Good morning, and welcome to CSPI's Third Quarter Fiscal Year 2023 Conference Call. At this time, all participants are in a listen-only mode and a question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Michael Polyviou. Sir, the floor is yours.

Thank you, Ali. Hello, everyone, and thank you for joining us to review CSPI's fiscal 2023 third quarter results, which ended June 30, 2023. 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 several uncertainties, risks and other influences, many of which are beyond the company's control, that may influence the accuracy of statements and 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 reports on Form 10-Q filed with the Securities 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, 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 it over to Victor Dellovo, Chief Executive Officer. Vic, please go ahead.

Thanks, Michael, and good morning, everyone. Today, we reported continued momentum for our business as revenue grew 33%. Our performance was driven by the continued outperformance of our Technology Solutions business, and I believe the results reaffirm our strategy to dedicate significant resources to this segment over the past couple of years. Our other product lines and business segments performed as expected during the quarter, and the business mix and tax treatment led to an increase in earnings. Gary is going to provide more details on the tax topic during his remarks. A major contributor to the momentum in the quarter was the continued conversion of the backlog to revenue, a good portion of which had been on the books for greater than 12 months as supply chain issues for the key components kept us from shipping completed orders to the customer. Our customers continue to remain loyal because our products and solutions are the most effective, cost-efficient answers to their critical needs, and we are extremely pleased to finally move this backlog to revenue. Our focus over the next few quarters is to convert the remainder of this older backlog to revenue, and our team is constantly engaged with our customers to keep them abreast of the supply timelines and options. It is worth noting that throughout this prolonged supply chain issue, we have not lost a single order, which I believe reflects the importance of our products and our services to the business. Turning to some of the segments' results. Our TS business revenue totaled $16.4 million compared to $12.6 million in the year ago fiscal third quarter. As evidenced by the dramatic year-over-year increase, this segment continues to be driven by our customers' increased use of our implementation, installation, and training capabilities. Our HPP revenue was approximately $1.3 million, in line with our expectations and compared to $700,000 in the year ago fiscal third quarter. While the ARIA customer base continues to grow and the pipeline remains high, recent developments will positively impact ARIA's solution in the HPP segment overall in the upcoming quarters and years. Perhaps our biggest achievement during this fiscal third quarter was our newest product launch, ARIA Zero Trust PROTECT, which we are internally calling AZT. It has generated a lot of enthusiasm within the organization, and the early industry feedback gives us reason to be excited. It is something that we have been developing internally, as we often do, and we believe it will be a major growth driver for our High-Performance Product, HPP, business as we move into fiscal 2024 and beyond. The advanced and patent AI-driven technology has garnered interest from leading customers and reaffirms our belief that gives us greater confidence that it will be a game-changer for CSPI. We have quite a few customers prior to the launch of AZT, and we envision it's going to accelerate adoption of the ARIA product line and generate a reliable stream of monthly revenue for our company. As we move through fiscal fourth quarter and expectations for fiscal 2024, we believe the success, reliability, and consistency of our TS business will be complemented by the HPP business, primarily as the buzz being generated from our AZT PROTECT converts to orders, positioning us to significantly expand revenue and gross margins from this product line in fiscal 2024 and well beyond. We believe our ability to develop this product sets CSPI apart from other companies in the space, especially among larger players, where we can identify a need and move on it quickly with limited development dollars. Other companies would need to evaluate and analyze the opportunity; even with unlimited funds, they may still lack the technical skills to develop something like AZT. So I'd like to spend a few moments describing why we are so excited about AZT. First, AZT's advancement allows us to offer our customers a giant leap forward in the evolution of cybersecurity solutions. AZT's performance surpasses anything available on the market today. It's a new generation of endpoint cybersecurity protection designed for critical operational technology environments. The unique patented solution protects all organization endpoints from the full spectrum of cybersecurity attacks and intrusion techniques, including the most advanced zero-day attacks, malware, ransomware, supply chain vulnerabilities, and even those threats that are completely unknown to security teams. By deploying artificial intelligence capabilities, AZT mitigates attacks before any damage occurs, ensuring seamless operations without disruptions or downtime. It lowers the risk of cybersecurity vulnerabilities and exploits on endpoint devices and applications to near-zero without the need for constant patching updates. Our team believes AZT is an excellent solution for a wide range of industries, including utilities, logistics, manufacturing, pharmaceuticals, banking and finance, healthcare, and energy. We are currently ramping up our sales and marketing investments to address these and other markets as we actively negotiate transactions with various key international markets in order to maximize the global opportunities. During the fiscal third quarter, we entered into one of these agreements in Australia. Rapid digital transformation is blurring the boundaries between IT and operational technology. OT networks have traditionally been air-gapped and kept isolated from the outside world. This is no longer the case. Cyberattacks on OT networks are most probable and best prevented by AZT. The product represents CSPI's latest offering of differentiated, value-enhanced solutions for the challenges faced by customers. As I mentioned before, we think it's going to be a significant growth driver for our company. To summarize, we have generated substantial growth during the first nine months of our fiscal year. The launch of AZT is underway. We are quite excited about the opportunities ahead. With that, I will now ask Gary to provide a brief overview of the fiscal third-quarter financial performance.

