Earnings Call Transcript
Csp Inc /Ma/ (CSPI)
Earnings Call Transcript - CSPI Q4 2020
Operator, Operator
Good day, everyone, and welcome to the CSP Inc. Fiscal 2020 Fourth Quarter Conference Call. Please note, this call is being recorded. Now, I will turn the conference over to Mr. Michael Polyviou. Please proceed.
Operator, Operator
Thank you, Leo, and hello, everyone, and thank you for joining us to review CSPi's fiscal fourth quarter and full year ended September 30, 2020. 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 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 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 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 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, Chief Executive Officer. Victor, please go ahead.
Victor Dellovo, CEO
Thanks, Michael, and good morning, everyone. We hope you and your families have not been impacted by our ongoing COVID-19 pandemic. Despite the impact of COVID-19 on our operations and our customers' operations since March, we have remained focused on executing our key objectives to ensure CSPi is positioned for long-term success. I would like to devote most of my prepared remarks to reviewing our progress on reaching these objectives and the adjustments we have made in our new fiscal year. One objective since the pandemic hit and began impacting our ability to aggressively pursue our marketing plans has been to maintain a full workforce. We have used government programs to help achieve this objective as we consider it an essential element to CSPi maximizing its long-term marketing opportunities. We've adjusted our operations and continue to do so as the situations merit to ensure our employees are working in a safe environment. For those working remotely, we have given them the tools to continue to operate at 100% efficiency. The broader objective of transforming CSPi into a cybersecurity, wireless, and managed service company is progressing and yielding encouraging results. As we continue to expand our managed service customers in the launch of our UCaaS and ARIA offerings, we are delivering on gross margin improvements. Total revenue for the fiscal fourth quarter was $16.1 million and for the full year, we reported $62.3 million. These are not the levels that we had expected when we entered fiscal 2020, as the year-over-year declines in both periods continue to be impacted by the COVID-19 pandemic. Further, the focus on higher-margin products and services allowed us to report robust gross margin improvements of 8% and 5% in Q4 and full year, respectively. In fact, this is the fourth quarter we have reported year-over-year gross margin improvement, demonstrating our effectiveness despite the lower revenue figures. I want to emphasize that as we continue to transition this process to cybersecurity, wireless, and managed service markets, our company continues to work for even greater gross margins in 2021. The pandemic continues to expose the weakness and limitations of network infrastructures as remote worker environments are leading to increased instances of threats and ransomware. In fact, according to some published reports, spear phishing attacks reached a near sevenfold increase since the pandemic began. I believe the new and positive prospective calls we are having with our customers demonstrate the seriousness of this issue and are creating opportunities for CSPi. We are hopeful that the companies are setting aside budgets in 2021 to resolve these issues. While COVID-19 has brought some of these security issues to the forefront, the underlying weaknesses and vulnerabilities were already there, and that is why we elected to devote resources to enter this market segment. Because we have a highly experienced team, in less than 2 years, we were able to develop our offering internally. I believe the numerous industry awards and accolades validate the strength and breadth of our offering in support of our view that ARIA and unified communications as a service are positively positioned to address today's critical network issues. For the quarter, our Technology Solutions, or TS, revenue was $12.5 million, and for the full year, it was $55.9 million. We received orders from larger customers, and we expect the pace to pick up once COVID-19-related impacts lessen, so small and medium-sized customers have the budget to proceed with new purchases. As you know, this is a transactional business, and we still need to be out in front of our customers. Our managed service practice continues to expand as we sign new cloud-based customers and UCaaS customers, including in the educational area, which is seeking to enhance the system during this current climate. By continuing to address our customers' needs, especially during these challenging times, we are demonstrating our value to them daily. Bottom line, the professionalism, commitment, and dedication of our team is why we continue to grow our customer base. Separately, the cruise ship industry remains one of the industries greatly impacted by the pandemic. When we spoke last in August, the Cruise International Association had announced that its ocean-going cruise line members had voluntarily extended the suspension of cruise line operations from the U.S. ports until mid-September 2020. However, given the severity of the impact, and not surprisingly, they pushed it back to March 2021. Further, Europe is experiencing a sharp rise in cases and new measures are being imposed by several European countries. Additionally, while