a unique set of products and services that continue to propel the TS business, while patiently waiting for HPP business to begin contributing in coming future. I believe each of these businesses, when performing to the best of their abilities, provide us with a significant revenue and gross margin opportunity, complemented by a balance sheet that gives as the resources to pursue our plans for the foreseeable future. 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 revenue was $13.7 million. While the year-over-year had a slight decline, we still experienced limitations imposed by COVID-19, especially with customer visits and interaction. We still managed to report gross profit of $4.2 million or 30.8% of sales compared with $42 million (sic) [ $4.2 million ] or 30.6% of sales in the year ago fiscal third quarter. I also want to point out that our cost of sales for service increased 38% in this year's Q3 as we had added staff to our Network Operations Center. We have achieved year-over-year gross margin improvement through the pandemic as we continue to sell a mix of higher-margin service business. Our near and short-term goal is to maintain an annual gross margin in the mid- to high 20s, and moving this up as the higher-margin products become larger contributors to the top line. Our engineering and development expenses for the fiscal third quarter were $700,000 compared to $693,000 in the year ago period. The increase is due to a higher headcount in engineering, where we filled open positions. As Victor mentioned earlier, this is a tight labor market for qualified engineers so we may see increased expenses in the coming quarter as we compete for talent. Our SG&A expenses in Q3 were $3.9 million, essentially flat with the year-ago Q3. We reported a net loss of $423,000 in the third quarter or $0.10 per share compared with a net loss of $110,000 or $0.05 per share for the third quarter of fiscal 2020. We ended the third quarter with cash and cash equivalents of $19.7 million as of June 30, 2021, a slight increase compared to cash and cash equivalents on September 30, 2020. We believe that the measures we implemented during fiscal 2020, including the suspension of our quarterly dividend, stopping our stock buyback program and in addition to the PPP loan proceeds enabled us to preserve our cash and maintain a robust balance sheet throughout the pandemic. We will maintain similar prudent cash preservation posture for the foreseeable future or until such time that the economy and the businesses resume normal operations. With that, I will turn it over to the operator to take your questions.

[Operator Instructions] And we'll take a question from Joseph Nerges with Segren Investments.

Real quick question, off the top of your statements, Victor, that is you mentioned that the supply issues were -- supply chain issues were a factor in this quarter. Has that been resolved to an extent going into this quarter, or are we still having a slow supply chain problem?

Yes. We're still having a slow supply chain. We're just 12 to 15 weeks on some products that it's taking on some of the major brands that we represent. So we're hoping what we closed like in Q2, we can ship in Q3, and what we closed in Q3, we're closing that -- it's kind of like a rolling quarter backlog. That's the way we're looking at it right now.

So essentially, the volume that you would have had last quarter is falling into the current quarter than in the supply?

Yes, correct.

Okay. You said there's no E-2D revenue in the third quarter, and you're expecting some E-2D royalty revenue possibly in the fourth quarter. Is that it?

Correct.

Correct.

On the points you made on your presentation about transferring transitioning the ADR product line to the Technology Solutions. I guess, that's a vital ADR service that you're offering. Doesn't that open up a whole series of additional potential customers in the managed security service providers, that's exactly what we're doing in Florida. Is it not? We're acting as a managed security service provider for the customers utilizing our earlier software.

Correct. Yes, yes. And the customers that we've closed this quarter have signed contracts for both MSP to manage the rest of their infrastructure plus the managed ADR. So there's multiple contracts that were signed for each of the customers. Yes.

But the question is -- I understand that. But the question is are we pursuing the other managed security service providers across the country that could be utilizing the service, just like we are in Florida?

We're talking to some of them. But there's an investment, right, that they -- if they want to get into it, they have to have people that someone has to monitor it. So it's not only talking about them purchasing the product and us helping them get it set up. It's the talent that they have to have looking at the monitors, right? So that's where it takes a little longer because we're talking to them about opening up a whole business unit for them in California or in other areas of the country. So that's a decision, of course, the CEO, CFO has to make in these companies about opening up a new business division inside their current [indiscernible].

So essentially, they're not doing that currently. They're not monitoring...

The security side. They could be monitoring the firewalls, but they may not have a SIEM that they're giving the customer as an offering.

Okay. One point you've made several times on previous calls, and that is the Three areas that we're emphasizing going forward: the cybersecurity, and that's obviously with ARIA and such; the managed services, which we're doing well with down in Florida; and the third area -- and maybe you could add more color that this is wireless, you've emphasized that several times. What do you see in that area that gives you some hope going down the road here, going for the future?

