CSP Inc.
Q2 2020 Earnings Call Transcript

Published: 14 May 2020

[Operator:]

Good day, everyone, and welcome to the CSPi Fiscal 2020 Second Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions. [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 EVC Group. Please go ahead, sir.

[Michael Polyviou:]

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 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'll open the call for questions.And 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. 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 wellbeing 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 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 am quite certain that Q2 revenue would have surpassed a 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 and Unified-Communications-as-a-Service business as we continue to transition to a cybersecurity, wireless and managed service company.We are currently conducting an average of five new product demonstrations a week, and I can say without hesitation that interest in our new product lines and services 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 required 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 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 Solutions, or TS revenue was $14.6 million. We entered the quarter with plenty of momentum in the first two months of the quarter were going like gangbusters. However, the impact of COVID-19 pandemic caused a slowdown in our cruise line business in some professional service engagements. Although, we finished much 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 cruise 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, is quite evident that is no longer a matter of – but 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 division. Our award-winning next-generation cybersecurity platform gives us reason to be optimistic about the growth potential for our HPP business. We will recognize that 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 four awards in the following categories. First was encryption, which recognizes ARIA key management proven ability to automatically generate and distribute encryption keys to manage lifecycle requirements.The second was network detection and response. Demonstrating that ARIA could successfully enable faster, better and more comprehensive threat detection, investigative 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 maybe happening and immediately notify the appropriate team. This helps any company improve compliance with GDRP, PCI, or DSS and other regulation.And finally, the fourth was threat detection, intelligence and response, which recognizes the ARIA SDS platform towards ability to orchestrate and protect any organizations 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 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 slowdown 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 highly trained security staff.Additionally, we integrated ARIA Cybersecurity Solutions with Juniper Networks', Juniper Secure Analytics Platform, providing deep network visibility, as well as the 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 insights 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 solutions 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?

[Gary Levine:]

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 continue 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 and 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 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 that is $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 and the UK.During the quarter, we had income tax expense of $1.2 million primarily from recording a valuation allowance against our deferred tax assets. We concluded that a portion of our deferred tax assets 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 and short-term investments of $15.2 million, which includes $9.9 million in the UK 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 dividends to preserve financial resources for working capital purposes.We also applied for and received two loans totaling less than $2.2 million from the Paycheck Protection Program included in the CARES Act. The PPP was established to help small business with under 500 employees.CSPi has approximately 116 employees. At no time that we layoff or furlough any employees because 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:]

Great. Thank you. [Operator Instructions] And we can take our first question from Joseph Nerges with Segren Investments. Please go ahead. Your line is open.

[Joseph Nerges:]

Good morning, guys. How are you today?

[Victor Dellovo:]

Good morning, Joe.

[Gary Levine:]

Hey, Joe.

[Joseph Nerges:]

I guess we take a little bit of a hit here with this dividend cut, your stock. But let me get some clarification here. Did you say – what's the employee count that you just mentioned, Gary, right now?

[Gary Levine:]

116.

[Joseph Nerges:]

116 employees?

[Gary Levine:]

Right, yes.

[Joseph Nerges:]

Okay. Is that pretty much what we had last quarter or last year? I thought we had a little more…

[Gary Levine:]

Yes. 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:]

Okay. All right. Obviously, absence of Germany. Now on the capturing back of income tax expenses 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 account…

[Gary Levine:]

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:]

Okay. So that was reported in this quarter you just reported now.

[Gary Levine:]

Correct. Yes. You had to show all the effect of the CARES Act within this quarter.

[Joseph Nerges:]

Okay. I'm still trying to calculate this $2,180,000, $160,000 we're getting from the CARES Act, approximately that's what is the number is, right? $180,000, I guess?

[Gary Levine:]

Yes.

[Joseph Nerges:]

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 we incorporated in this current quarter? Or am I wrong there, too? Or is that already been reflected?

[Gary Levine:]

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.

[Joseph Nerges:]

Okay.

[Gary Levine:]

That's going to be – you're not going to be – you get forgiveness of that.

[Joseph Nerges:]

Okay. So you're saying that 60 days will be after – isn't like an x-period under the CARES Act.

[Gary Levine:]

After the completion that goes in the middle of June. It was probably to be – we probably won't get an accounting until the fourth quarter.

[Joseph Nerges:]

Fourth quarter. All right. So any end result [indiscernible] year-end report, let's put it that way, most likely.

[Gary Levine:]

Right.

[Joseph Nerges:]

Now 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 of that is still pending on potential cable customer?

[Gary Levine:]

Correct. Yes.

[Joseph Nerges:]

Has that been…

[Gary Levine:]

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 picked back up in June with them.

[Joseph Nerges:]

Okay. Well, from what I understand, the R&D group out of Denver is rolling out – they're working on the [indiscernible] 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?

[Victor Dellovo:]

You're fishing on that one.

[Joseph Nerges:]

Okay.

[Victor Dellovo:]

Yes, what we're doing with them, it's an internal project, which has – it's stays internal. But everything that we're working with them is just been – just tabled for a month or two, but nothing has stopped. The interest is still there.

[Joseph Nerges:]

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.

[Victor Dellovo:]

We're still talking to all of them.

[Joseph Nerges:]

Okay. On the most recent ARIA, the ADR application. That's quite a dynamic product if it works as advertised. As I understand, listening to the webinar, in a lot of cases, it could automatically correct the problems that maybe involved with hacking and [indiscernible] without even any intervention from their security breach.

[Victor Dellovo:]

Right. Yes, with the ways ARIA is set up, it would – you set you 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 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:]

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 five new product demos per week, are you referring to some of it is ARIA, some of it connected with the UCaaS or a combination of both?

[Victor Dellovo:]

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:]

Okay, that's great. But what you're saying is you would need to get access to their facilities for proof-of-concept, in other words, we need the people on site to at least help them integrate it.

[Victor Dellovo:]

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 and blocking. So it could also just monitor and then they could feed that information to someone and they can make the manual changes.

[Joseph Nerges:]

Right.

[Victor Dellovo:]

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 our 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:]

Okay. And I'm assuming the time it takes to incorporate that would be based on the size of the customer?

[Victor Dellovo:]

That's correct.

[Joseph Nerges:]

The larger, more complex would be more work let's put it that from our standpoint.

[Victor Dellovo:]

That's correct.

[Joseph Nerges:]

All right. Thanks a lot. I appreciate – I mean, we seem to have the right products. Unfortunately, the pandemic is holding us back in many areas.

[Victor Dellovo:]

That's correct.

[Joseph Nerges:]

Thanks a lot guys.

[Victor Dellovo:]

Thanks, Joe.

[Gary Levine:]

Thank you.

[Operator:]

[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.

[Victor Dellovo:]

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.

[Gary Levine:]

Thank you.

[Operator:]

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