Ultralife Corp (ULBI) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ultralife fourth quarter 2012 earnings release. For opening remarks and introductions it is my pleasure to turn the call over to Jody Burfening. Please go ahead, ma'am.

Thank you, Leah, and good morning, everyone. This is Jody Burfening of LHA. Thank you for joining us this morning for Ultralife Corporation's earnings conference call for the fourth quarter of fiscal 2012. With us on today's call are Mike Popielec, Ultralife's President and CEO; and Phil Fain, Ultralife's Chief Financial Officer. The earnings press release was issued earlier this morning. If anyone has not yet received a copy, I invite you to visit the Company's website at www.UltralifeCorp.com, where you will find the release under investor news in the investor relations section.

Before turning the call over to management, I would like to remind everyone that some statements made during this conference call contain forward-looking statements based on current expectations. Actual results could differ materially from those projected as a result of various risks and uncertainties. These include potential reductions in US military spending, uncertain global economic conditions and acceptance of the Company's new products on a global basis.

The Company cautions investors not to place undue reliance on forward-looking statements which reflect the Company's analysis only as of today's date. The Company undertakes no obligation to publicly update forward-looking statements to reflect subsequent events or circumstances. Further information on these factors and other factors that could affect Ultralife's financial results is included in Ultralife's filings with the SEC, including the latest annual report on Form 10-K.

In addition, on today's call management will refer to certain non-GAAP financial measures that management considers to be useful metrics that differ from GAAP. These non-GAAP measures should be considered as supplemental to corresponding GAAP figures. With that, I would now like to turn the call over to Mike. Good morning, Mike.

Good morning and thank you, everyone, for joining the call this morning. Today I plan to start by making some high-level observations about our fourth quarter and total year operating performance and then I will turn the call over to Phil, who will take you through the detailed financial results for the quarter and year.

After Phil is finished, I will take the call back to provide a recap of the achievements towards the top 2012 priorities that we laid out at the beginning of last year, and then talk about what expectations we have along those lines for 2013. Lastly, I will share with you our thoughts on the full-year financial outlook for 2013 before opening it up for questions.

Regarding the fourth quarter 2012, we were pleased to deliver a profitable quarter for the second quarter in a row. Productivity initiatives and favorable mix drove gross margin of 32.3%, an increase of 230 basis points year over year and favorable year-end customer demand led to revenue levels enabling positive base cost leverage and an operating margin achievement of 8%, up 200 basis points.

Overall Company revenue was essentially flat, with Communications Systems revenue up 85%, while Battery & Energy Products revenues continue to be sluggish and down 21%. We said last quarter that we expected to return to profitability for the last half of the year 2012, though not at the magnitude required to offset the operating losses in the first two quarters of the year. We did just that.

In the first half, the Company posted an operating loss of $4.2 million on revenue of $46.2 million, yet swung back $8.3 million in the second half to a positive operating profit of $4.1 million, where revenue also increased 20% from the first half and was $55.5 million.

A strong fourth-quarter finish allowed us to come very close to breakeven in 2012. Looking at the total year, Communications Systems revenue for the total year was up 11% driven by strong international performance, while B&E was down 34% resulting in an annual total Company revenue decline of 25%.

At Battery & Energy Products, their sequential quarter revenue decline started in the third quarter of 2011 and lasted four quarters, before returning to some slight sequential quarterly revenue increases in the third and fourth quarter of 2012.

The present year-over-year revenue decline trend has been driven primarily by a military troop withdrawals and less US government defense spending, the prior year completion of a multiyear automotive contract and some buy-aheads associated with our next generation 9 volt product line transition. To mitigate the P&L impact during this time of revenue decline, the teams have been very active in achieving productivity gains, eliminating waste and sometimes unprofitable customers, such that during the last two years B&E products gross margins have actually improved approximately 200 basis points from 23% in 2011 to 25% in 2012.

Our fourth quarter 2012 Company operating expense spending of 24% to sales is consistent both with the previous quarter and year over year yet still a little over our goal of 20%. Despite lower revenues, we continue to invest on new product development and improving our sales force productivity which near-term has our business model little upside down until the targeted revenue streams start hitting the ledger. That said, for the total year, operating expenses were down 9% or $3 million.

In summary, we are pleased with our Company-wide variable cost productivity trends, prudent operating expense control and cash management discipline. We are also encouraged by the most -- we are also encouraged by the recent revenue growth shown by Communications Systems. In Q4 2012, we validated the profitability of our business model for the second quarter in a row, and demonstrated our positioning for further operating leverage achievement as we return the total Company to annual topline revenue growth.

In a few minutes I will talk further about the 2012 progress against our stated Company priorities, as well as implications for 2013, but first I would like to ask Ultralife's CFO, Phil Fain, to take you through additional details of our fourth quarter and total year 2012 financial results. Phil?

