CSP Inc.

everyone, and welcome to the CSP Incorporated Fiscal 2020 Fourth Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions. Please note, this call is being recorded. And now, it is my pleasure to turn the conference over to Mr. Michael Poliview. Please go ahead, sir. Thank you, Leo.

Hello, everyone, and thank you for joining us to review CSP's CSPI's fiscal fourth quarter and full year ended September 30, 2020. With me on the call today is Victor DeLavo, 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 statement 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 uncertainty discussed in the risk factor 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 CHPI should undertake the new 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 DeLobo, Chief Executive Officer. Victor, please go ahead.

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 the COVID-19 on your operations and our customers' operations, since March, we have remained focused on executing our key objectives to ensure our 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 begun 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 a central element to CSPI's maximizing its long-term marketing opportunities. We've adjusted our operations and continue to do so as the situation's 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 CSPIs to 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 UCAS 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 the fiscal 2020, as the year-over-year declines in both periods continue to impact by COVID-19 pandemic. further the focus on higher margin products and services allowed us to report robust gross margin improvements of eight percent and five percent in q4 and full year respectively in fact this is the fourth quarter we have reported year-over-year gross margin improvement demonstrating our effect effectiveness despite the lower revenue figures further i want to emphasize as we continue to transition this process to cybersecurity, wireless, and managed service markets companies and continue to work for even greater gross margins in 2021. The pandemic continues to expose the weakness and limitation of the network infrastructures as remote workers' environments are leading to increased instances of threat and ransomware. In fact, according to some published reports, spear phishing attacks reached a near seven-fold increase since the pandemic began. I believe the new and positive Perspective calls we are having with customers demonstrates the seriousness of this issue and is creating opportunities for CSPI. We are hopeful that the companies are setting aside budgets in 2021 to resolve it. While COVID-19 may have brought some of these security issues to the forefront, the underlying weakness and vulnerabilities were already there and is why we are elected to devote resources in entering this market segment. Because we have a highly experienced team, in less than two 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 positive 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 was $55.9 million. We received orders from larger customers, and we would 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 UCAS customers, including in the educational area, which is seeking to enhance the systems 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. And when we spoke last in August, the Cruise Line International Association had announced that its ocean-going cruise line members had voluntarily extended the suspension of the cruise line operations from the U.S. ports till 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, thus the already limited resale of the crews in the Mediterranean and other regions. Although the travel restrictions have hampered our ability to gain access to the ships, our teams have had regular scheduled communication with the operators to reassign the 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 gain access to two 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 continue to gain positive traction with our UCAS offerings. We added new customers, and we are in the process of expanding sites with our current customers. As a reminder, the UCAS 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 division revenue for the quarter was 1.7 million below our internal projections as well as the revenue related to the E2D program was pushed out. However, we do expect to recognize in the first half of fiscal 2021. We remain excited about ARIA in our award-winning next generation cyber security 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 for new projects, once frozen because of COVID-19, could be freed up as early as January. By raising our awareness at the vital trade shows and throughout the marketing campaigns, we have a solid lead flow. This is going to be meaningful revenue contributed for the company. To summarize, I believe we have successfully adapted our operations since March to sustain our business and grow our prospects. We have a solid base of recurring revenue and diversified customer base, essential ingredients to manage through the current market. Further, the interest in our products and services remain high. The pipeline continues to grow, and it's is a leading indicator for future periods for exceptional performance. With that, I will now ask Gary to provide a brief overview on the fiscal fourth quarter and full-year financial results.

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 business. 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 improvement 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. The 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 been an immense impact throughout our economy, and the effects will continue into 2021. Therefore, we will maintain 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.

At this time, if you would like to ask a question, Press star 1 now on your touchtone phone. Again, that is star 1 on your touchtone phone. One moment while we queue. And again, that is star 1 on your touchtone phone. We'll take our first question from Joseph Nerges of Segren Investments. Your line is open.

Good morning, guys, and happy New Year to you guys.

Same to you, Joe.

Thank you, Joe. One quick thing. You did say that there were, I guess, that there were no revenues from the E2D program in the fourth quarter. Is that correct?

There was some, Joe. We had some royalties in the fourth quarter.

Okay. And then you say you're expecting some in the first half of the year, too. Is that it?

Yeah, some rolled over. What we expected was some that has rolled into the first quarter.