the travel restrictions have hampered our ability to gain access to the ships, our teams have had regularly scheduled communication with the operators. We have reassigned team members to work on other projects that require assistance, with the goal to keep them engaged and ready to proceed at a moment's notice. This preparedness on our part has proved to be pivotal during the fourth quarter, as we gained access to 2 ships at dry dock to perform upgrades. While the procedures and safety protocols were rigorous, it was worth it to ensure the well-being of our personnel. Yes, it's a small step, but also a positive signal because we're moving in the right direction, and there's light at the end of the tunnel. Remember, the cruise line operators have already purchased the equipment, so these ships are giving us a backlog that will need to be dealt with. Turning to our Microsoft practice, it continues to perform well, and we are receiving tremendous amounts of interest. So I believe the momentum will continue to generate strong results in 2021. During the quarter, we continued to gain positive traction with our UCaaS offerings. We added new customers, and we are in the process of expanding sites with our current customers. As a reminder, the UCaaS market is expected to grow from $15.8 billion in 2019 to $24.8 billion by 2024. Despite our efforts being limited because of the pandemic, we are continuing to increase the number of vital product demonstrations on a weekly basis. In fact, the new business pipeline is higher today than compared to the fiscal third quarter. Moving on to our high-performance product, or HPP department, revenue for the quarter was $1.7 million, below our internal projections as royalty revenue related to the E-2D program was pushed out. However, we expect to recognize that in the first half of fiscal 2021. We remain excited about ARIA and our award-winning next-generation cybersecurity platform that helps organizations protect themselves from harmful hidden attacks with our human intervention. We have a few installations, both in the U.S. and internationally, and we continue to be well-positioned within a leading cable company that has created other OEM opportunities for ARIA. While the current pandemic is delaying physical deployment evaluation and decisions, we believe that there are indications that their posture could change in the next few months as budgets or new projects, once frozen because of COVID-19, could be freed up as early as January. By raising our awareness at vital trade shows and throughout marketing campaigns, we have a solid lead flow. This is going to be a meaningful revenue contributor for the company. To summarize, I believe we have successfully adapted our operations since March to sustain our business and growth prospects. We have a solid base of recurring revenue and a diversified customer base, which are essential ingredients to manage through the current market. Furthermore, the interest in our products and services remains high. The pipeline continues to grow, and it is a leading indicator for future periods of exceptional performance. With that, I will now ask Gary to provide a brief overview on the fiscal fourth quarter and full-year financial results.
Gary Levine, CFO
Thanks, Victor. As Victor mentioned in his opening remarks, our fiscal fourth quarter and fiscal year revenue was $14.3 million and $61.8 million, respectively. Our results also reflect the pursuit of higher-margin businesses. We reported gross profit of $4.4 million and $17.2 million in the fourth quarter and fiscal year, respectively, resulting in gross profit margin improvements in both periods. The Q4 gross margin was 31%, improved by approximately 8%, while the fiscal year gross margin was 27.8%, improved by 5%. Our engineering and development expenses for the fiscal fourth quarter was $717,000 compared to $691,000 in the year-ago period. For the full year, this was approximately $2.8 million, which is flat with the year-ago expense level. Our SG&A expenses in Q4 was $4.2 million, approximately $400,000 decrease from the $4.6 million in last year's fiscal Q4 due to the decrease in variable compensation costs. We reported a net income of $36,000 in the fourth quarter compared to a net loss of $334,000 in the year-ago fourth quarter. The company's income tax benefit for the fourth quarter was $725,000. This tax benefit was due to a partial valuation allowance against the U.S. deferred tax assets that are more likely to be partially realized, offset by current year federal research and development credits and the benefit resulting from the carryback of the federal net operating losses. For the fiscal year, we reported a net loss of $1.1 million compared to a net loss of $371,000. The measures we implemented earlier, including the suspension of our quarterly dividend, stopping our stock buyback program, and PPP loan proceeds, have preserved our cash. We ended the fiscal year with cash and short-term investments of $19.3 million, nearly identical to our cash at the end of Q3. The pandemic has had immense impacts throughout our economy, and the effects will continue into 2021. Therefore, we will maintain a similar cash preservation posture for the foreseeable future, allowing us the resources to execute our business plan and to be positioned to benefit from the investments we made over the past couple of years and leverage our business development efforts. With that, I will turn it over to the operator to take your questions.
