CSP Inc.
Q4 2019 Earnings Call Transcript

Published: 10 Dec 2019

[Operator:]

Good day, ladies and gentlemen and welcome to CSPi's fiscal fourth quarter and full year 2019 conference call. My name is Keith and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference call. [Operator Instructions].I would now like to turn the call over to Michael Polyviou. Please go ahead, sir.

[Michael Polyviou:]

Thank you Keith. Hello everyone and thank you for joining us to review CSPi's fiscal fourth quarter and full year ended September 30, 2019 results conference call. With me on call is Victor Dellovo, CSPi's Chief Executive Officer and Gary Levine, CSPi's Chief Financial Officer.Before we begin, I would like to remind you that during today's call, we will take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward-looking under the act. The company cautions that numerous factors could cause actual results to differ materially from forward-looking statements made by the company.Such risks include general economic conditions, market factors, competitive factors and pricing pressures and others described in the company's filings with the Securities and Exchange Commission. Please refer to the section on forward-looking statements included in the company's filings with the SEC.After Victor and Gary conclude their opening remarks, we will then open the call for questions. With that, I will turn the call over to Victor Dellovo, Chief Executive Officer. Victor, please go ahead.

[Victor Dellovo:]

Thanks Michael and good morning everyone. Gary will be reviewing the Q4 financial results in a few minutes. So I will focus my remarks on our full year performance. To begin, total revenue for fiscal 2019 increased 8% to slightly over $79 million. I am pleased with our results and I also believe the investments we have made over the past couple of years positions us for even greater success in fiscal 2020 and beyond as we transform CSPi to a cybersecurity, wireless and managed service company. Specifically, our new and exciting revenue opportunities, the Unified Communication as a Service and ARIA. I do expect these to begin generating revenue during the second half of our fiscal 2020 and I will discuss these in greater detail.But first, let me begin with a review of our technology solution business. For the full year, TS revenues increased to $71.1 million, representing a 14% increase over fiscal 2018. This reflects a healthy increase in the product and service revenue which grew by 13% and 18% respectively. Our managed service practice or MSP exceeded our expectations for a business that did not exist three years ago. We already had a significant number of new customers and the list keeps growing each quarter. In fact, in the first few weeks of our fiscal 2020 first quarter, we signed several new customers. So we are bullish on the full year results. However, what I am most proud of is the high customer satisfaction and I believe the continued positive customer experience is going to help us secure new customers. Kudos to the entire team. They are doing an amazing job and I am confident that they will continue to perform at a very high level.We also continued our work within the cruise industry, which if you recall, initially started with one operator and increased to include a second. Both are well-regarded and amongst the largest global operators. In fiscal 2019, we have completed a total of 17 ships and we currently have commitments for the next seven months or through fiscal third quarter. Finally, our Microsoft practice is performing well and is benefiting from the actions to recruit the right talent. While we still have opening positions, filling these together with our marketing spend will continue to strengthen our Office 365 business.We also continue to pursue our Unified Communication as a Service business or UCaaS, which is an all-in-one service for hard and soft phones, including 24/7 security and technical support, with redundant data centers located in Florida and Texas. This is a fast growing and dynamic market, which is controlled by just a few large players and according to published reports is expected to have a 29.4% compound average growth rate through 2024 when it's anticipated to reach a $79 billion market. As you would imagine, with these market characteristics, we have allocated significant resources to develop an offering which I believe is distinct and offers competitive differentiation. Currently we have two customers performing testing and since they have over 1,000 users being tested in multiple locations. The feedback is positive and we maintain our timeline to officially launch in January. There is a tremendous amount of interest in the UCaaS and the pipeline is getting deeper.I will now move to our high performance product division. Full year revenue was $7.9 million and while the $2.6 million decrease was not entirely unexpected, it's primarily due to $1.7 million decline in royalty revenue related to the E2D program plus another $3.5 million in lower multicomputer service and Myricom revenue. However, this was partially offset with nearly $1 million increase from multicomputer products and services. We remain confident we can secure additional purchases for both parts and royalties for fiscal 2020 for foreign military E2D planes.In addition to our legacy HPP revenue, we are very excited about the future revenue opportunities. As I mentioned earlier, ARIA, our award-winning next-generation cybersecurity platform is why we are cautiously optimistic about the growth potential for our HPP business segment. As a reminder, ARIA provides advanced protection for critical data assets that need to be assessed by end-users and applications, both in the cloud and on-site.I want to review the progress that we made since we last spoke and the initiatives that we have currently underway to ensure the successful launch of ARIA during the second half of current fiscal year. With the supplier issues successfully resolved, we can commence shipments as we have officially transitioned from beta stage to rollout stage. This increased level of confidence has allowed us to build a sales team. In the last three months, we have hired three trained direct salespeople with each a minimum of 15 years experience. I believe it's worth pointing out that each was fully employed at the other organizations and that they made a conscious decision to join the CSPi team.As many of you know, this is a historically tight labor market. So I believe that the decision is a game changer because they recognize ARIA's advantage and how we can potentially reshape the competitive landscape. Let me remind you, CSPi is relatively a newcomer in the cybersecurity space, an unknown entity. So it is a biggest moral boost when they join. And I can say without hesitation, their energy and enthusiasm is already permeating through CSPi. While we continue to downplay a rapid initial ramp-up, given the typical long sales cycle required when dealing with OEMs and MSSPs, the pace of sales meetings has increased and our sales funnel has risen exponentially.We are continuing to vet potential partners for our official channel program which is part of our two-pronged strategy to expand to include resellers with security expertise in order to improve the sales funnel of our cybersecurity products. We have signed three partners in the past three months and we are expecting more as we progress over the next coming months, since a robust channel program together with expanding direct sales team will give us a strong platform for revenue growth. As anticipated, the customer feedback remains positive, primarily regarding ARIA's ease of deployment and ease of use. So it's now just a matter of time before we get the first significant order. Actually, every potential customer has looked at ARIA is still in the sales funnel of more than two dozen or so.So I am pleased to report that not a single one has walked away. Each one is progressing throughout the sales process with a few approaching the more advanced stages. Also, the recent acknowledgement received from CyberDefense Magazine, the premier source of IT security information, validates our vision and is a key in the third-party endorsement that will drive further customers' interest and demand. I can't underestimate the importance of this reference and its combination with our sales and development efforts will remain, maintain our plans for further educate the market. I also believe due to the momentum we are generating and the positive customer experience, the timing will benefit us as customers are finalizing budgets for the new year, certainly the larger ones.In summary, we made significant progress in fiscal 2019 and we carry this momentum into the new fiscal year. As we enter the new year, we have a solid existing business and exciting new offerings in each of our business segments, UCaaS in our TS business and ARIA in our HPP business and believe we are positioned to succeed in the coming year and cement our migration to a cybersecurity, wireless and managed service market company. I believe we now have the pieces in place to significantly improve our topline and achieve profitability in fiscal 2020.With that, I will now ask Gary to provide a brief overview of our fiscal fourth quarter financial performance. Gary?

