CSP Inc. (CSPI) Q2 2022 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to today's CSPI Second Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note that this call may be recorded. [Operator Instructions] It is now my pleasure to turn today's program over to Mr. Michael Polyviou. Sir, please begin.

Thank you, Chelsea. Hello, everyone, and thank you for joining us to review CSPI's fiscal second quarter ended March 31, 2022. 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 projection 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, CEO. Victor, please go ahead.

Thanks, Michael, and good morning, everyone. I believe our team performed well during the fiscal second quarter. The results were better than we had contemplated entering the quarter, and I believe the trend in the underlying business is a positive long-term indicator for CSPI. We reported solid results across many of our key performance indicators, including sales of $12 million. Service revenue grew 21% compared to a year-ago second quarter. Backlog as of March 31 was $17.3 million compared to $7.8 million a year ago. And our disciplined approach enabled us to expand gross margins once again. This quarter, the gross margins were up 4% over the prior year and was a major factor behind us generating a profit of $0.03 per diluted share. We achieved these results despite many of our challenges that have been referenced on prior calls during the past year, such as supply chain and wage inflation. Let me review these with you before I share the results of the quarter. First, the global supply chain is disrupting our ability to receive components and deliver finished goods to our customers. However, I want to stress that the interest and demand for our products and services have never been higher as evidenced by our backlog. We believe our backlog represents a substantial undervalued asset. Our team is quite proud that we have not lost a single order in the backlog. Unfortunately, the supply chain issue is not going to be resolved quickly, and in fact, signs point to it becoming worse than before. It gets better. Second, we are also managing the effects of a tight labor market, which, in our case, has caused us to adjust wages to retain staff and help recruit new employees. Florida remains one of the hottest job markets in the U.S., and with unemployment rates of 3.2%, the scales are tilted to its high-skilled personnel. While the labor market was tight even prior to the pandemic, businesses were forced to transform and adapt quickly to the new environment. And even now the pandemic is continuing to ease, these businesses are continuing with their investments in IT implementations. A report from Gartner shows 58% of the IT leaders report either an increase or a planned increase in emerging technology investments. This is a double-edged sword in that it hurts us because we're all competing for the same talent, so we're spending nearly $100,000 for the 6 months ending 3/31/22 on recruiters to help fill the staff needs to meet the demand, which at this point is a necessity due to the continued growth of MSP business. However, we also bank from the lack of customers' in-house IT professionals, which drive customers to CSPI because we have the people to meet their needs. Third, people choosing to work from home even though the pandemic is easing and the employers are welcoming employees back to the office is forcing our team to adopt a go-to-market strategy. Prior to the pandemic, our teams are engaging with customers in person and these multiple touch points along with industry conferences were highly important in generating sales. I believe we have successfully adjusted our business model to account for these dynamics. And I can say this with the most confidence because our primary goal pre and post pandemic has been achieved. That goal is to migrate to higher-margin products and services, allowing us to report a solid gross margin of 35% for the second fiscal quarter, considerably higher compared to a year-ago gross margin despite the lower revenue year-over-year. Our Technology Solution, or TS business, generated revenue of $10.9 million in the fiscal second quarter. This exceeded our internal plans by a wide margin while the backlog remained strong. Approximately 75% of the backlog is this business, which has proven to be a reliable indicator of the future revenue performance due to high conversion rate. Our managed service practice, or MSP, is a consistent, strong and reliable performer. We're not expecting this to slow down anytime soon. In fact, the same dynamic accelerating MSP growth are expecting to be around for the foreseeable future. The continued growth of cloud technology; advanced cybersecurity threats, which have been experienced over the past 2 years as business went virtual; the shortage of IT talent, which I mentioned earlier; reduced IT budgets and organizational infrastructures to drive business growth are causing businesses, large and small, to outsource IT projects. According to MarketsandMarkets, a market research firm that estimates the global managed service market is expected to grow to $300 billion by 2025. Additionally, our cloud business also remains consistently strong, with our professional services closing deals and growing the pipeline. All MSP and cloud revenue is on MRR, monthly recurring revenue, under multiyear contracts and contributes heavily to the bottom line. I truly believe this consistent and stable business is not being reflected in the stock price. Regarding UCaaS, growing this business remains a methodical process. Very similar to the building the MSP practice, I believe we are demonstrating steady improvements each quarter, and I believe this progress is getting us closer and closer to our desired outcome. As you recall, we launched UCaaS offering just prior to the pandemic and has been expecting to meet customers in person. It took us a while to readjust our approach and expectations. However, I believe these added wins and broader name recognition is going to create an upswell of interest. I believe the team is on top of things, and I expect greater achievements in the coming quarters as we get more wins under our belt. Regarding the High-Performance Products, or HPP division, we reported revenue of $1.1 million and continue to build a multimillion-dollar backlog as the supply chain issues are hindering our revenue growth. Myricom continues to perform well. However, most of the expected royalty revenues related to the E-2D program was pushed out to the second half of fiscal 2022 due to the customers restructuring its business. We are experiencing more and more interest in ARIA as we sign new customers in the quarter, and we remain bullish on the long-term contribution. The monthly income being generated is encouraging and the growing pipeline raises my enthusiasm. In addition to benefiting from a shortened sales cycle compared to when we initially launched ARIA, we are looking to hire 2 additional internal sales reps to pursue mid-market accounts to build market share. To summarize, we reported a better-than-expected fiscal second quarter. This performance is consistent with our business plan to generate higher margins and profits. We have met the many challenges these past 2 years in the value-added solutions that position us for the future success. We also continue to attract talent despite the tight labor markets because we offer them opportunities for growth and success. We are in a rising sector that is expected to outpace many other industries for the foreseeable future. We have the products and services to achieve our own ambitious goals. During the pandemic, we ensured our team was equipped with the tools to succeed in a safe and healthy environment. Our execution is generating returns that is enabling CSPI to buy back shares as we repurchased nearly 13,000 shares on an average cost of $7.51 per share, which I truly feel the stock is undervalued and does not reflect the many positive things we are doing and can potentially achieve in the coming quarters. With that, I will now ask Gary to provide a brief overview on the fiscal second quarter financial performance. Gary?

