Earnings Call
Csp Inc /Ma/ (CSPI)
Earnings Call Transcript - CSPI Q2 2021
Operator, Operator
Good day, everyone, and welcome to today's CSPi Fiscal Second Quarter 2021 Operating and Financial Results Conference Call. Please note, this call may be recorded. It is now my pleasure to turn today's program over to Michael Polyviou. Please go ahead.
Operator, Operator
Thank you, everyone, and thank you for joining us to review CSPi's Fiscal Second Quarter ended March 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 will then open the call for questions. Statements made by CSPi's management on today's call regarding the company's business that are not historical facts may be forward-looking statements as the term is identified in federal securities laws. The words may, will, expect, believe, anticipate, project, plan, intend, estimate and continue as well as similar expressions are intended to identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results. The company cautions you that these statements reflect current expectations about the company's future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond the company's control that may influence the accuracy of the statements and the 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 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 the call over to Victor Dellovo, Chief Executive Officer. Victor, please go ahead.
Victor Dellovo, CEO
Thanks, Michael, and good morning, everyone. Our second quarter performance again highlights the type of success we can achieve even during unprecedented business climates. In addition to maintaining our business and migrating to a higher-margin product and services, we have also had the wherewithal to develop innovative solutions from the ground up to meet today's growing security concerns. This is becoming CSPi's trademark. We continue to advance the primary objective of transforming CSPi into a cybersecurity, wireless, and managed service company, and I believe the positioning will enable us to execute our long-term operating strategies. For example, our team has remained engaged with customers in the new business prospects and this continuous touch strategy during the pandemic. With a sizable customer base in Florida, I would expect CSPi to emerge from pandemic disruption quicker than most competitors as the state returns to a more normal business climate. Total revenue for the fiscal second quarter was $14.1 million. I am pleased with the overall performance as we experienced some positive indications such as new accounts, new product lines within some existing customers, and a growing pipeline of new opportunities. I continue to believe we will emerge from the pandemic in a more formidable company with an expanding complement of offerings to grow the top line. And consistent with previous quarters, the revenue mix, in pursuit of higher-margin offerings, allowed us to report our sixth consecutive quarter of year-over-year gross margin improvement with a 4% increase over fiscal Q2 2020. Now let me review a hallmark of CSPi. If you recall, this past December, up to 18,000 organizations were likely exposed by Sunburst, enabling cyber attacks, a new major attack as early as a few weeks ago. And the bad actors actively use the network to access many of the vulnerable systems as possible while using techniques to try to hide their actions. Our ability to quickly identify the attacker's action and stop them provides a unique solution for this emerging cybersecurity threat and demonstrates our capacity to adopt the overarching commitment to develop compelling solutions to meet modern-day threats. We achieved this with ARIA Advanced Detection and Response, or ADR, an out-of-the-box solution that requires no special configuration and is purpose-built to automatically find and stop all forms of attacks, including advanced persistent threats. The ARIA ADS solution was designed to detect such attacks as well as ransomware and malware, which are consistent threats to our organizations. In March, ARIA ADR received a Cybersecurity Excellence Award, an outstanding achievement for our recently released solution because it automatically finds and stops network-borne threats as soon as they become active in the network and, most importantly, before harm occurs. The single-platform solution provides an automated AI-driven Security Operations Center or SOC that offers organizations the benefits of a traditional SOC at a fraction of the cost. Unlike other solutions, ARIA ADR provides full threat service coverage for on-prem infrastructure, data centers, remote devices, and cloud environments. It could be operated anywhere by IT resources with little or no cybersecurity training. Since its introduction, we have already received purchase orders from several customers. And the win for us is that these orders are not only for ADR, they are also for total MSSP Solutions, where we will monitor all their security needs, but also their IT infrastructure, including firewalls, switches, and routers. With the expanding pipeline, I look forward to sharing the progress with you over the next few quarters. For the quarter, our Technology Solution or TS division revenue was $13.2 million. The TS division hit on all cylinders and was truly a strong quarter, exceeding our internal projections as revenue contribution came from our managed service, UCaaS, in selling third-party products and services, which is highly profitable and reflected in the quarterly gross margin. While budget-related delays due to COVID remain a fact, we have not shifted our strategy, and I believe the performance of the TS division demonstrates a laser-like focus. We are staying close to the customer, often meeting them informally in accordance with social distancing guidelines to remain top of mind when decisions are made. This is already bearing fruit, and I'm confident it will lead to new orders as we slowly emerge from the pandemic. Our managed service practice is performing well and continues to grow as we sign new cloud-based and UCaaS customers. Latin America, which I referred to in the Q1 conference call, is a bright spot right now as customers are adding bandwidth to a dozen of their locations throughout their region. Now let me share some thoughts on the cruise ship industry, which remains a vital market for CSPi. We have recently awarded a ship and expect to have a team in place this quarter. Further, another three ships are budgeted for retrofit by their own, and we believe the implementation can occur in the fiscal 2021 second half. This, along with operators planning to resume cruise in July, is perhaps the clearest sign yet that we are seeing the light at the end of the tunnel. We are also monitoring other developments such as the state of Florida filing suit against the Center for Disease Control and Prevention, or the CDC, to allow cruises to commence immediately. We also continue to expand our UCaaS presence during the quarter as we added several U.S.-based customers. I believe the virtual product demonstrations have helped tremendously, both from an educational and practical perspective. So I believe we will begin to leverage the pipeline and begin converting these into revenue. Remember, this is a multibillion-dollar market opportunity, and we only need to carve out a tiny sliver for it to be quite meaningful to CSPi. Now moving to our high-performance products, or HPP division. Revenue for the quarter was $0.9 million, below internal expectations. A couple of factors are responsible. Myricom sales are historically slowed during the fiscal second quarter, and we did not receive royalty revenue related to the E-2D program, but we believe the E-2D revenue will come in the second half of the year as scheduled. Nevertheless, we remain excited about the long-term potential of the business, especially as ARIA gains customer traction. As I mentioned earlier, we closed a few ARIA deals in the fiscal second quarter. However, because these occurred later in the quarter, we expect the recurring monthly revenue to initiate during the current quarter. In addition to ARIA ADR award recognition I mentioned earlier, ARIA Packet Intelligence also received a Cybersecurity Excellence Award. The ARIA PI application enables complete visibility into organizations' networks, including typical unmonitored lateral traffic patterns. It watches all communications and generates analytics for every packet. Security operation centers using security tools, such as a SIM or the ARIA ADR solution, leverage this enriched data to detect and stop network-borne threats. So as we wait for movement within a leading cable company, the added OEM opportunities we've created for ARIA and the industry accolades embolden us that even though we are competing against much larger organizations, because our solutions were selected due to the innovative approach to find and stop cyber attacks, including ransomware, malware, and zero-day attacks. We currently have over a dozen channel program partners, and we are speaking with several others to ensure a robust channel program, which increases our chances for success. To summarize, our approach since day one of the pandemic was to maintain contact with the customer. I believe the multiple touch points have and will continue to create an atmosphere that will allow us to emerge from the pandemic's disruption quicker than most competitors. Our performance highlights, especially over these past six quarters include our continued gross margin expansion and reinforcing our strategies to transition to a cybersecurity, wireless, and managed service company. The entire CSPi team has done a superb job to get us through the storm, and buoyed by a solid balance sheet, we continue to have the resources to execute our operating strategies and benefit greatly as customers seek to upgrade their critical infrastructure needs. With that, I will now ask Gary to provide a brief overview of the fiscal second quarter financial performance.
Gary Levine, CFO
Thanks, Victor. Our fiscal second quarter revenue was $14.1 million. The year-over-year decline is mainly due to COVID-19, but we saw a 24% increase compared to the first quarter of fiscal 2021, demonstrating our ability to navigate the pandemic's impact. We reported a gross profit margin of $4.4 million, or 31% of sales, compared to $4.5 million, or 27% of sales in the same quarter last year, showing a 4% improvement in product gross margin percentage along with a mix of higher-margin services. Our engineering and development expenses for the second quarter were $762,000, up from $716,000 a year ago, primarily due to an increase in headcount that was offset by reduced consulting services. Our selling, general, and administrative expenses in Q2 were $3.7 million, down from $3.9 million in last year's second quarter due to lower payroll, benefits, travel, and stock compensation costs. The income tax expense of $723,000 was mainly due to an increase in valuation allowance for our deferred tax asset, offset by a tax law change that allows immediate deductions for expenses related to the PPP loan. We reported a net loss of $847,000 for the second quarter, or $0.20 per share, compared to a net loss of $732,000, or $0.18 per share, in the same quarter last year. If we exclude the income tax expense and the negative impact of currency exchange, we would have recorded a slight income of $30,000 for the quarter. We ended Q2 with cash and cash equivalents of $20.4 million as of March 31, 2021, an increase of $500,000 from December 31, 2020. The measures we implemented during fiscal 2020, including suspending our quarterly dividend and halting our stock buyback program along with the PPP loan proceeds, helped us preserve our cash and maintain a strong balance sheet over the past year. We plan to continue similar cash preservation practices until the economy and businesses return to normal operations. Prior to the pandemic, we made significant investments in our business, such as developing the UCaaS and ARIA offerings, and our goal is to monetize them. Having the resources to commercialize these offerings is essential for executing our business plan.
Operator, Operator
And we will take our first question from Joseph Nerges.
Joseph Nerges, Analyst
By the way, great report. Finally, we seem to be moving forward with ARIA, and this has been a long time coming, but that makes me very happy about this, the long-term nature of these possibilities we have. Maybe a couple of quick questions off your press release. You mentioned that quite a few purchase orders have come in, I guess, on the ARIA product line in the last 30 days. So that was subsequent to the end of the quarter. So most or all of that revenue would be going forward. Is that correct? We're talking third and fourth quarter revenue.
Victor Dellovo, CEO
Actually, it's recognized on a monthly basis because there are three-year deals. We account for it over 36 months since they are managed services. So not only are we selling products, but we are also providing managed services, and that's structured on a monthly basis.
Joseph Nerges, Analyst
So we're talking about purchase orders in the Technology Solutions division in that department, not in high-performance products?
Victor Dellovo, CEO
No, it's a combination of both, Joe. We sold ARIA with the aim of enhancing our recurring revenue business, particularly within the MSP. We integrated the two divisions so that when ARIA is sold, it's as part of a managed service. This means we're not just providing the product, but also the maintenance and support, linking it to the managed service. While this won't always be the case, in our recent deals, we sold it as a complete managed service for both HPP and TSI. Thus, some revenue will be generated from both divisions.
Joseph Nerges, Analyst
All right. Well, it has been offering areas of managed service and Technology Solutions division. So that's what you're saying that through that division, you're getting the area sold as well as the managed services attached.
Victor Dellovo, CEO
Correct.
Joseph Nerges, Analyst
Okay. On the next question, on the two large or leading manufacturing organizations, are we talking Fortune 500 type companies here? Or are we talking to somebody very large?
Victor Dellovo, CEO
No, not that large, not Fortune 500. But they are connected with large organizations as subcontractors. I can't mention who they are.
Joseph Nerges, Analyst
No, I understand that. I'm just trying to understand, are we talking about ARIA here? Or are we talking about managed services here or a combination of both?
Victor Dellovo, CEO
Both, Joe. Both.
Joseph Nerges, Analyst
Okay.
Victor Dellovo, CEO
In a perfect world, Joe, there will never be an ARIA sale without our managed services in a perfect world.
Joseph Nerges, Analyst
But the managed services would be coming out of Florida, not out of Massachusetts?
Victor Dellovo, CEO
Correct.
Gary Levine, CFO
Correct. Yes.
Joseph Nerges, Analyst
What type of...
Victor Dellovo, CEO
But we will be selling the product out of Boston, and the support and maintenance out of Boston. But the support will come out of Florida manage service piece of it, yes.
Joseph Nerges, Analyst
What are we discussing? You mentioned multiple facilities. What is the expected timeline for implementation? Will it be relatively quick, or is this going to take the next couple of months, six months, or an extended period for these large projects?
Victor Dellovo, CEO
No. It could be as fast as the customer allows us to get into their setup.
Joseph Nerges, Analyst
Okay. A couple of quick things. So you mentioned about the two awards that you got for the Gold awards you got for both the ADR and the Pack Intelligence in the quarter. Who votes on these awards? Because they're both gold awards. How large a voting group was involved with that? Do we know?
Victor Dellovo, CEO
No, I don't know exactly.
Joseph Nerges, Analyst
Okay. No problem there. But this is more than once now that we've been recognized for both ADR and the Pack Intelligence operations.
Victor Dellovo, CEO
Yes. Every year, you have to apply for the awards. There are industry experts who vote on them.
Joseph Nerges, Analyst
Okay. And another one, which I consider a major announcement this quarter, and that is the NVIDIA release of their Morpheus platform in April, which supposedly expands various capabilities in identifying cybersecurity attacks. Am I correct in that?
Victor Dellovo, CEO
Yes. We partner with NVIDIA because they make some of the boards we use when we port over our software, and we work hand in hand. And the nice part about that announcement is if you look at the CA, they had an NVIDIA conference or asset, I think, just about a week, and they mentioned some of the security partners they work closely with. The CEO announced there were a few other major brands that are out there in the security space, but they mentioned CSPi, ARIA as one of their key partners of integrating their platform with ours.
Joseph Nerges, Analyst
Well, beyond that, not only did they mention us, they provided a link area on their press release, their press release. They didn't provide a link to anybody else except us, which at least, from my standpoint, says that the narrative that we've been trying to say for the next couple of years is a narrative that they're buying into wholeheartedly with this platform.
Victor Dellovo, CEO
Yes, absolutely. We're collaborating with several cable companies that we've mentioned before, as well as some other 5G providers on the OEM side. It can take a long time to integrate with these large organizations, but once that happens, it presents a long-term opportunity. We're very pleased with the progress we are making with NVIDIA, one of the major players in the industry.
Joseph Nerges, Analyst
One last point I want to highlight is that CSPi is relatively unknown in the cybersecurity industry among many major players. Therefore, the fact that NVIDIA would link to your website should help clarify who you are. I'm viewing this as very positive since it connects a large company to CSPi's ARIA platform.
Victor Dellovo, CEO
Yes. I agree with you, Joe.
Operator, Operator
And we will take our next question from Brett Davidson.
Brett Davidson, Analyst
Well, I'm glad to be here this morning. I have a couple of questions for you. I was looking at the press release from yesterday regarding the HP ProLiant servers, and I'm not entirely sure what that means. Let me run this past you. If I were to go on the HPE site and look to order a ProLiant server, would there be a drop-down offering ARIA equipment? Am I on the right track?
Victor Dellovo, CEO
No.
Brett Davidson, Analyst
Okay.
Victor Dellovo, CEO
Yes. So what we've done is we're working with their OEM team to help integrate the ARIA technology. So when we're selling an appliance, we were using Supermicro, and also, now we're using the HP platform. That's a possibility because some of the major brand companies, they don't want to use a third-party OEM like maybe a Supermicro. So we teamed up with HP. They will be promoting our product along with it to some of the OEMs, but it's more that we were able to get them to work with us on the design and the pricing model that makes it attractive for us. So when we do sell it, it will be profitable for CSPi.
Brett Davidson, Analyst
So is this kind of like a seal of approval that says that your stuff works with the HP equipment? Or...
Victor Dellovo, CEO
Correct.
Brett Davidson, Analyst
Okay. Got it.
Victor Dellovo, CEO
Yes, yes. And the next step potentially could be what you're saying, but we're not at that point yet. We're at step one of the relationship.
Brett Davidson, Analyst
Got it. Regarding those purchase orders, can you provide more details? I understand from Joe about the three-year agreements and their scale. Are we discussing amounts in the tens of thousands of dollars, six figures, or something else?
Victor Dellovo, CEO
With the German contract, they're hundreds of thousands.
Brett Davidson, Analyst
That's exactly the type of information I was looking for, so that works well. I have a question for Gary regarding the significant increase in long-term receivables and a similar rise in noncurrent liabilities. Could you clarify what that represents?
Gary Levine, CFO
Yes. We've made some long-term purchases with one of our customers, which we've been doing for years. These include three- and five-year agreements, and we are currently reflecting that on the balance sheet.
Brett Davidson, Analyst
And that's equipment software installed, that type of deal?
Gary Levine, CFO
Yes. So those kind of items, right.
Brett Davidson, Analyst
Yes. And that also is the noncurrent liability?
Gary Levine, CFO
Right.
Brett Davidson, Analyst
Understood. I see both aspects now. I believe I've covered everything. So, I don't expect this to result in a significant change. We won't suddenly see an additional $5 million in revenue on the income statement. This will be incremental, as ideally, we would capture both the hardware and management components, right?
Victor Dellovo, CEO
Correct. That's correct. Yes, we're trying to build our recurring revenue model, as I've been saying. And it's taken a few years with the MSP to build up a decent-sized percentage of the overall revenue. And we're hoping, if we could stay on the same track that we did with the MSP in UCaaS, it would be in another 12 to 18 months that will be significant revenue that you can count on quarter-over-quarter for years to come.
Brett Davidson, Analyst
Yes. And it's not as sexy as a big $5 million increase in revenues, but it sure probably has a lot more value to it. So I'm all...
Victor Dellovo, CEO
The multiple on recurring revenue is certainly more valuable than the one-time hits. Recurring revenue typically garners a factor of 10 to 15 times on the top line.
Gary Levine, CFO
When it gets to be a significant portion of it, we will.
Operator, Operator
And there are no further questions at this time. I will now turn the program back over to Victor Dellovo.
Victor Dellovo, CEO
Thank you. As always, I want to thank our shareholders for the continued interest and support. We have maintained our focus throughout the current climate. We have the resources and product and service portfolio to grow the business. Gary and I look forward to sharing our progress in the fiscal third quarter operating results in August. Until then, stay safe.
Gary Levine, CFO
Yes. Thank you.
Operator, Operator
This does conclude today's program. Thank you for your participation. You may disconnect at any time.