CSP Inc. (CSPI) Q2 2020 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the CSPi Fiscal 2020 Second Quarter Conference call. [Operator Instructions] Please note this call is being recorded. [Operator Instructions] And it's now my pleasure to turn the conference over to Mr. Michael Polyviou with the EVC Group. Please go ahead, sir.

Thank you, Tony. Hello, everyone, and thank you for joining us to review CSPi's fiscal second quarter ended March 31, 2020 financial and operating results. With me on the call today is Victor Dellovo, CSPi's Chief Executive Officer; and Gary Levine, CSPi's Chief Financial Officer. Before we begin, I'd like to remind you that during today's call, we will take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward-looking under the act. The company cautions that numerous factors that could cause actual results to differ materially from forward-looking statements made by the company. Such risks include general economic conditions, market factors, competitive factors and pricing pressures and others described in the company's filings with the Securities and Exchange Commission. Please refer to the section on forward-looking statements included in the company's filings with the SEC. After Victor and Gary conclude their opening remarks, we will open the call for questions. And with that, I'll turn the call over to Victor Dellovo, Chief Executive Officer. Vic, please go ahead.

Thanks, Michael, and good morning, everyone. We appreciate your interest and support of CSPi. Before we begin, I want to acknowledge the impact of the coronavirus pandemic and express our heartfelt concern to those who have been affected. The safety of our employees, customers, partners is our foremost concern, and we continue to take every precaution to ensure their well-being during this difficult time. To minimize the business disruption, we quickly adjusted our operations to comply with local, federal requirements, and currently, over 90% of the team is working remotely. Importantly, we have been able to build our contact with customers as well as potential customers via remote methods. Despite the operating restrictions brought on by regulations and guidelines to the -- to contain corona 19, we made solid progress during the quarter, doubled our sales in our service segment and increased gross margins. Total revenue for the fiscal second quarter was $16.1 million compared to $16.4 million. However, notwithstanding COVID-19, I'm quite certain that Q2 revenue would have surpassed the year ago level if business were permitted to operate normally. Nevertheless, our focus on higher-margin products allowed us to report improved gross margins despite the lower year-over-year revenue. Despite the current business disruptions, I also wanted to reaffirm the progress we are continuing to experience, a growing interest in ARIA in Unified-Communications-as-a-Service business as we continue to transition to cybersecurity, wireless and managed service company. We are currently conducting an average of 5 new product demonstrations a week, and I can say without hesitation that interest in our new product lines and services is at the highest level. More importantly, we are engaging with all our prospects. It validates the strength of our offerings. And as of today, we have numerous proof of concepts to perform with customers. However, performing the proof of concepts require the ability for CSPi's team to physically be on the customer premise. Therefore, the timing is too uncertain given the local, state regulations. So while we hope the near-term revenue impact is short-lived and minimal, our longer-term prospects are positive for CSPi as the remote working environment has exposed an increased threat to global digital infrastructure, which is the mode many corporations are using today to conduct their business. For the quarter, our Technology Solution or TS revenue was $14.6 million. We entered the quarter with plenty of momentum. In the first 2 months of the quarter, we're going like gangbusters. However, the impact of COVID-19 pandemic caused a slowdown in our cruise line business and some professional service engagements. Although we finished March strong due to the receipt of a few large orders, it's too early to tell if Q3 will be affected. Our managed service practice, or MSP, is performing well, and we increased our number of customers in the quarter, and Q3 is off to a good start. We have not lost a single customer, which demonstrates a high customer satisfaction, which is something we are keenly focused on at CSPi. And to ensure we maintain our high customer satisfaction, we expanded our engineering team even in this economic climate, as we view it vital to the overall performance and growth. Separately, the cruise ship industry is being severely impacted by the COVID-19 pandemic, with many operators looking to resume cruising during the summer months. Therefore, the