CSP Inc. (NASDAQ:CSPI) Q3 2024 Earnings Call Transcript

CSP Inc. (NASDAQ:CSPI) Q3 2024 Earnings Call Transcript August 13, 2024

Operator: Good morning, everyone, and welcome to the CSPi’s Third Quarter Fiscal Year 2024 Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Michael Polyviou. Sir, the floor is yours.

Michael Polyviou: Thank you, Matt. Hello, everyone, and thank you for joining us to review CSPi’s fiscal 2024 third quarter results, which ended June 30, 2024. With me on the call today 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’ll 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 terms 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 met 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 serve several uncertainties, risks and other influences, many of which are beyond the company’s control that may influence the age statements in 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 Factors section of the annual report on Form 10-K and the quarterly report on Form 10-Q filed with the Securities and Exchange Commission.

Forward-looking statements are based on 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 the 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. Vic, please go ahead.

Victor Dellovo: Thanks, Michael, and good morning, everyone. Earlier this morning, we announced our fiscal 2024 third quarter results, and with the supply chain issue well passed, I’m pleased to report our business has returned to a more normalized revenue run rate, and we have focused on driving our higher-margin business while building the required infrastructure to drive the success of the emerging AZT product — PROTECT product line. We have been able to consistently grow the service business and fiscal third quarter with no exception as the service revenue increased 10% and contributed 150 basis points improvement to the gross margin percentage over the prior year level. The AZT PROTECT offering has the capability to dramatically reshape our high-performance product business and our entire company.

Customer enthusiasm for the product line remains high, and the team is generating leads in building an attractive pipeline. Moreover, we are continuing to extend the brand awareness of AZT PROTECT through multiple awards, including being named winner in the Application Security category at the 2024 Fortress Cybersecurity Awards presented by Business Intelligence Group. Overall, the team has done an incredible job as this was the ninth major industry award for the AZT PROTECT since the launch of the following — follow success at the Cybersecurity Excellence Award, the Global InfoSec Award at RSA in the Global Award for Cybersecurity. During the quarter, we also signed some small mid-tier manufacturing customers located in the Midwest. We have many other similar opportunities that are being pursued to ensure we maintain the momentum and remain focused.

We recently hired Greg Pysher an experienced 20-year IT industry sales veteran as VP of Sales to head up the AZT product — PROTECT business. Throughout his career, Greg has consistently driven sales and is known for building and training high-performance teams in a complex solution sales and mentoring them to achieve ambitious goals. Greg is already transforming our sales team and in just a few weeks, his impact is being felt throughout the organization. While our multi-pronged sales strategy includes engaging with Fortune 500 companies, Greg immediate goals to ensure we have the right sales team to focus on small to mid-tier enterprise because of the shorter sales cycle. We will continue to pursue larger opportunities directly or through our partners despite the longer sales cycle because each one can represent multimillion-dollar contract opportunities, like the one we signed in the second quarter, which helped AZT PROTECT awareness in the market.

Greg is also helping the team prepare for several upcoming events such as the American Petroleum Institute Conference taking place in Houston. This conference is the only cybersecurity conference dedicated to oil and natural gas industry and has a loyal and dedicated attendee base. As we engage with the largest oil company in the world in the water treatment plants, the process to evaluate AZT in these large oil and water treatments have taken months. Just to get set up in the system to do a proof-of-concept or a POC has taken 4 to 6 months. The team will also attend the industry industrial control system cybersecurity conference being held in Atlanta. This conference is the largest and longest running event series focused on industrial cybersecurity.

Since 2002, the conference has gathered ICS cybersecurity stakeholders across various industries and attracts operations and control engineers, IT government vendors and academics. We believe these and other conferences are a ripe opportunity to further expand our brand presence within the OT marketplace. We have also successfully executed our AZT PROTECT Partnership program over the past few months. We entered a new integration partnership with Forescout Technologies, which offers comprehensive asset intelligence and control across IT, OT and IoT environments, trusted by Fortune 100 organizations, government agencies and large enterprises for over 2 decades. Forescout serves as a cornerstone for managing cyber risk, ensuring compliance and mitigating threats.

This full integration will take some time, but we believe the opportunity could be huge. In addition, Ebix’s a managed security service provider performed a lengthy in-house red team evaluation of AZT PROTECT prior to adding ARIA to its existing portfolio of technology partners. Ebix is a leading provider of innovative cybersecurity services and solutions to commercial as well as government and public sector customers in North America, EMEA and APAC regions. Lastly, worldwide technology, a large global reseller of IT and cybersecurity solutions will supply the award-winning AZT PROTECT solutions to its customers. I believe this approach ensures we are using our resources and those of our partners to significantly raise the profile of AZT offering and build revenue opportunities.

