CSP Inc. (CSPI) Q4 2021 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to CSPI Fourth Quarter and Full Year 2021 Results Conference Call. [Operator Instructions] Please note, this call may be recorded. It is now my pleasure to turn today's program over to Michael with EVC Group.

Thank you, Emma. Hello, everyone, and thank you for joining us to review CSPI's Fourth Quarter and Full Year ended September 30, 2021 financial results. 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 the 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. Vick, please go ahead.

Thanks, Michael, and good morning, everyone. Even though significant supply chain issues at several of our component suppliers crimped our product sales during the quarter, our team continued to build business in orders. As a result, we ended fiscal 2021 with a record backlog of $13 million, up 165% from September 30, 2020 level. The backlog growth reinforces our view that CSPI will emerge from these challenging times, a stronger and more formidable company. Our team also firmly believes that our award-winning product and service portfolio is enabling CSPI to compete for the increased market share. While the backlog is an encouraging development, our short-term revenue generation has been impacted by the pandemic and supply chain issues. Unfortunately, these factors will make it difficult to protect quarter-over-quarter performance with -- we are, however, confident our fiscal 2022 yearly projections. We are working with our customers and suppliers to resolve and mitigate these issues as quickly as possible. We are taking every step to build revenues in the areas where external forces aren't having as much of an impact. For example, we are increasing the resources we devote to our software sales since these products and services can be delivered near-term revenue and higher margin and are delivered remotely. We grew our fourth quarter service revenue by 27% year-over-year as we continue to add new customers. Our goal of migrating to higher-margin products and services is being achieved as we reported our eighth consecutive quarter of year-over-year gross margin growth despite tougher year-over-year comps. The product mix being sold, amount of revenue recorded and overall margin in the product are contributing to this increase from the prior year. The improved product gross margins as a percentage of revenue has been focused in fiscal 2021, particularly in the TS segment. Our Technology Solutions, or TS business, again led the way with revenues of $8.8 million in the fiscal fourth quarter. Our managed service practice, or MSP, continues to be a reliable source of growth and exceeded our internal expectations as we added new larger and several niche customers in the retail and consumer space. We remain focused and committed to build our recurring revenue business, which is contributing significantly to the bottom line. Now let me say a few words on the cruise line activity, which has steadily increased over the past few months. In fact, today, we are more bullish on this business compared to any other time during the COVID-19 pandemic, which effectively stopped our cruise activity. We received orders for 4 ships in Q4, which we expect to complete during the next few quarters. Aside from the revenue opportunity, this is a highly profitable business for CSPI and our decision to maintain our cruise-related workforce early in the pandemic, despite there not being much work for them is proving to be prudent because it is allowing our team to react quickly and meet the operator's time lines. However, the first and foremost is the health of our team, so we are taking all necessary precautions and adhering to local protocol to ensure a safe working environment. Now turning to our UCaaS offering. I'm pleased to report we experienced better-than-expected activity in the fourth quarter and momentum has carried into the current first quarter. In fact, we have doubled the size of the business over the past few months, which is a big deal since we launched 2 years ago and just prior to the worst imaginable business environment. Our goal in fiscal 2022 is to complement the team's progress with smaller accounts and pursue larger accounts. Regarding the high-performance product, or HPP division, we reported revenue of $1.2 million, which is slightly higher than compared to fiscal Q3 revenue. While the Myricom business has steadily picked up royalty revenue related to E2D, was lower than expected, so we anticipate the balance will be recorded in the first half of fiscal 2022. ARIA remains the primary growth engine for this business segment, and we closed several deals in the quarter and recently announced the receipt of a multimillion-dollar multi-site sale of ARIA SDS solution from a National Intelligence Agency. The ARIA SDS product will be a critical component of the government solution to improve network visibility, our networks provide to national security to detect communication performance in cybersecurity related issues, which are and will continue to be on the rise. The ARIA SDS approach is ideal for this application. Given its design for high-bandwidth processing, exceptional packet analytics and real-time packet filtering capabilities. The ARIA SIA will easily [ upgrade ] the data up to 120 gig from the multi 10-gig network found in over 40 sites. Upon ingest, the ARIA Packet Intelligence application performs specified filtering to isolate traffic of interest. This traffic is then directed to variety of cybersecurity tools such as an IDS for further threat hunting and investigation. We are especially pleased because ARIA SIA and Packet Intelligence application was envisioned for exactly this purpose to provide complete real-time visibility of the entire network for cybersecurity hunting. We were able to close several new ARIA deals that were included in Q3 sales funnel, but we also managed to grow the sales funnel as our messaging and marketing education efforts is yielding positive results. During Q4, we signed additional ARIA ADR customers, and our team is highly engaged with the prospects that their primary objective is to get later-stage opportunities over the finish line. We all recognize that this is -- has a potential of generating significant top line growth with a disproportionate benefit to the bottom line. To summarize, we ended the year with a record backlog that was up 165% from the prior year level. The manufacturing and supply chain issue remains a challenge. However, we are doing everything possible to get orders out. Revenue and margins up. We continue to have a solid foundation even during these turbulent times, and we are laser-focused on business execution and exploring new opportunities that strengthening our long-term growth and profit ambitions. I expect for at least the foreseeable future that we will maintain a prudent expense management that will allow us to have the necessary resources to execute multiyear growth strategies. With that, I will now ask Gary to provide a brief overview on the fiscal fourth quarter financial performance.