[Gary Levine:]

Thanks Victor. As Victor mentioned, our fiscal fourth quarter revenues increased to $22.2 million from $19.6 million a year ago. We generated gross profit increase of $0.3 million to $5.1 million compared to gross profit of $4.8 million in last year's fiscal fourth quarter. While the gross margin was 23% and was lower compared to the year ago gross margin of 24.7%, this was primarily is attributable to a higher amount of royalties in last year's Q4. Additionally, this year results include revenue from a sizable customer who are at lower margins who are strategically important for CSPi and allows us to foster a closer working relationship which will yield benefits for many years.Our first quarter engineering and development expense was significantly lower at $691,000 compared to $925,000 a year ago, which is attributed to a reduction in contract labor required last year to help in building out the foundation of the ARIA software platform and a recovery of consulting expenses where the services were not completed. Our SG&A expenses in Q4 were $4.6 million compared to $5 million in last year's fiscal fourth quarter. The decrease in expenses was primarily related to variable compensation and expenses related to the sale of our German subsidiary.The company had a tax expense of $395,000 for the quarter. This was a result of a change in the fourth quarter tax provision which includes the annual adjustment of the deferred taxes which resulted in an effective tax rate of 16.1%. In the third quarter, we had a tax benefit of $327,000 with an effective tax rate of 158%. The changes in the provision and the rates resulted in the large tax expense in the fourth quarter.We reported a fourth quarter net loss of $334,000 or $0.09 cents per share compared with net income of $16.2 million or $3.95 per diluted share for the fourth quarter of fiscal 2018. As a reminder, the year ago net income included a gain of discontinued operations related to the German sale of $16.8 million. However, excluding the gain, we would have reported a net loss of $0.7 million or $0.18 per share, a significant year-over-year improvement.We end of the fiscal year, September 30, with cash and short-term investments of $18.1 million. Lastly, our Board of Directors has voted to pay a quarterly dividend of $0.15 per share to shareholders of record on December 31, 2019 and payable on January 15, 2020. Looking to fiscal 2020, we will continue to focus on bottomline performance and to boost sales of our higher-margin products while managing costs around the company.With that, I will turn it over to the operator to take your questions.

