CSP Inc.

Good day, and welcome to the CSPI's first quarter and fiscal year 2023 conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Michael Poliview. The floor is yours.

Terrific. Thank you, Kelly. Hello, everyone, and thank you for joining us to review CSPI's fiscal 2023 first quarter results, which ended December 31, 2022. With me on the call today is Victor DeLovo, 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 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 several uncertainties, risks, and other influences, many of which are beyond the company's control, that may influence the accuracy of the statements and projections upon which the segments and statements are based. Factors that may affect the company's results 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 reports on Form 10-Q filed with the Securities and Exchange Commission. For a look at statements are based on the information available at the time those statements are made and management's good faith to believe 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. Victor, please go ahead.

Thanks, Michael, and good morning, everyone. This morning, we reported a very strong start to the fiscal year 2023. We grew product sales 63%, service sales 13%, and overall total sales 48% over the first quarter of prior fiscal year. When we last talked with you back in December, we noted that each of the business segments were hitting on all cylinders. We continue to execute with similar fashion during the first quarter and increase our overall gross margins by 2.5 percentage points over last year to 31.7%. The revenue and gross margin led to generating 21 cents in earnings per share, while last year we lost 9 cents a share during the last year's fiscal first quarter. All in all, we are quite proud of our performance to start fiscal 2023. During the past several years, we've stayed the course as we migrated our business to offer higher value cybersecurity, wireless, and managed service offerings. It was easy, especially It wasn't easy, especially with the onset of COVID-19 pandemic and its related challenges, but our business model is beginning to show both its value to our customers as well as its potential to our shareholders. The demand for our award-winning products and services is building. We are increasing business with our existing customers while at the same time gaining new customers. A technology solution business continues to grow during the first quarter. At the same time, our high-performance product business revenue more than doubled compared to a year-old first quarter. It was primarily due to sizable customer engagements, but they fully recognized during the quarter. While the timing of potential orders is subject to movement from one quarter to another, our business pipeline is robust, and we are cautiously optimistic that our HPP business will be growing contributed as the fiscal year progresses. In this morning's news releases, I noted our business and the opportunity pipeline we have in front of us is stronger today than any time in our company's history. Our strategy combined with our unique solutions and top-notch engineers are some of the leading factors. We are continuing to fund R&D so that our product continues to provide these unique solutions to our expanding base of customers. The early market reception to these prior capabilities is opening doors for us with companies that have never talked to CSPI before. And we hope to have some positive news over the coming months. While we have a strong momentum and our opportunities in the marketplace continue to expand, we do have hurdles to overcome to realize our full potential. One of the highest such hurdles is the continued supply chain constraints we are experiencing over a few of our suppliers. The problem has gotten a lot better since the height of last summer. However, the historic six-week delivery timeframe on orders is still being realized. However, the good news is that our customers continue to stay loyal to us. We believe the supply chain issues continue to exist because China is locked down until mid-December, and they are still enforcing very severe COVID-19 quarantines in certain areas. While some of our suppliers have moved their sourcing out of China, they can't ramp up overnight, so we remain hopeful that China will relax its regulations, which will reduce supply chain constraints over time. Our revenue growth during the fiscal quarter was driven by a technology solution, or TS, business and managed service practice. We generated revenue of $15.9 million, a 40% increase over a year ago, TS revenue, and we are winning new customers while earning while earning increased business from existing customers. During the beginning of the pandemic, we quickly shifted to this segment because it was short of sales cycles and sales were not being impacted by restrictions. And we have continued to focus on this segment as it's become a growth engine over the past couple of years. The managed service practice revenue grew 24.4% from prior year and was driven by customers' increased customers increasing use of the implementation installation and training capabilities. Our high performance products or HPP business had one of its strongest quarters in quite some time and reinforces the sentiment that we have been sharing with you over the past year. We reported revenue of $2.5 million, a significant increase compared to a year ago level of $1.1 million. The primary contributor was from a government contract which had been expected for some time and we We're just waiting for some critical components to finalize and ship the order. The quarter also included revenue contributions from royalty revenue related to E2D program as well as Mericom. To summarize, we had a great start to the fiscal year. A strategy of focusing on higher margin products and services that meet customer demand is yielding solid progress each quarter, and we have reported two consecutive quarters of 40% plus revenue growth. Despite converting some of the older backlog to revenue, we also booked nearly an equal number of new orders. This demonstrates the strength of our offering, yet it also highlights our continued engagement in customer loyalty during this period since we have not lost a single order from the backlog. We have successfully transitioned our business during this unprecedented period, and today we are an active player in the high growth and margin business. and we believe that we have the resources and wherewithal and strategy to realize our potential. With that, I will now ask Gary to provide a brief overview of our fiscal first quarter financial performance.