Thanks, Victor. As Victor mentioned in his opening remarks, we achieved significant growth in the fiscal third quarter compared to last year's fiscal third quarter. We reported revenue of $17.7 million, a 33% increase compared to $13.3 million in the year ago fiscal third quarter, as we have successfully converted some older backlog and delivered finished products to our customers. We reported gross profit of $5.9 million, or 33.4% of sales, compared to $4.9 million, or 37.4% of sales in the year ago fiscal third quarter. As a reminder, a function in the quarterly gross revenue is anticipated due to business mix. However, we continue to believe our annual gross margin will expand as the business transacts to higher-margin products. Our engineering and development expenses for the fiscal third quarter were $741,000, compared to approximately $884,000 in the year-ago period. The year-ago costs were higher primarily due to higher personnel costs, which included outside consultants, and the development of the AZT product, which, as mentioned earlier, was only recently unveiled. Our SG&A expenses in Q3 were $4.6 million compared to $4.1 million in the year-ago fiscal third quarter, due to an increase in variable compensation for bonuses and sales commissions from higher sales as well as payroll and initial costs associated with the unveiling and launching of the AZT. Our tax benefit was $1.7 million for the third quarter, primarily from the release of the valuation allowance against the deferred tax asset. We performed an analysis and determined that it is more likely than not that substantially all of the deferred tax asset in the US jurisdiction will be utilized. We reported net income of $2.5 million in the fiscal third quarter or a diluted earnings per share of $0.52 compared with net income of $684,000 for a diluted earnings per share of $0.15 for the fiscal 2022 third quarter. The company had cash and cash equivalents of $13.8 million as of June 30, 2023, compared to cash and equivalents of $23.9 million as of September 30, 2022. The lower amount is primarily due to the strategy we implemented last year to leverage our strong balance sheet and finance certain large customer orders at preferable interest rates, as well as the increased level of receivables created by product sales. However, in early Q4, a significant cash flow has been generated through the payment of receivables and the full repayment of financing provided to a customer during fiscal 2022. We believe the successful implementation of this approach also has yielded positive results, and we will entertain similar opportunities that meet our strictest criteria. I also want to highlight that the Board of Directors approved a quarterly dividend of $0.04 per share, payable on September 12, 2023, to shareholders of record on the close of business on August 23, 2023. With that, I will turn it over to the operator to take your questions.

Thank you. At this time, we will be conducting a question-and-answer session. Thank you. Our first question is coming from Mike Price, who is an Investor. Your line is live.

Thank you. Good morning. Congratulations on a great quarter. Previously, you had said that CSP has a problem with name recognition, and it seems like you have a revolutionary product, as you call it, the AZT. Has there been any discussions with anybody larger that can get this to the market faster and in a bigger way than CSP on its own?