[Operator:]

[Operator Instructions]. And we will take our first question from Jay Hill [ph], a private investor. Please go ahead. Your line is open.

[Unidentified Analyst:]

Hi. Thank you all for the presentation. I wanted to ask you a bit about the stock, which despite a lot of high growth industries remains really undervalued relative to its peers. Any plans or I should say what are your plans to generate some more interest in the stock to hopefully not only just help liquidity but valuation as well? Thank you.

[Victor Dellovo:]

Well, I think our plan right now is with some continued success in the ARIA, we will start attending some conferences as well as meet with prospective investors. We have recently changed our IR firm and are working with them to put a program together to talk to other potential shareholders and such things as family trusts and the fiduciaries. So we are going to concentrate more on some of that as we get more success coming out during the year.

[Operator:]

Thank you. We will take our next question from Joseph Nerges with Segren Investments. Please go ahead.

[Joseph Nerges:]

Good morning guys. Great job last year. It looks like we are moving forward very good here. Just a couple of quick questions. You did say that E2D royalties were about $1.7 million less this last fiscal year. Is that correct? Did I hear that correctly?

[Victor Dellovo:]

Yes. Between royalties and parts, right, there were some parts in there too, Joe.

[Joseph Nerges:]

But a fair amount was from our fiscal 2019 versus 2018, right?

[Victor Dellovo:]

Yes.

[Joseph Nerges:]

I was right then, about $1.7 million in that area?

[Victor Dellovo:]

Yes.

[Joseph Nerges:]

Okay. And you said you had some visibility. You don't have a lot of visibility, I know, on the E2D planes, but going forward you are anticipating an increase this year coming? Or we don't know that yet?

[Victor Dellovo:]

No. We don't see it really increasing. We probably believe it will be closer to sort of the level we had this year.

[Joseph Nerges:]

Okay. I don't know if you guys did notice, but beyond Japan ordering additional line of nine planes plus U.S. order 24 of those and France is now ordering three E2D planes. So as to when the orders are fulfilled, that's another story, but it seems like the book is increasing in that respect anyway. On the last call, you basically detailed or at least Victor detailed three areas that we are pursuing with the ARIA marketing. And the first one you came up was the carrier, a large carrier that might be rolling out a 5G network and they might be using it both internally and externally with their customers. Is that still that's still moving forward with that carrier?

[Victor Dellovo:]

The conversations are actually taking place as we speak right now. There's multiple meetings that have been going on over the last quarter with them.

[Joseph Nerges:]

Okay. Great. And then of course the integrations was the second area and we announced of course the Demisto press release on that just recently. And I am assuming we have other integrations that we are working on at the current time with other securities?

[Victor Dellovo:]

Absolutely. That's correct. As we as we get further down and the integration becomes finalized, I will announce those as we go.

[Joseph Nerges:]

Okay. Very good. And then of course the last one and the press release yesterday is indicative that your channel partners, MSSP resellers and as you indicated you are moving forward there too and you added, what, three new people in the last couple of months or so under that program.

[Victor Dellovo:]

Well, yes, three new buyers or resellers that are specialized in the security space. And then I mentioned that we hired three direct sales reps also that are targeting their own direct accounts. That will work through the channel ultimately but we are trying to prospect on our own and drive up some business and they all in large companies, whether it's financial or insurance, medical, those manufacturing. We are targeting those on our own also.