Thank you, Mike, and good morning, everyone. Earlier this morning we released our fourth-quarter and full-year results for our year ended December 31, 2012. For purposes of reviewing our fourth-quarter financial results, I will discuss operating results from continuing operations for 2012 compared to 2011. As noted in our earnings release, we recorded some exit costs in both continuing and discontinued operations related to our decision not to renew the lease for our UK manufacturing facility, which expires on March 24.

I will provide you with the background of these costs in a moment. Consolidated revenues for the fourth quarter totaled $29.3 million, essentially flat with the $29.5 million we reported for the fourth quarter of 2011. With declines in the Battery & Energy Products business equaling strong gains in Communications Systems.

Revenues from our Battery & Energy Products segment were $18.8 million, a decline of $5 million or 21% from last year. This decrease is primarily attributable to the continued slowdown in the US government and defense order rate for rechargeable and nonrechargeable batteries and charger systems, as well as the completion of some large orders in 2011. Partially offsetting this decline was another order for our M1 battery products to service an allied country's Department of Defense.

Communications Systems sales of $10.4 million increased by $4.8 million or 85% from the prior year. This increase was attributable to shipments of 20 watt amplifiers and accessories for soldier modernization programs undertaken by two allied countries and continued strong demand for these products by US special forces.

Our consolidated gross profit was $9.5 million compared to $8.9 million for the fourth quarter of 2011. As a percentage of total revenues, consolidated gross margin was 32.3% versus 30.0% for last year's fourth quarter, an increase of 230 basis points. The 32.3% represents the highest quarterly gross margin ever reported by the Company. As you may recall, I made a similar comment regarding the third-quarter gross margin of 31.4% during our November 1 call.

The year-over-year improvement reflects the strong Communications Systems product mix and productivity improvements resulting from the implementation of Lean processes. Gross margin for our Battery & Energy Products segment was 27.0%, a 210 basis point decline from the 29.1% reported last year, attributable to lower sales volumes. The business continued to benefit from the transition of 9 volt manufacturing to China, where cost advantages are yielding improvement in gross margin and our continued focus on increasing the average selling price of our newly designed product.

For our Communications Systems segment gross margin was 41.9% compared to 34.0% last year, an improvement of 790 basis points. This also represents the highest quarterly gross margin reported for this business segment. This improvement, as well as the sequential improvement over the third-quarter gross margin of 36.1%, resulted from the higher volume of amplifier production and shipments. Continued improvements to our manufacturing process through our lean initiatives have magnified the impact of the volume throughput.

Operating expenses totaled $7.1 million, on par with the fourth quarter of 2011. Operating expenses for the 2012 fourth quarter include a $0.2 million reserve classified as G&A expense related to our decision not to renew the lease on our current UK building which expires in March. Excluding this nonrecurring charge, G&A expenses have been reduced by $0.6 million or 18% between periods and have provided the funding for the expansion of our sales force. As a percentage of revenue, operating expenses represented 24.3% compared to 24.0% a year ago. Excluding the UK charge the current period percentage would have been 23.6%.

Fourth-quarter non-cash operating expenses, including depreciation, intangible asset amortization and stock compensation expense, amounted to $1.4 million consistent with the year-earlier period. Operating profit increased 32% and was $2.4 million for the fourth quarter, representing an operating margin of 8.0% compared to $1.8 million or 6.0% for the year-earlier period, and adjusted EBITDA -- defined as EBITDA including non-cash stock-based compensation expense -- amounted to $3.7 million versus $3.0 million for the fourth quarter of 2011.

Other expenses, primarily comprised of foreign currency translation and interest expense, amounted to $0.2 million which is favorable to the $0.3 million reported in the fourth quarter of 2011 by 42%. Interest expense continues to be favorable as the outstanding revolver was reduced to zero throughout most of 2012. There were no draws made upon our revolver at any point during the fourth quarter. And our fourth-quarter tax provision was $0.1 million, primarily reflecting income taxes for our profitable China operations versus $0.2 million for the 2011 period.

Net income from continuing operations was $2.1 million, or $0.12 per share, compared to net income of $1.3 million or $0.08 per share for the same period last year. Our decision not to renew the existing lease for our UK manufacturing facility will result in annualized cost savings of approximately $500,000, which will commence in April. We are in the process of relocating into a new facility which is better suited to our sales and service needs going forward.

The costs associated with the nonrenewal of our current lease are approximately $950,000, which represents our estimated liability to return the facility back to its original condition for our previous contractual commitment. We have recorded a liability for this amount in our fourth-quarter results, and in line with Generally Accepted Accounting Principles, $200,000 has been included in continuing operations and classified as general and administration expense, and $750,000 has been recorded as discontinued operations.

The Company's liquidity remains solid. With cash on hand of $10.1 million, no debt, working capital of almost $44 million and a current ratio of 3.2. By comparison, the cash on hand at the end of the fourth quarter of 2011 was $5.5 million and the current ratio was 2.8. Our efforts to reduce inventory levels through the Lean process are starting to take hold with a $4.6 million or 13% reduction from the end of 2011.