Okay. So you didn't get as much revenue as you thought in the fourth quarter. Some rolled into the first quarter. Right. It didn't go away. Right. Okay. I assume you did see, or I don't know whether you're aware of that, the evidently the Taiwanese, we're receiving royalties on the foreign purchases. Is that correct? That's basically where the revenues are coming from. And the Taiwanese, I see they contracted for four planes in the fourth quarter, in your fiscal fourth quarter. So that's coming down the road little by little, one plane a year, whatever, but it's still – added revenue sometime in the future. Correct. You did see that or you didn't? I assume you did.

Well, the problem we have is we don't... Yeah, as far as the contract being awarded. Right, right. Yeah, we saw that.

Okay. I realize you don't know when you're going to get it, but at least it's out there. We know that. Yeah. Let me go back to the press release a week ago. The free three-month offer that was on the SolarWinds platform, that is strictly for SolarWinds customers and organizations. In other words, we're not offering a three-month free for other customers. Is that correct?

Right. That was just targeted to SolarWinds right at this point. 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?

Not yet, Joe. Not yet. And plus with the holidays and stuff, everything is really, really slow right this second.

Best week in the world to try to get people to get back to you on it. And that's a fairly large base of people, right? We're talking a lot of 18,000 that you had mentioned in the press release, something like 18,000 to 30,000. I've seen figures on that. Yeah, right.

Do we have some sort of a hit list of who we can contact on that?

Do we know? Uh, who, who, uh, several, several organizations that have that currently?

We don't, but we'll look, talk in a marketing companies to see if we can get that list of who has, you know, solo wins, or we can, you know, just start calling and ask, you know, if they currently have it, that's, you know, sometimes it's just roll up your sleeves.

Usually that's out there on a database someplace. Uh, people make, um, emails targeting certain customer bases. So I just was curious. That is strictly for the three-month offer, strictly for the SolarWinds platform, though.

Uh, yeah. If someone else has an opportunity, it's for something else and we can help them and it makes sense financially. I, you know, I leave it open to, you know, some, you know, cause right now in these trying times of budgets are just being allocated. If we have to give them a little bit, you know, 90 days or so to get things rolling, you know, for a three year contract, it, it will make sense in the longterm.

One of the, uh, interesting things in the press release, at least from, from my standpoint was the, uh, dimension that, um, I guess Gary Southwell mentioned that we often, and we're talking about the area platform, often we place legacy security information systems and other security tools. In other words, the ADR platform or the area platform, in some cases, customers or potential customers don't need all of what they have currently. We can literally, is that correct? We can... By implementing ARIA, we can sometimes eliminate some of their older stuff, older security tools?

Well, yeah, sometimes, depending on what they have, we could take sometimes three different manufacturers and cut it down to one, so you have one management platform and one tool, you know, managing everything.

And I'm guessing in some cases the cost of even maintaining the existing legacy systems is, can be substantial in the fact that we can literally replace some of the older stuff. So implementing ARRI might not be – we could be pretty competitive by eliminating even some of the older stuff.

Correct.

So, I mean, your return on investment on ARRI is extraordinary, and I'm a little bit dumbfounded as to why we're not getting a little more. I realize you have the whole pandemic thing, and it's difficult. But the traction that we should be getting in that should be substantial going forward. And more and more people, I assume, are aware of it now that it's been out there for, what, six, eight months now? You're at least talking to customers about it.

Yeah, we're doing the trade shows. And, you know, right now it's name recognition. You know, we've got to get our name out there and get more and more evals. And getting more and more wins.

Well, you know, you mentioned at the beginning about, you know, the platform continues to generate enthusiasm. So I'm assuming, you know, people are interested in the matter of whether or not they're spending the time or have the opportunity to let us into help with the implementation.

Exactly.

Okay. And we did mention the R&D for about $2.8 million for the year approximately, right? Any resolution? Have you guys submitted the PPI loan to the government? The paperwork for the PPI loan?

The one that we received? Yes.

$2.1 million. And I'm assuming you got no response from the government as of yet?

Yes, we have. We received a response just before Christmas, and it's been forgiven.

Oh, okay. That might have been interesting to at least mention because I think that, you know, we don't want to have it hanging out there. But it has been forgiven. We got that information. All right, great.

If it falls in Q1, we'll share more information in Q1.

Okay, because it fell into Q1. Correct. Well, at least going forward, that's a very positive thing. All right, thanks. I'm going to step back and let somebody else ask a question if possible.

