CSP Inc.

Please stand by, your program is about to begin. Good day and welcome to the CSPI Fiscal Q1 2022 Earnings Conference Call. Currently, all phone lines are in a listen-only mode. Later, there will be an opportunity to ask questions during a question-answer session. You may register to ask a question at any time by pressing the star, then 1, on your telephone keypad. Please be advised, today's program may be recorded. It is now my pleasure to turn the program over to Michael Polivio. You may begin, sir.

Thank you, Aaron. Hello, everyone, and thank you for joining us to review CSPI's fiscal first quarter ended December 31, 2021. With me on the call today is Victor DeLobo, 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 term 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 and risks and other influences, many of which are beyond the company's control and may influence the accuracy of the statements and 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 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 DeLobo, Chief Executive Officer. Vic, please go ahead.

Thanks, Michael, and good morning, everyone. We reported a solid fiscal first quarter performance as we achieved many of our objectives. For example, revenue of $12.4 million increased 9% year-over-year and 24% sequentially. Service revenue grew 23% year-over-year. During the quarter, we continue to manage through a variety of issues during the quarter. Some of the key factors continues to be the impact of COVID-19 Omicron variant. We had multiple internal COVID outbreaks during the quarter, which slowed us down from completing certain projects. Then, of course, the supply chain issue, which has delayed many customer orders and with our backlog increasing to over 15 million. Under a normal environment, we would have had a significant profit for the quarter. We also had to give our employees raises to keep the turnover at a minimum. The Florida job market is one of the hottest in the U.S., so there are many options for our employees. We also had recruiting fees in the tune of $80,000 for the quarter. With the labor market being so tight, we had to hire multiple recruiting companies to help backfill some of the open positions and as well as new positions because of the growth in the MSP. division. Despite the challenges, we were able to generate growth during the quarter as well as build our backlog. Our performance during the first quarter resulted from our continued high engagement with our customers and suppliers to proactively resolve and work through issues. Our team is quite proud that today we have not lost a single order in the backlog. Additionally, being nimbler than our larger peers, we have been able to quickly shift gears to refocus our resources to the services side of the business, which has not been nearly as impacted by as a plain chain issues and have captured meaningful revenue opportunities during this period of certainty. A primary goal of migrating to higher margin products and services continues to be achieved as we reported solid gross margins of 29.1%. Similar level compared to a year ago fiscal first quarter. by heading into a period of tougher year-over-year comparison and facing inflationary pressures with our costs. We do believe at this point we should be able to make further progress with our overall gross margin as compared to Q1 as the year progresses. Our technology solution or TS business generated revenue of $11.3 million in the fiscal first quarter. An outstanding result that exceeded our plan. Our managed service practice, or MSP, remains a bright spot because business is a challenge to retain or attract internal talent. I don't expect this dynamic to change much in the coming year, so we will continue to dedicate the necessary resources to capture our share of this market to build our portfolio of service contract customers. Moving on to the cruise line business, the team is currently deployed and working It is progressing on four ships, as I mentioned in Q4 call. While the Omicron variant has lowered the operator's optimism regarding the timing of additional retrofits, there is another set of ships that could be awarded later this quarter or early Q3. As a reminder, this business provides CSPI with an attractive business opportunity, and we are decidedly focused on winning additional business as our fiscal year progresses. Regarding UCAS, we added several new customers during the quarter, and I'm encouraged with our progress. We do face continuing obstacles that are hindering our ability to maximize the revenue potential of this offering. Name recognition is always an issue, and we also have a smaller sales force than compared to our larger pairs. Regarding the high-performance product, our HPP division, we reported revenue of $1.1 million as the AmeriCom business performed better than expected. This growth was offset by lower than expected royalty revenue related to the E2D program. Approximately 50% of the royalty expected revenue was recorded in Q1, with the remaining balance now expected to be recorded in the second half of fiscal 2022. While ARIA remains the primary growth engine for this business segment, in December we announced the availability of the Miracom ArcC TXO network interface adapter designed to act as a secure unidirectional network bridge. This product has already been deployed in organizations including a large public cloud operator and in government applications requiring a network gateway that allows one-way data transfer between classified and unclassified networks. While we don't expect this product to significantly change the upward trajectory of Miracom business, it does demonstrate our ability to respond to an increased demand from our OEM and large customers to create a one-way data path. With regards to ARIA, the emergence of Omicron in the timing of holidays slowed down the momentum as we had experienced earlier in the quarter. However, we did manage to close a few MDR customers, and the revenue contributed from these commenced in the current fiscal Q2. As of today, we continue to grow our ADR customers, generating recurring monthly revenue the team is working hard to sign new contracts the orders in the backlog along with deals we are pursuing are sizable and we will dramatically transform the revenue landscape for the hpp business although the timing to bring these opportunities across the finish line is unpredictable at this point to summarize we increase our backlog demonstrating the heightened interest for our products and services, and also due to the supply chain issue, which has limited our sales growth. We continue to implement and execute on the initiatives aimed to improve a near-term performance, such as focusing on service business while strengthening our long-term interest as we continue to make progress with the UCAS and ARIA, but at a slower pace than we would like. Gary and his financial team has excelled over the past two years, and the prudent expense management that have implemented allowed us to maintain our resources to execute a multi-year growth strategy of transforming to a cybersecurity wireless and managed service company. With that, I will now ask Gary to provide a brief overview on the fiscal first quarter financial performance. Gary.