Thanks, Victor. As Victor mentioned in his opening remarks, our fiscal second quarter was $12 million. We reported gross revenue of $4.2 million or 35% of sales compared to $4.3 million or 31% of sales in the year-ago fiscal second quarter, representing a 4% improvement. Further, while service revenue was similar to the year ago, we were quite pleased that the gross margin -- the product gross margin was slightly ahead of last year's product gross margin despite the year-over-year decline in product revenue. Additionally, the product-based backlog will also have a more favorable gross margin, so we are making every effort to get these shipments out to customers. Our engineering and development expenses for the fiscal second quarter were $717,000 compared to $762,000 in the year ago period. The decrease is primarily due to lower personnel costs. Our SG&A expenses in Q2 were $3.5 million, a slight decrease due to the lower headcount in sales and administration from the year-ago SG&A cost of $3.7 million. We reported net income of $156,000 in the fiscal second quarter or $0.03 per diluted share compared with a net loss of $847,000 or $0.20 per share for the fiscal second quarter of fiscal 2021. We ended the second -- the fiscal second quarter with cash and cash equivalents of $20.3 million as of March 31, 2022, which was an increase of $1 million from December 31, 2021. During the second fiscal quarter, we purchased nearly 13 million shares from the recent reactivated stock repurchase program. We've authorized to buy an additional 181,000 shares of CSPI common stock. We believe the stock at these levels represents value. However, we will continue to exercise prudent expense management to ensure we have the resources to execute our multiyear growth strategy of 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] Our first question will come from Joseph Nerges with Segren Investments.

Congratulations. You did a great job in the quarter, a tough quarter for all around from standpoint of getting the product that you need to deliver some of those products. But let me start off with a brief overview of the situation from our stock standpoint. Currently, and this is my estimate, we are currently trading at about 60% of our sales, with the stock price around $7. And we're trading -- and our cash position is around $4.75 a share with no debt. Now it's absolutely -- as you stated, we're undervalued -- unbelievably undervalued in looking at any scenario. And so let me ask you this. You only purchased 13,000 shares and I realize that the restrictions are difficult in purchasing in an open market when we have so few shares outstanding. Have you thought about at all going directly to some of the larger people who file 13G forms and asking to buy block purchases of 5,000, 10,000, 15,000 shares rather than trying to execute through the existing daily markets? Have you ever looked at it?

At this point, no, but we would certainly take that under advisement and speak with the Board about that.

