Gary Levine - Chief Financial Officer Victor Dellovo - Chief Executive Officer.

Joseph Nerges - Segrum Investments.

Good day, everyone and welcome to today's CSP Inc. First Quarter Fiscal 2017 Conference Call. [Operator Instructions] Please note, this call may be recorded. And I'll be standing by, should you need any assistance. It is now my pleasure to turn today's program over to Mr. Gary Levine. Please go ahead, sir..

Thank you. Good morning, everyone, and thank you for joining us. With me on the call today is Victor Dellovo, CSPI's Chief Executive Officer.

Before we begin, I'd like to remind you that during today's call, we'd like to 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 prescribed in the company's filings with the SEC.

Please refer to the section on forward-looking statements included in the company's filings with the Securities and Exchange Commission. During today's call, Victor will provide an update on our business segments and on our strategic progress. And then I will review the first quarter financials. Then we'll open it up to your questions.

Victor?.

Thanks, Gary. Our first quarter results were affected by difficult comparison year-over-year on the top line, and restructuring actions to improve our long-term operations result had a short-term negative effect on the bottom line.

First quarter's revenues were down 15.9% to $19.9 million, mostly due to a difficult comparison in Germany with the first quarter of the prior year when we recognized revenue from our large product order in the first quarter of last year from one of our major customers.

We reported a loss per share of $0.01 versus income per share of $0.07 a year ago due to the recruiting fees for our managed service business in Germany and restructuring charges in both Germany and the U.K.

In the High Performance Product division, our legacy LANai business continued to perform above expectations and we're working on the launch of our Myricom nVoy, a 2-card solution that helps to verify and analyze threats to the enterprise organizations. And in the Technology Solutions Division, our managed service pipeline is strong.

Our recurring revenue stream continues to grow, and our cross-selling strategy is taking hold. With that, I'll get right into the segment review, starting with High Performance Products division. HPP revenues were down 2.6% in the first quarter driven by slow ramp up of the packet capture network adapter sales.

We received royalty revenues for 1 E-2D plane in addition to some additional royalty revenues on a second plane. This compares with E-2D royalty revenues for 1 plane, in addition to some miscellaneous E-2D revenues in the comparable quarter a year ago.

Looking ahead, our expectation is to receive royalties for 2 E-2D planes in Q2 and three additional planes in the back half of fiscal year. In the Myricom legacy products, based on LANai processor, continues to perform better than we have anticipated but revenues from these products are starting to slowly decrease.

To offset this expected sales decline, we're investing in next-generation products which have the potential to expand commercial market's reach of the division and be the primary growth driver for HPP. The ramp-up for the Myricom ARC Series 10Gbit adapter for network packet capture market has been slow today.

At the same time, we're gearing up to launch our Myricom nVoy Series, which we have announced at the RSA Conference in San Francisco last week. The nVoy Series is comprised of two products; a 1-100Gbit Packet Broker and a 10Gbit Packet Recorder.

The nVoy Series gives security teams the ability to isolate and closely monitor access to the data that most matter to the organizations; such as personal identification, PII, or intellectual property, [PI].

The Packet Broker powerful filtering and replication capability allow end users to direct their network traffic flow that customers are most interested in, such as specific traffic at risk, thereby reducing what has to be captured in depth and search and its companion, the nVoy Packet Recorder.

The nVoy Packet Recorder provides dropless data recording and on-the-fly indexing when running any intrusion detection system application or forensic tool. One of the most attractive aspects of the nVoy solution is how easy it is to set up. By performing two simple configuration steps on any firewall tool a simple user interface.

Security teams have a fully functional threat visibility in data capture solution, improving their ability to detect critical threats like optimizing the objects for managing and maintaining it. This is a departure from the traditional approach where you have to be a network expert, as well as a security expert to deploy such solutions.

We expect to launch our Myricom nVoy Solution in March. We have, already have our first customers lined up for evaluation. In addition to ramping up our Myricom products suite, we're making excellent progress with our strategy to cross-sell between High Performance Products Division in our Technology Solutions Division.

Turning now to our Technology Solutions business. Quarterly revenues were down 17.7% year-over-year, driven by shipments pushed out to the second quarter in the UK, and Germany and lower than anticipated year-end budgets for us than we have experienced in prior years.