Thanks, Victor. As Victor mentioned in his opening remarks, our fiscal fourth quarter revenue was $10 million and still reflects a challenging business environment. However, we managed to report gross profit of $4.2 million or 41.7% of sales, compared to $4.4 million or 31% of sales in the year ago fiscal fourth quarter. This represents the eighth consecutive quarter of gross margin expansion as we continue to sell a mix of higher-margin service business. The higher gross margin is due to product mix being sold, amount of net revenue recorded and overall margin products contributing to this increase from prior year. The gross to net adjustment for sales and cost of sales for the year and the fourth quarter were $4.6 million and $12.7 million. Our near- and short-term goal is to maintain an annual gross margin in the mid- to high 20s and move this up as higher-margin products become a larger contributor to the top line. Our engineering and development expenses for the fourth quarter was $696,000, compared to $717,000 in the year ago period. This decrease is primarily due to lower ARIA development costs compared to the year ago quarter. Our SG&A expenses in Q4 were $3.8 million, a slight decrease from the year ago SG&A cost of $4.2 million. The company had a tax expense for the year, which was due, which was primarily driven by a full valuation allowance against our deferred tax asset, offset by the exclusion of the income from the forgiveness of the Paycheck Protection Program loan. The exclusion of the gain of the German subsidiary under U.K. law and current year federal R&D credits and benefit of federal carryback of net operating losses in years in which the statutory federal rate was 34%. We reported net income from continuing operations of $353,000 in the fiscal fourth quarter or $0.08 per share, compared with net income of $36,000 or $0.01 per share for the fourth quarter of fiscal 2020. Also in Q4, we reported a onetime gain of $465,000 from the sale of our discontinued German operation, which was previously disclosed and reported net income was $818,000 or $0.19 per share for the fourth fiscal quarter of 2021. We ended the fourth fiscal quarter with cash and cash equivalents of $20 million as of September 30, 2021, an increase of over $700,000 from September 30 2020. We believe the measures we implemented during fiscal 2020 and maintained fiscal -- throughout fiscal 2021 included the suspension of quarterly dividend and stopped our stock buyback program 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 a 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'll turn it over to the operator to take your call -- your questions.

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

Congratulations on the fourth quarter, considering that the revenue was considerably less than we would like, but to come out with an operating profit that's really admirable in this environment, let's put it that way. A couple of quick questions. I think the last conference call, you indicated quite a few people were evaluating ARIA at that time. And is that the same situation today? Do we have quite a few people that are -- contracts proposals out there that are evaluating the situation?

Yes. Yes. Some we win, some we lose, and then we have new ones that get into the funnel.

And you're basically saying you've signed a few since the end of the year as well as in the fourth quarter?

That's correct.

And on the contract that was announced early last month, the government contract, the $1.8 million. I think you indicated in that press release that the revenues would not be -- or at least the implementation would be to the second half of next year, 2022? Is that correct?

That's what we're shooting for. Right now, we still struggle with getting some of the components through some of our -- yes through some of ours...

That was going to be my question. What was delaying? Is that the component part of it? It's certainly not the software, you could release software.

No -- yes. Correct, correct. But this chips that we need from some of the chip makers that the lead times keep moving in the right direction, put it that way.

So what you're saying is, hopefully, hopefully, sometime next year, we can roll that out. So right now, we're not getting any revenue whatsoever. Obviously, we haven't implemented anything on that contract.

That's correct.

Correct.

And just to -- just a follow-up a little bit on the press release you issued a couple of weeks -- a week or so ago, on NVIDIA. I guess they have launched their Morpheus platform. They announced it in April. The latest is there -- was that a software upgrade on that, the DOCA software? Is that what they announced in early November?

Well, they're coming -- they have software, AI software that constantly being released, but we're also working with their Boards also to put our software onto their new boards that are out there currently and the new ones that are coming out scheduled for April. So that's a constant wheel that we're always on trying to work with the...

These are upgraded boards? Is that for the...

It's their new version, yes.

New version.

The new version, yes.

So are they beta testing that right now? They indicated in their press release that they're working with partners and we're one of the partners...