Not currently. Right now, we just announced it less than 30 days ago, so we're looking to build a customer base. And then, as always, everything is on the table. If we were approached, it would always be something we would consider.

Okay. You mentioned that the payment of the receivable is occurring in the fourth quarter. Will that result in cash exceeding $20 million?

Pretty close to that.

Yes. Yes, pretty close. It's constantly changing based on payables. It's constantly moving, but it is close to that $20 million.

Right. Understand. You've categorized $2.4 million as held-to-maturity with interest rates. Short-term rates where they are, I assume that cash is earning a fair return even on a short-term basis?

Yes.

Okay. Because I'm looking at the cash that you have invested at short-term rates. That probably covers what the current dividend is on an annual basis. And it goes back to the question of having a company with a $60 million market cap with $20 million in cash and cash equivalents. The dividend is quite a bit lower than pre-COVID. And also, a question about the share repurchase. I think you authorized $194,000. I don't think you did anything in the previous quarter. What about the quarter just completed? Have any shares been repurchased?

A very small number.

Okay. Well, with the runway that you have, isn't this a good use of funds? I mean, it seems like this AZT PROTECT is the future of this company. And as shareholders, we can certainly get out in front of that by using some of the cash to repurchase shares. I appreciate the illiquidity in the stock, but whenever possible. I noticed Victor, in the last window, you bought a few hundred shares, which shows your confidence by opening up your wallet. It seems like the shareholders should be able to do the same.

Well, we'll take that under advisement, and we're constantly reviewing that with the Board. Right now, we're just investing in the AZT. But we'll take your advice.

Yes, cash fluctuations do occur. Sometimes we have $20 million, but that amount can decrease due to the financial deals we are making with larger customers. We offer them lower interest rates to ease their budgeting processes, which are typically annual rather than multi-year. This is why we engage in self-financing with these larger institutions. Having cash is essential for us. Additionally, our reseller business provides credit lines to purchase equipment, enabling us to secure significant credit with major distributors and manufacturers. This allows us to place multimillion-dollar orders without needing outside financing, especially considering current interest rates. Therefore, maintaining cash is crucial for financing potential deals and ensuring we can buy the necessary products using our credit lines with these distributors.

Why? And last question or comment is, I understand, at the end of the fiscal year, you have 90 days to report. But it's a little frustrating that you take usually till mid-December. It's a full, what, 75 days to see results. Is there a reason that it takes so long? I mean, I don't see anybody in the full 90 days.

A lot depends on the audit. Much of this is influenced by the timing. We are dealing with numerous factors in our closing related to the many products shipped by the manufacturer. Additionally, we need to invest a significant amount of time to determine whether the cutoff falls within the quarter or not. This process consumes considerable time, along with the time required to complete the audit.

Okay. All right. I appreciate your time.

We are trying to move it up.

Appreciate your time and great quarter and looking forward to the end of the year. Thanks a lot.

Thanks, Mike.

Thank you.

Thank you. Our next question is coming from Joseph Nerges with Segren Investments. Your line is live.

Good morning, everyone. Congratulations on a successful quarter and the launch of the AZT PROTECT software. In your initial press release, you referred to it as revolutionary, and in today’s announcement, you called it a potential game-changer for our product, and I completely agree. I want to suggest that anyone interested, whether current or potential investors, should check out the detailed write-up on your website. There’s a wealth of information that is difficult to communicate fully during a conference call. The depth of information you provided really enhances the understanding of this new product, so it’s worth their time to look into it.

I appreciate it, Joe.

You mentioned on your last call about the possibility of expanding the managed service providers, specifically regarding overseas opportunities. Have we made any progress on that? I am aware of the new Australian MSP contract that was recently signed. However, I assume there is significant potential in other regions, particularly Europe and the UK. Are we in discussions with any candidates in those areas?

We're talking to them, but we want to make sure they have commitment, right? It's not just now the product on their catalog. But they're going to put time and resources, not just sign a reseller application in our agreement. So the conversations are going on, but we're not going to just sign up people to be another line on their catalog. We want to make sure that they are committed to sell it.