revenue opportunities, which we expected to incur this quarter, have now been pushed to later in the year when travel restrictions have been lifted and our team can gain access to the ships. Our Microsoft practice had another stellar quarter, and we continue to believe we will achieve a greater growth rate this year compared to a full-year growth rate of 140% we achieved in 2019. I believe this is a combination of actions we have taken to strengthen our Office 365 business and increase the demand due to COVID-19. For those that are new to the story, UCaaS is an all-in-one service for hard or softphones, including 24/7 security and technical support. With redundant data centers located in Florida and Texas, this market segment is estimated to reach $79 billion in a few years. And based on the continued interest we are experiencing, it is quite evident that is no longer a matter if or when we will get our fair share of the revenue. Now I will move on to our High-Performance Product, or HPP, division. Revenue for the quarter was $1.5 million and reflects the expected decline in Myricom, which was partially offset by slightly higher-than-expected multi-computer royalties. We continue to expect the legacy business to improve throughout the year, which includes anticipated royalties for foreign E-2D military planes. Turning to our ARIA offering and division. Our award-winning next-generation cybersecurity platform gives us reason to be optimistic about the growth potential for our HPP business. We were recognized at the Cybersecurity Excellence Award held in March. The annual competition honors individuals and companies that demonstrate excellent innovation and leadership in information security. CSPi's ARIA Cybersecurity Solution took home 4 awards in the following categories: first was encryption, which recognizes ARIA key management server proven ability to automatically generate and distribute encryption keys to manage all -- manage life cycle requirements. The second was network detection and response for demonstrating that ARIA could successfully enable faster, better and more comprehensive threat detection, investigate response and immediate network threat containment, all without impacting network or application performance. The third was GDRP compliance. ARIA showed that they can validate any type of intrusion while it may be happening and immediately notify the appropriate teams. This helps any company improve compliance with GDRP, PCI or DSS and other regulations. And finally, the fourth was threat detection, intelligence and response, which recognizes the ARIA SDS platform for its ability to orchestrate and protect any organization's environment by improving visibility into all network traffic. ARIA SDS helps modern security teams find threats that may normally be missed and using surgical precision to stop them without disrupting valuable operations. Along with validating our decision to put the time, energy and resources in developing ARIA, the recognition by our peers will likely force prospective clients to slow down decisions they are having with someone else and looking at our directions. We are well prepared as we spent the better part of the past few months to build out the organizational infrastructure. And despite the COVID-19 pandemic, our staffing level is the same, and the continuity within the team will benefit our customers. While we remain well positioned within a leading cable company, the development during the quarter positions us for even greater success in the future. For example, introduced the new ARIA Advanced Detection and Response, ADR application, which automatically detects and stops cybersecurity attacks without requiring high trained security staff. Additionally, we integrated ARIA Cybersecurity Solutions with Juniper Networks' Juniper Secure Analytics platform, providing deep network visibility as well as accelerated incident response needed to disrupt cybersecurity threats before extensive harm can be done. We also integrated ARIA Cybersecurity Solutions with Sumo Logic's Continuous Intelligence Platform to provide security teams with cloud, native, real-time security intelligence and insight to help stop network-borne threats, including those involved with IoT or Internet of Things devices. Without interfering with the business operations, these and other integrations will increase our solution's impact as well as our market reach by leveraging access to these partners' customer base and prospects. In closing, I want to reiterate that our business was executing on all fronts prior to the COVID-19 pandemic. I want to thank CSPi's team for adjusting to this difficult period. They are doing a phenomenal job, and their continued commitment during this most difficult of times further strengthen CSPi. With that, I will now ask Gary to provide a brief overview on the fiscal second quarter financial performance. Gary?

