CSP Inc. (CSPI) Q1 2022 Earnings Report, Transcript and Summary

Good day, and welcome to the CSPI Fiscal Q1 2022 Earnings Conference Call. [Operator Instructions] Please be advised today's program may be recorded. It is now my pleasure to turn the program over to Michael Polyviou. You may begin, sir.

Thank you, Aaron. Hello, everyone, and thank you for joining us to review CSPI's first -- fiscal first quarter ended December 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'll 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 term 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 key performance or events and are subject to a number of uncertainties and 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 -- 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 at the time with respect to future events. All forward-looking statements are qualified in their entirety by this cautionary statements 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. We reported a solid fiscal first quarter performance as we achieved many of our objectives. For example, revenue of $12.4 million increased 9% year-over-year and 24% sequentially. Service revenue grew 23% year-over-year. During the quarter, we continued to manage through a variety of issues during the quarter. Some of the key factors continues to be the impact of COVID-19 Omicron variant. We had multiple internal COVID outbreaks during the quarter, which slowed us down from completing certain projects. Then of course the supply chain issue which has delayed many customer orders and with our backlog increasing to $15 million under a normal environment we would have had a significant profit for the quarter. We also had to give our employees a raises to keep that turnover at a minimum. The flow to job market is one of the hottest in the U.S. so there are many options for our employees. We also had recruiting fees in the tune of $80,000 for the quarter. But the labor market being so tight we had to hire multiple recruiting companies to help backfill some of the open positions and as well as new positions because of the growth in the MSP division. Despite the challenges, we were able to generate growth during the quarter as well as build our backlog. Our performance during the first quarter resulted from our continued high engagement with our customers and suppliers to proactively resolve and work through issues. Our team is quite proud that today we have not lost a single order in the backlog. Additionally, being nimbler than our larger peers, we have been able to quickly shift gears to refocus our resources to the services side of the business, which has not been nearly as impacted by our supply chain issues and have captured meaningful revenue opportunities during this period of uncertainty. Our primary goal of migrating to higher-margin products and services continues to be achieved as we reported solid gross margins of 29.1%. And similar level compared to a year ago fiscal first quarter despite heading into a period of tougher year-over-year comparison and facing inflationary pressures with our cost. We do believe at this point, we should be able to make further progress with our overall gross margin as compared to Q1 as the year progresses. Our Technology Solutions or TS business generated revenue of $11.3 million in the fiscal first quarter, an outstanding result that exceeded our plan. Our Managed Service Practice or MSP, remains a bright spot because business is a challenge to retain or attract internal talent. I don't expect this dynamic to change much in the coming years. So we will continue to dedicate the necessary resources to capture our share of this market to build our portfolio of service contract customers. Moving on to the cruise line business. The team is currently deployed and working -- is progressing on 4 ships, as I mentioned in Q4 call. While the Omicron variant has lowered the operators' optimism regarding the timing of additional retrofits, there is another set of ships that could be awarded later this quarter or early Q3. As a reminder, this business provides CSPI with an attractive business opportunity and we are decidedly focused on winning additional business as our fiscal year progresses. Regarding UCaaS, we added several new customers during the quarter, and I'm encouraged with our progress. We do face continued obstacles that are hindering our ability to maximize the revenue potential of this offering. Name recognition is always an issue and we also have a smaller sales force than compared to our larger peers. Regarding the High-Performance Product or HPP division, we reported revenue of $1.1 million as the Myricom business performed better than expected. This growth was offset by lower-than-expected royalty revenue related to the E2D program. Approximately 50% of the royalty expected revenue was recorded in Q1 with the remaining balance now expected to be recorded in the second half of fiscal 2022. While ARIA remains the primary growth engine for this business segment. In December, we announced the availability of the Myricom ARC-C TxO network interface adapted designed to act as a secure, unidirectional network bridge. This product has already been deployed in organizations, including a large public cloud operator and in government applications requiring a network gateway that allows one-way data transfer between classified and unclassified networks. While we don't expect this product to significantly change the upper trajectory of Myricom business, it does demonstrate our ability to respond to an increased demand from our OEM and large customers to create a one-way data path. With regards to ARIA, the emergence of Omicron in the timing of holidays slowed down the momentum as we had experienced earlier in the quarter. However, we did manage to close a few MDR customers and the revenue contributed from these commenced in the current fiscal Q2. As of today, we continue to grow our ADR customers generating recurring monthly revenue and the team is working hard to sign new contracts. The orders in the backlog, along with the deals we are pursuing are sizable and we will dramatically transform the revenue landscape for the HPP business. Although the timing to bring these opportunities across the finish line is unpredictable at this point. To summarize, we increased our backlog, demonstrating the high-end interest for our products and services and also due to the supply chain issue, which has limited our sales growth. We continue to implement and execute on the initiatives aimed to improve a near-term performance, such as focusing on service business while strengthening our long-term interest as we continue to make progress with the UCaaS and ARIA, albeit at a slower pace than we would like. Gary and his financial team has excelled over the past 2 years and the prudent expense management that have implemented allowed us to maintain our resources to execute a multiyear growth strategy of transforming to a cybersecurity, wireless and managed service company. With that, I will now ask Gary to provide a brief overview on the fiscal first quarter financial performance. Gary?