In only 3 weeks, Greg has currently signed multiple resellers. And Greg is confident we can increase the number of OT-focused sell by December to over a dozen. Locations of these resellers are all over the world, including Chile, Peru, Brazil, Morocco, Norway, India, Australia and Iberia. Our largest partnership is Rockwell, and we have recently been selected to update the industry on how to measure the cybersecurity risk facing industrial operations and how to got against them at the Rockwell Automation Fair in November. The event is being held in Ana High California; and [Gary Selfe], Vice President and General Manager of High Performance Products segment will be a guest speaker. He will be presenting an in-depth review of the latest attack techniques in their financial impact.

Gary will outline how insurance providers are measuring the risk of how companies can comply with the new insurance and regulatory requirements, and we’ll share a range of use cases to demonstrate how companies can apply reduction techniques to reduce measurable risk, including a high-profile ransomware attack on Merck, which resulted in a $1.4 billion impact and led to a lengthy legal battle with this insurance to recover losses. Working with Rockwell together, we will be delivering new solutions to manufacturing environment that complement existing passive and active defense, and pick up what they miss. Before I review the Technology Solutions, TS business, I wanted to spend a couple of minutes highlighting the recent CrowdStrike, induced window outage and the opportunity it presents for AZT.

While the target market for AZT PROTECT was initially focused on operational technology, or OT, it was always our intent to engage the information technology or IT market professionals. We’ve had already commenced discussion with IT professionals. So the timing of the outage was a benefit to our efforts. We believe — had AZT PROTECT been previously deployed, the outage would have been controlled at the corporate level. It has been estimated that the cost of the outages in the billions of dollars and a Delta Airlines CEO has said, this company $500 million. We believe companies using AZT PROTECT protection capability can prevent both malicious code as well as flat updating from taking critical systems down. We’ve proven this capability in the field under real-life operational circumstances.

We can ensure that the untested updates do not become active on the systems, helping corporations and organizations that at all levels avoid another CrowdStrike type of disaster. As become the norm for IT applications and cybersecurity vendors to send updates directly to their applications. Unfortunately, as a CrowdStrike event has demonstrated a few customers to test these updates and just allow them to update automatically, whether intentional or not, untested supply chain updates can more have it on a critical system than most cyber-attacks. If an update to the system puts lives and danger due to the outage, it should not be deployed without some formal verification test. Same goes for servers running any critical business process. The Technology Solution, our TS business continues to perform well and generate the majority of the quarter’s revenue.

The success of the TS continues to be driven by our customers, increased use of implementation, installation and training capabilities. We continue to add new MSP customers, and we are currently awaiting decisions on several big orders that if they go in favor could positively impact our results in fiscal 2025 and beyond. The activity is encouraging. And to add more color, we are in the process of implementing a wireless conversion to over 70 to 80 locations of a global hospitality company. This work will continue through 2025. We also are working with one of the largest freight operators specializing in containerized ocean exports serving numerous ports worldwide, and we will be double the number of container ships for which we are performing equipment conversions and will continue to be their MSP for each and every ship.

We also continued to generate higher levels of interest in our UCaaS offering. And during the current fiscal fourth quarter, we already signed several new customers, the momentum with the UCaaS is building, and we expect to enter the new fiscal year with an annual revenue run rate that is more than double that what it was entering in fiscal Q4. In summary, the strength of the TS business has allowed us to fund and develop AZT PROTECT. The TS business has 3 lines of recurring revenue, the UCaaS, the cloud practice and managed service practice, this was a slow methodical process over the last few years, but we now have all 3 generating consistent profits. We are building the AZT practice with the same methodology and determination as we did with the other lines of business.

So I’m highly confident we will be generating consistent profits in the near future. Today, we are in the process of deploying additional resources to ensure we have organizational infrastructure to support the business in 2025 and thereafter. AZT PROTECT has the potential to revolutionize on our OT professionals approach their responsibilities in recent events reinforce that IT professionals also need to be vigilant and ensure their business are not compromised, whether from external threats or third-party software update. Our commitment to develop, innovate in high-margin products in services has enabled us to expand our gross margins and grow our cash balance to a near record level. With that, I will now ask Gary to provide a brief overview of the fiscal third quarter financial performance.

Gary?

