CSP - Q2 2024

Transcript

Operator (participant)

Morning, everyone, and welcome to CSPI's second quarter fiscal year 2024 conference call. At this time, all participants are in a listen-only mode, and the floor will be open for questions after the presentation. If you do have any questions, we ask that you limit them to one question and one follow-up question in the interest of time. Thank you. If anyone should require operator assistance during this conference, please press star 0 on your phone keypad. Please note, this conference is being recorded. I will now turn the conference over to your host, Michael Polyviou. You may begin.

Michael Polyviou (Head of Investor Relations)

Thank you, Jenny. Hello, everyone, and thank you for joining us to review CSPi's fiscal 2024 second quarter results, which ended March 31, 2024. With me on the call is Victor Dellovo, 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. During the Q&A session, we ask participants to limit themselves to one question and one follow-up question, and then re-queue if they have additional 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 meant 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 and that may influence the accuracy of those statements and the projections upon which such 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 the 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 Dellovo, Chief Executive Officer. Victor, please go ahead.

Victor Dellovo (CEO)

Thanks, Michael, and good morning, everyone. Early this morning, we announced our fiscal 2024 second quarter results, which once again demonstrates the return we are generating from our strategic shift towards higher margin products and services. While we continue to invest in the broadening the launch of AZT PROTECT, we grew services revenue 23%, increased our gross margins 47%, and realized a five-fold increase in net income compared to a year ago fiscal second quarter. Our progress during the first half of the year, combined with the building of the pipeline of AZT, positioned us for future success. I'll start my review of the operations with our high-performance product, or HPP, which is benefiting from the growing market interest in AZT offering. During the quarter, HPP contributed $2.5 million total revenue compared to $1.5 million in a year ago quarter.

The AZT offering is changing how we operate and how the industry perceives CSPi. We are generating significant attention and interest in industry events and conferences, and this interest is from some of the largest global corporations. Despite only being months into AZT launch, we are building traction in the market, and the level of customer enthusiasm remains high, as does the new business lead pipeline. During the quarter, we signed our largest contract for AZT, a multimillion-dollar agreement with a global pharmaceutical company which is deploying AZT across its global manufacturing platform and is in the process of protecting over 40 facilities from the growing cybersecurity threat to operational technology from hostile nations, terrorism, and organized crime. Early this week, a case history of AZT PROTECT was published in the journal, an award-winning publication from Rockwell Automation.

We can't begin to tell you how critical and important this is to reach a subscriber base of over 50,000, a targeted audience that is committed to keeping up to date with leading-edge methods, trends, and technologies that protect the industrial automation segment from cybersecurity attacks. Our partnership with Rockwell is expanding, as tomorrow we are co-hosting a webinar titled "Cyber RX: How to Automatically Protect Rockwell OT Customers from Today's Cyber Attacks." Gary Southwell, General Manager of CSPi ARIA Cybersecurity, will be joining Thomas House, Life Science Cyber and Digital Consultant at Rockwell Automation. They will be discussing why the Purdue Model passive defense and AV/NGAV are not stopping the most dangerous attacks.

The webinar enables Rockwell to discuss the unique set of requirements that are needed to protect an organization's production applications attack surface and how ARIA AZT PROTECT plays a unique and critical role in meeting this need. Gary and Thomas will delve into the composition of supply chain attacks and finally hear about a case study of how one of the world's largest pharmaceutical manufacturers used ARIA AZT PROTECT in combination with Rockwell's industrial automation suite to protect their environment and meet their challenging OT requirements. As we outlined during our last call, we are leveraging the height of the trade show season and attended several of the more intimate OT-focused events as we continue to further expand our brand presence within the OT marketplace. This is part of our wider launch strategy, which is to engage with Fortune 500 companies to demonstrate the need for AZT PROTECT solutions.

We believe our approach is building interest with the slowest sales cycle customers, and we are building a pipeline opportunities focused on oil, gas, energy, and water treatment plants, just to name a few of the focus industries. To increase shorter-term revenue opportunities for AZT PROTECT, we implemented phase two of our multi-pronged sales strategy and hired three new salespeople to focus on middle-market enterprise. As a result of this investment, we have doubled the dedicated AZT sales team. To further expand AZT PROTECT market penetration, we are actively expanding existing partnerships and exploring the creation of new ones. We see this part of our go-to-market strategy as a pathway to address the government segment, as we are very close to signing one of the largest government-focused distributors.