Thanks, Victor. As Victor mentioned in his opening remarks, our first fiscal revenue -- first quarter revenue was $12.4 million, representing an increase of 9% year-over-year and 24% compared to Q4 fiscal 2021. We reported gross margin of $3.6 million or 29.2% of sales compared to $3.4 million or 29.7% of sales in the year ago fiscal first quarter. Although we are entering a period of tougher year-over-year gross margin comparisons, as the pandemic-related conditions allowed us to record a disproportional level of higher-margin service revenue. We had previously started that -- we stated that our near- and short-term goal is to maintain an annual gross margin in the mid- to high 20s, which was achieved. Our engineering and development expenses for the fiscal first quarter were $627,000 compared to $729,000 in the year ago period. The decrease is primarily due to lower personnel cost. Our SG&A expenses in Q1 was $3.4 million, a slightly -- increase due to the increased payroll and commissions in the TS segment from the year ago SG&A costs of $3.2 million. We reported a net loss of $366,000 in the fiscal first quarter or $0.09 loss per diluted share compared to net income of $1.2 million or $0.26 per diluted share for the first fiscal quarter of fiscal 2021. If you recall, the 2021 fiscal first quarter included a gain on a debt forgiveness of the Paycheck Protection Plan, SBA loans at the TS and HPP segments totaling $2.2 million, which was established as part of the CARES Act. Excluding the gain on the debt forgiveness of the Paycheck Protection Plan, SBA loans, the company would have reported a net loss of $1.1 million or $0.26 loss per diluted share for the first quarter of fiscal 2021. We ended the first fiscal quarter with cash and cash equivalents of $19.3 million as of December 31, 2021, a decrease of over $700,000 from the September 30, 2021. In late December 2021, we reactivated the stock repurchase program with the authorization to buy up to 194,000 shares of CSPI common stock. We did not purchase any shares in the first fiscal quarter ended December 31, 2021. As a common practice, we will update on a quarterly basis as the program is executed. We will continue to exercise expense management to ensure we have the resources to execute the multiyear growth of our transforming to a cybersecurity, wireless and managed service company. With that, I will turn it over to the operator to take your questions.

[Operator Instructions] And we can take our first question from Scott Caldwell, who is a private investor.

I'm a longtime shareholder. Can you just box in the aggregate cost of being a publicly traded company on an annual basis, please?

That's probably -- I don't have the numbers right off hand. But in the past, it's been about $1.8 million to $2 million a year.

Okay. Has the board explored any potential to put the company up for sale?

We've explored that over the years. We have talked to a number of companies over my tenure here at the company. There is no active program to do that at the moment.

I just -- I'm concerned by the fact that you mentioned that we are not as substantial as some of our competitors and that puts us at a severe disadvantage in the marketplace.

Yes, I understand that. Yes.

Well, I'd certainly like to encourage you to explore opportunities because $2 million of cost it seems to be completely out of whack.

[Operator Instructions] And we can take our next question from Mike Price, who's a private investor.

I's just have a quick question about the share repurchase that you announced. And the way the press release was worded, it's at management's discretion. Can you provide the shareholders some assurance that the management's discretion to buy shares does not coincide with management's potential sale of shares.

