CSP (NASDAQ:CSPI) Q2 2020 Earnings Call

0:01 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'll have the opportunity to ask questions during the question and answer session. You may register to ask a question at any time by pressing the star and one on your touchtone phone. You may withdraw yourself from the queue by pressing the pound key. Please note this call is being recorded. I will be standing by if you should need any assistance. and it's now my pleasure to turn the conference over to Mr. Michael Poliviu with the EVC Group. Please go ahead, sir.

0:39 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 its Securities and Exchange Commission. Please refer to this section on forward-looking statements included in the company's filings with the SEC.

1:37 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.

1:48 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. 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 contain COVID-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 the Q2 revenue would have surpassed the year-ago level if business were permitted to operate normally.

3:03 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 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 the 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 strengths 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.

3:57 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 two 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.

4:44 Although we finished much strong due to the receipt of a few large orders, it is 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 our 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.

5:33 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, UCAS is an all-in-one service for hard or soft phones, including 24x7 security and technical support.

6:19 With redundant data centers located in Florida and Texas, this market segment is estimate to reach $79 billion in a few years. And based on the continued interest we are experiencing, it is quite evident that it is no longer a matter of 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 Mericom, 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 E2D military planes. Turning to our ARIA offering in Division, our award-winning next-generation cybersecurity platform gives us reason to be optimistic about the growth potential for our HPP business.

7:14 We will recognize the Cybersecurity Excellence Award held in March. The annual competition honors individuals and companies that demonstrate excellence, innovation, and leadership in information security. DSPI's ARIA cybersecurity solution took home four awards in the following categories. First was encryption, which recognizes ARIA key management server's proven ability to automatically generate and distribute encryption keys to manage all managed lifecycle Lifecycle Requirements. The second was Network Detection and Response. For demonstrating that ARIA could successfully enable faster, better, and more comprehensive threat detection, investigate response in immediate network threat containment, all without impacting network or application performance.

8:04 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 team. 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 stop them without disrupting valuable operations.

8:49 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 in 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, introduce the new ARIA Advanced Detection and Response, ADR application, which automatically detects and stops cyber attacks cybersecurity attacks without requiring high-trained security staff.

9:43 Additionally, we integrated ARIA cybersecurity solutions with Juniper Networks. Juniper's 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.

10:28 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 in their continued commitment during this most difficult of Times further strengthened CSPI. With that, I will now ask Gary to provide a brief overview on the fiscal second quarter financial performance. Gary?

11:08 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 in building out the foundation of the ARIA software platform and a recovery of a consulting expense where the services were not completed.

12:22 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 as $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 US dollars in the UK. During the quarter, we had income tax expense of $1.2 million, primarily from recording a valuation allowance 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.

13:31 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 UK, where we have a pension liability of $5.3 million.

14:27 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 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 did we lay off or furlough any employees because they are vital to our future success.

15:19 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. Great, thank you. If you would like to ask your question, you may do so by pressing the star and one on your touch tone telephone. And if at any time you wish to be removed from the queue, simply press the pound key.

16:06 Again, that's star and one to ask your question. And we'll pause one moment to allow those questions to queue. And we can take our first question from Joseph Nergis with Segrin Investments. Please go ahead. Your line is open.

16:28 Good morning, guys. How are you today?

16:30 Good morning, Joe.

16:31 Good, Joe. We're getting a little bit of a hit here with this dividend cut in the stock, but let me get some clarification here. Did you say – what's the employee count that you just mentioned, Gary, right now?

16:44 116. 116 employees?

16:46 Right. Okay. Is that – that's pretty much what we had last quarter or last year? I thought we had a little more, but –

16:57 No, it's consistent within what we've had over the last year. I mean, we had much higher when we had Germany.

17:05 Okay. All right. Obviously, absent 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? I'm trying to get the account.

17:23 No, it's already been. I mean, we've done a preliminary calculation on it. And it's, you know, in the numbers that we reported. So that benefit is offsetting right off of the deferred tax.

17:38 Okay. So that was reported in this quarter. You just reported now. Correct. Yeah.

17:43 You had to show all the effect of the CARE Act within this quarter. Okay.

17:49 Okay. I'm still trying to count the $2,180,000, $160,000 we're getting from the CARE Act. Approximately, that's what the number is, right? $180,000, I guess. Now, will some of the employee salaries be subtracted on that? In other words, you subtract that from the loan, let's put it that way. want to be incorporated in this current quarter, or am I wrong there, too? Or has that already been reflected?

18:25 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 what's going to be, you know, you're not going to be, you get forgiveness of that.

18:42 Okay, so that, you're saying that 60 days will be after Isn't there like an eight-week period under the CARES Act?

18:51 It would probably be, we probably won't get an accounting until the fourth quarter.

18:55 Fourth quarter. All right. So any end result won't be in front of our year-end report, let's put it that way. Most likely. Right. 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 on that is still pending? are potential capable customer. Has that been?

19:23 It's just been pushed out just due to, you know, they're concentrating on keeping their internal customer service going and they had, everything's kind of on hold temporarily. I'm hoping, you know, things pick back up in June with them.

19:41 Okay, well, from what I understand, their 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?

20:03 You're fishing on that one. What we're doing with them, it's an internal project, which stays internal.

20:15 but yeah everything that we're working with them is is just been just tabled for a month or two but nothing has you know stopped you know that the interest is still there yeah but you indicated in the last conference call that that the other table companies you know some of what you're doing and would say customer a is applicable to other customers within this group and you had some interest or at least you were talking to some of the other... We're still talking to all of them. Okay. On the most recent area, the ADR application, that's quite a dynamic product if it works as advertised.

21:02 As I understand, listening to the webinar, the In a lot of cases, it can automatically correct the problems that may be involved with hacking and that's going into this without even any intervention from their security people.

21:19 Right. When you – yeah, with the way 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 – you know 24 by 7 sock monitoring it you know you could come in the next day and see all the changes and easily undo them if there was anything that you wanted to set back to normal after inspection. But yeah, 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 by 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.

22:08 Game-changing stuff right now.

22:10 When you refer to, 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 this area, some of it connected with the UCAS or a combination of those?

22:27 No, that was just ADR, what I was talking about. It has nothing to do with the additional UCAS demos and everything else that we're doing. That's strictly ADR.

22:38 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.

22:53 Correct. We need to put the Aria product in line. 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. But if you want a full line POC, which they do, because 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.

23:38 Okay. And I'm assuming the time it takes to incorporate that would be based on the size of the customer.

23:47 That's correct.

23:48 The larger, more complex would be more work. Let's put it that way from our standpoint. All right. Well, thanks a lot. Appreciate it. I mean, we seem to have the right products. Unfortunately, the pandemic is holding us back in many areas.

24:04 That's correct.

24:05 Thanks a lot, guys. Appreciate it. Thanks, Joe. Thank you. Thank you. And as a reminder, if you'd like to ask your question, simply press star and 1 on your touch-tone telephone. We'll pause momentarily to allow further questions to queue. 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.

24:37 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 UCAS 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.

24:56 Thank you. Thank you. This does conclude today's conference. You may disconnect and have a great day.