Thanks, Victor. As Victor mentioned in his opening remarks, our first fiscal revenue first quarter revenue was $12.4 million, representing an increase of 9% year-over-year and 24% compared to Q4 fiscal 2021. We reported gross margin of $3.6 million or 29.2% of sales compared to 3.4 million or 29.7% of sales a year ago fiscal first quarter. Although we are entering a period of tougher year-over-year gross margin comparisons as the pandemic-related conditions allowed us to record a disproportional level of higher margin service revenue, we had previously stated that our near and short-term goal is to maintain an annual gross margin in the mid to high 20s which was achieved. Our engineering and development expenses for the fiscal first quarter were $627,000 compared to $729,000 in the year-ago period. The decrease is primarily due to lower personnel costs. Our SG&A expenses in Q1 was $3.4 million. a slightly increase due to the increased payroll and commissions in the TS segment from the year-ago SG&A costs of $3.2 million. We reported a net loss of $366,000 in the fiscal first quarter, or $0.09 loss per diluted share, compared to a net income of $1.2 million, or 26 cents per diluted share for the first fiscal quarter of fiscal 2021. If you recall, the 2021 fiscal first quarter included a gain on a debt forgiveness of the Paycheck Protection Plan SBA loans at the TS and HPP segments totaling $2.2 million, which was established as part of the CARES Act. Excluding the gain on the debt forgiveness of the Paycheck Protection Plan SBA loans, the company would have reported a net loss of $1.1 million, or $0.26 loss per diluted share, for the first quarter of fiscal 2021. We ended the first fiscal quarter with cash and cash equivalents of $19.3 million as of December 31, 2021. a decrease of over $700,000 from the September 30th, 2021. In late December 2021, we reactivated the stock repurchase program with authorization to buy up to 194,000 shares of CSPI common stock. We did not purchase any shares in the first fiscal quarter ended December 31st, 2021. As a common practice, we will update on a quarterly basis as the program is executed. We will continue to exercise expense management to ensure we have the resources to execute the multi-year growth of our transforming to a cybersecurity wireless and managed service company. 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, please press the star then 1 on your telephone keypad. You may withdraw your question at any time by pressing the pound key. Again, it is star then 1 to ask a question. And we can take our first question from Scott Caldwell, who is a private investor.

Yes, good morning. Thank you very much. I'm a longtime shareholder. Uh, can you just box in the, uh, aggregate cost of being a publicly traded company on an annual basis, please?

Uh, that's probably, I don't have the numbers right off hand, but in the past it's been about 1.8 to $2 million a year. Okay. Um,

Has the board explored any potential to put the company up for sale?

We've explored that over the years. We have talked to a number of companies over my tenure here at the company. There's no active program to do that at the moment.

I'm concerned by the fact that you mentioned that we are not as... substantial as some of our competitors, and that puts it at a severe disadvantage in the marketplace.

I understand that, yes.

Well, I'd certainly like to encourage you to explore opportunities because at $2 million a cost, it seems to be completely out of whack.

Thank you.

Once again, it is star then one to ask a question. We'll pause for additional questions to queue. And we can take our next question from Mike Price, who is a private investor. Your line is open.

Good morning, Victor, Gary. Thanks for taking my call. I just have a quick question about the share repurchase that you announced earlier. And the way the press release was worded, it's at management's discretion. Can you provide the shareholders some assurance that the management's discretion to buy shares does not coincide with management's potential sale of shares?