[Joseph Nerges:]

So basically the direct sales people are not necessarily soliciting channel partners. They are out there soliciting individual accounts or both?

[Victor Dellovo:]

If they have some relationships that they have worked with in the past that they know that the companies would be interested in ARIA, then of course we are engaging with those resellers also and they are passing some of that relationship over to the channel people that are running our channel division. But they will continue to work with them to drive joint sales calls together at the same time.

[Joseph Nerges:]

Okay. Just the last quick question that is the, you said you noticed an increased inbound traffic, let's put it that way, after the CyberDefense Magazine nominated you guys for the Best Network Security Management Product. And that's been fairly recent. That's something that came out in October or at least the press release on that was in October. So you are seeing something and you are tying that particular award acknowledgment and the increased traffic possibly from that?

[Victor Dellovo:]

I think it's a combination of that. We re pushing out that announcement through social media, through press releases, through via email. We are trying to get that out not only to explain what the product does but to validate that it's not just CSPi saying it, it's an independent party that looked at the product and determined it's validity in the market space.

[Joseph Nerges:]

Okay. Great. That's all I have. You guys are moving. It sounds good to me. And I am pretty excited about the next year and the following year. Thanks again guys.

[Victor Dellovo:]

Thanks Joe.

[Gary Levine:]

Thanks Joe.

[Operator:]

We will take our next question from Terry Keratsopoulos with Upstream Investment Partners. Please go ahead.

[Terry Keratsopoulos:]

Your company has about a third of its market cap in cash, trades at less than one-time sales, which is very unusual for a technology company. I was just wondering, what advantage does the ARIA product line bring to the market to the direct competitors? And lastly, what do you think the market potential of your ARIA cybersecurity product line could potentially be?

[Victor Dellovo:]

Well, to your first question, there's a lot of products that are out there. You can name some of the big players are out, some other smaller ones. But I think taking some of the technology that we have developed, well, package inspection that we have been doing on the Myricom side for 20-plus years with the latency that it has and the accuracy of basically no package drops. Using that to analyze East-to-West traffic because a lot of the products that are out there are looking in North-to-South, I think that's kind of where we separate our advantage to do that.And then, also we could be an individual product by itself or we could team up with companies that maybe customers that have bought like Splunk and a few other products that are out there that gets costly on ingestion. The more you ingest, the more to Splunk. We can look at a lot of those packets before it hits that and ingest it and only pushed through the packets that have issues. So we get rid of a lot of the false positives that a lot of these products look at but yet pay for even on the false positives based on ingestion alone.So I think those are the few areas that I think we really separate ourselves from some of the other products that are out there. And we are looking at, Demisto is one of the companies that Palo Alto ended up purchasing not too long ago, so we were already talking to them prior to that purchase and looking at their dashboard and us being able to quickly look at the data and send it through accurately of only truly what the problems are not just massive flows of data that has to be looked at and sometimes not completely inspected accurately and things get through.So we will be teaming up with other third-parties that we look at that they inspect packets but I think we can inspect it and add to that value and make it a lot more accurate compared to the way these other companies are doing it. And like I said, East-to-West traffic is now looked at by most products it's North-to-South. And I think that's where we really separate ourselves from the other third-parties out there.And what was your other question?

[Terry Keratsopoulos:]

And what do you think the market potential of the ARIA cybersecurity product lines could potentially be?

[Victor Dellovo:]

If we get into some of the big MSSPs, we target this, it could be 100s of millions of dollars. Some of the stuff that we are looking at now is tens of millions. It's based on server base and the more service these data centers have, the more boards you need, the more software licensing, the maintenance and support. It could be huge. That's what we are counting on.

[Terry Keratsopoulos:]

That sounds good.

[Operator:]

[Operator Instructions]. We will go next to Brett Davidson, a private investor. Please go ahead.

[Brett Davidson:]

Good morning.

[Victor Dellovo:]

Good morning Brett.

[Brett Davidson:]

I have a couple of questions. How are you? I am looking to back up a little bit and back up to the balance sheet and there is so much going on that it's hard for me to keep this all straight here. But nonetheless, there was $2 million increase in current assets. I wonder if you guys could give a little color on that? And a $5 million in other assets?