Yes, I understand that. I agree with you. However, if they do not see the potential of the AZT PROTECT product we just launched, there should be much more serious discussions when it becomes available for them in the future.

Yes, there are quite a few in the US that we're engaging with, and things are progressing well. I'll leave it at that.

How many channel partners do we have? Approximately how many channel partners have we signed over the years?

I would probably say five or six that are specialized in selling security.

Yes. And then you're talking to more, as you just mentioned.

Yes. Yes.

Are we still anticipating any royalties on E-2D, this year or possibly next fiscal year?

It's liquid, but I'm thinking it's going to be Q1.

Okay. Okay, Q1.

Yes, Q1 of next year. It could roll into Q4, but I'm more comfortable saying Q1.

You mentioned in the press release significant interest from industry leaders. I believe you elaborated on this in your current presentation. Are we referring to leaders specific to the industries you mentioned, such as pharmaceuticals, transportation, and energy?

Yes.

We are reducing the base, and I believe some of these reductions are quite substantial. When discussing utilities, most of them tend to be quite significant.

Yes, they're all big, the ones that we've been talking to.

All right. Cool. Well, that's great. So the market there is huge.

Yes. We are currently in discussions with companies in the operational technology space, particularly in manufacturing, oil, and gas.

Sure. Just to follow up on the previous question regarding the stock buyback, I understand we are using funds for marketing efforts and securing new deals. However, considering we have a potentially revolutionary product and our stock is currently trading at less than one-times sales, it suggests that there could be an opportunity to buy back shares when possible. I know the open market can be challenging, as there are days with very low trading volume, which limits our options. Nevertheless, given our current situation and the fact that we are valued at less than one-times sales—an uncommon scenario for a technology company—it's definitely something to consider. Thank you for a great quarter, and I look forward to hearing from you again in early December. Thanks once more.

Thanks, Joe.

One other point before I leave you. I want to share a perspective and a prediction. Many years ago, a small company called Haloid Corporation released a new product, the Xerox copier. The product was so successful that soon after, they changed their company name to Xerox. I believe we have similar potential ahead of us. We might consider changing our company name to ARIA Cybersecurity if the AZT PROTECT product becomes as successful as I anticipate. So, I'm suggesting a name change for the company. Thank you all for your support.

All right. Thanks, Joe.

Thank you. Our next question is coming from Brett Davidson, who is an Investor. Your line is live.

Maybe you guys can answer for me what the new ticker is going to be?

Yes. ARIA.

Yes. It sounds like that might work. I got all kinds of different items I want to touch on. Was there any revenue this quarter from the cruise ship business?

Limited. Limited. There were some, though.

But that's still winding up?

They are currently slow to make decisions. Although they are performing well, they are focusing on different projects at this time. We are in discussions and prepared, but we are keeping the engineers occupied with other projects while this other work is progressing very slowly.

So probably not Q4, maybe sometime in the future.

No, there'll be some revenue there; it's just not at the same peak it was once. But we are still getting revenue in projects for the various cruise lines.

So it's kind of like the beginning of just accelerating back to more normal levels.

Yes, we're optimistic. We have a plan in place, and now we just need to ensure that it gets implemented effectively.

Got it. The supply chain, I know it used to take about nine months to obtain components for the ARIA hardware. What is the current situation? Can you obtain what you need in a timely manner?

For the ARIA hardware, we're looking at about six weeks. The AZT PROTECT, being all software, is available instantly. On the TS side, delivery times vary by product line and manufacturer, typically ranging from four to eight weeks. However, for some product lines with the same manufacturers, it can still take up to nine months. There are many product switches across different manufacturers, and with some major players, the process remains lengthy. Some expected delivery dates are even stretching to 2025 in certain cases.

Oh, no.

In some of the larger switches, the backlog is quite significant. However, with different models, we can receive them in about four weeks. It varies depending on the product line and manufacturers. Overall, the situation is improving; it's not worsening, which benefits us. Some of the backlog we managed to clear was nearly a year old, and we're optimistic about continuing to reduce the backlog and recording that revenue.