Gary Levine: Thanks, Victor. For the third quarter ended June 30, we reported revenues of $13.1 million compared to revenue of $17.7 million for the fiscal third quarter ended June 30, 2023. I want to point out that at the year ago fiscal third quarter, we converted a sizable portion of backlog to revenue as the supply chain issues had eased, and we were able to get key components to complete and ship customer orders. As Victor said earlier, we have returned to a more normalized business environment. In fact, revenue was relatively flat compared to the 2024 fiscal second quarter. Gross profit for the three months ended June 30, 2024, and was $4.6 million or 35% of sales compared to $5.9 million or 33.5% of sales, representing 150 basis point gross margin percentage improvement despite the lower year-over-year revenue as higher margin services revenue fuel the improvement.

For the third quarter, our engineering and development expenses were $734,000 compared to $741,000. Our SG&A costs include continuing investment required to build out the AZT sales, support and marketing where — and the amounts were $4.6 million for both fiscal years. For the fiscal third quarter, we reported a net loss of $185,000 or $0.02 per common share compared to a net income of $2.5 million or $0.26 per diluted common share for the fiscal third quarter ended June 30, 2023. In the prior year, our tax benefit was $1.7 million for the fiscal third quarter, primarily for the release of the valuation allowance against our deferred tax asset. For the third quarter, we generated operating cash flow of $2.4 million. And as of June 30, 2024, we had cash and cash equivalents $28.9 million compared to $13.9 million in the year ago fiscal third quarter and $25.2 million at the end of our 2023 fiscal year.

We believe that the continued success of the TS business, our ability to focus on selling higher-margin products and services gives us the flexibility to leverage our resources to execute the multipronged sales strategy to target small, medium and large enterprises for AZT PROTECT. During the fiscal third quarter 2024, the company repurchased 4,800 shares for a total cost of $70,000. We currently have 9.7 million shares outstanding. Lastly, the Board of Directors approved a quarterly dividend of $0.03 per share payable on September 10, 2024, to shareholders of record on the close of business on August 23, 2024. With that, I will turn it over to the operator to take your questions.

Q&A Session

Operator: [Operator Instructions] Your first question comes from Joseph Nerges from Segren Investments.

Joseph Nerges: Well, first, congratulations on all the awards that AZT PROTECT has gotten. And of course, the expansion of the partnerships to some very large organizations is also positive going forward. My first question is really on the integration of AZT PROTECT into the Forescout platform. Where is that? And how long do you anticipate that to take?

Victor Dellovo: We haven’t started it yet. We are planning on — they’re doing planning sessions right now, and it could be anywhere from 4 to 6 months for that to be fully integrated in testing.

Joseph Nerges: Okay. So it’s going to be obviously — some from our end and some from their end –.

Victor Dellovo: Yes. They’ve engaged a team that’s been — that we’ll work with to build all the APIs but it’s a lengthy process — it’s a lengthy process, right? In dealing with these large companies as usually even on the integration. And it could be faster. I’m just not exactly sure I don’t know how fast the team is going to be and there’s going to be a lot of testing that has to be that we have to go through with them. So we’re hoping it’s faster, but we’ll see.

Joseph Nerges: I’m not aware if they have any outside. Are you unique in this in the Forescout, do you know that? If you’re unique in that almost all their platform was either developed internally or was via mergers, where they have integrated other systems after they bought the company. Do you know if there was any other outside suppliers to their platform like — our case would be and outside –.

Victor Dellovo: I didn’t ask the question, to be honest with you. When we met them and we said we were pretty happy that they saw how we could — they have a great product and how we can complement that product and not cannibalize anything that they currently already have, right, because they wouldn’t want 2 competing products against each other, whether it was — I’m guessing whether it was another outside partner or something that they own internally if we were doing the same thing, then I’m sure they wouldn’t have signed this up.

Joseph Nerges: Yes. Well, I don’t know of anything where they have a product that stops an attack like AZT PROTECT what would you do. Just another follow-up here on with Rockwell. With — and of course, with the bottle with the CrowdStrike faulty software download, you — there’s got to be a significant number of their clientele or customers that have been — that were affected — it have to be in the OT environment because of such a dramatic amount of people were effective. So I would assume that they have a number of customers currently that we’re going through that problem. Do we know of anything? Have we gotten any update or any feel for what happened at Rockwell via the CrowdStrike the bottle, if you want to call it that.

Victor Dellovo: Yes, they pointed us to work with their partners that sold the systems, and that’s kind of what we’re building a food chain with their partners. The biggest thing with the Siemens or Rockwell’s, the Emersons of the world and the process that we’re going through is to get certified on the systems. And that’s kind of what we do with Rockwell and they love what we have to offer. I think that’s why they invited us to do a talk at the upcoming show because like they said, we’re very unique on how we go-to-market with the way we protect applications at the core level. So that’s kind of what we’ve been doing now that we’ve got approved and we’re working with the marketing team in the magazine and all that stuff, now they — we’ve had their blessing and now we’re setting up each and every one of their partners.