In Germany, as I mentioned last quarter, we incurred revenues that were pushed out from Q4 and into Q1. However, part of our efforts to realign our engineering team to focus on security services versus legacy offerings, we recorded larger than expected restructuring charges and recruiting fees, which negatively affected the bottom line.

During the quarter, we hired several new sales people for our managed service business as we continue to see more opportunities and deals in the pipeline. Penetration testing also continues to be very strong market for us, and we're seeking additional engineers and penetration testers to support that growth. Looking forward, our backlog is strong.

And we expect to have solid Q2, both on the top and bottom lines in Germany. Looking at the UK, we took actions to restructure the sales force following the nonrenewal of some of our legacy PCDA products. The good news is we saw some new orders come in during the quarter, which should translate into better results in the second quarter.

Our new sales reports are generating larger, high margin opportunities, which we expect will be positive -- positively affect the second half of the fiscal year. Looking forward, our focus remains on cost savings and improved efficiency to drive better profitability out of the business.

In the U.S., our business activity picked up in December after a modest start to the quarter. Our Managed Service pipelines remains robust, and we closed a few new deals. We are closing managed service deals at a greater frequency, and recurring revenue stream is increasing.

We continue to have success in the vertical markets such as hospitals, school systems, and wireless. The wireless security area has been very consistent and especially strong for us. As I mentioned on last quarter's call, we recently hired three new wireless security engineers to keep pace with the growing demand.

With the overview of the two divisions, I'll turn it over to Gary for the financial review. .

Thank you, Victor. For the quarter, revenues decreased 15.9% to $19.9 million from $23.7 million a year ago. Our total cost of sales for Q1 was $15.5 million, down 16.3% from the prior year. Gross profit for the quarter was $4.5 million compared to $5.2 million a year ago.

Gross margins increased to 22.4% from 21.9% in the prior year as a result of product mix in the High Performance Products sales combined with increased royalty sales. First quarter engineering and development expenses decreased to $596,000 from $799,000 a year ago due to lower consulting and outside service costs.

As a percentage of sales, Q1 engineering and development expenses were 3% compared to 3.4% last year. This is below our expected range of between 3.5% and 4% of sales with the reduction in expenses. SG&A expenses were $4 million or 19.9% of sales compared to $4 million or 17.1% of sales in the previous year.

Based on our planned investment, we expect the SG&A expenses in the range of 17% to 19.3% for the rest of fiscal 2017. The effective tax rate for the quarter was 26.5% compared to 23.8% in the prior year. We expect our overall tax rate going forward to be approximately 38%.

Net loss was $43,000 or $0.01 per share compared to a net income of $283,000 or $0.07 per diluted share a year ago. Cash and short-term investments increased to $15 million from $13.1 million at fiscal year-end as a result of receipt of accounts receivable receipts received at the end of the quarter.

Lastly, our Board of Directors voted to pay a quarterly dividend of $0.11 per share to shareholders of record on March 3rd and payable on March 17, 2017. We aim to improve our bottom-line and perform by focusing on our growth program, increasing the level of high-margin products and aligning our cost-containment initiatives across the organization.

We delayed the filing of our quarterly report, Form 10-Q, which is due to the compressed time between the delay filing of our Annual Report for fiscal 2016, and the delay in the quarterly report for the first quarter of fiscal 2017 and expanded testing of revenue transactions for the company's European operation.

As a result of the compressed time period and expanded testing, our independent auditors had not completed their review of our company's financial statements for the quarterly report. They completed their review, and we filed our Form 10-Q yesterday.

We have taken a number of steps and are taking additional actions to ensure that the revenue transactions in our European operations will be reported properly. I'll now turn the call over to Victor. .

Thanks, Gary. Looking ahead in our High Performance Products division, we anticipate royalty revenues from two E-2D planes during Q2 and another three planes in the back half of fiscal year. We'll focus on the ramp-up of the 10-gig adapters for the network sensor space and on launching a new Myricom nVoy Solution in March.

In the Technology Solutions Division, we remain focused on executing against our MSP strategy, which we expect to be an excellent driver of growth in recurring revenues for the long term.

As noted in our announcement on February 9th that our German subsidiary secured a three-year service contract worth $6 million to provide managed security service to an international IT service provider. Our pipeline is strong, and we look forward to capitalizing on the opportunity further.