Thanks, Vic. As Victor mentioned in his opening remarks, we had a solid fiscal first quarter with revenue of $18.3 million, a sizable improvement over the year-ago fiscal first quarter. We reported gross profit of $5.8 million or 31.7% of sales compared with $3.6 million or 29.2% of sales in the year-ago fiscal first quarter. And with each of the revenue sources, we experienced a significant increase in product gross margin compared to the year-ago fiscal first quarter level while service gross margin again surpassed 50%. Our engineering and development expenses for the first fiscal quarter were $836,000 compared to approximately $627,000 in the year-ago period. As we have disclosed previously, the increase is primarily due to higher personnel costs, which include outside consultants. Our SG&A expenses in Q1 were $3.6 million, up slightly compared to the year-ago fiscal first quarter due to increased variable compensation based on higher gross margin profit. We reported net income of $1 million in the first fiscal quarter, or 21 cents per diluted share compared with a loss of $366,000, or 9 cents per common share for fiscal 2022's first quarter. The company had cash and cash equivalents of $19.6 million as of December 31st, 2022, which is approximately $4.4 million lower as compared to the September 30th, 2022 level. primarily due to a previously referenced large financing customer sale recognized in revenue in the fourth quarter of fiscal year 2022, but the cost was paid in the first quarter of fiscal year 2023 during the fiscal 23 first quarter. We have authorized to issue an additional $300,000 shares of common stock as part of our CSPI 2014 Employee Stock Purchase Plan. I also want to highlight that the Board of Directors approved a quarterly dividend of $0.03 per share payable on March 14, 2023 to shareholders of record on the close of business on February 24, 2023. The vigilance we have employed over the past couple of years have ensured that we have the resources to execute the multi-year growth strategy of transforming to a cybersecurity, wireless, and managed service company. With that, I will turn it over to the operator to take your questions.

Certainly. The floor is now open for questions. If you have any questions or comments, please press star 1 on your phone at this time. We ask that while posing your question, you please pick up your handset if listening on a speakerphone to provide optimum sound quality. Please hold just a moment while we poll for questions. Your first question is coming from Joseph Nurgis at Surgeon Investments. Please pose your question. Your line is live.

Good morning, guys. How are you today?

Hi, Joe. Very good.

Okay. A couple of quick questions. You mentioned in the press release about HPP having a sizable customer engagement in the first quarter. I'm assuming you don't want to name that sizable engagement. Am I correct in that? You don't want to name the customer itself.

Right. The customer per se.

Right. And you said the supply chain issues are still... a little better than they were last year, but still not up to snuff at this point in time.

What you experienced, let's say, two, three years ago. That's correct. It's gotten a little better, but in certain vendors that we happen to do quite a bit of business, it's not that much better.

Okay. Another one would be on a previous call, you mentioned about the issues of obtaining new personnel or hiring new people, I assume with the latest amount of announcements on high-tech layoffs, is that lessening to any extent? In other words, are you able to find people a little easier than you were, let's say, six months ago?

Well, we haven't really hired anyone else that we're looking for, but I can tell you it's slowed down from people leaving quickly. you know, looking for other opportunities. The environment here at CSPI has been really stable, both on engineering sales and internal support, which is good. I think people are, you know, respecting the job positions they currently have and may be nervous to be, you know, the new person at any other organization in case there are layoffs.