Operator, Operator
We'll take our first question from Joseph Nerges of Segren Investments.
Joseph Nerges, Analyst
One quick thing. You mentioned that there were no revenues from the E-2D program in the fourth quarter. Is that correct?
Gary Levine, CFO
There were some, Joe. We had some royalties in the fourth quarter.
Joseph Nerges, Analyst
Okay. And then you said you're expecting some in the first half of the year, too? Is that the first half of fiscal '21?
Gary Levine, CFO
Yes, some rolled over. What we expected was some that has rolled into the first quarter.
Joseph Nerges, Analyst
Okay. So you didn't get as much revenue as you thought in the fourth quarter. Some of it rolled into the first quarter of the next year.
Gary Levine, CFO
Right, it didn't go away. Right.
Joseph Nerges, Analyst
Okay. I assume you are aware that the Taiwanese were receiving royalties on the foreign purchases. Is that correct? That's basically...
Gary Levine, CFO
Correct.
Joseph Nerges, Analyst
Where are the revenues coming from? I see that the Taiwanese contracted for four planes in the fourth quarter of your fiscal year. That means revenue is expected to come in gradually, with one plane a year, but it will still contribute to revenue in the future.
Gary Levine, CFO
Correct. Correct.
Joseph Nerges, Analyst
You did see that or you didn't? I assume you did.
Gary Levine, CFO
Well, the problem we have is we don't see...
Joseph Nerges, Analyst
No, as far as the contract being awarded.
Gary Levine, CFO
Right. Right. Yes, we saw that.
Joseph Nerges, Analyst
I understand that you may not have all the details yet, but we acknowledge the situation. Referring back to the press release from last week, the free three-month offer available on the SolarWinds platform is exclusively for SolarWinds customers and organizations. To clarify, this offer is not extended to other customers. Is that accurate?
Victor Dellovo, CEO
Right. That was just targeted to SolarWinds right at this point.
Joseph Nerges, Analyst
Okay. I know it's really early because you just offered it last week, but have you gotten any kind of feedback or response on that offer? I mean potential people or customers?
Victor Dellovo, CEO
Not yet, Joe, not yet. Plus with the holidays and stuff, everything is...
Joseph Nerges, Analyst
Yes, I realize. It's not the best week in the world...
Victor Dellovo, CEO
Really, really slow week...
Joseph Nerges, Analyst
Best week in the world to try to get people to get back to you on. And that's a fairly large base of people, right? We're talking about 18,000 that you had mentioned in the press release, something in the range of 18,000 to 30,000 I've seen as figures on that. Sort of quite a few...
Victor Dellovo, CEO
Right. That's right.
Joseph Nerges, Analyst
Do we have a list of organizations we can reach out to regarding this? Are we aware of several that currently have that?
Victor Dellovo, CEO
We don't have that information, but we are in discussions with marketing companies to see if we can obtain a list of who uses SolarWinds, or we can start reaching out directly to ask if they currently have it. Sometimes it's just for obvious reasons.
Joseph Nerges, Analyst
Usually, it's available in a database somewhere. People send emails targeting specific customer groups. I was just curious if the 3-month offer is only for the SolarWinds platform.
Victor Dellovo, CEO
Yes. If there are opportunities for collaboration with others that are financially viable, I am open to it. Given the current challenging environment, if we need to provide some initial support for about 90 days to initiate a 3-year contract, it would be beneficial in the long run.
Joseph Nerges, Analyst
One of the noteworthy points in the press release, particularly from my perspective, was the aspect that Gary also mentioned. When discussing the ARIA platform, we frequently replace outdated security information systems and other security tools, such as the ADR platform or the ARIA platform. In some instances, customers or potential clients may not require all the tools they currently possess. By implementing ARIA, we can sometimes remove some of their older security tools.