I mean, basically, no one in the management group at this point has sold, and you have a very limited period of time that we don't have blackout periods. But at least at this point, I mean, I can't answer for the rest of the management team, but I don't see us selling large amounts of shares.

Well, obviously, the stock is very illiquid. And if I go to sell 10 or 15,000 shares, I'm going to affect the price of the stock. So the question basically is management has the discretion to buy shares with corporate cash that if you decide to sell 20,000 shares, you don't have the liquidity that I would not have. That's basically the question.

Well, our intent is not to support the management's

team buying shares i mean to go out and buy shares that they're actively selling that's for sure so okay that's it thanks yeah once again it is star then one to ask a question we'll go next to joseph nurges with seagram investments your line is open hi guys how are you i thought i didn't pick my

questions were being answered here. I didn't know if a star one was working on my phone. A couple quick things. On your press release, you talked about increasing the managed services in the quarter at a brisk pace, I guess that's the way you stated it, because of a talent drain at a lot of the smaller companies. I'm assuming that means a lot of the smaller companies can't attract the talent to even watch their security and are outsourcing most of their IT work outside the traditional in-house staff. Am I correct on that?

It's partially that, but they can attract them at times, but they're not staying long enough, and then you have a training process of X amount of months, and then all of a sudden, before you know it, they're leaving You know, for a higher salary or bonus structure, whatever it may be, and then they have to start from ground zero again, that's been one of the driving factors of some of the, you know, where they hire us. Not that we don't have the same issue, but at least we have, you know, a lot of people that they can count on, not just one or two.

And obviously, so outsourcing becomes an option that a lot of times they may not have considered in the past, right? and they are considering it today. Correct. On the second part of the press release, you talked about the UCAS. I think you mentioned something to the point that there would have been a significant profit. Are we referring to specifically UCAS here? No, no, overall, overall, overall, yeah. If you could have supplied... You know, a sufficient amount. If, and I assume a lot of, and you mentioned that in the last conference call, about, you know, you can sign up a UCAS customer, but if you can't deliver the telephones or you can't deliver some of the hardware and required, you can't obviously.

It's not just for UCAS. It's for everything. The UCAS is just a small piece of the overall package. you know, backlog, you know, it's hardware, the software that goes along with it, we could deliver it, but without the hardware, where's it going? And then the services that go along with it, you know, to install it.

So let me rephrase my question. If this was three years ago and there were no supply chain issues, or essentially there wasn't supply chain issues three years ago, I assume we were pretty much pretty normal. Let's put it that way. You're saying that we would have been considerably profitable on a normal schedule. That's two issues. One, the supply chain, obviously, and the virus. Absent those two things, we would have been pretty profitable because of normal delivery schedules.

Yeah, we've never had a $15 million backlog like that ever. It's been half or less than that, historically.

So, obviously... It wouldn't take much to increase the quarterly sales if you didn't have the supply problems. On the cruise business, you said that you're working on cruises now, and then you expect more orders down the road.

Yeah, we're working on the next set of ships. Just things are moving a little slower, I think, just with with the uncertainty, you know, with the cruise line, you know, the decisions that normally take, you know, months have taken a little longer, but you know, the conversations are there.

And did we, did we have some E2D royalty in the first quarter? Uh, or you're expecting more later in the year?

That was probably in the third and fourth quarters.

The remainder of the E2D. Okay. One, uh, Let me just go back to the press release you had in December, and that's the one on the new product, the data diode, the one-way transmit product that you introduced with Miracom. And in that press release, you specifically, you talked about existing customers, where I guess a data center is using it, or a cloud provider is using it, or somebody's using it, and a government agency.

Yeah.

now so it has it has been beta tested uh or it has been no no that's been we've actually the beta is over we actually sold it okay yeah and also on that call in that press release you also mentioned potential use by oems original uh or oems for this product have have you implemented any of that or is that being tested by them or to whether or not they want to incorporate it into their well the testing phase is over we've been awarded a couple large opportunities um but we can't get the boards to deliver it that was just that was going to be my next with a million dollar question how it's a multi-million dollar question actually we can't ship I got you. Okay, so that's great. So in a way, it's good that you got the opportunity, but, you know, pending delivery of product as opposed to not being able to, you know, not having the product acknowledged and accepted by the OEMs. So what are we talking about on board? What does it take to get a Meyercom board approved? Time-wise, you're talking three months?

It's a moving target. I could tell you today and it will change tomorrow, so I'd rather just not give you a delivery date because it has changed like three times already.