Well, I mean, basically, no one in the management group at this point has sold and you have a very limited period of time that we don't have blackout periods. But at least at this point, I mean, I can't answer for the rest of the management team, but I don't see us selling large amounts of shares.

Well, obviously, the stock is very illiquid. And if I go to sell 10,000 or 15,000 shares, I'm going to affect the price of the stock. So the question basically is management has the discretion to buy shares with corporate cash that if you decide to sell 20,000 shares, you don't have the liquidity that I would not have. That's basically the question.

Well, our intent is not to support the management team buying shares, I mean to go out and buy shares that they are actively selling. That's for sure.

[Operator Instructions] We'll go next to Joseph Nerges with Segren Investments.

I didn't think my questions were being answered here. I didn't know if the star 1 was working on my phone. A couple of quick things. On your press release, you talked about increasing the managed services in the quarter and at a brisk pace, I guess, this way you stated it versus -- because of a talent drain at a lot of the smaller companies. So I'm assuming that means a lot of the smaller companies can't attract the talent to even watch the security or outsourcing most of her IT work outside the traditional in-house staff. Am I correct on that?

It's partially there, but they can attract them at times, but they're not staying long enough and then you have a training process of x amount of months and then all of a sudden, before you know it, they're leaving for a higher salary or bonus structure or whatever it may be, and then they have to start from ground 0 again, that's been one of the driving factors. Some of the -- where they hire us, not that we don't have the same issue, but at least we have a lot of people that they can count on, not just 1 or 2.

And obviously, so outsourcing becomes an option that a lot of times, they maybe not have considered in the past and they are considering it today, that's sort of plausible.

Correct.

On second part of the press release, you talked about the UCaaS. I think you mentioned something that a point that there would have been a significant profit are referring to specifically UCaaS, here?

No. No. Overall. Overall. Overall. Yes.

If you could have supplied a sufficient amount. If -- and I assume a lot of -- and you mentioned that in the last conference call about you can sign up a UCaaS customer, but if you can't deliver the telephones or you can't deliver some of the hardware and required you can't obviously...

It's not just for UCaaS, it's for everything. The UCaaS is just a small piece of the overall backlog. It's hardware, the software that goes along with it, we could deliver it, but without the hardware, where is it going and then the services that go along with it to install it.

So let me rephrase my question. If this was 3 years ago, and there were no supply chain issues or essentially, there wasn't supply chain issues 3 years ago. I assume we were pretty much pretty normal, let's put it that way. You're saying that we would have to be considerably profitable on a normal schedule let's -- 2 issues: one, the supply chain, obviously, and the virus. Absent those 2 things, we would have been pretty profitable because of normal delivery schedules.

Yes. We've never had a $15 million backlog like that ever. It's been half or less than that historically.

So obviously, it wouldn't take much to increase the quarterly sales if you didn't have the backlog or the supply problem. On a cruise business, you said that you're working on cruises now and then you expect more orders down the road. Is that what you were...

Yes, we're working on the next of ships, just things are moving a little slower, I think, just with but the uncertainty with the cruise line, the decisions that normally take months have taken a little longer, but the conversations are there.

And did we have some E2D royalty in the first quarter? Or are you expecting more later in the year? Or that was...

Yes, probably in the third and fourth quarters.

The remainder, the E2D, Okay. One, let me just go back to the press release you had in December, and that's the 1 on the new product, the data diode, the one-way transmit product that you introduced Myricom. And in that press release, you specifically -- you talked about existing customers. where, I guess, data center issues or cloud providers using it or somebody is using it and the government agencies.

Yes.

Now -- so it has been beta tested or it has been...

No. That's been -- we've actually -- the beta is over. We actually sold it.

Okay. Yes. And also on that call -- in that press release, you also mentioned potential use by OEMs, original OEMs for this product. Have you implemented any of that? Or is that being tested by them or to whether or not they want to incorporate into their...

Well, the testing phase is over, we've been awarded a couple of large opportunities, but we can't get the boards to deliver it.

That was going to be my next million dollar question. How...

It's a multimillion dollar question, actually, we can't ship.