Well, again, like I said, with the numerous announcements in the last month or so in the high-tech industry, I assume that's helping. Let's put it that way. A couple quick things. From your letter, your newsletter, or your end letter, you talked about unified communications as a service growing. And I was just wondering, is that something that you're finding a solid... potential down the road here?

Yeah, the pipeline's been real strong. We closed multiple deals in the quarter and the pipeline is as strong as it's been and we're hopeful that there's some large opportunities, multi-year opportunities that we're trying to close now that will definitely help because all these deals that we're signing are three-year deals you know, build on a monthly basis.

Okay, that sounds good. How about the cruise industry? Has that opened up a little bit in the last, let's say, couple months?

Conversations have opened up, which are good, and we are doing some planning right now to roll out either software, security software on the ships or some wireless, but the talks are and the engagements are happening on a more frequent basis. Nothing confirmed of exactly when we're going to start doing the work on the ships or with the cruise lines, but the conversational piece has been active lately.

Just for my information, what were you actually doing prior? Is it Wi-Fi? What were you putting in the cruise ships in past years?

Yeah, it was... It was the Wi-Fi, and it was not only doing the configuration of the wireless, but we were also doing the pre-configuration, and we were all doing the site maps. So we'd go on the ship first, and we would do the site maps of where all the APs would be placed or need to be placed. And then we were also doing the NAC solution, which is called ClearPass. Okay. And that's made by HP Aruba.

So some of the ships have this capability and some ships are still awaiting this capability. Is that correct?

No, they all have them, but it's just they were upgrading to, you know, a better quality of product. You know, some of those ships have older products and older APs and, you know, being on a vessel where there's a lot of steel and, these APs were a lot more efficient.

Okay. One other point here, and that is, you didn't mention, how did the exchange rate, the currency exchange rate affect this quarter versus, you know, previously we've had some benefits of the currency exchange rate in previous quarters. Was there a negative to this quarter with the currency exchange?

Yes. Yes, we did. We had it was negative this quarter. The dollar weakened against the... Yeah, it was negative almost $500,000.

Okay. So, again, if it was equal, that would be $500,000 more that we would have had down there.

Correct. Correct. Yeah, it was $400,000 and I forgot exactly the number. It was $460,000, $70,000. Yeah.

And one other point I want to make, just basically a statement. There's a great deal of current hype around artificial intelligence, between Microsoft buying into it, Google buying into it. And I just want to make the point that have we not incorporated artificial intelligence in our area platform two to three years ago?

Yeah, we did, absolutely.

So, you know, I'm just trying to say we're not behind the game in that particular aspect. But, again, thanks a lot, guys.

Yep. Thank you, Joe. Talk to you soon.

Your next question is coming from Brett Davidson with InvestLighter. Please pose your question. Your line is live.

Good morning. Good morning, Brett. Good morning. I'm not much of a morning person, but let's just say that helped. I just got one quick question. Well, Joe already touched on the cruise business, which I was going to get an update on that. The high-performance product, I know you indicated that the supply chain is still an issue. If you could have gotten your hands on everything you needed – What, you know, if you could give me an estimate of what the additional sales volume would look like over there.

On the HPP or the total company?

No, the HPP. I mean, with the product sales, what, you know, the Miracom stuff, what would it have looked like, you know, if you guys could have gotten your hands on all the parts that you needed to ship, you know, what you have orders for?

The backlog is about $4.4 million. Now, some of that is related to the ARIA contracts because they're deferred over time. So you keep them in backlog. So that's a portion of it. as well as some we've got product, but the customer doesn't want it. They've got to spread over time. So it isn't that we would get the entire amount at one moment.

So, I mean, the supply chain issue, the supply chain, did that impact your ability to deliver product or not really? Yes.