And the Australian distributor, now is that strictly services? Or are they also hardware?

They're strictly a security company, so they're both interested. Yes. We have opportunities both on the ADR and MDR. And we are talking to a few customers on the new release of the AZT product.

So are they directing customers to you? Or are they just reselling the ARIA?

They would be reselling it, but we're supporting it on the technical side.

Got it. The significant cash flow, so I'm assuming that's all coming back from one customer. Is that accurate?

The majority of the cash flow is from one customer, but there are likely a couple of different customers contributing to it.

So the one big customer, I mean, is there a potential to run this through again with them? Or it's kind of like a one shot, one hit?

We have been working with them for five years. Recently, we signed another deal with a different customer for a five-year contract that involves a multimillion-dollar order spread out over five years.

Got it. Are you using this as part of the sales pitch for these products, or are there requests because it's been done before or heard from other customers? How do these fees develop?

We've been engaging in this for about a decade, albeit on a smaller scale as we weren't actively pursuing it. Several of our large customers, with whom we have significant business ties, expressed interest in three or five-year pricing. However, they faced constraints with their budgets, which were allocated on an annual basis. Once we successfully completed one deal, those customers continued to request similar arrangements, and given their strong financial standing, the risk was negligible. So, we agreed to it. Recently, another customer asked us to arrange something similar, and we gladly agreed due to their reliability and capacity to meet these terms.

Is everything related to the delivery of the product now, or is any of this structured to allow for product delivery over the duration of the financing?

No, the product is provided upfront and they are utilizing it, along with the support that comes with it.

So I mean has anybody approached you to do this as an extended delivery? So we need 10 this year, 10 next year, we'll finance it through you guys and sign a long-term deal, like that? Or nothing like that?

It's project-by-project; that's how it appears. It could involve a storage product, a networking project, or a wireless initiative. The timelines depend on the projects, which typically last either three or five years. Recently, we secured an order worth a couple of million dollars, priced for three years. Additionally, the customer needs to upgrade all their equipment, so we established another agreement with them for five years this year.

But do any of them involve equipment delivered over a multiyear time frame? Or is it all upfront?

No, they get it all upfront.

And I mean, do you see a scenario where you guys could possibly pitch that to have a recurring sales stream over like three to five years or something? Or nobody wants to commit that far out, though?

No, nobody wants to commit. We do one deal, either three equal payments or five equal payments, depending on our preference for three-year deals. Five-year deals are uncommon, but it varies. That’s how we set it up. When the project is renewed, perhaps because the maintenance or equipment is becoming outdated, we aim to transition them into a new opportunity.

Got it. I just want to add one comment directed at Mike. There is a huge CPA shortage, huge accounting graduate shortage. I can't see the audit ramping up any sooner because all of those firms are operating shorthanded. So I would be shocked if somehow that process can be shortened.

Yes. And then one thing that a year-end close is way different than a quarterly close, right? The amount of work that the audit firm does is quite significant compared to our quarterly close. So that's why it takes extra time. And to Gary's point, we have to wait at least two weeks or so to make sure the cutoff is correct in the orders and the product are getting put in either the Q4 or Q1. And that takes time because we have to work with the manufacturers or the distribution, looking at the cutoff in invoice dates. So there's a lot more tedious work that goes into a year-end close to make sure that all the revenue goes into the correct quarter.

Yes, I mean, like that way, there is revenue recognition. Yes, heavy.

Got it. Yes, I understand that the rules have become so complex that it's hard to follow them regarding revenue recognition.

Exactly.

And the last thing, have there been any sales booked yet on that AZT product? Or we're still looking out like Q4?

Q4.

Got it. All right. Well, thanks so much for taking the time to answer the question. This one was pretty entertaining. Mike and Joe, thanks again, guys. You take care. As I sit here in a comfortable 73 degrees, SUNY Buffalo.

Have a good one.

Yeah, take care.