Well, that's been a big part of what we've done for a long time to where we're one of Aruba's biggest Southeast partner. We have the talent and expertise to help different companies have different sizes sell. We sell not only the profit the product, but also the services to install it. And we've also been offering a managed service wireless offering to. So where the customer doesn't have to buy the product. they just basically rent the product with the services. So we started opening up that as an offering inside our MSP. And we probably have, I'd say, half a dozen accounts already. under of various sizes to where they don't want to have to worry about any of the wireless getting it up and running and making sure the security on the wireless and all that, we take care of all that for them. So we've been doing wireless for years, right, over a decade, but now we brought that piece of it into the MSP offering also.

And is our engineering expertise allowing us to, let's say, advance because we're buying the product from some of our suppliers.

Correct.

But the engineering that we're putting into, I assume, separates us to some extent from some of our competitors.

Yes. There's a product out there that we represent, a couple of them, that are NACs. It gives -- it allows people to come on and off different networks of different companies. We have engineering expertise in that area. There are some of the large hospitals that we're actually doing business with in some of the large financial institutions. I can't mention their names, but you would know who they are. We're doing all that. So we're setting up the NAC for them, all the security policies along with the wireless, right, because the wireless alone is not that difficult. But it's the access to getting on to the wireless and who has the right credentials to get on certain pieces of the network and stuff like that, that's what we're really good at. And that's why different organizations, this school systems, you name it, we have -- we're doing engineering work in those segments all around the NAC and the wireless.

Well, it sounds like to me, it's just a matter of time for some of these proposals that are out there, some of them have got to close. And the more you have out there, the possibilities of, let's put it this way, HPP do a much, much more. Could you...

Yes. The pipeline is getting -- is growing at a steady rate, and we're actually closing business to get some of those referenceable accounts that are so important because that's the question that you're asked all the time, are you in the Garden or the Forrester? No we're not. Well, do you have any references? Well, up until recently, we didn't have any. And that was a -- it was a big issue, right? How do you say your product is great, but you have -- nobody wants to be the first one, right? So there's been some trust that we've had with some customers on the MSP side. They demoed. We did a POC. They bought off on it. And now we're building that referenceable account list that we're able to distribute to all the companies that we're talking to.

Okay. Great. That's all from my stand. But it sounds like you're doing fine. It's just a matter of getting some more volume, and hopefully, yes, not too distant future.

That's it. Yes.

Thanks, Joe.

[Operator Instructions] And it does appear we have no further questions. I'll return the floor to Victor Dellovo for any additional or closing remarks.

Thank you. As always, I want to thank our stakeholders....

Keith or Victor, if you could just -- Keith, it looks like you have somebody that jumped into the queue.

Yes. Someone jumped in just now. We can go to Brett Davidson, private investor.

Yes. Apparently, it's didn't work the first time I tried to get in the queue, so I'm a little late to jump on -- I've got just a couple of quick questions. Some time ago on one of these calls, Vic, you talked about issuing press releases. And the quarterly release here indicates that there's 3 new ARIA customers. And I'm just wondering, going forward, are we going to find out about these through press releases, or is this going to come in the quarterly? And is that because you're prevented from discussing these through releasing press release?

Yes. They are customers no one wants to know what they're doing internally with the security policies and stuff like that. So I'll mention -- coming forward, I might mention the area of business, the vertical, but I won't be able to mention the customers, unfortunately. Everybody's higher lift on that.

Okay. Are these of a nature size-wise that you guys could just do a generic press release, saying we inked in a new customer, or...

Yes, we could. Yes. No, there's -- the two that we -- two out of the three are of size on a monthly basis. So we're working with them to get something approved. But we just put them on. And they want to -- they're still just -- they want some time to go by before they -- we do a press release on that, just before we do that. So it will be coming up in the next month or two, I would say, on at least a couple.

Yes, for us, keeping score, it might be helpful [indiscernible].

No, it's definitely, definitely there. We're just -- like I said, we got a little time. We just signed them up. We just got them installed. So we had a little time to go by. And then we'll get our marketing department to write something that they're comfortable with. And we'll do some generic press releases for sure in the upcoming months.

Great. That sounds good. And the other thing is a follow-up with Joe's question regarding other managed service providers using the ARIA product. And how would those contracts be structured? Would that be like a licensing agreement, or would this be like that same 3-year lease or whatever that you're doing with your customers?