But there’s a process that goes through that. And I think that’s part of the thing. I think everybody has to understand is that when you sign up new partners, you have to educate them and then you have to get mind share and it’s not the only thing they do all day and every day. So it’s definitely a process and putting training material for and then we had to put training material for companies outside the country and changing the language so they could read it. There’s a lot that goes in. And because we’re a small company, you can only do so much so fast, right? So I feel like we’re building the base, the partnerships, getting inside these resellers doing training material, marketing material — there’s a process with setting the foundation at this stage.

Joseph Nerges: Well, I guess my only point on the Rockwell question was basically a number of their customers were affected. And let’s [indiscernible], there’s more urgency from a customer standpoint, when there are being affected with different things as to how we could stop it. And I’m sure Delta does not want to go through what they went through again. And it has to be the same case with the Rockwell group. There’s got to be a lot of them that were affected, that don’t want to go through it again. So — well, I’d say there’s an urgency there for correction, some — a solution, let’s put it that way. And I’ll take one quick more follow-up here. What’s different with your IT version of AZT PROTECT? You say — you’ve come out with an IT version. And how do we differentiate ourselves a little bit. Can you add a little color to that or attempting to do with the IT version?

Victor Dellovo: Well, the IT version, because of all these updates, they — in the OT space, it’s kind of more locked down, right? Everything is kind of scheduled. So it’s a more stable environment with the IT where there’s constant updates, whether it’s any type of any software you’re running. We had to build a product that scans all the updates, looks at if it’s from a valid source. And then in a lot of cases, the way we built it was for the individual to approve the update. We’re going to tell it’s from a source, a valid source. And then it will — at that stage, it will be up to the individual to basically approve the update. And that’s kind of where in the CrowdStrike, it wouldn’t have been an automatic update, we would have basically stopped to look at it and would have given the customer the time to test it and not just automatically let it go through.

And that’s kind of where I think some of the messaging on the CrowdStrike is like nothing happens unless you approve it, you analyze it, and then you should be testing it, but that’s, of course, not every company is going to do that, and that’s kind of where they get into some problems.

Joseph Nerges: And this is not really available outside in many other cases. In other words, this idea of testing before has not been implemented too often other places — on the software competitors.

Victor Dellovo: Yes. Well, see, the other thing we do too is, while a lot of these patches is because they have a gap, right? And then — so they’re vulnerable potentially without that patch. When if you had AZT to complement all these products, we would still protect you 100% while a CrowdStrike or Sophos or Trend Micro or whoever else that’s out in the marketplace ran their testing and before they were updated.

Joseph Nerges: Okay. Well, great. Sounds like pieces in place, just a matter of time —

Victor Dellovo: Yes, yes, we got — we’re building — it’s — I had mentioned it at least the last two quarters, so everybody has a clear understanding that we have built three other profitable practices on the umbrella, it takes time. You build a food chain, you build a sales force, you have to build rebate programs, you have to build marketing. And the sub-30 people in the HPP just to give a concept of how many people are doing all this. And most of those guys are engineers, so that developed the product. So — and we hire sparingly, and we try to do that what makes sense, and we try to hire the right — I can’t hire enough salespeople. We can’t afford it. So what we’re trying to do is to build a — the food chain using partners and getting the right partners and getting the right OT, right?

We’ve never been in the OT space historically. So all these partners, and that’s kind of why when we chose to bring Greg on, he’s 20 years of working basically for the same company that only sold into the OT space. Nothing else.

Joseph Nerges: Just a matter of time. That’s for a…

Victor Dellovo: Yes. Like I said, we built three other little businesses inside the MSP are recurring revenue models, by the way, it took a little time, but guess what? It’s a consistent business now that generates profits, month-in and month-out.

Operator: [Operator Instructions] That concludes our Q&A session. I will now hand the conference back to Victor Dellovo for closing remarks. Please go ahead.

Victor Dellovo: Thank you. As always, I want to thank our shareholders for your continued interest and support. Good things are happening, and the industry is taking notice of CSPi’s award-winning AZT PROTECT. The activity we are experiencing is exciting, and we look forward to sharing our progress in fiscal 2024 fourth quarter and full year results quarter in December. Until then, be well, stay safe and enjoy the rest of the summer.

Operator: Thank you, everyone. This concludes today’s event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.