Earnings Call Transcript - CSPI Q2 2024

Operator, Operator

Good morning, everyone, and welcome to CSPi's Second Quarter Fiscal Year 2024 Conference Call. Please note, this conference is being recorded. I will now turn the conference over to your host, Michael Polyviou. You may begin.

Michael Polyviou, Host

Thank you, Jenny. Hello, everyone, and thank you for joining us to review CSPi's fiscal 2024, second quarter results, which ended March 31, 2024. With me on the call 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 the 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 those statements and the projections upon which the 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 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. Earlier this morning, we announced our fiscal 2024, second quarter results, which once again demonstrate the return we are generating from our strategic shift towards high-margin products and services. While we continue to invest in broadening the launch of AZT PROTECT, we grew services revenue 23%, increased our gross margins to 47% and realized a fivefold increase in net income compared to a year ago's fiscal second quarter. Our progress during the first half of the year, combined with the building of the pipeline for AZT, positions us for future success. I'll start my review of operations with our high-performance product or HPP, which is benefiting from the growing market interest in the AZT offering. During the quarter, HPP contributed $2.5 million total revenue compared to $1.5 million in the year-ago quarter. The AZT offering is changing how we operate and how the industry perceives CSPi. We have generated significant attention and interest at industry events and conferences, and this interest comes from some of the largest global corporations. Despite only being months into the AZT launch, we are building traction in the market, and the level of customer enthusiasm remains high, as does the new business lead pipeline. During the quarter, we signed our largest contract for AZT, a multimillion-dollar agreement with a global pharmaceutical company, which is deploying AZT across its global manufacturing platform and is in the process of protecting over 40 facilities from the growing cybersecurity threat to operational technology from hostile nations, terrorism, and organized crime. Early this week, a case history of AZT PROTECT was published in an award-winning journal for Rockwell Automation. We can't begin to tell you how critical and important this is to reach a subscriber base of over 50,000, a targeted audience that is committed to keeping up-to-date with leading-edge methods, trends, and technologies that protect the Industrial Automation segment from cybersecurity attacks. Our partnership with Rockwell is expanding; tomorrow, we are co-hosting a webinar titled CyberRx, how to automatically protect Rockwell OT customers from today's cyber-attacks. Gary Southwell, General Manager of CSPi, ARIA Cybersecurity, will be joining Thomas House, Life Science, Cyber and Digital Consulting at Rockwell Automation. They will be discussing why the Purdue model, passive defense, and AV/NgAV are not stopping the most dangerous attacks. The webinar enables Rockwell to discuss the unique set of requirements that are needed to protect an organization's production applications, attack surface, and how ARIA AZT PROTECT plays a unique and critical role in meeting this need. Gary and Thomas will delve into the composition of supply chain attacks and you'll finally hear about a case study of how one of the world's largest pharmaceutical manufacturers uses ARIA AZT PROTECT in combination with Rockwell's industrial automation suite to protect their environment and meet their challenging OT requirements. As we outlined during our last call, we are leveraging the height of the trade show season and attended several of the more intimate OT-focused events as we continue to expand our brand presence within the OT marketplace. This is part of our wider launch strategy, which is to engage with Fortune 500 companies to demonstrate the need for AZT PROTECT solutions. We believe our approach is building interest with customers that have a slower sales cycle, and we are building a pipeline of opportunities focused on oil, gas, energy, and water treatment plants, just to name a few of the target industries. To increase shorter-term revenue opportunities for AZT PROTECT, we implemented Phase 2 of our multipronged sales strategy and hired three new salespeople to focus on the middle-market enterprise. As a result of this investment, we have doubled the dedicated AZT sales team. To further expand AZT PROTECT market penetration, we are actively expanding existing partnerships and exploring the creation of new ones. We see this part of our go-to-market strategy as a pathway to address the government segment as we are very close to signing one of the largest government-focused distributors. We believe our direct sales team and the ability to use our partners' depth is going to significantly raise the profile of the AZT offering and build revenue opportunities. We also announced two major awards that ARIA Cybersecurity won: the Global InfoSec Cybersecurity Product Award for AZT PROTECT at RSA, and ARIA Cybersecurity won the prestigious Globee Cybersecurity Protect Award for AZT PROTECT. The Technology Solutions (TS) business continues to perform and contributed $11.2 million to the total revenue of $11.8 million in the year-ago quarter. During the first fiscal quarter, we announced a five-year multimillion-dollar contract to provide managed services for a prominent Florida public college, one of the largest and most diverse institutions of higher education in the nation. We will deliver proactive monitoring, management, and support for the college's critical technology infrastructure, including network, security, and private cloud services. The success of TS continues to be driven by our customers' increased use of implementation, installation, and training capabilities. This component of our company remains robust as we added new UCaaS customers during the quarter. The TS pipeline is currently running above average. The cloud business currently has a record pipeline. This is a highly stable business as we have achieved a customer retention rate of more than 90%. The shipping business remains relatively unchanged from prior quarters. We did sign a new customer, and we are looking forward to fostering a strong relationship over the coming years. As I stated on the prior call, we are currently working with one of the largest freight operators specializing in containerized ocean exports, serving numerous ports worldwide with an extensive global agent network. We have ordered over 14 ships that are expected to be retrofitted over the next few months, and upon completion, we expect to provide our managed services for each of these ships, which will add to our monthly recurring revenue. To summarize, with the successful launch of the AZT offering, I believe we have positioned the company for sustained long-term growth and success. Our two businesses are growing, and the pipelines are growing, which will translate to increased revenue margins and profitability. Lastly, we believe the recent two-for-one stock split increased the liquidity of CSPi shares, and I believe it will provide greater opportunities for institutional participation and enhance shareholder value at the time we are broadening our business prospects. We also believe the success of the AZT launch and growing cybersecurity threats allow us to engage in an active investor relations strategy. We will keep you posted as we schedule conferences, participation, and other related events. With that, I will now ask Gary to provide a brief overview of our fiscal second quarter financial performance. Gary?

Gary Levine, CFO

Thank you, Victor. For the fiscal second quarter ended March 31, we reported revenue of $13.7 million compared to $13.3 million in the year-ago fiscal second quarter. Our revenue performance was driven by a 23% growth in the service business. Our Q2 gross profit, which was greatly impacted by the higher service revenue, was $6.5 million or 47.3% of revenue compared to $5 million or 37.6% of revenue. For the fiscal second quarter, our engineering and development expenses were $726,000 compared to $858,000 as we reduced outside contractors and elected not to fill some open positions. Our SG&A costs for the fiscal second quarter were $4.5 million compared to $3.9 million in the year-ago fiscal second quarter as we continue to invest in the AZT offering, including building out the dedicated sales team and participating in trade conferences. Benefiting from the higher service revenues and higher margins, we recorded net income of $1.6 million or $0.16 per diluted common share for the fiscal second quarter ended March 31, 2024 compared to net income of $0.3 million or $0.03 per diluted share for the fiscal second quarter ended March 31, 2023. Per share amounts have been retroactively restated to reflect the two-for-one stock split. Following the two-for-one stock split, we currently have 9.5 million shares outstanding. The company had cash and cash equivalents of $27.1 million as of March 31, 2024. We believe our robust financial position allows us to execute our multi-prong sales and growth strategy for the AZT offering as well as other products and service lines and to financially support large customer agreements, which have been highly successful in the past for CSPi. Lastly, the Board of Directors approved a quarterly dividend of $0.03 per share payable on June 12, 2024, to CSPi shareholders of record on the close of business on May 24, 2024.

Operator, Operator

Your first question is coming from Joseph Nerges of Segren Investments.

Joseph Nerges, Analyst

How's everything going? I have one question and a follow-up. Going back to the last conference call, Victor, you mentioned that we're close to rolling out a full production line version of AZT for the IT environment. Is that still in beta testing since it hasn't been released yet?

Victor Dellovo, CEO

Correct. Yes. It should be May. We're doing some additional testing just to make sure everything is where it needs to be. But we have rolled it out to a few of the customers already with no issues, but we have some enhancements and other developments that we're working on right now.

Joseph Nerges, Analyst

And how will that enhance what we already have out there? What do we expect that add-on will help us with?

Victor Dellovo, CEO

In the OT space, right, updates and patches are not as important, and that's why our product fits into where it protects even without the patches. In the IT space, they still want to do patching. So we needed to allow for that, whether it's manual or automated. So that's where the enhancements came in on the IT side. Like I said, in the OT space, patching is not as important just because you can't really interact with the machines in the IT, whether it's a Microsoft patch or any other patch that's out there. We need to allow for that, and that's kind of where we've been developing and making sure it works with all of the other products that are out there.

Joseph Nerges, Analyst

Okay. Just one quick follow-up. Last time, you mentioned a Fortune 500 chemical company where we have multiple sites. It ultimately comes down to the plant manager's decision on whether to implement the AZT PROTECT. Oil sales are only just starting to come in now. I can't imagine the conversation I would have with any plant manager where I would ask, do you really want to be the one who decides not to implement this and then faces a hack at your facility? That could really end your career, right? The manager would be in serious trouble if several have implemented it and avoided hacks, while he ends up being the one that gets breached.

Victor Dellovo, CEO

Yes, that makes sense, but sometimes common sense is not what people use all the time.

Joseph Nerges, Analyst

No, I certainly wouldn't mind. I would suggest keeping that in mind, if nothing else.

Victor Dellovo, CEO

No, we always do. We always do.

Operator, Operator

We've got a question from Brett Davidson, who's a private investor.

Brett Davidson, Private Investor

Question regarding those three new salespersons who are targeting larger mid-market companies, what does that look like? Are these guys going out and meeting at their locations? What exactly does it mean that they're targeting mid-market companies?

Victor Dellovo, CEO

When we talk about the mid-market, instead of looking at the top Fortune 500 companies, the huge gas companies, the big corporations that definitely have a need, but move really slowly. We're trying to get into that next layer where they are not as large, and we can target them, and hopefully, decision-making can come a lot faster. POCs could go a lot faster. So it's a combination of meeting some of the customers at trade shows, calling them on the phone, visiting them locally, whatever it takes. It's a combination of everything.

Brett Davidson, Private Investor

And is there a pipeline right now regarding the AZT product? Is there stuff that is in process, it's not quite at the sales line?

Victor Dellovo, CEO

Yes, it's a combination of having current proofs of concept where customers are testing the product, either in a lab or in their own environment. There are also others further along in the process where initial discussions have taken place. Now, it's about obtaining the necessary authorizations and security clearances, along with completing all the required paperwork and contracts. We're concentrating on seizing large opportunities and collaborating with automation partners like Rockwell and others to utilize their sales teams. This strategy helps us build relationships that can accelerate our entry as a smaller company competing with larger brands by leveraging the longstanding connections of these salespeople.

Brett Davidson, Private Investor

Is there a way to kind of measure that in like a dollar figure? Or is that more like a fool's area at the point we're at selling these things? Or is there a way to measure this pipeline of potential deals?

Victor Dellovo, CEO

We have done some measuring internally, which I'm not willing to share, but we look at the initial opportunities based on conversations, and we do have a pipeline that we're managing against. We have seen with some of the initial conversations and we put an estimation of an amount of dollars. As the conversations go on, the pipeline actually increases based on other needs and other people we talk to in the organization. So yes, we are putting a pipeline in estimation of revenue that we're managing internally based on the initial conversations we are having with each organization.

Operator, Operator

Your next question is coming from Mike Price, who's a private investor.

Mike Price, Private Investor

I know that you want to have wider distribution of shares and shareholders. With a $120 million market cap and what you paint in front of you with AZT and having $27 million in cash, it seems like there’s room to be buying shares. I've asked this question each of the last three conference calls and you have the authorized shares, but you haven't bought any shares. Any thoughts along those lines?

Victor Dellovo, CEO

Yes. Over the last quarter or two, when the stock was higher than it is currently, we didn't see the need. But at this price level, we are definitely considering supporting it and buying shares in the upcoming quarter.

Operator, Operator

Your next question is coming from Sergio Hibar of Hibar Research.

Unknown Analyst, Analyst

Congratulations on a huge improvement on the bottom line. I think you gave investors a head start in looking at the reaction today to the news. Investors are used to seeing improvements in the top line and not the bottom line, so I think that’s fantastic that you're concentrating on that. I was wondering if you can give us some color on bundling with major security products like, for example, with Palo Alto.

Victor Dellovo, CEO

That is definitely an option. We do complement if it was Palo Alto or CrowdStrike or any of the other players. We can work in conjunction with all of them, especially where some of the old licenses in the XP world or Windows 7 that they may not be supporting, we can definitely take over any system that's running an older version. It's up to the customer; if they love Palo or CrowdStrike, they can continue using it, and we will work side by side. If they see us as a product they want to fully implement across the platform, we'll be more than happy to take all the business from them. So yes, we are not looking to rip and replace any of the major players out there at this stage of the game.

Unknown Analyst, Analyst

So we're not bundled directly so that it's sold, like, for example, Palo Alto will include your offering with the Palo Alto product?

Victor Dellovo, CEO

I would love to get that relationship going. If you have any contacts that could help do that, please let me know.

Unknown Analyst, Analyst

So you have a contact with the unnamed company, which I think is Palo Alto, and that's why I'm asking that. I know you can't answer, so I'll move on to another question. Can you explain why the dividend was decreased?

Gary Levine, CFO

Yes, we looked at it from the standpoint that if we took the shares in, it would have been really at $0.025.

Victor Dellovo, CEO

So yes, we went to $0.03.

Unknown Analyst, Analyst

Okay. And are you going to be giving...?

Operator, Operator

Apologies, you've had your allotted questions. If you do have any more, Sergio, you can press Star 1 and join back in the queue.