Yes. If you saw what they did, they announced about 10 of their key partners that they work with and we happen to be one of them, which was considering the thousands of partners they have. It was an honor to be mentioned as one of their top ones.

In their initial press release in April, they not only announced us, but they liked our -- link ARIA Cyber website. So obviously, that was a positive way to issue a press release. We didn't issue the press release, they did. But are we able to get involved? They mentioned partners and customers. So I'm assuming they've released some of their customer base try to test the possibilities. Are they beta testing that with some of their customers, this whole platform?

No, they're actually -- what they're doing directly, I'm not sure, but they are working with us, and there's a few customers, large customers that we're talking to. But the customers that we talk to want some customization, and that's kind of where we come in. We're taking their boards, potentially their software, in some cases, by our software to take full function -- full functionality of their boards, and that's kind of where our partnership is the strongest.

Well, that's great. I mean because now we're at with some pretty -- I assume, pretty sizable customers that would want to customize, and if we customize them, then we get the business, I would hope?

Yes, that's our OEM play that we integrate into their boards that would be integrated into other customers' products or services.

And have we seen a fair amount of interest from that standpoint on that group? Or is it by request? Or -- I know they have...

It's a work in progress, but there's a couple of things that their boards that they were supposed to have out has been slow rolling just because of -- I'm guessing some of their component issues that they've had. So some of the boards that we were supposed to get early to do some of the development on it have been dragged out, on delays, everything right now is kind of being pushed out a little bit. But it's moving. And we do have customer meetings with NVIDIA and ourselves.

Okay. Great. And did you say that we did not -- or we got minimal E2D revenue in the fiscal year, and we're expecting more of this, the first half of this fiscal year?

Correct. Some of it, the planes got pushed.

Okay. Did we get any revenue in the fourth quarter, E2D revenue?

Very small amounts of [indiscernible]. We expect to get some more in this...

Very small.

All right. I guess that's basically it. You mentioned that -- in the press release about -- we anticipate some dramatic changes in revenue in HPP down the road as we roll out more of the ARIA -- as we get more ARIA customers is encouraging. One more thing, one more question. And that is the question -- the last conference call, you indicated that, of course, we're working with the ARIA ADR managed under our via technology solutions, in service contracts. Has that been -- have we moved -- have acquired additional customers in that area?

Yes. I think all the customers have been ADR, except one. So yes. So mostly everything is being managed.

All right. So I mean, the last time we had introduced it, we got it out there, and so we're progressing from that -- in Florida, let's put it that way, with the customer base. Appreciate it. And let's hope this supply situation ends sooner rather than later.

Absolutely.

And we'll go next to Brett Davidson, a private investor.

It's good to be here. I've got a couple of questions, hoping you guys can help me with. Press release that was welcome. Do you anticipate any more of those coming in the near future?

Absolutely. As soon as we have something of value, we will definitely let them -- put them out there, Brett.

Okay. That's good to hear. The 27% increase in service revenue, can you just give a feel for how much of that is represented by ARIA? And how much of the increase is from UCaaS? Is one of them a bigger contributor than the other?

The majority, I would say, of the service revenue on that side came from the TS side, and that's a mixture of professional services, of MSP services and UCaaS services, overall.

Okay. Is one of those driving that 27% increase? Or that's more like an across-the-board thing?

It's pretty much across the board. All the services we do are at a much higher rate, and that's kind of where we've been trying to concentrate as much as we can on building that service business.

Yes. The recurring revenue stream.

Yes, absolutely.

All right. The backlog. I mean it's not something that we usually see reported. So I'm just trying to get a handle on what exactly backlog represents? So I'm thinking something like UCaaS doesn't really get...

No, it's not -- UCaaS. No. Because we already built that platform. The stuff that's there right now, the MSP and the UCaaS -- the MSP does get affected because we have a large customer that we've been rolling out 50-plus sites and to get a whole -- we have to get their infrastructure to a place to manage it. So we're waiting for firewalls. We're waiting for switches. We're waiting for whatever else, PC, servers. And so part of that backlog of getting this product to get to the customer to a point that we can actually manage them is slowing down some of the billing of the recurring revenue on the MSP side of it. By now, we were hoping to have 50 locations rolled out, and I think we have approximately maybe 20. And so until that gear comes in, I can't do the upgrade, and I can't start billing it for the MSP on that. The other thing on the UCaaS, which hasn't been a huge factor right now, but it does affect it to a small percentage is that the phones that customers need on their desk when they move over to our platform, they're so far backlogged right now that we're actually implementing softphones. And if the customer is willing to do that and then use the hardphones when they come in. But right now, the Cisco phones are the same, March, April, May. That's just giving you an idea of how long it takes. So we're asking customers to go with softphones now, get it implemented and then as the phones come in, roll it out. And then the other piece of it is whether it's other product, major products, like some of the big players that have firewalls service, the professional services to install that. I can't -- at a higher margin, I can't bill for something I haven't installed yet, so that's slowing down some of that also. And it's across the board. You name the manufacturer right now, and there is a delay.

