Earnings Call Transcript - CSPI Q1 2022

Operator, Operator

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

Michael Polyviou, Host

Thank you, Aaron. Hello, everyone, and thank you for joining us to review CSPI's first fiscal 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 defined 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 and 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 statements are based.

Victor Dellovo, CEO

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 various issues. Some of the key factors continue to be the impact of the 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, with our backlog increasing to $15 million. Under normal conditions, we would have had a significant profit for the quarter. We also had to give our employees raises to keep turnover at a minimum. The job market is one of the hottest in the U.S., which means many options for our employees. We also incurred recruiting fees amounting to $80,000 for the quarter. Given the tight labor market, we employed multiple recruiting firms to help fill open positions and new positions due to growth in the MSP division. Despite these challenges, we generated growth during the quarter and built our backlog. Our performance in the first quarter was a result of our ongoing high engagement with our customers and suppliers to proactively resolve and overcome issues. Our team is proud to say that we have not lost a single order in the backlog. Additionally, being more nimble than our larger peers, we shifted gears to refocus our resources on the services side of the business, which has not been nearly as impacted by our supply chain issues, and we captured meaningful revenue opportunities during this uncertain period. Our primary goal of migrating to higher-margin products and services continues to be achieved, as evidenced by our solid gross margins of 29.1%, similar to the year-ago fiscal first quarter, despite heading into a period with tougher year-over-year comparisons and inflationary pressures on our costs. At this stage, we believe we can make further progress with our overall gross margin 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 as this business faces challenges in retaining or attracting internal talent. I don't expect this dynamic to change much in the coming years, so we will continue to allocate the necessary resources to capture our share of this market and grow our portfolio of service contract customers. Moving to the cruise line business, our team is currently deployed and progressing on four ships, as mentioned in the Q4 call. While the Omicron variant has dampened operators' optimism regarding the timing of additional retrofits, there is another set of ships that could be awarded later this quarter or early Q3. This business presents an attractive opportunity for CSPI, and we remain focused on winning additional business as our fiscal year progresses. Regarding UCaaS, we added several new customers during the quarter, and I'm pleased with our progress. We continue to face obstacles that hinder our ability to maximize the revenue potential of this offering, including name recognition and a smaller sales force compared to our larger peers. Concerning 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 expected royalty revenue was recorded in Q1, with the remaining balance now anticipated to be recorded in the second half of fiscal 2022. While ARIA remains the primary growth driver for this business segment, we announced in December the availability of the Myricom ARC-C TxO network interface adapted, designed to act as a secure, unidirectional network bridge. This product has 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 do not anticipate this product to significantly change the upper trajectory of the Myricom business, it demonstrates our ability to respond to increased demand from our OEM and large customers for a one-way data path. Regarding ARIA, the emergence of Omicron and the timing of the holidays slowed down the momentum we had earlier in the quarter. However, we managed to close a few MDR customers, with revenue contributions commencing in the current fiscal Q2. As of today, we continue to grow our ADR customers, generating recurring monthly revenue, and the team is diligently working to sign new contracts. The orders in the backlog, along with the deals we are pursuing, are sizable, which will dramatically transform the revenue landscape for the HPP business. Although the timing to finalize these opportunities is unpredictable, we have increased our backlog, showcasing high interest in our products and services, influenced by supply chain issues that have limited our sales growth. We continue to implement and execute initiatives aimed at improving near-term performance, such as focusing on the service business while enhancing our long-term prospects as we progress with UCaaS and ARIA, though at a slower pace than we desire. Gary and his financial team have excelled over the past two years, and the prudent expense management they have implemented allowed us to maintain our resources to execute a multiyear growth strategy to transition to a cybersecurity, wireless, and managed service company. With that, I will now ask Gary to provide a brief overview of our fiscal first quarter financial performance. Gary?

Gary Levine, CFO

Thanks, Victor. As Victor mentioned in his opening remarks, our first fiscal quarter revenue was $12.4 million, representing a 9% increase year-over-year and a 24% increase compared to Q4 fiscal 2021. We reported a 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, due to pandemic-related conditions, we managed to record a disproportionate level of higher-margin service revenue. We previously stated that our near- and short-term goal is to maintain an annual gross margin in the mid- to high-20s, which we 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 costs. Our SG&A expenses in Q1 were $3.4 million, a slight increase due to higher payroll and commissions in the TS segment compared to 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 a 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 debt forgiveness from 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 this gain, the company would have reported a net loss of $1.1 million or $0.26 loss per diluted share for the first fiscal quarter of 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 September 30, 2021. In late December 2021, we reactivated the stock repurchase program with 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 is common practice, we will provide updates on a quarterly basis as this program is executed. We will continue to exercise expense management to ensure we have the resources to support our multiyear growth as we transition to a cybersecurity, wireless, and managed service company. With that, I will turn it over to the operator to take your questions.

Operator, Operator

And we can take our first question from Scott Caldwell, a private investor.

Scott Caldwell, 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?

Gary Levine, CFO

I don't have the exact figures available at the moment, but in the past, it has been around $1.8 million to $2 million each year.

Scott Caldwell, Private Investor

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

Victor Dellovo, CEO

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.

Scott Caldwell, Private Investor

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.

Victor Dellovo, CEO

Yes, I understand that. Yes.

Scott Caldwell, Private Investor

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

Operator, Operator

We can take our next question from Mike Price, who is a private investor.

Mike Price, Private Investor

I 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?

Victor Dellovo, CEO

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

Mike Price, Private Investor

Obviously, the stock is very illiquid. 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.

Victor Dellovo, CEO

Well, our intent is not to support the management team buying shares while actively selling them. That’s for sure.