Because obviously, some people are trying to -- they're liquidating a couple of thousand here, a couple of thousand here, they do it little by little. And so now there could be individual investors but in some cases, it may be some of the larger owners that are dribbling out the stock because they can't sell 15,000 or 20,000 shares in a block at a given time. So that's my only point. A couple of corrections on your statements. One, the average price we paid is $7.81, not $7.51. I think Victor mentioned $7.51.

Yes, that's my mistake.

And it was 13,000 shares, not 13 million shares that you mentioned, Gary. So we still have 181,000 shares left, you said it something approximately that, that are authorized for repurchase?

Yes.

Okay. And subsequent to the end of the quarter, in other words, since April 1, have we purchased shares since April 1 to the current date?

Yes. We did some shares in...

You don't have the number?

Not very many. It's very small.

Okay. That seems like -- I mean, the volume has picked up a little bit in the stock but not dramatically. So obviously, you're having difficulty getting the volume necessary up.

Yes, that's fair. That's absolutely true.

One other point. Have you -- are you -- I was just looking, before the call started, looking at the treasury bill rates, and the current 1-month treasury bill is around almost 0.5%. I'm wondering if you're able to deploy some of that cash. I mean, we've got -- I know you have to -- you need the cash for operations, but some additional return on our heavy cash position, even a minor amount over last year should be -- are we doing anything in that respect?

Yes, definitely. We're definitely investing and we've been -- as the rates have moved up, we've benefited from that, but we've got a fair amount of it in the U.S. that we have invested.

Okay. Well, I mean, obviously, we -- if nothing else, we could -- in the current environment with interest rates jumping pretty rapid, I would imagine over the next couple of months, you might be able to increase that a fair amount, even on a very, very short-term rate itself.

Yes. Definitely.

Getting back to -- you're pretty positive on what's happened with HPP and TS or Technology Solutions division as far as the backlogs are concerned. And like you said, the biggest difficulty is still getting our chips necessary as well as the other items necessary to deliver. But have we -- has there been any idea that we might be able to be getting some delivery a little bit faster in certain sectors anyway? Or are we still...

We're working it, Joe. We're constantly dealing with the distributors and the manufacturers and it's just a very difficult situation. And we looked at, is there incentives or things we could do to do it. But most of the manufacturers either want a king's ransom to do that or they're still saying that the estimated dates are out there and we're in the queue.

Okay. So like you're not unique in this. Almost everybody in the industry is under the same circumstance.

That's right.

All right. So basically, that's all I have. It seems like you're doing what you need to do. You mentioned about the UCaaS. I think you were pretty positive about the UCaaS product line coming in. And has that been helpful that people -- more people want to stay at home now? Even with the increase in energy prices, it seems like people don't want to commute to work if they can operate at a house because why would you spend the added expense of going to a place if they can do it from home? Does that help the UCaaS product line sales force, looking to expand that product line in that area?

I think it's kind of neutral because you still need it for both the office and at home. I don't think it's adding one way or the other. It's just getting in front of customers and talking to them, and it's a timing issue, too, where if they have other contracts with other UCaaS providers or phone companies, that we're hitting that timing issue where they're willing to look at us based on their contract coming up for renewal.

Okay. And so -- and then you did mention, is that -- did you say that you're expecting some royalties in the second half of this fiscal year with each of these programs?

We're planning on it but there's no guarantee just because they keep moving things out, but we're hoping that it all comes in the second half.

So you've got more -- hardly anything in the first half is what we're saying?

Yes.

Okay. Well, thanks a lot. Appreciate it.

Talk to you soon, Joe.

We're going in the right direction. And obviously, with cost controls, you're able to stay profitable, let's put it this way in this quarter.

Thanks, Joe.

[Operator Instructions] It appears that we have no further questions in the queue at this time. I would now like to turn the program back to Mr. Victor Dellovo for any additional or closing remarks.

Thank you. As always, I want to thank our shareholders for your continued interest and support. The demand for our high-margin product and services is rising, and we believe this demand will lead to further gains in our financial performance as we evolve into a more normalized business environment. We remain committed to growing the business, and we believe our backlog represents a substantial undervalued asset. Gary and I look forward to sharing our progress in fiscal 2022 third quarter operating results in August. Until then, be well, stay safe. Thank you.

Ladies and gentlemen, this does conclude today's program, and we thank you for your participation. You may disconnect at any time.