CSP Inc.

Please stand by. Your program is about to begin. Should you need audio assistance during today's program, please press star zero. Good day, everyone, and welcome to today's CSPI Fiscal Week. Second quarter 2021 operating and financial results conference call. At this time, all participants are in a listen-only mode. Later, you will have an opportunity to ask questions during the question and answer session. You may register to ask a question at any time by pressing the star and 1 on your touchtone phone. Please note, this call may be recorded, and I will be standing by should you need any assistance. It is now my pleasure to turn today's program over to Michael Polyview. Please go ahead.

Thank you, Brittany. Hello, 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 DiLovo, 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 a 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 the number of uncertainties, risks, and other influences, many of which are beyond the company's control. They 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 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. So, our look at 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 thorough look at 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 DeLobo, Chief Executive Officer. Victor, please go ahead.

Thanks, Michael, and good morning, everyone. A second quarter performance, again, highlights the type of success we can achieve, even during an unprecedented business climate. 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 cybersecurity, wireless, and managed service company. And I believe the positioning will enable us to execute our long-term operative operations 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 a 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 a more formable company with an expanding complement of offerings to grow top line. And consistent with previous quarters, the revenue mix The pursuit of higher margin offerings allowed us to report a sixth consecutive quarter of year-over-year growth margins 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 sunbursts, enabled cyberattacks, a new major attack as early as a few weeks ago. and bad actors actively use the network to access many of the vulnerability systems as possible while using techniques to try to hide their action. Our ability to quickly identify the attacker's action and stop them provides a unique solution for this emerging cybersecurity threat, 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 ADR solution was designed to detect such attacks as well as ransomware, malware, which are consistent threats to all organizations. In March, ARIA-ADR received a Cybersecurity Excellence Award, an outstanding achievement for a recently released solution. 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 provides organizations with benefits of a transitional 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 can 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, UCAS, in selling third-party products and services, which is highly profitable and reflecting in the quarterly gross margin. While budget-related, delays due to covid remain a fact that 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 with 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 UCAS customers. Latin America, which I refer to in Q1 Conference Call, is a bright spot right now as customers are adding bandwidth to dozens 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 an expected to have them have a team in place this quarter. Further, another three ships are budgeted for retrofit by their own, and we believe that 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 UCAS 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, our HPP division. Revenue for the quarter was $0.9 million, below internal expectations. A couple of factors are responsible. Miracom sales are historically slow during the fiscal second quarter, and we did not receive royalty revenue related to the E2D program. But we believe the E2D 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 reoccurring monthly revenue to initiate during the current quarter. In addition to ARIA ADR awards, I mentioned earlier, ARIA Packet Intelligence also received a Cybersecurity Excellence Award. The ARIA PI application enables complete visibility into an organization's network, including typical unmonitored lateral traffic patterns. It watches all communication 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 then 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 that multiple touchpoints has 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 strategy to transition to a cybersecurity, wireless, and managed service company. The entire CSPI team has done a superb job to get us through this storm, employed by a solid balance sheet. We continue to have the resources to execute our operating strategies and the benefit greatly as customers seek to upgrade their critical infrastructure needs. With that, I will now ask Gary to provide a brief overview on the fiscal second quarter financial performance.

Thanks, Victor. Gary. Thanks, Victor. As Victor mentioned in his opening remarks, our fiscal second quarter revenue was $14.1 million. While the year-over-year decline is primarily related to COVID-19, the 24% increase compared to fiscal 2021 first quarter as the company demonstrates our success continues to navigate the impact of COVID-19. We reported gross profit margin of $4.4 million, or 31% of sales, compared to $4.5 million, or 27% of sales, in the year-ago fiscal second quarter, reflecting improved product gross margin percentage plus a mix of higher margin services business. This is an improvement of 4%. Our engineering and development expenses for the second quarter was $762,000 compared to $716,000 a year ago, in the year-ago period. The increase is due to a higher headcount of two, which was offset by our reduction in consulting services. Our SG&A expenses in Q2 were $3.7 million compared to $3.9 million in last year's fiscal Q2 due to a decrease in payroll, benefits, travel, and stock compensation. The $723,000 of income tax expense was primarily driven by an increase in valuation allowance for our deferred tax asset, which is a non-cash item offset by a benefit for the effects of a change in the tax law allowing immediate deductions of the covered expenses through the PPP loan. We reported a net loss of $847,000 in the second fiscal quarter, or 20 cents per share. compared to a net loss of $732,000, or 18 cents per share, for the second quarter of fiscal 2020. Excluding income tax expense, the negative impact of currency exchange of $154,000, we would have reported a slight income of $30,000 for the quarter. We ended the second quarter with cash and cash equivalents of $20.4 million as of March 31, 2021, an increase of $500,000 compared to cash and cash equivalents on December 31, 2020. We believe the measures we implemented during fiscal 2020, including the suspension of the quarterly dividend, stopping our stock buyback program, in addition to the PPP loan proceeds, enabled us to preserve our cash and maintain a robust balance sheet throughout these past 12 months. We will maintain a similar proven cash preservation posture for the foreseeable future or until such time that the economy and businesses resume normal operations. We made a significant investment in our business prior to the pandemic, such as the development of the UCAS and the ARIA offerings. And our goal is to monetize them so we have the resources to fulfill commercializing these is vital to our executing our business plan. With that, I'll turn it over to the operator to take your questions.

