Csp Inc /Ma/ Q1 FY2020 Earnings Call

Good day, everyone, and welcome to the CSPi Fiscal 2020 First Quarter Conference Call. Please note, today's call is being recorded. And it's 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 first quarter ended December 31, 2019. With me on the call today is Victor Dellovo, CSPi's Chief Executive Officer, and Gary Levine, CSPi's Chief Financial Officer. Before we begin, I'd like to remind you that during today's call, we will take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward-looking under the act. The company cautions that numerous factors could cause actual results to differ materially from forward-looking statements made by the company. Such risks include general economic conditions, market factors, competitive factors, and pricing pressures, among others described in the company's filings with the Securities and Exchange Commission. Please refer to the section on forward-looking statements included in the company's filings with the SEC. After Victor and Gary conclude their opening remarks, we'll then open the call for questions.

Thank you, Michael, and good morning, everyone. Since this is our first call since 2020, I would like to wish everyone a happy new year. To begin, total revenues for the fiscal quarter were $16.6 million compared to $19 million, slightly ahead of our internal projections. Despite the business mix, I am pleased that our gross margins improved compared to the year-ago quarter, despite a $2.4 million revenue decrease. I believe this reflects the investments we have made over the past couple of years to develop higher-margin products as we remain focused on driving profitability. Additionally, we continued to make progress on our Unified Communications as a Service, or UCaaS, and ARIA. Apart from driving our top line growth, these higher-margin offerings will have a disproportionate benefit to our bottom line. In a few minutes, Gary will discuss our first-quarter financial results in greater detail. But first, I will review our business segments, and I'll begin today with our Technology Solutions business. For the quarter, our TS revenue was $15.5 million, our managed service practice, or MSP, performed well as we continue to expand our customer base as well as our current customers' monthly spend on new services due to our high customer satisfaction, which is something we track closely. As someone who has been in the industry for a long time, it's difficult for our investment to achieve this high level, let alone maintain it. But we do this on a consistent basis, so hats off to our entire team. Other areas of growth, such as the cruise industry, represent significant revenue opportunities, and we currently have commitments through the next two quarters. The Microsoft practice is a steadfast performer as we experienced a 247% increase in the number of licenses in 2019. I believe we can surpass that growth rate in fiscal 2020 based on our current trend line in addition to exploring ways to further strengthen our Office 365 business. Our UCaaS, which is an all-in-one service for hard and soft phones, including 24/7 security and technical support with redundant data centers located in Florida and Texas, I believe we have developed something unique, a testament to our innovative and startup mentality. Everyone at CSPi is eager to get this underway so we can capture our piece of the pie and participate in this growing market, which is estimated to reach $79 billion in a few years. This is a market dominated by a few large players. However, I believe that cookie-cutter offerings leave a big portion of the addressable market open to CSPi to service. This provides an opening for small, nimble, and more customer-centric companies such as CSPi. We continue to have a strong pipeline, both new and existing customers, as they appreciate our secure product, not to mention it can be customized to fit their specific needs. As we mentioned on the Q4 conference call, we had two companies performing beta testing, each with over 1,000 users. I'm pleased to report that one of them has signed a contract, and we feel confident that the other one will sign in a few weeks. From their earliest days, we have recognized that we developed something special, so we made sure our infrastructure can support the expected demand. I look forward to providing progress updates over the coming few months. Now I'll move over to our High-Performance Products division. Revenue for the quarter was $1 million and reflects a decline in the product revenue, primarily from Myricom. However, we expect our legacy business to improve throughout the year, which also includes anticipated royalties in the second half of the year for foreign military E-2D. In terms of new offerings, ARIA, our award-winning next-generation cybersecurity platform, gives us reason to be optimistic about the growth potential for the HPP business segment. We have several discussions in various phases of the sales funnel, including a few that would be categorized as being later or advanced stages. In fact, we are well positioned within a leading cable company and believe this could lead to multimillion-dollar opportunities. As you would imagine, it's a small, tight-knit community, and they all know what the other is up to, so this has opened discussions with other similar companies. In addition to our direct sales team, we continue to vet potential partners for our official channel program. We currently have eight partners, and we are speaking with several others to increase our roster, ensuring a robust channel and increasing our chances for success. In addition, you will see multiple announcements from integrations with go-to-market partners in the coming weeks. These are security vendors whose solutions benefit from our capabilities. These integrations will increase our solution impact as well as our market reach by leveraging access to these partners' customer base and prospects. In summary, notwithstanding the foreign exchange and anticipated ramp-up of the HPP business, there were no surprises, and Q1 was a solid quarter. We made progress and launched our new UCaaS offering, so we expect to see improvements over the remaining quarters of fiscal 2020, especially in the second half of our fiscal year. With that, I'll now ask Gary to provide a brief overview of our first fiscal quarter financial performance.