We believe our direct sales team and the ability to use our partners' depth is going to significantly raise the profile of AZT offering and build revenue opportunities. We also announced two major awards that ARIA Cybersecurity wins: Global InfoSec Cybersecurity Product Award for AZT PROTECT at RSA, and ARIA Cybersecurity wins prestigious Globee Cybersecurity Product Award for AZT PROTECT. The technology solution, or the TS business, continues to perform and contribute $11.2 million to the total revenue of $11.8 million a year ago's quarter. During the first fiscal quarter, we announced a five-year multimillion-dollar contract to provide managed services for a prominent Florida public college, one of the largest and most diverse institutions of higher education in the nation. We will deliver proactive monitoring, management, and support for the college's critical technology infrastructure, including network, security, and private cloud services.

The success of TS continues to be driven by our customers' increased use of implementation, installation, and training capabilities. This component of our company remains quite robust, as we added new UCaaS customers during the quarter. The TS pipeline is currently running above average. The cloud business currently has a record pipeline. This is a highly stable business, as we have achieved a customer retention rate of more than 90%. The shipping business remains relatively unchanged from prior quarters. We did sign a new customer, and we are looking forward to fostering a strong relationship over the coming years. As I stated on the prior call, we are currently working with one of the largest freight operators specializing in containerized ocean exports, serving numerous ports worldwide with an extensive global agent network.

We have an order for over 14 ships that are expected to be retrofitted over the next few months, and upon completion, we expect to provide our managed services for each of these ships, which will add to our monthly recurring revenue. To summarize, with the successful launch of AZT offering, I believe we have positioned the company for sustained long-term growth and success. Our two businesses are growing, and the pipelines are growing, and we will translate to increased revenue margins and profitability. Lastly, we believe the recent two-for-one stock split increased the liquidity of CSPi shares, and I believe it will provide greater opportunities for institutional participation and enhanced shareholder value at the time we are broadening our business prospects. We also believe the success of AZT launch and growing cybersecurity threats allow us to now engage in an active investor relation strategy.

We will keep you posted as we schedule conferences, participation, and other related events. With that, I will now ask Gary to provide a brief overview of our fiscal second quarter financial performance. Gary?

Gary Levine (CFO)

Thank you, Victor. For the fiscal second quarter ended March 31st, we reported revenue of $13.7 million compared to $13.3 million in the year ago fiscal second quarter. Our revenue performance was driven by a 23% growth of the service business. Our Q2 gross profit, which was greatly impacted by the higher service revenue, was $6.5 million, or 47.3% of revenue, compared to $5 million, or 37.6% of revenue. For the fiscal second quarter, our engineering and development expenses were $726,000 compared to $858,000 as we reduced outside contractors and elected not to fill some open positions. Our SG&A cost for the fiscal second quarter was $4.5 million compared to $3.9 million in the year ago fiscal second quarter, as we continue to invest in the AZT offering, including building out the dedicated sales team and trade conferences participation.

Benefiting from the higher service revenues and higher margin, we recorded net income of $1.6 million, or $0.16 per diluted common share, for the fiscal second quarter ended March 31st, 2024, compared to net income of $0.3 million, or $0.03 per diluted share, for the fiscal second quarter ended March 31st, 2023. All such amounts have been retroactively restated to reflect the two-for-one stock split. Following the two-for-one stock split, we currently have 9.5 million shares outstanding. The company had cash and cash equivalents of $27.1 million as of March 31st, 2024. We believe our robust financial position allows us to execute our multi-pronged sales and growth strategy for the AZT offering, as well as other products and service lines and financial financing large customer agreements, which have been highly successful in the past for CSPI.

Lastly, the Board of Directors approved the quarterly dividend of $0.03 per share payable on June 12th, 2024, to CSPI shareholders of record on the close of business of May 24th, 2024. With that, I will turn it over to the operator to take your questions.

Operator (participant)

Thank you very much. At this time, we will be conducting our question-and-answer session. If you would like to ask a question, please press star one on your phone keypad. A confirmation tone will indicate that your line is in the queue. You may press star two if you would like to remove your question from the queue. For any participants using speaker equipment, it might be necessary to pick up your handset before you press the keys. Please pause a moment while we poll for questions. Thank you. Your first question is coming from Joseph Nerges of Segren Investments. Joseph, your line is live.

Joseph Nerges (Managing Director)

Thank you. Good morning, guys. How's everything going?

Gary Levine (CFO)

Good, Joe. How are you doing?

Victor Dellovo (CEO)

Good, Joe.

Joseph Nerges (Managing Director)

Okay. One question and one follow-up. You're cutting me down here. One question. I'm going back up to the last conference call you did, Victor. You mentioned that we're close to rolling out a full production line version of AZT, which sort of for the IT environment. Is that still in beta testing because that hasn't been released as of yet?

Victor Dellovo (CEO)

Correct. Yeah. It should be May. We're doing some additional testing just to make sure everything is where it needs to be. But we have rolled it out to a few of the customers already with no issues, but we have some enhancements and stuff like that we're developing right now.

Joseph Nerges (Managing Director)

How will that enhance what we already have out there? In other words, what do we expect that add-on will help us with?

