Earnings Call Transcript - CSPI Q2 2020

Operator, Operator

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

Michael Polyviou, EVC Group

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.

Victor Dellovo, CEO

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, and 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 and federal requirements, and currently, over 90% of the team is working remotely. Importantly, we have been able to maintain 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 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 five 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 requires the ability for CSPi's team to physically be on the customer premise. Therefore, the timing is too uncertain given the local and 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 were going like gangbusters. However, the impact of the 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 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 it is no longer a matter of if or when we will capture 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 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 lifecycle requirements. The second was network detection and response for demonstrating that ARIA could successfully enable faster, better, and more comprehensive threat detection, investigation response, and immediate network threat containment, all without impacting network or application performance. The third was GDPR compliance. ARIA showed that it can validate any type of intrusion while it may be happening and immediately notify the appropriate teams. This helps any company improve compliance with GDPR, PCI, 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 uses surgical precision to stop them without disrupting valuable operations. Along with validating our decision to put the time, energy, and resources into developing ARIA, the recognition by our peers will likely cause prospective clients to slow down decisions they are having with competitors and look at our direction. We are well prepared as we spent the better part of the past few months building 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 developments during the quarter position us for even greater success in the future. For example, we 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 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 involving IoT (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 strengthens CSPi.

Gary Levine, CFO

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 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 an 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 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 challenges posed by COVID-19, we are focusing on liquidity, cost containment, and 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 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.

Operator, Operator

And we can take our first question from Joseph Nerges with Segren Investments.