Thanks, Victor. As Victor mentioned, our first-quarter revenue was $16.6 million compared to $19 million in the year-ago fiscal first quarter. The decrease in revenue is the result of a $1.2 million decrease in product revenue in our U.K. division and equal declines of $500,000 in the Myricom and multicomputer products. Our gross profit of $4 million, which was slightly lower compared to the year-ago quarter, is due to the lower sales. However, despite our gross margin of 24%, which was up 100 basis points compared to the year-ago gross margin of 23%, it was due to higher combined service revenues from the TS and HPP business segments. Our fiscal first quarter engineering and development expense continued to trend lower at $672,000 compared to $750,000 a year ago. This is due to a reduction in contract labor required last year to help build out the foundation of the ARIA software platform and a recovery of consulting expenses where the services were not completed. Our SG&A expenses in Q1 were $3.8 million compared to $3.6 million in last year's fiscal Q1. A slight increase is due to additional sales personnel for ARIA as we prepare to launch the product this year. Due to the strength in the British pound relative to the U.S. dollar and the euro during Q1, we were negatively impacted by a noncash charge of $335,000 in the quarter compared to a favorable impact of $7,000 in the year-ago fiscal Q1. We had a tax benefit of $70,000 for the first quarter compared to a minimal tax expense in the year-ago fiscal quarter. The effective tax rate for the current quarter was 11.4%. The lower effective tax benefit rate was due in part to no tax benefit recorded for the U.K. for the foreign exchange adjustment. We reported a net loss of $540,000 or $0.14 per share in the 2020 fiscal Q1 compared to net income of $50,000 or $0.01 per share for the fiscal first quarter of 2019. We ended the first quarter with cash and short-term investments of $17.6 million. Our Board of Directors has voted to pay a quarterly dividend of $0.15 per share to the shareholders of record on February 28, 2020, payable on March 13, 2020. In summary, we have a solid financial foundation and continue to manage our costs. We remain focused on driving our bottom line performance and boosting sales of our higher-margin products.

We can take our first question from James Stewart with CSPI.

Yes. I have a question for Victor. I know the significance of a lot of the businesses and local governments that have been hacked—either in data stolen or actual funds—and it's a serious problem. But I'm kind of curious as to where your main focus is going to be. I know you're doing a collaboration with Palo Alto Networks, but are you going to be focusing on direct end users as the primary strategy since there are so many of them? And if so, are you going to be gearing up with additional salespeople this year?

We are looking to—and we are currently talking to direct customers, either through direct contact that we have with our current salespeople or through the channel partner program that we have set up and brought on channel partners that focus in the security area, so we can have more reach. So it will be a combination of bringing on more of these security partners and hiring internal salespeople as well. It will be a combination of both.

Do you have any plans to do any other collaborations with other IT providers in addition to Palo Alto?

Yes. As I mentioned in the script a few minutes ago, we'll have some new announcements coming in the next couple of weeks.

Our next question is from Joseph Nerges with Segren Investments.

Just a couple of quick questions. You did say you signed a contract for UCaaS just recently. So I'm assuming some of that revenue will start in the current quarter and, of course, continue through the remainder of the year. Am I correct in that?

Correct, yes. As I said, these are companies with over 1,000 users. We will be bringing on different offices as they request over the next 12 months. So it will roll out over the next year, and then the contracts are either 1-, 3-, or 5-year contracts that we try to sign with them.

And basically, you're saying that we signed one now, and you anticipate the possibility of the second beta test site, if you want to call it that, signing in the not-too-distant future?

That's correct. We're hoping within the next couple of weeks. And we'll probably have another dozen or so in the pipeline right now at various stages that are looking promising.

Could you just add a bit more color? You mentioned that in the UCaaS product launch here, you have some unique—developed some unique capabilities. Could you just elaborate slightly on what's unique that you think you've added?

Where we use the Cisco foundation for the back end, there are customers that have custom applications that they would like to integrate into the phone system, whether it's financial or automakers, for instance, where we're able to do that integration and customize it to their needs. Where some of the other players out there, it kind of needs to fit into three different categories, we were able to do that customization. So basically, it's truly mimicking a phone system that they would have on their own premise, but they don't have to worry about the support, maintenance, or security around it.

Have we integrated any of the ARIA security into this product line at all?

No.

Not really?

No, not into the UCaaS.

Do you have any feel for how many people might want customization?

To be honest, I have no idea. We can still offer what everyone else does, but what kind of separates us from everyone else is that customization.

Are you still anticipating most of this revenue will start to generate in the second half of our fiscal year?

Correct.

Correct.

We'll take our next question from private investor, Brett Davidson.

Just got one quick question this morning regarding the channel partners. Have there been any of the ARIA sales through any of the channel partners yet?

No, we're just bringing them on board, educating right now.

Got it. So that hasn't kicked into gear yet.

No.

And so obviously, then with the guidance, that would start occurring in the second half of the year?

We're hoping, yes. The pipeline is growing with the partners or in talking to customers. Some of the customers they've brought us into are very large organizations. As you know, those take a little longer than some of the smaller markets. But they're talking to us and they're interested. So right now, we're in different phases of each sales, depending on the customer, there's different phases of where we are with each particular customer.

All right. Well, I'll just try and sit here, waiting patiently, as tough as it's been. But the next couple of quarters?

Yes.

We'll go next to Jonathan Hoenig with also a private investor.

I wanted to ask a question about the stock, which is at the higher end of a 3-year range. Do you think it's overvalued? Is the stock undervalued? What's your comment on valuation?

Well, I think, Jonathan, we believe it's certainly undervalued because I think we've got a lot to offer here, but we're in a startup phase. So I think that what we're doing is looking to get more information out to the public going forward as we have these successes. We will reap the benefits within the upside of the company as we discuss these new product lines. We believe these are intriguing areas with good growth and opportunity for us. But we're not known in these areas, so we're going through an educational process of educating the market about who we are and what we can do.

And it does appear we have no further questions. I will return the floor to our speakers for any additional or closing remarks.

Thank you. As always, I want to thank our shareholders for the continued interest and support. Our core business remains strong, and the launching of our game-changing UCaaS and ARIA offerings is extremely exciting. Financially and organizationally, we are in a much stronger position, and we will continue to focus on the bottom line performance and drive sales of higher-margin products while managing costs to meet our objectives for fiscal 2020. Gary and I look forward to sharing our progress with you on the next fiscal Q2 conference call in May. Thank you.

Thank you.

And this will conclude today's program. Thanks for your participation. You may now disconnect, and have a great day.