Victor Dellovo (CEO)

Oh, in the OT space, right, updates and patches are not as important, and that's why our product kind of fits into where it protects it even without the patches. In the IT space, they still want to do patching, so we needed to allow for that, whether it's manual or automated. So that's where the enhancements came in the IT side of it, where, like I said, in the OT space, patching is not as important just because you can't really touch the machines. In the IT, whether it's a Microsoft patch or any other patch that's out there, we need to allow for that, and that's kind of where we've been developing and making sure it works with all the other products that are out there.

Joseph Nerges (Managing Director)

Okay. Just one quick follow-up here, and that is I think the last time you mentioned with the chemical company, our Fortune 500 chemical company, where we have multiple sites, but basically, it's the plant manager's decision whether he wants to implement the AZT PROTECT. Well, the old sales only comes out now. I can't imagine the approach that I would make to any plant manager would be, "Do you really want to be the plant manager to decide to not implement, and yet you were hacked at your plant?" I mean, that's sort of a career ender, isn't it? He's going to be in real trouble if X number have implemented it, and they're not hacked, and he happens to be the plant that's hacked or breached.

Victor Dellovo (CEO)

Yeah. That makes sense, but sometimes common sense is not the thing that people use all the time, so.

Joseph Nerges (Managing Director)

Well, I certainly wouldn't mind. I would put that in the back of their mind, if nothing else.

Victor Dellovo (CEO)

Oh, we always do. We always do.

Joseph Nerges (Managing Director)

Okay. Well, I'll open up for other questions for other people. Thank you.

Victor Dellovo (CEO)

Thanks, Joe.

Operator (participant)

Thank you very much. Just a reminder there, if you do have any questions, you can press star one on your phone keypad now to join the queue. It doesn't look like we've got any further questions. Oh, we do. We've got a question from Brett Davidson, who's a private investor. Brett, your line is live.

Speaker 6

Good morning, gentlemen.

Victor Dellovo (CEO)

Good morning, Brett.

Speaker 6

I had a question regarding those three new salespersons. Talks about targeting larger mid-market companies. What does that look like? Are these guys going out and meeting at their locations? What exactly does it mean that they're targeting mid-market companies?

Victor Dellovo (CEO)

Well, instead of looking at the top Fortune 500 companies, the huge gas companies, the huge companies that definitely have a need but move really, really slow, we're trying to get into that next layer where they're not as large, and we'll be able to target them, and hopefully, decision-making can come a lot faster. POCs could go a lot faster. And that's a combination of meeting some of the customers at trade shows, calling them on the phone, visiting them locally, whatever it takes. It's a combination of everything.

Speaker 6

Is there a pipeline right now regarding the AZT product? Is there stuff that is in process that's not quite to the sales line?

Victor Dellovo (CEO)

Yeah. It's a combination.

Speaker 6

Is there a pipeline for this?

Victor Dellovo (CEO)

Yeah. Yeah. It's a combination of we have current POCs going on where they're actually testing the product, whether it's in a lab or whether it's in their environment, and there's other ones that are lower down the line where we started talking to them, and now it's about getting these large companies all have big labs and getting the authorization and getting the security clearance and getting everything else that gets through so we could go into the lab and get set up. That's a process, a lot of paperwork, a lot of contracts, but getting into these large opportunities, that's what we've been focusing on. And we're using the automation partners like the Rockwells of the world and other players that I can't mention to leverage their sales staff to try to get into the relationships that they already currently have.

So that's kind of why we brought into the big. We're trying to work with the big security players that are out there also to leverage the long-term relationships they may have that can kind of move us, get us in faster. As a smaller company, CSPi, competing with the Palo Altos and the name brands, by leveraging those salespeople in the relationship that they had for maybe years, we're able to have conversations with these large companies that might take us a year just to get a conversation going. We're able to have an immediate conversation within weeks and try to get the next level with a POC.

Speaker 6

Is there a way to kind of measure that in a dollar figure, or is that more like a fool's errand at the point we're at and selling these things? Or is there a way to measure this pipeline of potential deals?

Victor Dellovo (CEO)

We have done some measuring internally, which I'm not willing to share, but we look at the initial opportunities based on the conversations we have, and we do have a pipeline that we're managing against. We have seen where some of the initial conversations started, and we put in an estimation of X amount of dollars, and as the conversations went on, the pipeline actually increased based on other needs and other people we talked to in the organization. So yeah, we are putting a pipeline, an estimation of revenue that we're managing internally based on the initial conversations that we're having with each and every organization.

Operator (participant)

Okay. Thank you very much. Your next question is coming from Mike Price, who's a private investor. Mike, your line is live.