Thank you. We have a question from Joseph Nerges from Segren Investments. Your line is live.

Just to update Brett on the question about Australia, the company in question is Logitech. There's a helpful article available regarding its association with ARIA. If he searches for Logitech and ARIA Cybersecurity on Google, he should be able to find the article titled Cybersecurity for Manufacturers' Legacy OT Systems. It's a nice commentary by Gary Southwell, our General Manager, about that specific product, which anyone interested can look up.

All right. Thanks, guys.

We have a question from Will Lauber with Visionary Wealth Advisors. Your line is live.

Can you clarify what the status of Hawkeye is regarding international sales? If there are any international sales, do you receive that revenue? How does that work?

Yes, it's really slowing down. There haven't been many transactions. We're nearing the end of the program, so we expect only a few hundred thousand dollars to be available.

Okay. Because every once in a while, I see something about some other country buying some. But are the international people starting to get some of the more advanced planes now that you guys aren't getting that anymore?

That's what we believe because there are not that many orders coming through.

Can you describe the current level of interest in the new ARIA product compared to when you first started this product line a couple of years ago or even a year later?

We have spoken to many customers about the AZT, and we've hired a few new salespeople. Although we've just launched it, the feedback has been very positive. Our approach is somewhat different from what other companies are doing, and customers are eager to learn more about our methods. The demonstrations are going well, and we’ve engaged with some large clients who have already inquired about pricing after just the first meeting. We are excited about this and are actively seeking their feedback, which has been very candid. Fortunately, there hasn't been any negative feedback at this stage. Our focus is on utilizing our resources effectively and promoting our brand more vigorously than before. This product represents a segment that deserves more attention, and we believe our unique approach will make a difference. We are committed to investing time and money in making our name known. In the past month, we've also added two new salespeople to our team to concentrate on this initiative, with hopes of beginning to generate revenue and reinvest those profits for continued growth. This encapsulates our immediate strategy.

So you said these are all very large potential customers. Usually, that might imply a longer sales cycle. What is the standard sales cycle in the cybersecurity space? And how would you expect that to compare to this product?

Big companies tend to be slow to move, but this product can be implemented within their infrastructure quickly, in about 10 minutes. Therefore, the proof of concept timeline should not be lengthy. If the budget aligns, we are optimistic about closing sales rapidly. In larger companies, our strategy is to target specific divisions for product adoption rather than attempting a company-wide rollout, which could take at least a year. We aim to have a department or division adopt the product first to facilitate easier promotion as it becomes integrated into the organization. After that, we will also look to medium-sized companies, where decision-making is generally faster. I can't specify the average sales cycle for this particular product yet because it's still new. However, for our SIEM product, the sales cycle is usually around six months; it can be shorter, sometimes just two months, but the average is likely four to six months for the ADR and MDR segments.

So would it be safe to say, I mean, one of the possible good points about going with the clear customers is that the price point is probably somewhat of a drop in the bucket for them. I mean would that be safe to say or?

I would love to say that. But everybody is looking at every dollar right now. But compared to the security budget, I don't think we would cause a lot of harm if they were to adopt it throughout the organization. It's a necessary evil. And I got to believe security is going to be number one on their list to make sure that those dollars are put to securing their assembly lines, and whether it's a pharmaceutical organization or manufacturing.

Okay. All right. Well, thank you very much.

Have a good one.

Thank you. As we have no more questions in queue at this time, I will hand it back to Mr. Dellovo for any closing comments he may have.

Thank you. As always, I want to thank our shareholders for their continued interest and support. We had success in the quarter converting some of the older backlog, which, I believe, demonstrates we are committed to fulfilling our customers' orders. Our reputation within the industry is stronger today and continues to rise, and the introduction of the AZT product will only help our cause as we move forward. Gary and I look forward to sharing our progress in the fiscal 2023 fourth quarter and the full year ending September 30 operating results later this year. Until then, be well, stay safe, and enjoy the rest of the summer. Goodbye.

Bye.

Thank you. This concludes today's conference call. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation.