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Edited Transcript of CSPI earnings conference call or presentation 7-Aug-19 2:00pm GMT

Q3 2019 CSP Inc Earnings Call

BILLERICA Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of CSP Inc earnings conference call or presentation Wednesday, August 7, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary W. Levine

CSP Inc. - VP of Finance, CFO. Treasurer & Secretary

* Victor J. Dellovo

CSP Inc. - CEO, President & Director

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Conference Call Participants

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* Joseph Nerges

Segren Investments - Managing Director

* Brett Davidson

- Private Investor

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to CSPi's third quarter fiscal 2019 conference call. My name is Priscilla, and I will be your coordinator for today. (Operator Instructions) I would now like to turn the call over to CSPi Chief Financial Officer, Gary Levine. Please proceed, sir.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [2]

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Thank you, Priscilla. Hello, 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 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.

During today's call, after Victor's introductory remarks, I'll discuss our third quarter financials. Victor will then provide an update regarding our business segments and strategic progress, and then we'll open it up to your questions. With that, I'll turn it over to Victor.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [3]

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Thanks, Gary, and good morning, everyone. We are continuing in our transformation to cybersecurity, wireless and managed services company. In the third quarter, strong demand for our managed services IT was partially offset by soft multicomputer sales. Overall, however, we had a solid year-over-year revenue growth as we invest in our cybersecurity products and pipeline including our ARIA platform, which is poised for growth over the next fiscal year. After Gary reviews our financial results for the quarter, I'll come back with a review of our progress in Q3 by segment. Gary?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [4]

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Thanks, Victor. For the third quarter, revenues were up 8%, $21.6 million compared to $20 million a year ago. Our total cost of sales was $16.7 million compared to $14.8 million a year ago. Gross profit for the third quarter was $4.8 million, down from $5.2 million a year ago. Gross margin was 22.4% compared to 26% a year ago.

Third quarter engineering and development expenses was $583,000, down from $895,000 a year ago. The decline is attributed 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 consulting expenses where the services were not completed. As a percentage of total sales, engineering and development expenses was 2.6 -- 2.7%, down from 4.5% last year. Q3 SG&A expenses were $4.1 million or 19.1% of sales compared with $4.1 million or 20.4% of sales in the previous year.

We had a third quarter tax benefit of $326,000 compared with a tax expense of $249,000 last year. The tax benefit was a result of a higher effective tax rate due to no tax expense for the U.K. income due to a large pension contribution, adjustment of the taxes payable and reconciliation of the tax provision to the prior year's tax return and benefit of the research and development credit. The effective tax rate for the quarter was 158% compared to 36.6% in the prior year.

Net income from continuing operations was $532,000 or $0.12 per diluted share compared with income of $3,000 or 0 per diluted share a year ago. Net income in the third quarter of 2018 included a loss of $428,000 from discontinued operations. Cash and short-term investments were $16.8 million at the end of the third quarter, down from $25.1 million at the close of the fiscal year 2018. The decrease was due to $3.6 million increase in accounts receivable due to order timing, an increase in inventory of $2.7 million, primarily for in-transit shipments that were not received by the customers until after the end of the quarter, as well as $1.8 million paid in dividends.

Lastly, our Board of Directors has voted to pay a quarterly dividend of $0.15 per share to shareholders of record on August 30, 2019, and payable on September 13, 2019.

Looking to the fourth quarter, we will continue to focus on bottom line performance and to boost sales of our higher-margin products while managing costs around the company.

I'll now turn the call back to Victor.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [5]

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Thanks, Gary. I'll now provide a segment review, starting with our High-Performance Products division. HPP revenues were down $2.1 million compared to $3.1 million last year. The delay in our launch of our ARIA SDS cybersecurity platform related to supplier issues we have discussed previously is behind us and we are now shipping. In fact, we are looking to build up our sales resources for this exciting product. At the same time, as of right now, demand for our legacy Myricom products continues.

In our multicomputer product business, we continue to see additional purchases for both parts and royalties for foreign military E-2D planes in the amount about $0.5 million during the third quarter. As it is typical for our military business, we have limited visibility into our E-2D order levels but expect similar performance in Q4. During the quarter, we saw a solid demand for our legacy Myricom ARC series products, including our first sale of our Secure Intelligence Adapter, or SIA, which enhances threat detection and incident response of OEM products. We're also selling to companies that use dedicated teams of security operation centers to look for threats in their networks, including MSSPs.

Moving now to ARIA, our award-winning next-generation cybersecurity platform, which provides advanced protection for critical data assets that need to be assessed by end-users and applications, both in the cloud and on-site. As noted, we have put supplier issues that had delayed ARIA launch behind us. We are now shipping after ensuring that the ARIA card supports all the developed applications. While we do not anticipate a rapid initial ramp-up given the typical long sales cycle required when dealing with OEMs and MSSPs, we are excited about the growth prospects for the next year and are expanding our sales capabilities accordingly.

First impressions from our customers have been very positive regarding ARIA's ease of deployment and ease of use. That is, of course, very encouraging for us. So from here, it is a matter of educating the market and staying committed to our sales and development efforts.

We are seeing progress in the carrier/MSO segments for our ARIA products. We are in the formal planning process with one large operator who is looking to improve threat detection and investigations around the latest service offerings. Operators are motivated to add such capabilities for 2 reasons; first, as they roll out SD-WAN, 5G and other services needed to ensure the infrastructure around offering packages of advanced services is properly protected from attack, much in the same way commercial organizations have to protect their own internal networks. Second, they can offer their customer protection of their applications and data from network-borne threats as a value-added cybersecurity service. Such deals are complex, often require special integration efforts and have long sales cycles, but can provide a substantial long-term revenue impact for our business.

We recently developed integration functionality with Demisto, SOAR product, that's a security orchestration, automation and response. The integration allows for greater automation of -- and push-button capabilities for security investigations when using ARIA out-of-the-box. This kind of functionality enables security teams to lower-level team members to identify and isolate threats. This is the first of many high-potential integration opportunities that we are working on. We continue to vet potential partners for our official channel program, which is aimed to expand to include resellers with security expertise in order to improve the sales funnel for our cybersecurity products. A robust channel program and expanded sales team will give us a strong platform for revenue growth.

Turning now to our Technology Solutions business. Revenues in the third quarter were up 15% year-over-year. Our MSP or managed services practice continues to grow our existing customer base while bringing on new and exciting customers. We recently closed a significant deal with a large airline manufacturer, which we will start recognizing revenues in Q4. We also continued to grow our UCaaS, or Unified-Communications-as-a-Service, which is an all-in-one service for hard or soft phones, including 24x7 security and technical support, with redundant data centers located in Florida and Texas. We also continued to do well with our Microsoft practice after building up our engineering talent and investing in marketing.

In closing, we remain committed to transforming CSPi from a focus on defense-related multicomputer to focusing on growth opportunities in cybersecurity, wireless and managed service markets. We are encouraged by our recent progress with ARIA, and expect to begin building revenues from this exciting product in the coming fiscal year. We look forward to sharing our progress with you in the quarters ahead.

With that, I'll turn it over to the operator to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take over first question today from Joseph Nerges with Segren Investments.

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Joseph Nerges, Segren Investments - Managing Director [2]

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Okay. So you did say, on the E-2D, you got about $0.5 million on E-2D planes, about $0.5 million this quarter in revenue?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [3]

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Planes and parts, Joe.

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Joseph Nerges, Segren Investments - Managing Director [4]

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Planes and -- was that $0.5 million? Is that the number you (multiple speakers)?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [5]

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Yes. That's correct.

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Joseph Nerges, Segren Investments - Managing Director [6]

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And you're saying, you're expecting the same in the fourth quarter or something similar in the fourth quarter?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [7]

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Right.