At this time, if you would like to ask a question, please press star and 1 on the touch-tone phone. You may remove yourself from the queue at any time by pressing the pound key. Once again, that is star and 1 if you would like to ask a question. And we will pause for just a moment to allow questions to queue. And we will take our first question from Joseph Negris. Your line is now open.

Good morning, guys. How are you doing today? Good, Joe. Good morning, Joe. By the way, a great report. Finally, we seem to be moving forward with area, and this has been a long time coming, but that makes me very happy about the long-term nature of the possibilities we have. A couple quick questions off your press release. You mentioned that quite a few purchase orders have come in, I guess, on the area product line in the last 30 days, so That was subsequent to the end of the quarter, so most or all that revenue would be going forward. Is that correct? We're talking third and fourth quarter revenue?

Oh, it's actually over the next – it's on a monthly basis, Joe, because they're – There are three-year deals, so we recognize over 36 months because they're managed, right? So not only are we selling product, we're doing managed services. So that's built on a monthly basis.

So we're talking about purchase orders in technology solutions division in that department, not in high-performance products?

No, it's a combination of both, Joe. So we sold Aria. But the goal was to build the recurring revenue business, and that was both in the MSP. So we tied the two divisions together to where when Aria is sold, we sell it as a managed service. So not only are we getting the product, we're getting the maintenance, the support, and then we're tying it into the managed service. It won't always occur like that, Joe, but in the last couple deals that we have sold, we sold it as a complete managed service. um, on the both umbrellas, the HPP and on the TSI. So revenue will be, you know, some revenue will be on both sides of the house.

Okay. Uh, well, you have been offering, um, areas of managed service in, in, in technology solutions division. So that's what, that's what you're saying that through, through that division, uh, you're, you're getting, uh, the area sold as well as the managed services attached. Okay. Correct. On the, on the next question, on the two, large or leading manufacturing organizations. Are we talking Fortune 500-type companies here, or are we talking something very large?

No, not that large, not Fortune 5. But they're tied into large organizations as subcontractors. We can't mention who they are, Joe.

No, I understand that. I'm just trying to understand. Are we talking about area here, or are we talking about managed services here, or a combination of both?

Both, Joe. Okay. Both. In a perfect world, Joe, there will never be an area sale without managed services. You know, in the perfect world.

but the managed services would be coming out of Florida, you know, not out of Massachusetts. Correct.

What type of... 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. Managed service piece of it, yeah.

What are we talking about... Because you said multiple facilities. What are we talking about time of implementation on this? Is that pretty quickly, or is this over the course of the next couple months, six months, whatever, on these large facilities?

No, it could be as fast as the customer allows us to get into their setup.

Okay. A couple of quick things. You mentioned about the two awards that... you got for the gold award you got for both the ADR as well as the Packet Intelligence in the quarter. Who votes on these awards? They're both gold awards. How large a voting group was involved with that? Do we know?

I don't know exactly.

Okay, no problem there. But this is more than once now that we've been recognized for both ADR and the Pack of Intelligence Operations.

Yeah, every year you have to apply for them, you know, for the awards. And, you know, I guess there's industry experts that vote on this.

Okay. And another one which I consider a major announcement this quarter, and that is the NVIDIA release of their Morphis platform in April. which supposedly expands areas' capabilities in identifying cybersecurity attacks. Am I correct in that?

Yeah, 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 CE, they had an NVIDIA conference that lasted, I think, just about a week, you know, and they mentioned some of the security partners they work closely with, the CEO announced, you know, there was a few other major brands that are out there in the security space, but they mentioned, you know, CSPI Aria as one of their key partners of, you know, integrating security. you know, their platform with ours.