Thanks, Vic. As Vic mentioned in his opening remarks, our fiscal second quarter revenue was $16.1 million compared to $16.4 million in the year ago quarter. Our gross profit was $4.5 million, up approximately 20% compared to last year's Q2 gross margin of $3.7 million, even on a slightly lower revenue base. Our gross margin of 27.9% improved several hundred basis points compared to the year ago gross margin of 22.9% due to the favorable mix of higher-margin business. As expected, our fiscal second quarter engineering and development expenses continued to trend lower at $716,000 compared to $781,000 a year ago due to a reduction in contract labor required last year to help in building out the foundation of the ARIA software platform and a recovery of a consulting expense where the services were not completed. Our SG&A expenses in Q2 were $3.9 million, which is slightly -- which increased slightly compared to the $3.7 million in last year's fiscal Q2 due to bad debt reserve, additional staff at TS and additional sales personnel for the ARIA, which we continue to launch in this fiscal year. We had income before taxes of $437,000 in Q2 compared to a loss of $761,000 in the prior year. We had a significant foreign exchange gain from our cash position in euros and U.S. dollars in the U.K. During the quarter, we had income tax expense of $1.2 million, primarily from recording a valuation allowance against our deferred tax asset. We concluded that a portion of our deferred tax asset will not be realized considering recent financial results, the coronavirus pandemic and the results and economic fallout. The current quarter and year-to-date income tax expense is net of tax benefits anticipated from the carryback of current and prior year federal net operating losses as allowed under the recently enacted Corona Aid Relief and Economic Security Act, known as CARES Act, to recover federal taxes paid in prior years. The prior year quarter had a tax benefit of $142,000. In the end, the second quarter with cash of -- and short-term investments of $15.2 million, which includes $9.9 million in the U.K., where we have a pension liability of $5.3 million. As we face the challenge posed by the COVID-19, we are focusing on liquidity, cost containment, prudent cash management, so we have suspended our share repurchase program and cash dividend to preserve financial resources for working capital purposes. We also applied for and received 2 loans totaling less than $2.2 million from the Paycheck Protection Program included in the CARES Act. The PPP was established to help small businesses with under 500 employees. CSPi has approximately 116 employees. At no time did we lay off or furlough any employees as they are vital to our future success. Given the current situation, it was unlikely that we could access the public equity markets to raise cash to help make up for the experiences during the first quarter of 2020 and likely to continue into the second quarter of 2020. In summary, we remain focused on driving our bottom line performance and boosting sales of our high-margin products. With that, I will turn it over to the operator to take your questions.

[Operator Instructions] And we can take our first question from Joseph Nerges with Segren Investments. Joseph Nerges;Segren Investments;Managing Director: Well, I guess we're taking a little bit of a hit here with this dividend cut on the stock, but let me get some clarification here. Did you say -- what's the employee count that you just mentioned, Gary, right now?

116. Joseph Nerges;Segren Investments;Managing Director: 116 employees?

Right, yes. Joseph Nerges;Segren Investments;Managing Director: Okay. Is that pretty much what we had last quarter or last year? I thought we had a little bit more, but...

Yes. It's been -- no, it's consistent within what we've had over the last year. I mean, we had a much higher when we had Germany. Joseph Nerges;Segren Investments;Managing Director: Okay. All right. Obviously, absence of Germany. Now on the capturing back of income tax expenses, what -- under the CARES Act, are we going to be able to capture some of that in this third quarter? Or am I missing that? I'm trying to get the accounts receivable here.

No. It's already been -- I mean we've done a preliminary calculation on it, and it's in the numbers that we reported. So that benefit is offsetting with the write-off of the deferred tax. Joseph Nerges;Segren Investments;Managing Director: Okay. So that was reported in this quarter you just reported now?

Correct, yes. You had to show all the effect of the CARES Act within this quarter. Joseph Nerges;Segren Investments;Managing Director: Okay. On the -- I'm still trying to calculate this $2,180,000 or $2,160,000 we're getting from the CARES Act, that -- approximately, that's what is the number is, right? $2,180,000, I guess.

Yes. Joseph Nerges;Segren Investments;Managing Director: Now will some of the employee salaries be subtracted on that via the -- or you subtract that from the loan, let's put it that way in what would incorporated in this current quarter? Or am I wrong there, too? Or has that already been reflected?

It will be -- the effect of that will -- what happens is at the end of the period, they have 60 days to review it and get back to you with what's going to be -- you're not going to be -- you get forgiveness of that. Joseph Nerges;Segren Investments;Managing Director: Okay. So that -- you're saying that 60 days will be after -- is there like an age period under the CARES Act?

After the completion that goes in the middle of June, it was probably going to be -- we probably won't get an accounting until the fourth quarter. Joseph Nerges;Segren Investments;Managing Director: Fourth quarter. All right. So any end result won't be probably on year-end report, let's put it that way, most likely.