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Joseph Nerges, Segren Investments - Managing Director [8]

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By the way, congratulations, we finally got the ARIA out the door. Are you saying that -- you did say we shipped something in the third quarter? You said there was very little revenue, but something was shipped in the third quarter that was included in this report?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [9]

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Correct.

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Joseph Nerges, Segren Investments - Managing Director [10]

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But you are also saying that there was some supplier -- still supplier issues caused us to not ship some of the product that we could have probably if the supplier issue was taken care of?

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [11]

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No. It's just -- over the last 2, 3, 4 months, we were just -- we had the supplier issue, so it kind of slowed us down from developing our applications on the final chip that they had. And then when we finally were able to get a pretty much finished product from them, then we're able to do a full testing on all the applications that we had started to develop. And then we had to finish test and go through the beta sites and go through all that. So now, all of that is -- we will continue to develop applications and enhance performance. But right now, we were able to take what was available in the marketplace and load our applications on and we were able to make our first sale.

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Joseph Nerges, Segren Investments - Managing Director [12]

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Okay. Great. And so we -- are we still beta testing some applications? Or is the beta testing pretty much complete?

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [13]

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No. Beta testing will continue for as long as we hope. Just we continue to work with other manufacturers -- like I mentioned Demisto, with companies like -- just big manufacturers of networking security gear. So it's just now integrating into their products as well as continue our custom applications that we can sell standalone.

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Joseph Nerges, Segren Investments - Managing Director [14]

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Okay. And another question would be on our R&D expense, which you said was about $583,000 or something like that for the quarter. That was down because of less consulting expenses as I -- as you indicated.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [15]

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Correct.

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Joseph Nerges, Segren Investments - Managing Director [16]

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So is that approximately the level that we're anticipating, approximately in that $600,000 range per quarter going forward?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [17]

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A $600,000 to $700,000 kind of range, Joe, because we did have a credit that we got back from a vendor who didn't complete a project.

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Joseph Nerges, Segren Investments - Managing Director [18]

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Okay. I also see where your -- you indicated you're expanding your sales efforts, particularly in the ARIA product line. You're looking for channel directors for the both the central part of the country and the west according to your all-new website, let's put it that way.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [19]

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We're looking for direct salespeople in those locations. We hired a channel person last quarter, that started, I don't, about 3, 4 months ago, who's developing the channel, the resellers in the marketplace across the U.S. So he may -- he's developing those and as we grow, we'll continue to develop the channel. But now that we have a viable product that's working, we're looking to invest in it somewhere between 2 and 3 initial salespeople and then as they grow, continue to open up different marketplaces.

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Joseph Nerges, Segren Investments - Managing Director [20]

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It sounds like things are rolling pretty well and this ARIA pipeline is very exciting.

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Operator [21]

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(Operator Instructions) We'll go next to [Brett Davidson], a private investor.

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Brett Davidson, - Private Investor [22]

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I'm a little confused this quarter. Looks like there is quite a few changes and I get the impression, I'm looking at the new CSP and -- which kind of spawns some of these questions here. So if I -- so there was very little multicomputer revenue and I take it that it was maybe a little less than the prior year's quarter.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [23]

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Correct.

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Brett Davidson, - Private Investor [24]

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Have any orders showed up for that? Or it's still looking pretty thin through rest of the year?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [25]

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For...?

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Brett Davidson, - Private Investor [26]

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For the multicomputer?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [27]

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The multicomputer products?

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Brett Davidson, - Private Investor [28]

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(multiple speakers) Yes.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [29]

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Yes. That's -- it's very thin right now.

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Brett Davidson, - Private Investor [30]

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And I assume you did see the release where the next 24 planes are funded? And I believe the Japanese got a couple of orders in right now.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [31]

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Right.

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Brett Davidson, - Private Investor [32]

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The change in receivables, is that something that's going to be the new normal? I don't know, we're going to see higher receivable levels now because of increased shipments of the ARIA products or is that just a one-time end-of-quarter thing?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [33]

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That was -- we got some large orders out of the TS group towards the end of the quarter. It's not any -- and obviously, we'll have some building in that as we get into the cybersecurity product. But right now, the large volume is going through the TS group.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [34]

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Yes. The growth of the TS side, both on some of the larger projects and managed services side of it has been really, really good this year, as you can probably tell, which is generating a lot of the revenue and almost all the profits for the organization. So yes, it's just timing. The way some customers purchase, it's always at the last day, at the last day and hour of the quarter. So just based on us having to purchase the gear and then able to invoice it or ship it, so like Gary said, it's all a timing issue. And then that will fluctuate, just depends on customers.

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Brett Davidson, - Private Investor [35]

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So are the sales of the ARIA products, is that more likely to lead to receivables than on the service side or no real difference?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [36]

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More on the services side.

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Brett Davidson, - Private Investor [37]

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Got it. So the change in inventory, I mean is that the same thing, is this going to be...?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [38]

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(multiple speakers) receivables.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [39]

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That's all TS, yes, that's all just timing. We probably went out the next day or 2 days later, it just depends on when we receive it or sometimes the purchase orders from the customers, the FOB destination and that means it has actually to land for us to be able to recognize revenue.

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Brett Davidson, - Private Investor [40]

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So at least in the next couple of quarters, next quarter, next 2 quarters, there is not going to be a real change in inventory levels from a switch-over to the new ARIA products versus the legacy stuff?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [41]

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Right. We're not going to be building a lot of inventory balances. I mean there will be fluctuations, but we're not going to build it up.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [42]

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Yes. No, if we're able to get the products fairly quickly to where we're able to meet deadlines at this stage of the game. And then as -- with some of these larger customers that we are talking to right now, some of the MSSPs, where it's -- could be hundreds of thousands as they potentially give us a rollout, we may stock a few months or whatever as that comes up, but that's early stages right now, let's put it that way.

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Brett Davidson, - Private Investor [43]

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So is there anything like long-term purchase order for the that? Or is it you guys are just pretty much ordering as needed currently?

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [44]

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For?

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Brett Davidson, - Private Investor [45]

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For the ARIA products.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [46]

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Right now, we're still just talking to -- building pipeline and trying to close large -- these large MSP -- MSSP opportunities or working with the OEMs, you're talking long-term potential contracts.

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Brett Davidson, - Private Investor [47]

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Long-term as in long-term before they're signed or long-term as far as the length of contracts?

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [48]

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The length. When you get specced into a potential manufacturers -- as long as they sell their product, then either we do a licensing software agreement or we sell our boards, either way, it could go on 4, 5, 6, 7 years.

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Brett Davidson, - Private Investor [49]

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So I mean is that going to change how the orders for the product work? I mean are you guys going to need to change how that operates? Or is it just same thing? You guys just send out an order and they -- once they have it built, they send it back to you.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [50]

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Exactly.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [51]

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We'll keep the necessary inventory to keep our customers happy, not more, not less.

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Brett Davidson, - Private Investor [52]

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Got it. So you talk about it in terms of high growth, but that kind of leaves me scratching my head a little. Can you just add a little bit of clarity to what you guys are looking at as far as high growth? And how much of that will be at the extent of the legacy products? Or is this like a -- in total over and above what we've seen previously? Is this like a 10% to 20% high growth or 15% to 30% high growth, or maybe you can give us some idea what that looks like?

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [53]

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Well, the growth of the -- don't compare it to the legacy product, that's a different animal whatsoever. That will continue until -- we're not investing much at all in the legacy stuff. So as that disintegrates and just falls off, this is the new life of the organization, is this new product line. So the growth -- we're looking at significant growth over the next 12 to 24 months. If it all goes well, it should dwarf what we have ever done in the last 20 years.

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Brett Davidson, - Private Investor [54]

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So is that going to be at the expense of the legacy products? Or the customers are really kind of differentiating (multiple speakers)

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [55]

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The legacy product is an old tech...

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [56]

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We haven't invested...

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [57]

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We haven't invested in that product in -- since I don't even know when.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [58]

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Over the last...

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Brett Davidson, - Private Investor [59]

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What I'm trying to get at, are the customers that are ordering those products, those customers are going to switch over to new products down the road? Or is this -- are these 2 going to exist -- coexist with each other or is...

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [60]

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It's a different customer base. It's a different customer base, it's a different target.

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Brett Davidson, - Private Investor [61]

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So that might still just putter along like it's been for the next couple of years and just (multiple speakers)

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [62]

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If I go back -- If you go back to where, I don't know, 2 years ago, 3 years ago, if you remember, I said, it was going to diminish at -- I think it was like 15% or 20% year-over-year. It's hung along way better than we thought it was ever going to and there's still a need and some of the things that we've done with it has kept it going. And there's definitely still need for the price and what we do out there, but it's something that -- we'll support it as long as people want it, but the investment is all in this new technology.

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Brett Davidson, - Private Investor [63]

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Yes. But that's a lot of help to -- those are going to continue at the same time the new product ramps up.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [64]

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Absolutely. That was the goal and we'll keep taking the E-2D as long as that goes. And we aren't turning anything away. We're just kind of moving on. And then the other step that we've talked about where we talk about all the other stuff, but the stuff that was the TS side has been -- over the last 2, 3 years has really been generating all the profits of the organization. And now we've built the MSP 2, 3 years ago and that's a recurring-revenue model, right? Every month, we get -- we bill our customers and the profit margins are in -- they aren't in the low digits, they're in the middle 50%, 60% margin level. So it's like selling a product, but it's a recurring-revenue model.

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Brett Davidson, - Private Investor [65]

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Yes. So during the third quarter, how much of the sales was from the new ARIA products versus the legacy? Did that start to transition at all? Or is it pretty much (multiple speakers)

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [66]

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No.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [67]

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It's just the initial.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [68]

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No. It's just initial. And we expect it to continue for a little while until we close some of these opportunities.

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Brett Davidson, - Private Investor [69]

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So it's the big OEM deals are going to be the ones that are going to kind of drive this?

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [70]

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We're hoping to -- we're hitting all of it, the MSSPs, the OEMs and then direct commercial accounts like banks and all types of financial institutions, hospitals. We can focus on -- it fits into every organization. So there would be a commercial play that we develop with some of our partners, like a government play, and then also selling to the OEMs and to the MSSPs. Which, like I said, that's a -- when you're talking with those, it takes longer, but you're talking millions and millions of dollars for a long period of time.

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Brett Davidson, - Private Investor [71]

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Got it. So like the individual sales might be the first thing to come on board then?

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [72]

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Absolutely.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [73]

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Right.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [74]

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But they are a lot smaller. They may be $100,000, $200,000, $500,000 type of opportunities depending how deep and wide and how big the organization is.

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Brett Davidson, - Private Investor [75]

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Got it. All right. That was a huge help. And I'm very excited to see that we're decently profitable with that.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [76]

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That's the thing that we've -- I've mentioned on the call before, it's a start-up company, that's public, that's small, that's starting to drive profits at the same time and pay a dividend -- and pay a dividend all at the same time.

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Brett Davidson, - Private Investor [77]

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Yes. It's been a long time since the company has been profitable on a standalone standpoint minus the multicomputer stuff. Looks pretty good to me from my view.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [78]

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Yes.

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [79]

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Good. Good.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [80]

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So hopefully you're a little less confused, Brett, after that.

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Operator [81]

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I am showing that we have no further questions at this time. I'll turn the call back to our presenters for any additional or closing remarks today.

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Victor J. Dellovo, CSP Inc. - CEO, President & Director [82]

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

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Gary W. Levine, CSP Inc. - VP of Finance, CFO. Treasurer & Secretary [83]

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Thank you.

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Operator [84]

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This does conclude today's program. Thank you for your participation. You may now disconnect at any time.