Well, beyond that, not only did they mention us, they provided a link area on their initial pressure. 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 last couple of years is a narrative that they're buying into. wholeheartedly with this platform.

Yeah, absolutely. We're working, you know, that's a lot of the stuff we're working with them is, you know, with the cable companies that we have mentioned in the past and there's some other 5G providers on the OEM side of the house. You know, nothing that we've, it just takes a long time to get integrated, you know, with some of these large organizations. But once you do, you know, it's an opportunity that lasts for years. So, you know, we were very happy with the progression we're making with NVIDIA as, you know, such one of the large key players that are out there.

Well, one last point I'll make on this, and you mentioned this on several conference calls, and that is because CSPI is basically – fairly unknown in the cybersecurity industry by a lot of major players, the idea that NVIDIA would link to your website should take a lot of who you are out of the equation. That's how I'm looking at it anyway. It's very positive to have a big company tie in CSBI's area platform.

Yep, I agree with you, Joe.

All right, thanks a lot, guys. Appreciate it.

Talk to you soon, Joe. Yeah, thank you.

And once again, if you would like to ask a question, that is star and one on your touchtone phone. And we will take our next question from Brett Davidson. Your line is now open.

Well, I'm glad to be here this morning, but I've got a couple questions for you guys. Yeah, I'm looking at that press release yesterday, the HP – ProLiant servers, and I'm not entirely sure what that means. Let me just run this past you. So if I were to go on HP's site and look to order a ProLiant server, there would be a dropdown offering ARIA equipment. Am I somewhere on the right track?

No. No. Okay. Yeah, 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, you know, That's a possibility because some of the major 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 everything. and the pricing model that makes it attractive for us so when we do sell it, you know, it'll be profitable for CSPI.

So is this kind of like a seal of approval that says that, you know, your stuff works with the HPA segment? Correct. Okay, got it.

Yeah, yeah. The next step potentially could be what you're saying, but we're not at that point yet. You know, we're at step one of the relationship.

Got it.

In a perfect world, it would be what, you know, you suggested if we could do that on the cybersecurity, you know, on the HP, but we're not at that stage yet. Not that it's out of the question. We're just not there yet.

It's kind of like the provis-type things where – you guys got to get new stuff on some of their equipment and we're still, we're still dating.

We're still doing, we're not in the marriage state stage yet.

It comes with a lot of pitfalls. I'm okay with that. Um, so, uh, on the, on those purchase orders, can, can you add a little color as to, uh, I think, you know, I know I got from Joe, they're three year deals and, uh, The size of these, I mean, are we talking like tens of thousands of dollars? Are we talking six figures or, you know?

Well, with the term of the contract, they're hundreds of thousands.

Oh, nice. Yeah, that's exactly the type of color I was looking for, so that works good. I do have a question that's probably more pointed to Gary here, and there is a big jump in a long-term receivable, and likewise – similar increase in non-current liabilities. Can you add some color as to what that represents?

We've done some long-term purchases with one of our customers, and we've done these over the years. So that and their three- and five-year deals. So that's what we're doing is putting that on the balance sheet.

And that's equipment, software install, that type of deal?

Yeah, so it's kind of items, right.

Yep, and that also is the non-current liability?

Right.

Got it. Okay, that's both sides of it. All right, I got it. Oh, yeah, I think that's about all I got. So, yeah, I don't – so this isn't going to be like a huge splash. This isn't going to be where all of a sudden, you know, $5 million in revenue shows up on the – On the income statement, this is all going to be incremental because, you know, like you said, in the perfect world, you're going to capture both the hardware and the management side of this. Correct?

That's correct. All right. Nice. Yeah, we're trying to build that recurring revenue model, as I've been saying, and, you know, it's – It took a few years with the MSP to build up, you know, a decent-sized percentage of the overall revenue. And, you know, we're hoping if we could stay on the same track that we did with the MSP and UCAS, it would be, you know, in another 12 to 18 months, it'll be significant revenue that you can count on quarter over quarter for years to come.

Yeah, 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.

Well, the multiple on recurring revenue is definitely, you know, the one-time hits, it's worth something, but the recurring revenue, you know, you get a 10 to 15x factor on, you know, top line. So it's definitely.

Are you guys going to start breaking that out in the quarterly, the amount that is from recurring revenues? When it gets to the significant portion of it, we will. Got it. All right. That sounds good. Thank you so much. You guys have a good day.

Yeah, you too, Brett. Nice talking to you. Bye-bye.

And there are no further questions at this time. I will now turn the program back over to Victor DeVillo.

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.