Got it. So hardware is converting some of these software-as-a-services to backlog, which in -- with normal supply chains wouldn't necessarily land there?

Correct.

Got it. And is there any -- what generally makes up the component of backlog in this? I guess, now there's some of the UCaaS stuff that could possibly like the example you gave, what other?

The MSP side of it, I mentioned that how that backlog does that in a normal professional services. So if I'm rolling out 50 firewalls or 500 firewalls and the services that go -- there's a big deal that we closed last quarter for, I think, it was just under $2 million with services of a significant amount. But we're waiting for all the gear, which I don't know when it's going to roll out, so I can't recognize $300,000, $400,000, $500,000 of services until I get this all implemented. It's affecting every aspect of our business right now.

Got it. Does the cruise ship in the E2D stuff also land in the backlog total?

Well, no, the E2D, as soon as we get the PO, there's a delivery data...

We do have some in there, correct?

Yes.

There is some E2D because we're expecting some to be in December, and there's others that have been given for the year, but they haven't released. So it's -- they give us a PO -- we get a PO for x number of units and then they roll them out. So we were getting a lot of them at the end of the year, but we have a fair amount for royalties right now.

Okay. And some of those are folded into the backlog total?

Absolutely. Those are hard [indiscernible].

All right. And how about the timeframe for chewing through this backlog? Is this like next quarter, next 2 quarters, next year, extend greater than a year? What kind of timeframe it's going to take the work that -- ordinarily work that through, I realize supply chains might impact that? But ordinarily, how quickly are we going to churn through this?

Well, on the normal circumstances, everything is a couple of weeks if there was no -- the most you would ever weight is 6. Now everything is 12 to 15 weeks minimum on everything. So -- in some cases, yes, on the chips that we're waiting for on the ARIA side, it's 26 to 52 weeks.

Wow. That's kind of crazy. Let's see. All right, UCaaS generating enthusiasm in Q1. So those generating enthusiasm in Q1 include adding new customers during the quarter?

Absolutely. Yes. We've been consistently adding new customers every month in UCaaS. So -- of various sizes. And some of our customers that we actually just signed end up being an MSP customer, a UCaaS customer and then ARIA customer. They did the trifactor and bought all 3. So in a perfect world, all our customers move -- would move in that type of environment, but we're pushing.

You had many customers where you backed up and you crossed sold some of these products and handed them as customers to one of the other services?

Yes. We try. Sometimes they take 2 of them. Sometimes they take all 3. We're trying to push them into definitely to try to -- all 3 of them, it will be, like I said, the perfect scenario, and we push it. And in some cases, it takes a little time. They'll be like, oh, let us bring UCaaS and MSP first, let's see how you guys do. We want to make sure before we put everything in one basket that we're comfortable with your services and that could take 6 months. It could take a year. And then when the renewal comes up, we'll be like, hey, listen, we've done a good job over the year. Can we add another service? And then you quote it out, and it's timing and a lot of the stuff, too. But yes, no, our goal is to get that recurring revenue on all 3 facets.

So now these things have been rolled out for a little while. I would imagine that, that opportunity is going to increase during this calendar year?

That's our goal. That's our goal. It took a few years for MSP to really pick up stride and get those customer references and we're building up the UCaaS references. And of course, ARIA, we're building up some references there, too. So little by little, we're moving in the right direction.

Got it. And the last thing I want to touch on is the cash balance back up to $20 million. And I guess that the timing might not be right, currently, but I know there was talk about reinstituting the dividend after a couple of profitable quarters. The buyback program is on hold. I'm just wondering what the current thought process is there, seeing the cash just keeps slowing?

Well, I think we have numerous discussions at the Board level. And obviously, we bring it up at every Board meeting. So it's something we're scrutinizing. And I think once we get some continuing quarters correct, we'll take a good hard look and could consider implementing, but we need to get profitability on a consistent basis.

Has there been any talk about making the buyback program active again? Has that changed at all?

We have that -- that's part of that discussion. So we can address that also.

All right. That would be good to take a look at. I think at this point, it might be able to strategically to go in there and grab some shares on the cheap and might work out good.

Yes.

There are no further questions for the program. Back over to Victor for any closing additional remarks.

Thank you. As always, I want to thank our shareholders for your continued interest and support. Rest assured that your management team is committed to success and is diligently working to grow the business. Gary and I look forward to sharing our progress in fiscal 2022 first quarter operating results in February. Until then, be well, stay safe and enjoy the holidays.

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