Speaker 7

Thank you. Good morning. Thanks for taking my question. Hey, I know that you want to have wider distribution of shares and shareholders, but with a $120 million market cap and what you paint in front of you with AZT and having $27 million in cash, it seems like there's a room to be buying shares. I've asked this question each of the last three conference calls, and you have the authorized shares, but you haven't bought any shares. Any thoughts along those lines?

Victor Dellovo (CEO)

Yeah. Over the last quarter or two, when the stock was higher than it is currently, we didn't see the need. But at this price level, we are definitely considering supporting it and buying shares in the upcoming quarter.

Speaker 7

Okay. All right. Thank you.

Operator (participant)

Thank you very much. Your next question is coming from Sergio Heiber of Heiber Research. Sergio, your line is live.

Sergio Heiber (Analyst)

Hi. Good morning, guys, and congratulations on a huge improvement on the bottom line. I think you gave investors a head start in looking at the reaction today to the news. Investors are used to seeing improvements in the top line and not the bottom line. So I think that that's fantastic that you're concentrating on that. And I was wondering if you can give us some color on bundling ARIA with the major security products, for example, with Palo Alto?

Victor Dellovo (CEO)

That is definitely an option. We do complement. If it was a Palo Alto or a CrowdStrike or any of the other players, we can work in conjunction with all of them, especially where some of the old licenses in the XP world or Windows 7 that they may not be supporting, we can definitely take over any system that's running an older version. It's up to the customer. If they love the Palo or the CrowdStrike or whoever they're using, they can continue using it, and we'll work side by side. If they see us as a product that they want to fully implement across the platform, we'll be more than happy to take all the business. So yeah, we are not looking to rip and replace any of the major players out there at this stage of the game.

Sergio Heiber (Analyst)

But when I bundle directly so that it's sold, for example, Palo Alto will include the ARIA with the Palo Alto product?

Victor Dellovo (CEO)

I would love to get that relationship going. If you have any contacts, could that help do that? Please let me know.

Sergio Heiber (Analyst)

Yeah. So you have a contact with an unnamed company, which I think is Palo Alto, and that's why I'm asking that. I know you can't answer it, so I'll go on to another question. Can you talk about why the dividend was decreased?

Victor Dellovo (CEO)

Stock split. Yes. We looked at it from the standpoint that if we took the shares in, it would have been really at $0.025, so.

Gary Levine (CFO)

Yeah. So we went to $0.03. Yeah.

Sergio Heiber (Analyst)

Okay. And are you going to be giving it?

Operator (participant)

Apologies. You've had your allotted questions. If you do have any more, Sergio, you can press star one and join back in the queue. All right?

Sergio Heiber (Analyst)

All right. Thank you very much.

Operator (participant)

Thank you. Your next question is coming from Paul Scolardi, who's a private investor. Paul, your line is live.

Speaker 8

Hello, gentlemen. Two quick questions. First of all, we constantly see in the news the government warning against threats against utilities, water utilities, all utilities. Can you give us some color on, are we approaching this industry? Have we approached the industry? Are we getting traction? Are we getting the government aware that we have a solution to what they're warning about?

Victor Dellovo (CEO)

To summarize it, yes, on all parts. I had mentioned just a few moments ago that we are focusing on the energy, the water treatment. We've done marketing outreaches to all them. We've talked to individuals at shows, and I mentioned also very, very close to signing one of the largest government distributors out there that would allow us to do business directly with these different agencies. That would speed up the process because the distributor holds all the unnecessary contracts that would allow us to move through the system as quickly as possible. Let's put it that way. But yeah, it's all over the news. You cannot not see it. It's definitely something we focused on, and some of the trade shows, these folks show up there, and we've had conversations with them. But as I mentioned.

Speaker 8

Are your people going out to the water utilities?

Victor Dellovo (CEO)

If they will take a meeting, absolutely. Believe it or not, we're still in the world that nobody really goes to work any longer. Mostly, everything is over Zoom. They may go in once a week or twice a week, so a lot of the calls are over Zoom, but those conversations are happening.

Speaker 8

Okay. And then last question. With AZT, we have—can you give us some visibility now that you've been in the market trying to with these large companies, they take time. I mean, do you expect to be in this calendar, in this fiscal year of 2024, to be closing AZT contracts, or do you think the sale cycle now is going to—this is a longer-term story now that you've been in the marketplace, or do you expect to start closing contracts? You've closed some already. Should we expect to see in this year? And you can't predict the future, but you're the CEO. Do you expect to see AZT contracts continue to be signed in this fiscal year?

Victor Dellovo (CEO)

Oh, absolutely. Of what magnitude, I cannot say for sure, but contracts, absolutely. We are signing contracts, and I know everyone gets excited when we put announcements out there, but major contracts, I will announce, but there are other contracts that we have closed that don't warrant a public announcement. It could be $100,000, a $10,000. There are different levels of contracts that we are.