Thanks, Joe. And once again, that is star one to ask a question. We'll move next to Brett Davidson. Your line is open.

Good morning, gentlemen. Good morning. 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.

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. You know, it's built a pipeline, you know, 3, 4X from where it was a few months back.

And is that, like, spread across the board, or is it focused more in one area than another?

No, you know, everything we're focused on, as I mentioned in the past, was based on recurring revenue models, whether it's UCAS, MSP, CloudBase, or ARIA. So it's, you know, if you look at those four funnels, that's where the increase across the board kind of came from. And it varies percentage-wise, but it's all been favorable, you know, across those recurring revenue models. 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, you know, we'll sell the product, we'll put, you know, service it, we'll install it, maintain it, and then, you know, we'll try to get them as an MSP client and, you know, so we can manage it for them on a monthly basis. So, you know, that's kind of the model that we're looking at. And that can go across the board for UCaaS or could go for cloud, anything with Azure or whether it's ARIA.

And is any area represented by a larger dollar amount than other areas, or, again, it's kind of like evenly split?

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. UCAS is increasing, and, you know, 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.

And this one might swing to Gary in a little bit here. The operating lease asset and liabilities, I'm assuming that relates to some of either the managed service or the UCAS. Maybe you can give some color on how that is split up and what it represents.

Well, there's a new pronouncement relative to putting leases up on financials, so that there's obviously certain aspects with some of the longer-term contracts that we have, as well as just the standard leasing that we have to disclose now within the financial statements, Brett.

Got it. So it's not necessarily something new. It's just change in reporting.

You're right. It's the reporting the requirements under the accounting rules. Got it.

And is that split kind of evenly between some of these different lease activities that, you know, that are going on? Or is it dominated by certain areas?

Some of the long-term commitments we got on, you know, financing, some of these sales, but also just your standard leasing obligations that you have that has to be recognized within the financial statements. And that's why you've got a long-term aspect to it in there. Got it.

Now, switching back to that press release, I generated some questions from that. So what exactly does the use of the REI advanced detection response entail. Is that all software or is that combination software and hardware?

Both, correct. If you want to install it and you don't want it to automatically fix it, then it can be software only. But if you want to put taps in and put the appliance in line... then you can set rules to where as you see things happening inside either the network in or out through the firewalls, then it could automatically, based on the rules you set, it could automatically fix them, you know, and then you could look at the logs the next day. I had talked about it on the last conference call that, you know, you look at the logs and you can either reverse back if you don't want it or you can let it go through and, you know, it would automatically fix. fix it based on the rules you had set.

And is that based on like a signature of the activity that's going on or is it more like IP based?

It's IP-based. It's taking it, you know, 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, you know, sell 600 licenses. And then it depends if it's redundant. And then the second aspect of it is if you want us to manage it and monitor it 24 by 7 or you'll do it internally. Okay.

All right. And inside the press release, it indicated that ARIA-ADR stops the activity associated with that sunburst attack. And my first thought was, well, okay, how do you guys know that?

That's why we have our engineers internally that would test it. It's the way we You know, it monitors how it exactly does it. That's what the engineers, you know, figure out. But the way we look at all the data and the changes, you know, the team is, like I said, very confident that it stops all the ransomware and everything else going through.

I mean, has this been tested and proven out, or is this theoretically it stops all the activity?

No, it's tested in labs, and we work with other companies. that some of the big players, too, in conjunction with their firewalls, you name the big players, and we have tons of lab gear and software and everything that goes across. We're an integrated partner, so we get a lot of feeds from these manufacturers, and we have to test a lot of this stuff. No, we're not just saying it.

Got it. So this is proof of concept. You guys have actually gone out and been able to demonstrate that. Mm-hmm. So more or less it's just the traffic related. If you're knocking these people off the network, preventing them from using whatever it is that they're using to get in and out.

Yeah, one of the biggest things that we do, and like I said, I had mentioned it prior, is we're looking at east-to-west traffic inside the network, right? Everybody looks north to south, in and out, the firewall coming from outside in. We're looking across the traffic. So the way it analyzes it, when you have something that could be inside your network that shouldn't be there, that's why things get pushed. you know, they put these little probes inside there and then they start festering inside and, you know, and they could be there for months and months and months gathering data. So the way we analyze that is the east to west traffic. And, you know, I think that's why, you know, we're different than a lot of players out there.

And that's where the AI component comes in.

Correct.