Right. Right. Joseph Nerges;Segren Investments;Managing Director: Let's get back to some other quick questions here. Did you say that the cable -- did Victor say that the cable customer is still -- the status on that is still pending on potential cable customer? Has that been...

Correct, yes. It's just been pushed out just due to -- they're concentrating on keeping the internal customer service going, and they had -- everything's kind of on hold temporarily. I'm hoping things pick back up in June with them. Joseph Nerges;Segren Investments;Managing Director: Okay. Well, from the -- from what I understand, the R&D group out of Denver is rolling out -- they're working on the 10G rollout. So I'm assuming, if I'm correct, a lot of this may revolve about increasing their wireless product line down the road. Am I correct in that? Or am I fishing?

You're fishing on that one. Yes, what we're doing with them, it's an internal project, which has to -- it stays internal. But yes, everything that we're working with them has just been -- just tabled for a month or 2, but nothing has stopped. The interest is still there. Joseph Nerges;Segren Investments;Managing Director: Yes. But you indicated in the last conference call that the other cable companies, some of what you're doing, let's say customer A is applicable to other customers within this group. And then we had some interest or at least you were talking to some of the other...

We're still talking to all of them. Joseph Nerges;Segren Investments;Managing Director: Okay. On your -- on the most recent area, the ADR application. That's quite a dynamic product if it works as advertised. As I understand, listening to the webinar, they -- in a lot of cases, they can automatically correct the problems that may be involved with hacking and what's going -- this is -- without even any intervention from their security breach.

That's correct. Right. When you -- yes, with the ways ARIA is set up, it would -- you set your policies and you could literally be sleeping at night and it would make all those changes automatically, and then you could review them the next day if you don't have a full 24/7 SOC monitoring it. You could come in the next day and see all the changes and easily undo them if there was anything that you wanted to take a step back to normal after inspection. But yes, that's the magic sauce that I think separates us is that AI built in that can do this seamlessly while not monitoring it 24/7. So that's where the interest in -- when we show them what it can do, people are very, very interested in it, and things are going really well. Game-changing stuff right now. Joseph Nerges;Segren Investments;Managing Director: What -- when you refer to it, and I'll just let you go on this, I'm not going to prolong this, but when you refer to 5 new product demos per week, are you referring to some of it as ARIA, some of it connected with the UCaaS or a combination of both?

No, that was just ADR, what I was talking about there. It has nothing to do with the additional UCaaS demos and everything else that we're doing. That's strictly ADR. Joseph Nerges;Segren Investments;Managing Director: Okay, that's great. But what you're saying is you would need to get access to their facilities for proof of concept, is that -- in other words, you're -- we need the people on site to at least help them integrate it.

Correct. We need to put the ARIA product in line. If they want -- if you don't put it in line, ARIA inside their network, it can't do the automatic fixing and adjustments in blocking. So it could also just monitor and then they could feed that information to someone and they can make the manual changes. But if you want a full-line POC, which they do because they -- of course, they want to see it working. We need to get product in line and set it up for them. So we're scheduling things right now for June, if we can get in. And then if it has to move out, then we'll move it out. But right now, we are scheduling the POCs for June. Joseph Nerges;Segren Investments;Managing Director: Okay. And I'm assuming the time it takes to incorporate that would be based on the size of the customer?

That's correct. Joseph Nerges;Segren Investments;Managing Director: Obviously, the larger, more complex would be more work, let's put it that from our standpoint.

That's right. Joseph Nerges;Segren Investments;Managing Director: All right. I appreciate -- I mean we seem to have the right products. Unfortunately, the pandemic is holding us back in many areas.

That's correct.

[Operator Instructions] And it appears we have no further questions at this time. I'll turn the conference back over to Mr. Dellovo for any closing comments.

As always, I want to thank our shareholders for their continued interest and support. Despite the COVID-19 pandemic, our core business remains strong, and UCaaS and ARIA offerings point to a bright future. Gary and I look forward to sharing our progress with you on fiscal Q3 conference call in August. Thank you.

Thank you.

Thank you. This does conclude today's conference. You may disconnect, and have a great day.