Victor Dellovo, CEO
Well, yes, sometimes depending on what they have, we could take three different manufacturers and reduce it to one. So you have one management platform and one tool managing everything.
Joseph Nerges, Analyst
In some instances, the cost of maintaining existing legacy systems can be quite high, and we have the ability to replace some of the older components. By implementing ARIA, we could be competitive by removing some of the outdated systems.
Victor Dellovo, CEO
Correct.
Joseph Nerges, Analyst
Your return on investment with ARIA is extraordinary, and it's surprising that we aren't seeing more traction. I understand that the pandemic has made things challenging, but I believe the momentum we should be gaining is significant moving forward. I assume that more people are becoming aware of it now that it's been available for several months, at least a year, as we've been discussing it with customers.
Victor Dellovo, CEO
Yes. We're doing the trade shows. And right now, it's name recognition. We got to get our name out there and get more and more evaluations and getting more and more wins.
Joseph Nerges, Analyst
Well, you mentioned at the beginning about the platform continuing to generate enthusiasm. So I'm assuming people are interested. It's a matter of whether or not they're spending the time or have the opportunity to let us in to help with the implementation?
Victor Dellovo, CEO
Exactly.
Joseph Nerges, Analyst
Okay. We mentioned that the R&D expenditure for the year is around $2.8 million. Have you submitted the paperwork for the PPI loan to the government?
Gary Levine, CFO
The one that we received? Yes, we did, and we...
Joseph Nerges, Analyst
Yes, was it $2.1 million?
Gary Levine, CFO
$2.2 million.
Joseph Nerges, Analyst
And I'm assuming you got no response from the government as of yet.
Gary Levine, CFO
Yes, we have. We received a response just before Christmas, and it's been forgiven.
Joseph Nerges, Analyst
Okay. That might have been interesting to at least mention because I think that we don't want to have it hanging out there. But it has been forgiven. We got that information. All right, great. Okay. Well, I...
Victor Dellovo, CEO
In Q1, we'll share more information in Q1 because...
Joseph Nerges, Analyst
Okay, because it fell into Q1 the...
Victor Dellovo, CEO
Correct.
Gary Levine, CFO
Correct.
Joseph Nerges, Analyst
Great. Well, moving forward, that's a very positive thing.
Operator, Operator
We'll move next to Brett Davidson.
Brett Davidson, Analyst
I've got a couple of questions. I'm kind of split, like Joe is here, a little bit between the financials and the press release. The headline on the press release talked about record new business pipeline. I was wondering if you could just give a little color on what exactly that means?
Victor Dellovo, CEO
Well, just the amount of events we're doing. We're talking to customers and potential quotes that we put out to the various prospects. It's built a pipeline 3, 4 times from where it was a few months back.
Brett Davidson, Analyst
And is that like spread across the board? Or is it focused more in one area than another?
Victor Dellovo, CEO
No. Everything we're focused on, as I mentioned in the past, was based on recurring revenue models, whether it's UCaaS, MSP, cloud-based, or ARIA. So if you look at those 4 funnels, that's where the increase across the board kind of came from. It varies percentage-wise, but it's all favorable across those recurring revenue funnels that we try to build up. We always have the product and services behind it, which is still a big piece of the business, which in a lot of cases, we're trying to position everything. We'll sell the product, we'll put service it, we'll install it, maintain it. Then we'll try to get them as an MSP client so we can manage it for them on a monthly basis. That's kind of the model that we're looking at. And that can go across the board for UCaaS or it could go for cloud, anything with Azure or whether it's ARIA.
Brett Davidson, Analyst
And is any area represented by a larger dollar amount than other areas? Or again, it's kind of like evenly split?
Victor Dellovo, CEO
No. The cloud base and the MSP is a little heavier right at this point, just because we've been doing it a little longer. UCaaS is increasing. And ARIA, as you know, we're positioning it right now, as both, they can buy it and manage it themselves, as I mentioned in the past, or we can fully manage it for them, of course, at a cost.