[Gary Levine:]

So let me look at it quick. Well, obviously, we had increases within the receivable area and as well as the inventory because there's a lot of different pieces in there that we are doing now and have really focused more on the long term side, Brett.

[Brett Davidson:]

Would it be easier if I give you a call later, Gary?

[Gary Levine:]

Yes. Because then we can go through but right now it just didn't, then we can talk through that.

[Brett Davidson:]

Got it. That sounds good. So the E2D, do you guys have an idea how many planes that you ended up billing for this year?

[Gary Levine:]

Well, we do it based on, it's really boards, Brett, that we are dealing with. We have sort of gotten away because the footprint of the foreign military stuff of different size depending on the radars and they are not comparable to what the U.S. has. So we really just look at it from a board standpoint and the revenue comes in on a board basis, not really on a plane.

[Brett Davidson:]

So how many were linked to the U.S. versions of the plane?

[Gary Levine:]

I would have to check. I can't answer that because it's difficult for us to say because there's some that comes in as spares that go to the U.S. military and then there's others that are going to the foreign. And they don't really earmark it to us. So we don't really know. We know based on the number of boards, they are smaller numbers that they are taking would be for the foreign military. But they don't really say this is U.S. and this is foreign to us. It's really, we track as much information but Lockheed doesn't really disclose a lot of that.

[Brett Davidson:]

Makes it fun tracking it.

[Gary Levine:]

Well, it's a bit difficult from that side, yes

[Brett Davidson:]

Yes. Okay. I know you guys used to include in your release like how many planes the content was for. It become a little bit tougher to get that pinned down.

[Gary Levine:]

Right. Now it's just

[Victor Dellovo:]

We weren't getting foreign before. It was just --

[Brett Davidson:]

Yes.

[Victor Dellovo:]

Because it's all U.S. based.

[Gary Levine:]

And Lockheed was more forthcoming with that which related to more of the public information that was coming out.

[Brett Davidson:]

Got it. So in that press release that came out yesterday, can you guys just give me an idea how long it took to develop those relationships with those two partners?

[Victor Dellovo:]

They vary because we are targeting. So we are not just signing everyone up, right, because if we just want to sign a piece of paper, say, hey, you want to be a partner, great. That would be one thing. What we are doing is when we are looking at the resellers, it's kind of they are interviewing us, we are interviewing them. There's a relationship there because I got a channel person came from one of the larger networking companies out there. So he knows, they sign up everybody and whether they sell $50 or 50 million, they just sign them up.Our goal was to have security partners that focus around that and had the bandwidth to bring on ARIA and not only bring it on as a product but get trained, have access to our lab. So that interview was talking to the owner of the business, their CIO or business product development person to make sure that they understood the technology and they were, A, they bought in on what we were selling and two, they understood the value of that.So we didn't just blow it out. So it was a process of probably two or three, four months just getting together and making sure that, you are talking to their engineers or our engineers and then we are doing evals, the whole thing went through it. So it does take a little longer than just signing up a resell partner. But we have a pipeline of probably another dozen or so that we are doing that with right now. So you should see a little bit more, bringing on a few more.But we are trying not to boil the ocean because just because of the size of our organization we won't be able to give them the attention they need on the sales side if we sign up 50 partners overnight. So my goal is to have somewhere between 15 and 20 by end of next year that can generate significant revenue.

[Brett Davidson:]

Got it. So you guys want to manageable amount. So then with that, then there must be others, like you said, you got others in the pipeline here at various stages.

[Victor Dellovo:]

Yes.

[Brett Davidson:]

So it is reasonable that we could expect to see more press releases in the near future similar to what we saw yesterday?

[Victor Dellovo:]

I am going to put as much press out there that I possibly can to keep you guys informed of what we are trying to do and how we are moving forward, whether it's with awards, bringing on partners. I may not be able to mention customers but if we get significant wins, I am not going to let them, if they are $100,000, $200,000, I am not going to announce that. But if it's a long term significant win that's tens of millions, we are going to try to get you that information as soon as possible when we can.

[Brett Davidson:]

Got it. Yes. That's good.