I got you. Okay. So that's great. So in a way, it's good that you got the opportunity, but the pending delivery of product as opposed to not being able -- not having a product acknowledged and accepted by the OEMs. So what are we talking about on boards? How -- what does it take to get a Myricom board time-wise, you talk in 3 months.

It's a moving target. I could tell you today and it'll change tomorrow. So I'd rather just not give you a delivery date because it has changed like 3x already.

Okay. And of course, on the board, is some key chips that are that you're utilizing. But -- so are these OEMs pretty sizable type customers. I assume from the backlog that it is, we're talking about some pretty big companies.

Yes, absolutely, absolutely. So I don't know exactly what the rollout is. They're a little hesitant to give us a rollout schedule. Moving forward, considering we're not sure of the first set of delivery, but we're hoping that it continues not only on the opening orders but into the future.

But you mentioned that you would have some considerable -- you thought a considerable volume in revenue if you could deliver the board?

We have budgeted to put the orders in this year, and it's up in the year, whether they'll hit in this year or next year. It's just -- we have no control of -- we're talking to them constantly, we're pushing. But in the scheme of things, on the totem pole, I'm not sure where we stand to be completely honest with you.

Okay. Well, very good. I appreciate it. It sounds like we're making progress absent what we can't control. Let's put it that way.

Definitely.

[Operator Instructions] We do have another question, it comes from Brett Davidson, private investor.

I'm looking for just a little color and a couple of items. The receivables show as about a quarter and a half, the move to the managed service thing, is there any insight that, that may start to contract?

Well, there are couple of things. Brett, let me just clarify some things, too. Remember that a lot of the revenue that we have is booked net, not gross, but the receivable is gross. So that can be a little deceiving within taking some of that. And I'd like Victor to follow on. Vic, I didn't mean to interrupt you.

No, go ahead, Gary.

No. And that's what I was just trying to say within the receivable, there are those items. So that could skew it off from that standpoint, Brett.

Got it. On the ship business, maybe you could add some detail as to how that whole process works. So you guys land a contract I mean, are these multi-hundred thousand contracts? And are you out there for 2 weeks, 2 months, 6 months, what does it take to complete one of these contracts?

There's different contracts for different -- 1 of them could be where we just go on 4 or 5 ships all over the world, and we'll do a site map of where all the new APs and wireless needs to go. That's Phase 1. Then Phase 2 is you get the order, delivering of the APs. They have their own set of individuals that actually put them where they go. And then we'll come back on and usually while the ship is sailing will be -- the guys will be on there, configuring them and then making sure that it's fully covered all over the ship and the interference because of the metal walls, they take care of all that. And then they come back and then another Phase 3 is to write that all up and do a full description of where everything is, the configurations, all the paperwork that goes along with it. So it's in different stages, and it doesn't happen all the time. And then there's the retrofit where they are docked out of the water and we'll come in and do the site map and everything will be done and it has to be done in 2 weeks, they literally work 18 hours a day for 2 weeks straight, just because it has to be done while it's on dry dock. So there's different things that happen, it just depends on the customer and their needs. And they usually give them like 4 ships at a time and it just depends. And the size of the ship matters, too, right? There's usually 3 different sizes and it just each one is the bigger the ship, the more it cost to do it.

And these are multi-hundred thousand dollar jobs or $1 million jobs or...

No, hundreds of thousands.

Got it. And so from a billing standpoint, are each phase being built separately? Or is this wait till the end and it's all.

That's how we kind of separated them, so we're now waiting to the end because it could be months in between. So we've kind of tried to separate them at stages so we can get paid as we go.

Got it. All right. I want to switch gears to the E-2D thing. Are we still bringing in any revenue for spares for the American planes? Or are we just limited to the foreign content now?

It's primarily the foreign content. There may be a few spares that are done for the Americans, but they're shifting over to newer technology.

Got it. So even the spare stuff is drying up.

Yes.

[Operator Instructions] There are no additional questions at this time. I'd like to turn the program over to Victor Dellovo for any additional remarks.

Thank you. As always, I want to thank our shareholders for their continued interest and support. These remain challenging times. However, we are executing on our plan to deliver a near short-term and long-term results as we remain committed to growing the business. Gary and I look forward to sharing our progress in fiscal 2022 second quarter operating results in May until then, be well and be safe.

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