Brett Davidson, Analyst
This might go to Gary for a moment. The operating lease assets and liabilities likely relate to either managed service or UCaaS. Could you provide some insight on how that is divided and what it signifies?
Gary Levine, CFO
Well, there's a new pronouncement relative to putting leases up on financials so that there are obviously certain aspects with some of the longer-term contracts that we've got as well as just the standard leasing that we have to disclose now within the financial statements, Brett.
Brett Davidson, Analyst
Got it. So it's not necessarily something new. It's just a change in reporting.
Gary Levine, CFO
Right. It's the reporting requirements under the accounting rules.
Brett Davidson, Analyst
Got it. And is that split kind of evenly between some of these different lease activities that are going on? Or is it dominated by certain areas?
Gary Levine, CFO
Some of the long-term commitments we've got on financing some of these sales, but also just through standard leasing obligations that have to be recognized within the financial statements. And that's why you've got a long-term aspect to it in there.
Brett Davidson, Analyst
Got it. Now switching back to that press release, I generated some questions from that. So what exactly does the use of the ARIA advanced detection response entail? Is that all software? Or is it a combination of software and hardware?
Victor Dellovo, CEO
Yes, that's correct. If you choose to install it without automatic fixes, it can operate solely on software. However, if you decide to add taps and integrate the appliance into the line, you can establish rules that allow it to automatically address issues based on your settings, monitoring any activity within the network or through firewalls. The next day, you would be able to review the logs. As I mentioned in the previous conference call, you can either revert any changes you don’t want or let the system proceed with the automatic fixes based on the rules you configured.
Brett Davidson, Analyst
And is that based on like a signature of the activity that's going on? Or is it more like IP-based?
Victor Dellovo, CEO
It's IP-based. It's taking it all from all the data that's coming. And so we actually sell it per IP, we license it per IP. So if someone has 600 IPs, then we would have to sell 600 licenses. Depending if it's redundant. The second aspect of it is if you want us to manage it and monitor it 24/7 or you'll do it internally.
Brett Davidson, Analyst
All right. And inside the press release, it indicated that ARIA ADR stops the activity associated with the Sunburst attack. And my first thought was, well, okay, how do you guys know that?
Victor Dellovo, CEO
That's why we have our engineers internally to test it. The engineers determine exactly how it works, but we are very confident that, based on all the data and changes, it effectively stops all ransomware and other threats.
Brett Davidson, Analyst
Has this been tested and validated, or is it just a theoretical claim that it stops all activity?
Victor Dellovo, CEO
No, it's tested in labs, and we collaborate with other companies, including some major players, alongside their firewalls. We have a significant amount of lab equipment and software that we utilize. We are an integrated partner, so we receive numerous updates from these manufacturers and conduct extensive testing. No, we’re not just making assertions.
Brett Davidson, Analyst
Got it. So this is proof of concept. You guys have actually gone out and been able to demonstrate that. So more or less, it's just the traffic related. If you're knocking these people off the network, we're getting them from using whatever it is that they're using to get in and out.
Victor Dellovo, CEO
Yes. One of the biggest things that we do is focus on east to west traffic within the network. While many concentrate on the north to south flow, which includes incoming and outgoing traffic from external sources, we analyze the internal traffic. This is crucial because if something inappropriate enters your network, it can linger for months and collect data. By examining east to west traffic, we can identify these issues, which sets us apart from many other competitors.
Brett Davidson, Analyst
And that's where the AI component comes in?
Victor Dellovo, CEO
Correct.
Brett Davidson, Analyst
So, I know Joe had asked if there is anyone taking advantage of this. Have you received any feedback about how this release has been received, or is it still too early?
Victor Dellovo, CEO
Still too early.
Operator, Operator
We'll move next to James Stewart.