[Victor Dellovo:]

I think, Brett, you have seen the difference between how we try to share information as we get it compared to keeping things behind closed doors.

[Brett Davidson:]

Yes, yes. And like I said, there's just so many moving parts right now. It's tough for me to keep it all straight. So the last quarter when you talked about the ARIA platform and was high-growth potential, this quarter, you say the company is positioned to deliver strong revenue growth. So how much of that 13% revenue growth was on the ARIA side? Was it anything significant yet? Or we are still just early stages of ramping up?

[Victor Dellovo:]

Yes. It's early stages. And that's the thing that I have been trying to highlight also is that some of the investment we made not just an ARIA but on the other sides of the business that building that MSP practice with a recurring revenue model the third year out is delivering positive results that are putting true earnings to the bottomline. The UCaaS is just another piece of it and then we built the Microsoft 365 practice. All that is our recurring revenue model. So it just keeps giving month in and month out and that's kind of what we are trying to focus the other side of the TS business which at this point is really generating all the profits of the organization at this stage. So that side of the business we continue to invest in heavily because I said they have been successful over the last three, four years of generating true dollars to the bottomline as we build the ARIA and the new products moving forward.

[Brett Davidson:]

So that's generating all the revenue growth right now.

[Victor Dellovo:]

Correct.

[Brett Davidson:]

Got it. So have you seen any shift yet from the legacy maritime stuff to the ARIA? Has any of that occurred? Or is this like we talked last quarter that that legacy stuff just keeps plugging away and it's going to continue to generate revenues from the people that aren't looking for the new shiny object and separate distinct set of customers?

[Victor Dellovo:]

Yes, it works. And we keep developing for like the new Apple software that came out, we did all the drivers. So we are doing some development and investment in the legacy Myricom product just to make sure it continues to work inside the servers and stuff like that that are out there. So it's not just we are just watching dying out. There is some development and maintenance on it that we continue to do to keep the product moving forward and in certain areas it's above and beyond what they need, in some areas it's not. So where it's not, we start looking at the new platform and try to move customers to that.

[Brett Davidson:]

So they have been just plugging away still generating sales revenues and that hasn't like fallen off a cliff or nothing and just doing their thing.

[Victor Dellovo:]

It's slowed down but it hasn't fallen off a cliff. It's some months are better than others but consistently, we still get sales every week from that business. And like I said, some months are better than others but it's still there. It's not as strong since we bought it but considering it's been five or six years but it's still going pretty strong.

[Brett Davidson:]

Yes. I thin you have got a pretty good return on the price.

[Victor Dellovo:]

Yes. If I could find five more of those, then I probably hit the lottery at the same time.

[Brett Davidson:]

So just maybe add a little color and I am just looking for qualitative not quantitative there. And that kind of backs up to that question earlier on improvement in the share price. My take is, generates sales, you won't have to worry about the share price. So the revenue growth over the year you are projecting to see more of that in the second half. And does that directly tie into the ramp up of the ARIA products? Or there's other factors that are playing into that?

[Victor Dellovo:]

The majority is the ARIA and then whatever foreign military planes have more in the second half of the year also.

[Brett Davidson:]

Got it. And do you have any feel for, I mean, what that's going to look like over the course of the year? Or just no visibility whatsoever?

[Victor Dellovo:]

No visibility right now. No visibility.

[Brett Davidson:]

So it's all that is right now, so no surprise there. But the last thing I would like to touch on, I would just like to say that I strongly support the new government's governance policy and agree wholeheartedly that Directors should be held accountable, if that's a necessary thing. But I think that was a great move. Love seeing the press release and thank you guys for taking my questions. Enjoy your holiday season.

[Victor Dellovo:]

All right. You too. Thanks Brett.

[Operator:]

And it does appear we have no further questions. I will return the floor to Victor Dellovo for closing comments.

[Victor Dellovo:]

I want to thank everyone for your continued interest and support. We wish everyone a happy and safe holiday season and a joyous New Year. I believe we are successfully repositioning in the business and Gary and I look forward to sharing our progress with you on the fiscal Q1 conference call in February.

[Gary Levine:]

Thank you.

[Operator:]

Thank you. This conclude today's program. Thanks for your participation. You may now disconnect.