So, yeah, I guess I know Joe had asked if there's anybody that, uh, taking advantage of this and have you guys received like any kind of feedback as to how this release has been received or still too early still too early all right well that's all I got for now thank you very much and talk to you guys soon have a good one have a good one bye bye and once again to ask a question that is star one

Please be advised that you may ask one question and one follow up. We'll move next to James Stewart. Your line is open.

Good morning, gentlemen. My question is really directed towards Victor at the moment. I want to congratulate you first on the execution you've done on moving forward on new products, but also on the phenomenally high margins that you're getting. My question is, you know, our company, our investment firm, has a screener for all the companies in the U.S., and CSBI was always in the top 10 as far as being undervalued. And I know you're working in one of the primary as your ARIA products are proven and award-winning. And I'm sure that the cybersecurity firms that you're working with, it's not going unnoticed that you have such high margin and a product that works. Are there any discussions at all on further joint ventures or possible acquisition? Because Obviously, the acquisition of CSPI would be accretive to any company that bought you. I just wondered if you could discuss any of those things you might be looking at in the future.

Well, everything's always on the table, right? You know, whether if someone comes to us to purchase us or if there's other things that I could see that would be accretive immediately. You know, we do talk to other companies constantly. And if something happened to make sense, we would bring it, you know, to, you know, potential shareholders, you know, to vote on whatever would be needed. But right now we're just focused on, you know, building the product, trying to generate sales and go from there. But, you know, everything's on the table both ways.

Well, again, I congratulate you. I think you've done both. Your entire team has done a phenomenal job. Thank you very much. Appreciate it.

We'll move next to Jonathan Hennig. Your line is open.

Good morning, gentlemen. Happy New Year. Congratulations also on these really encouraging results. I'm a longtime holder of the stock. And I'm just kind of curious, given the strong transformation, is there any way you can explain? I mean, for years, CSPI outperformed a lot of the small cap indices, the micro cap index. And now the Russell is at all-time highs. The micro cap index has rebounded. So I'm wondering if there's just any explanation you might have of why the stock, given the strong fundamental transformation, the stock is such an underperformer as of late. Thanks again, and Merry Christmas, Happy New Year.

Merry Christmas, Happy New Year.

Well, it's kind of a difficult thing. There's just such low volume in it, and I think it's – The thing that we're really trying to do is more to get out there to get CSPI known, and I think once we start getting more success with the high-performance group as well as the TS new products, I think the story will start to resonate more. Obviously, we've got the strong margins and are pursuing those things, and I think we'll do more of IR once the story starts to germinate. Any further comments, Victor?

No, you summed it up. You know, I think, I believe it's undervalued too, you know, where there's a lot of aspects of CSPI that we've been working on for years that are actually, you know, showing great profits. You'll see it in the margins. One thing about the story from years past was the margins were always very low. On the TS group, we have fixed that to where we got the recurring revenue model. We have products and services that all tie together. The messaging is unified now on both sides of the house, bringing in the security products. into into into play also and now just getting that aria piece of it um which like i said it hasn't been long and the pandemic kind of i think put the brakes on it a little bit um as fast as we will you know we like to get more and more success with that but i think the messaging The strategy all makes sense. It's unified, and it all ties together. And with that being said, go ahead.

I'll say one quick follow-up before I know. My time is very limited, and it's great to hear, Victor, you say that you think the stock is undervalued. I think from a market's perspective, any regular and frequent insider purchases, however small, 1,000 shares, 2,000 shares, I know as an investor sends a real signal to the market that, you guys are bullish on the future. And I will heed my mic and thank you once again.

Yep. And we have time for two more questions. We'll take that first question from Douglas Johnson. Your line is open.

Thank you. Question on the balance sheet, the notes payable of $2.5 million, is that all PPP?

And we'll take our final question from Terry Karatsopoulos. Your line is open.

I was kind of curious on the ARIA software, what do you believe the total adjustable 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?

Oh, you know, it's in the billions. I would, you know, 20 to 30 billion of that could fit, you know, because we hit a lot of silos of that overall market. So, you know, conservatively, you know, 20, 30 billion.

Okay, that sounds great.

And that concludes our question and answer session. I'd be happy to return the call over to Mr. Victor DeLobo for any concluding remarks.

Thank you. As always, I want to thank our shareholders for their 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.

Thank you.

This does conclude. the CSP Incorporated Q4 2020 Earnings Conference Call. You may now disconnect your lines. And everyone, have a good day.