Operator, Operator

We'll go next to Joseph Nerges with Segren Investments.

Joseph Nerges, Investor

I felt like my questions weren't being addressed here. I wasn't sure if the star 1 feature was functioning on my phone. A couple of quick points. In your press release, you mentioned an increase in managed services during the quarter at a rapid pace, likely due to a talent drain at many smaller companies. I'm presuming this means that a lot of smaller companies are struggling to attract the talent necessary to even oversee security or are outsourcing most of their IT functions instead of relying on traditional in-house staff. Is that correct?

Gary Levine, CFO

It's partially there, but they can attract employees at times, but they're not staying long enough. Then you have a training process of several months, and then before you know it, they're leaving for a higher salary or bonus structure, and then they have to start from ground zero again. That's been one of the driving factors. 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 one or two.

Joseph Nerges, Investor

So outsourcing becomes an option that a lot of times they may not have considered in the past and are considering today. That's sort of plausible.

Victor Dellovo, CEO

Correct.

Joseph Nerges, Investor

On the 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 referring specifically to UCaaS, here?

Victor Dellovo, CEO

No. No. Overall. Overall. Yes.

Joseph Nerges, Investor

If you could have supplied enough. I assume a lot of people understand that in the last conference call, you mentioned that while you can sign up a UCaaS customer, if you can't deliver the telephones or some of the hardware required, you obviously can't proceed.

Victor Dellovo, CEO

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, it doesn't go anywhere, along with the services that go with it for installation.

Joseph Nerges, Investor

Let me rephrase my question. If this were three years ago and there were no supply chain issues, I assume we were operating normally. You're saying we would have to be considerably profitable on a normal schedule. Let's address two issues: one, the supply chain, and the other, the virus. Without those two factors, we would have been profitable due to normal delivery schedules.

Victor Dellovo, CEO

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

Joseph Nerges, Investor

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

Victor Dellovo, CEO

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

Joseph Nerges, Investor

Did we have some E2D royalty in the first quarter? Or are you expecting more later in the year?

Gary Levine, CFO

Yes, probably in the third and fourth quarters.

Joseph Nerges, Investor

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

Gary Levine, CFO

Yes.

Joseph Nerges, Investor

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

Victor Dellovo, CEO

No. The beta phase is complete. We have actually sold the product.

Joseph Nerges, Investor

Okay. Yes. In that press release, you mentioned potential use by original equipment manufacturers for this product. Have you implemented any of that, or is it being tested by them to determine whether they want to incorporate it?

Victor Dellovo, CEO

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

Joseph Nerges, Investor

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

Victor Dellovo, CEO

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

Joseph Nerges, Investor

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

Victor Dellovo, CEO

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

Joseph Nerges, Investor

Okay. Are these OEMs significant customers? Based on the backlog, I assume we're discussing some substantial companies.

Victor Dellovo, CEO

Yes, absolutely, absolutely. So I don't know exactly what the rollout is. They're a little hesitant to provide a rollout schedule considering we're unsure of the delivery. However, we're hopeful that this continues not only with the opening orders but into the future.

Joseph Nerges, Investor

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

Victor Dellovo, CEO

We have budgeted to place the orders this year, and it's up in the air whether they'll hit this year or next year. It's out of our control. We’re in constant communication with them, working to push forward. However, among all the other priorities, I’m not sure where we stand in terms of urgency.

Joseph Nerges, Investor

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.

Victor Dellovo, CEO

Definitely.

Operator, Operator

We have another question from Brett Davidson, a private investor.

Brett Davidson, Private Investor

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

Gary Levine, CFO

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

Victor Dellovo, CEO

No, go ahead, Gary.

Gary Levine, CFO

That's all I wanted to clarify in terms of the receivable. There are those aspects that could skew the figures.

Brett Davidson, Private Investor

Got it. On the ship business, could you provide more detail about how that whole process works? So you guys land a contract. 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?

Gary Levine, CFO

There are different contracts for different projects. One could be where we go on four or five ships worldwide, and we conduct a site map of where all the new access points need to go. That's Phase 1. Then in Phase 2, we get the order and deliver the access points. They have their own teams to place them where they are needed. Usually, while the ship is sailing, our team will configure them and ensure complete coverage across the ship, considering any interference from the metal walls. Then they return to write up everything and provide a complete description of configurations and paperwork involved. It occurs in different stages and doesn’t happen all the time. There’s also retrofitting when ships are docked. We conduct a site map and everything needs to be done within 2 weeks, requiring the crew to work 18 hours a day for two weeks straight. It varies based on the customer and their needs.

Brett Davidson, Private Investor

So these contracts are multi-hundred thousand dollar jobs?

Gary Levine, CFO

No, hundreds of thousands.

Brett Davidson, Private Investor

Got it. From a billing standpoint, are each phase billed separately? Or do we wait until the end to bill everything?

Gary Levine, CFO

We've structured it to bill at different phases instead of waiting until the end, since there can be months between phases. This way, we can receive payment as we proceed.

Brett Davidson, Private Investor

Got it. I want to switch gears to the E-2D program. Are we still bringing in any revenue for spares for the American planes, or are we limited to the foreign content now?

Victor Dellovo, CEO

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

Brett Davidson, Private Investor

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

Gary Levine, CFO

Yes.

Operator, Operator

There are no additional questions at this time. I would like to turn the program over to Victor Dellovo for any additional remarks.

Victor Dellovo, CEO

Thank you. As always, I want to thank our shareholders for their continued interest and support. These remain challenging times. However, we are executing our plan to deliver near-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.

Operator, Operator

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