Yes, they will be buying the product if it's a cloud-based customer than they will be licensing and support. So we built the product for multi-tenant solution, so we could sell one tenant to them and then they could have multiple tenants underneath. And we basically kind of price it per our key. So as they have -- if the customer has 50 IPs or 500 or 5,000, is priced that way. So they could manage it on one screen and have multi-tenant on each and every one. We do the same for our internal SOC that we have here, one tenant and everybody manages the customers as we go. So they'll be able to do that. And if it's product, then they'll just buy the product for their customer straight out, or if they want to do it on a monthly basis, they could do it that way, too. We'll offer them the same as we would do if we were selling direct to them.

Right. So they've got 5 customers this month and they got 10 next month. Do you rely on them to report back how many IPs that are used for...

Yes, because their license -- yes, they don't have an unlimited license key, right? We sell them as they go. We would have to know who the end-user is also, and then we would say, okay, how many IPs. And then we were chew up on a monthly basis or a quarterly basis if they grew. So just because the customer started off with 1,200 IPs doesn't mean the following month or a quarter, they're not at 1,500. So there's a true-up process inside the contract that we're constantly monitoring. And they can't hide it because we're right, it's -- they won't be able to add those IPs on to it if we don't allow them to access keys to it.

Got it. And the last thing I have is it's kind of tough from our end having no real insight whatsoever into the contract size, the timing of adding these revenues, the scale that you guys anticipate these new things arriving at your door. Are you guys doing any kind of modeling internally to determine what revenues are going to look like next quarter and then maybe a couple more quarters out or next year?

Yes. We're doing budgeting modeling now for 2022. So we're putting some models together what we estimate it could look like, right? Just it's all in the timing at this stage. But yes, of course, we're doing that. We're going to build a budget for next year, and we're looking at. And then we're looking at the current pipeline and then the growth of how fast we're adding new potential customers or -- to the list. And then the size, just to give you an idea, some of the stuff that we're dealing with on potentials are from $2,000 a month on a customer to $50,000 a month to some of the customers we're talking to. So there's a range of possibilities on what that would look like. You start getting a couple of $50,000 a month clients, it moves the needle pretty fast. So -- but that's -- but the piece of it is that we have a lot of -- the pipeline has grown quarter-over-quarter in the POCs or POVs, whatever you want to call them, they're growing, right? We have quite a few to where we're actually installing it to the customer site, and they're kicking the tires. Of course, they're looking at other competitors that we have -- we're dealing with, too, but hopefully, we're doing the right job to show value compared to some of the other players that are in the market space.

Yes. So is some of this modeling some of these scenarios leading to concerns about not having enough bodies to carry out this work. Is it impacting like hiring decisions now?

No. The thing is one thing about -- there's plenty of engineers out there, the only thing is how much you have to pay them, right? It's not like there's not -- with the salesperson, there's a lot out there, but only so many good ones. But in the engineering world, you can put them through the ringer pretty quick to find out how good they are. And then you just have to figure out what the right salary is to bring them on board, right? And the good and the bad is, all engineers are looking for better opportunities right now. And the good is that we're getting a lot of people knocking on the door. The bad is you always got to make sure you try to keep your internal engineers that are really good, happy and they stay with your company. So it's definitely a -- it's a weird place right there with the engineering world we live in right now, constantly looking. And the headhunters are -- they call me, not even knowing my position, asking if I want a job for a security engineer. That I'm like, you don't even know who you're calling and -- but I get 4, 5 of those calls a week from headhunters. So if I'm getting them, you know everyone who works here is getting them also.

Yes. So -- but you don't see that as an issue of being able to team [indiscernible] to carry this out?

No, not at all. No, not at all. And I think some of the awards we won to recently and consistently over the last 2, 3 years, one of the best places to work, I think, are helping when people check us out that their feedback between the benefit package, the atmosphere, everything else that goes along comes out pretty positive. And then the one thing with engineers, too, it's not like you're working for one company with one infrastructure. work for a reseller or a network integrator, you're constantly in different networks. So if you like change and you like challenge, this is a perfect place for an engineer that wants that challenge on a weekly or monthly basis. You won't be bored with the same infrastructure.

Interesting. Yes, that to me that's huge taking care of your employees and that should pay off down the road for us. But I appreciate you taking the time to answer the question, and I look forward to talking to you guys next time around.

[Operator Instructions] It looks like we have no questions. Victor, I'll turn it back to you.

Okay. Thank you, operator. As always, I want to thank our shareholders for their continued interest and support. We have maintained our focus throughout the current climate, and 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 fourth quarter and full year 2021 operating results in December. Until then, be well and stay safe.

Thank you.

This will conclude today's program. Thanks for your participation. You may now disconnect.