Paul Scolardi, Private Investor

Two quick questions. First of all, we constantly see in the news warnings from the government against threats, threats against utilities, water utilities, all utilities. Can you give us some color on whether we are approaching this industry? Have we approached the industry? Are we getting traction? Are we getting the government aware that we have a solution to what they're warning about?

Victor Dellovo, CEO

To summarize, yes, we are focusing on the energy and water treatment sectors. We have conducted marketing outreach and engaged with individuals at various shows. We are on the verge of signing with one of the largest government distributors, which would enable us to work directly with different agencies and expedite the process since the distributor has all the required contracts. This is indeed a prominent topic in the news, and we have made it a priority. We have had discussions with key players at the trade shows related to this matter.

Paul Scolardi, Private Investor

But are your people going out to the water utilities?

Victor Dellovo, CEO

If they will take a meeting, absolutely. Believe it or not, we're still in the world where nobody really goes to work any longer; mostly everything is over Zoom. They may go in once a week, twice a week. So a lot of the calls are over Zoom, but those conversations are happening.

Paul Scolardi, Private Investor

Okay. And then for my last question regarding AZT, can you provide some insights now that you're in the market and working with these large companies, which may take some time? Do you expect to close AZT contracts in fiscal year 2024, or do you believe the sales cycle will be longer now that you're established in the marketplace? Will we continue to see AZT contracts being signed this fiscal year?

Victor Dellovo, CEO

Absolutely. Of what magnitude, I cannot say for sure, but contracts, absolutely. We are signing contracts, and I know everyone gets excited when we put announcements out there, but major contracts I will announce. There are other contracts that we have closed that don't warrant a public announcement. They could be $100,000 or $50,000; there are different levels of contracts we are closing, but they don't warrant a public announcement. So the major ones that are in the millions will be announced. But yes, there are contracts that are closing and will continue to close at different levels. If we hit another major one, then yes, I'll announce it when the time is right.

Operator, Operator

Our next question is coming from Joseph Nerges of Segren Investments.

Joseph Nerges, Analyst

Yes. Just one follow-up on you mentioned the webinar tomorrow with Rockwell and then you mentioned the journal article that Rockwell put out. Will you be putting those on the website? Can we access those on the website?

Victor Dellovo, CEO

Yes. I think you had the invite already that's out there, right? You can join the webinar tomorrow, right? And then once we get a copy of the journal, we'll definitely post it on the website so you can access it.

Operator, Operator

Your next question is coming from Brett Davidson, who's a private investor.

Brett Davidson, Private Investor

Yes, I guess I was getting a little long-winded, so I didn't get to wrap this up. But getting back to that kind of pipeline or how you guys want to refer to it, can you just give some characterization of what the size of these deals potentially are? Are we talking hundreds of thousands, millions, tens of millions, or all of the above?

Victor Dellovo, CEO

Tens of millions. We don't have anything in the millions and hundreds of thousands in the pipeline.

Operator, Operator

Your next question is coming from John Crotty, who is a Private Investor.

John Crotty, Private Investor

I really want to tell you that it was great seeing the awards you won, but more importantly, you put out a PR the other day that really has some great information in it. You mentioned the new industries you had won. I was wondering if we could just get a little color on them. You had stated that you had won in energy and utility as well as pharma manufacturing. Now we're aware of the pharma company, but the other three are new, and I knew that you were going after energy companies, especially with the show in Houston. Can you give any color as to what types of utility it was and maybe what type of energy company it was as well as the manufacturing?

Victor Dellovo, CEO

The manufacturing, utilities, and energy are like oil and gas. I can't mention any of the names, but you would know who they are. They're just some of the big oil and grid companies that we're talking to, and we met at shows, getting POCs together and trying to get into their labs. So yes, the shows have been really good to get us in front of different companies and build some relationships a lot quicker. We will continue to do the necessary shows that make sense for us.

John Crotty, Private Investor

Right. Because we were aware that the targets that they're coming after in the U.S. be in the operational infrastructure, electrical grid, as well as pipelines; those are the types of levels of quality we're talking about in the industry you're involved with, right?

Victor Dellovo, CEO

Correct.

Operator, Operator

Thank you very much. While that appears to be the end of our question-and-answer session, I will now hand back over to Vic for any closing remarks.

Victor Dellovo, CEO

Thank you. As always, I want to thank our shareholders for their continued interest and support. We are entering a period of increased activity, and we look forward to sharing our progress in our fiscal 2024 third quarter in August. Until then, be well, stay safe, and enjoy the summer.

Operator, Operator

Thank you very much. This does conclude today's conference. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.

Gary Levine, CFO

Bye.

Victor Dellovo, CEO

Bye.