I would say about $2 million, around $2 million, maybe just shy of $2 million would have been able – been able to go in if we had the components to build the systems. Yeah, I would say about half. And that's at a very high profit margin.

And I would imagine that since the end of the quarter, I've got to imagine that pressure is continuing to ease. You know, getting your hands on the parts.

No, not really. No. To be honest with you, in some cases, it's getting worse. Yeah.

Oh, my God. Well, let's hope that swings the other way because, yeah, you know, $2 million today sounds better than $2 million next quarter. Yeah.

That's all I got. Thanks a bunch. As soon as we can get it shipped out, we do. We're at the mercy of some of these larger organizations.

Your next question is coming from Mike Price. Please pose your question. Your line is live.

Good morning. Congratulations on a good quarter. Can you tell us what the ARIA revenues were for the quarter and how much of the backlog is ARIA-related?

The ARIA revenue was about, I think, about $140,000, and then the backlog is probably half a million dollars.

Is this not a big growth area? I mean, it seems like there's huge upside with ARIA. Is that not the case?

There is. Yeah, it is. It's what we're focusing on and moving forward with it. But as I mentioned on previous calls, the technology, once we get in, you know, we have a really good chance of winning it. But, you know, we've had some name recognition problems. You know, it's just we're not on the gardener. You don't get there until you have revenue. And it's, you know, sometimes they go with the larger company even if they're, you know, if they're not – If our product outperforms them, they still kind of go with a company that's a multi-billion dollar organization. We've seen that quite a bit, actually. So, you know, we have over a dozen accounts now, so it's getting a little easier, but we're still not on that magic quadrant. And when you get into, you know, a SIM product, they do a lot of, some of the organizations are looking for that magic quadrant, and we're not on it yet. And, you know, we're talking to Gardner, but there's a lot to go through. And there's a revenue requirement. So it's a chicken and the egg effect. You know, how do you get on there? Unless you have revenue and how do you get the revenue if you're not on it? So, but it's our biggest area. It's just taking time.

Is the industry aware of the technology and as good as you think it is?

Well, we're providing as much information as we can to, you know, to as many people that will listen.

Okay. The question is, can somebody larger do more with ARIA than if you can't get in the door, is the question.

Yeah, absolutely.

Okay. A couple other quick questions. I didn't see anything about the share repurchase. The original 194,000 shares, I think only something on the order of 20,000 or 22,000 has been repurchased. Is that correct?

Yeah, we didn't purchase any stock in the quarter.

Anything since the end of the quarter that you can discuss?

No.

Well, we're in a period where we couldn't buy.

Well, again, it seems like with what you've outlined as far as the prospects and everything going forward, it seems like if you don't buy it now, you're not going to be able to buy it. Is that not the case? I know you want to keep the powder dry, but at the same time, it looks like there's huge upside for what you're doing.

Yeah, absolutely.

Okay. Last question has to do with the dividend. You've never been in a better position, good cash position. Interest rates are up, so you hopefully are earning some, have interest income on the cash. And the dividend is 20% of what it was pre-COVID, pre-PPP. Any prospects there for raising the dividends?

We talked about it at our last meeting. We decided right at this stage with some of the financing deals we've been doing with our customers to keep that sticky, we're looking at keeping the cash at hand right at this particular point. Things may change in the near future. Okay.

Okay. All right, I appreciate it and look forward to the next call. Thank you.

Thank you.

Once again, if there are any remaining questions or comments, please press star 1 on your phone at this time. There appear to be no further questions in queue. At this time, I would like to turn the floor back over to the CEO, Victor DiVolo, for any closing remarks.

Thank you. As always, I want to thank our shareholders for continuing interest and support. We have now reported consecutive quarters of significant growth and momentum we are continuing to experience in the current quarter excites us for the remainder of the year. We have solid revenue conversion, strong pipeline, and a product and service portfolio are generating favorable gross margins. Gary and I look forward to sharing our progress in fiscal 2023 second quarter operating results in May. Until then be well and stay safe. Thank you.

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