Okay. And, of course, on the board is some key tips that you're utilizing. But so are these OEMs pretty – sizable type customers? I assume from the backlog it is. We're talking about some pretty big companies?

Yeah, absolutely. I don't know exactly what the rollout is. They're a little hesitant to give us a rollout schedule because moving forward considering we you know we're not sure the first set of delivery um but you know we're hoping that it continues um not only on the opening orders but you know into the future but you mentioned that that you know you would have a some considerable you thought a considerable volume and revenue if if you could deliver the the board We have budgeted to put the orders in this year, and it's up in the air whether they'll hit in this year or next year. It's just we have no control. We're talking to them constantly. We're pushing, but in the scheme of things, on the totem pole, I'm not sure where we stand, to be completely honest with you.

Okay, well, very good. Thank you very much. I appreciate it. It sounds like we're making progress absent what we can't control. Let's put it that way.

Definitely.

Thanks a lot.

And as a reminder, it is star then 1 to ask a question. We'll pause briefly for any additional questions to queue. We do have another question. It comes from Brett Davidson, a private investor. Your line is open. Good morning.

I'm looking for just a little color on a couple of items. The receivables show as about a quarter and a half. As the move to the managed service thing, is there any insight that that may start to contract?

Well, there's a couple of things, Brett. Let me just clarify some things, too. Remember that a lot of the revenue that we have is booked net, not gross, but the receivable is gross. So that can be a little deceiving within taking some of that. And I like Victor to follow along. Vic, I didn't mean to interrupt you.

No, go ahead, Gary.

No, and that's what I was just trying to say within the receivable, there are those items. So that sort of skews it off from that standpoint, Brett.

Got it. On the shift business, maybe you could add some detail as to how that whole process works. So you guys land a contract. I mean, are these multi-hundred-thousand contracts? contracts? And are you out there for, you know, two weeks, two months, six months? What does it take to complete one of these contracts?

Well, there's different contracts for different, that one of them could be where we just go on four or five ships all over the world, and we'll do a site map of of where all the new APs and wireless needs to go. That's phase one. Then phase two is you get the order, you know, delivering of the APs. They have their own set of individuals that actually, you know, put them where they go. And then we'll come back on. And, you know, usually while the ship is sailing, we'll be, you know, the guys will be on there configuring them and then, you know, making sure that, you know, it's fully covered all over the ship. any interference because of the metal walls, they take care of all that. And then they come back and then another phase three is to write that all up and do a full, you know, description of where everything is, the configurations, you know, all the paperwork that goes along with it. So it's in different stages and, you know, it doesn't happen all the time. And then there's the retrofit where they're docked out of the water and And we'll come in and do the site map and everything will be done and it has to be done in two weeks. You know, they literally work 18 hours a day for two weeks straight just because it has to be done while it's on dry dock. So there's different things that happen. It just depends on, you know, the customer and their needs. And they usually give them like four ships at a time, and, you know, it just depends. And the size of the ship matters too, right? There's usually three different sizes, you know, and it just each, you know, each one is, you know, the bigger the ship, the more it costs to do it.

And these are multi-hundred-thousand-dollar jobs or million-dollar jobs? No, hundreds of thousands. Got it. And so, you know, from billing standpoint, are each phase being billed separately or just wait till the end and it's all?

That's why we kind of separated them. So we're now waiting to the end because, you know, it could be months in between. So we've kind of tried to separate them as stages so we can get paid as we go.

Got it. All right. I want to switch gears to the E2D thing. Are we still bringing in any revenue for spares for the American planes, or are we just limited to the foreign content now?

It's primarily the foreign content. There may be a few spares that are done for the Americans, but they're shifting over to newer technology.

Got it. So even the spare stuff is drying up?

Yeah.

Got it. All right, thank you very much, and you guys have yourself a good afternoon.

Yeah, you too, Brett. Yeah, Brett. Once again, it's star then one for a question. We'll pause briefly. There are no additional questions at this time. I'd like to turn the program over to Victor DeLovo for any additional remarks.

Thank you. As always, I want to thank our shareholders for their continued interest and support. These remain challenging times. However, we are executing on our plan to deliver near short-term and long-term results as we remain committed to growing the business. Gary and I look forward to sharing our progress in fiscal 2022 second quarter operating results in May. Until then, be well and be safe.

Thank you for your participation. This does conclude today's program. You may disconnect at any time.