Unknown Shareholder, Shareholder
My question is directed towards Victor. First, I want to congratulate you on the excellent execution in advancing new products and achieving remarkably high margins. Our investment firm has a screener for all U.S. companies, and CSPi has consistently ranked among the top 10 for being undervalued. I understand you are working in a key area with your proven and award-winning ARIA products. It's clear that the cybersecurity firms you collaborate with are noticing your high margins and effective products. Are there any discussions regarding joint ventures or potential acquisitions? Acquiring CSPi would clearly benefit any company that pursues it. Could you share any thoughts on these possibilities for the future?
Victor Dellovo, CEO
Well, everything is always on the table, right? Whether if someone comes to us to purchase us or if there are other things that I could see there would be accretive immediately. We talk to other companies constantly. If something happened to make sense, we would bring it to potential shareholders to vote on or whatever would be needed. But right now, we're just focused on building the products, trying to generate sales and go from there. But everything is on the table, both ways.
Unknown Shareholder, Shareholder
Well, again, I congratulate you. I think you've done both your entire team has done a phenomenal job.
Victor Dellovo, CEO
Thank you very much. Appreciate it.
Gary Levine, CFO
Thanks, James.
Operator, Operator
We'll move next to Jonathan Hoenig.
Unknown Shareholder, Shareholder
Congratulations on these encouraging results. I'm a long-time holder of the stock and I'm curious about the strong transformation. CSPi has historically outperformed many small-cap indices, including the MicroCap index. Now that the Russell is at all-time highs and the MicroCap index has rebounded, I'm wondering why the stock, despite this strong fundamental transformation, has been underperforming recently.
Gary Levine, CFO
Well, that's kind of a difficult thing. There's such low volume in it. I think what we're really trying to do is more to get out there to get CSPi known. I think once we start getting more success with the High-Performance group as well as the TS new product, the story will start to resonate more. Obviously, we've got strong margins and are pursuing those things, and I think we'll do more of investor relations once the story starts to germinate. Do you have any further comments, Victor?
Victor Dellovo, CEO
No, you summed it up. I believe it's about the value, too, as there are many aspects of CSPi that we have been working on for years that are now showing great profits. You will see it in the margins. One issue from years past was that the margins were always very low. In the TS group, we have addressed that with a recurring revenue model. We have products and services that are interconnected, and the messaging is now unified on both sides, incorporating the security products as well. The ARIA piece has not been around long, and the pandemic somewhat slowed our progress more than we would have liked, but I believe the messaging and strategy all make sense. It's unified and interconnected. With that being said, go ahead.
Unknown Shareholder, Shareholder
I just want to add a quick follow-up before my time runs out. It’s encouraging to hear, Victor, that you believe the stock is undervalued. From a market standpoint, any regular and frequent insider purchases, no matter how small, whether it's 1,000 shares or 2,000 shares, truly sends a strong message to the market that you are optimistic about the future. I’ll turn it over now, and thank you again.
Operator, Operator
And we have time for 2 more questions. We'll take that first question from Douglas Johnson.
Unknown Shareholder, Shareholder
Question on the balance sheet, the notes payable of $2.5 million, is that all PPP?
Gary Levine, CFO
Yes.
Operator, Operator
And we'll take our final question from Terry.
Unknown Shareholder, Shareholder
I was kind of curious on the ARIA software. What do you believe the total addressable market size potential for that particular product would be? I think, in 2020, global cybersecurity was estimated to be about $167 billion spend. What do you think the ARIA market is?
Victor Dellovo, CEO
It's in the billions. I would estimate that $20 billion to $30 billion could be relevant, as we have access to many different segments of that overall market. So, conservatively, $20 billion to $30 billion.
Operator, Operator
And that concludes our question-and-answer session. I'd be happy to return the call over to Mr. Victor Dellovo for any concluding remarks.
Victor Dellovo, CEO
Thank you. As always, I want to thank our shareholders for your continued interest and support. We are excited about our long-term growth prospects, and I believe the foundational progress we made this year will drive our revenue and profitability in the coming years. Gary and I look forward to sharing our fiscal first quarter results in February. Until then, stay safe and happy new year.
Operator, Operator
Thank you. This does conclude the CSP Inc. Q4 2020 Earnings Conference Call. You may now disconnect your lines, and everyone, have a good day.