In addition, we expect to see continued progress on the cross-selling strategy between Technology Solutions locations, as well as between Technology Solutions and High Performance Products. In total, we're expecting improved performance in Q2 and our backlog in both divisions.

Long term, we're making very good progress against our strategic initiatives, and we are positioning CSPI to capitalize on many growth opportunities. And now, we'll take your questions. .

[Operator Instructions] And we'll take a question from Joseph Nerges. Please go ahead. .

A couple of things. One thing you mentioned restructuring charges on both, I guess, Germany and the UK.

What did that total to? How much were those charges approximately?.

A little over 200,000. .

In total for both Germany and..

Yes..

And what was that? Were you eliminating some of the old sales people and adding new ones?.

It was a salesperson in the UK. And as you know, in Europe, every time you lay someone off, it cost you to do that. It's not like here in the U.S.; and also some engineers that we have to lay off that weren't in line with our current business. And then because of the MSP that we just -- the new deal, we had to hire some new people.

So the recruiting cost to get the people in a timeline that we needed was another 100,000 something of that. .

So you're really setting up for the future, basically add up -- realign the people. Is that...

Yes, yes, correct. .

Well, going to that $6 million contract, that was an existing customer previous to this announcement.

Is that correct?.

Correct. The original contract was that we did was about $3 million. So it basically doubles from redoing it over from three years ago. .

So we're expecting approximately $2 million a year for the next three years, approximately.

And we were getting maybe close to $1 million a year for the previous three years?.

Yes, previous was $1 million, and then the new contracts were about $2 million. .

Okay. Concerning the new nVoy products, I assume that you're at the RSA Trade Show last week, your people.

Any initial feedback, anything? I mean obviously, the setting up of time is got to be a positive for some but any reaction from them on the show?.

Yes, we talked to some OEMs, and we talked to some end-user customers. They took the product very well and now there is a bunch of follow-ups to get, to get to more questions answered and to get to more evals inside some of the customers' hands. But it was well accepted on the initial conversations.

As you know, at the trade show, everyone is gathering information. The most important piece of it now is to make sure that there is real interest in the follow-up. .

Okay, understandable. I've been at them. Does these new nVoy products help us at all with the ARC series adapters? In other words, I noticed that in the Packet Recorder, there is a software component to it, where Sniffer's involved with also, there is also a, I guess, end box component in the software that we're licensing for that product.

But is that, does the ARC adapter working in conjunction with that benefit of..

Our adapters will be inside those chassis, yes. .

Okay, that's great. So we can also have the adapters outside the tool..

Yes, absolutely. They can go into regular servers, any type. But in these appliances that we're selling with the software, there will also be our board inside it also..

And can we basically utilize the same distribution system that we're doing for the current adapters with these new products?.

Yes, we will leverage our distribution that we currently have. The one thing that we're doing now because it's a security appliance, we're opening up to the sales team, both in Germany and to the sales team here in the States also to try to provide the product to our current customers that are looking at it.

There are other competitors that are out there, but they're much more expensive. They're in the $100,000 range and up. So we think we have a competitive product that doesn't have all the bells and whistles. But at the price point, it's a very, very big, large space that we think we can be competitive in. .

Well, less bells and whistles, but easier to set up. That's what you are. .

Easier set up, right. If you need every bells and whistles, then you’re going to have to spend, you're in the $500,000 range and up. If you're looking for 75% of the bells and whistles, then our products has it. And we think we fit into a space that most people may look at it, so we'll see. The launch is in March, and we're excited.

So we'll see what happens. .

On the backlog, you mentioned that the backlogs are up.

Do you have an approximate number on the backlog for both HPP and TS at the end of the quarter?.

We don’t disclose those..

Okay. So but I know that they were up considerably over last year and the year-end report. In other words, the backlogs that reported for your fiscal 2016, was considerably higher than it was the previous 2015. So I don't know if that's -- I assume it's continuing in that area. .

They're up currently, right. .

I did see you also had a -- I know we don't put it into our earnings. But we did have a currency gain of 138k for the quarter so... .

Correct. .

So that helped a little bit with the numbers from a cash standpoint. .

Correct. .

[Operator Instructions] And it appears we have no further questions at this time. .

Thank you all for joining us this morning. We look forward to speaking with you again on our next call. .

Thank you. Bye. .

This does conclude today's conference. You may disconnect at anytime and have a wonderful day..