In summary, we made considerable improvements in our business model during 2012, particularly in the latter half of the year, driving down our revenue breakeven from $35 million to $24 million. The fourth quarter demonstrates the operating leverage of our business model in our quality of earnings. With the lower base cost structure and further productivity improvements, we are well-positioned to generate further leverage on revenue growth and make continued progress towards achieving our interim goal of a 10% operating margin.

I will now turn it back to Mike.

Thank you, Phil. At the start of my tenure in early 2011, we established specific priorities to drive efficient operational execution and to reposition the Company for growth. These priorities, which included, one, improving profitability; two, implementing a growth game plan; and, three, leveraging our China operations for growth and cost competitiveness, were further focused in 2012.

At this time I would like to update you on the progress that has been made against each item and provide some commentary on our 2013 plans. The cornerstone of our first priority of improving profitability was the adoption two years ago of our 30, 5, 5, 10 equals 10 business model. Simply, if we can achieve 30% gross margins, allocate 5% to sales spending for each of new product development and selling expenses, and keep G&A costs at 10% to sales, we can achieve our interim goal of a 10% operating margin. This framework has guided both the Company portfolio and day-to-day business decisions that enabled us to achieve the 8% operating margin in the fourth quarter on flat volume.

Equally important is that it allowed for us to achieve this profitability without sacrificing our future organic growth opportunities by keeping us focused on ample, yet efficient spending on our new product development and sales force productivity efforts. With the exit of the Energy Services business, the divestiture of RedBlack, the elimination of unprofitable product lines and customers, and the elimination of redundant facilities like the one in the UK announced today, we have good visibility to what the remaining components of the Company are capable of achieving.

In 2013, we will increase our focus on the overall sales and operations planning process to gain better inventory efficiency, cycle time reduction and continued variable cost productivity. Regarding our second priority, with Company profitability and product reliability as prerequisites, going forward there is no greater focus in the Company than on revenue growth.

During the annual strategic planning process over the last two years, we have continued to refine our overall revenue growth plan based on the following core components -- market and sales reach expansion, new product development, and moving up in importance for 2013 -- mergers and acquisitions. In our Communications Systems business, the leadership team has done a great job on execution with their new sales team in a very difficult government defense market, where 100% of their business comes from.

As you may recall, in 2011 our Communications Systems business significantly retooled their sales focus, realigning their sales channels and large project business development efforts, and in 2012 they achieved the positive revenue growth results reported today, largely driven by increased participation in international projects and better channel management.

Their mix of international business as a percent of total revenue increased from a historical single-digit level to approximately 40% in 2012. This expansion of Communications Systems reach into international markets is important to us for a couple of reasons. Not only does it allow us to pursue revenue growth opportunities during the slow times in the US, but by maintaining a reasonable business sales volume, we generate the gross profit dollars necessary to continue to fund the new product development activities critical to our ongoing participation in the constantly advancing high-technology field of military communications.

This dynamic, when combined with better channel management, which has allowed us to reallocate resources to larger business development program opportunities, makes us confident in the continued growth prospects for the Communications Systems business.

In the case of our Battery & Energy Products business to turn around a downward -- down revenue trend in 2012 we underwent a significant re-weighting of our resource location towards driving revenue growth activity versus back-office overhead and infrastructure expense. As a reference, while reducing overall costs, our front office expense dollars spend as a percent of total operating expenses actually increased 500 basis points in 2012, with headcount showing a similar shift.

The B&E market segments we currently serve can generally be defined as government defense, safety, security and medical, and energy and infrastructure. During last quarter's call, we mentioned that we had retained an outside firm to help us identify particularly attractive subverticals given our existing capabilities and new product development. Two of the priority targets fell within the medical and off-grid standby power markets. To help drive revenue growth along these lines, we previously reported bringing on board a new corporate Executive Vice President of Global Sales.

By working closely with several new members of the B&E sales team, we have already started to see the impact from this leadership addition and new focus. Recently we signed multiyear, strategic supplier contracts with two leading medical device companies for batteries and chargers for CPAP machines and medical cards. The contracts represent several million dollars of revenue over the next two years with deliveries expected to begin in the second quarter of 2013.

These contracts represent just a few examples of us starting to grow our business outside of our core government and defense business segments and into commercial markets where customers demand the proven military-grade reliability of our batteries and chargers. To continue to grow our presence in the medical device space, we are currently in the process of qualifying for ISO 13485, which is associated with medical device design and manufacturing and certification is expected later this year.

In addition to the new Executive Vice President of Global Sales I am also very pleased to announce today that we recently recruited an experienced veteran of the energy storage space to the position of Vice President of Corporate Business Development. Having joined our team on February 1, this industry expert will be focused on accelerating our new product development go-to-market and revenue realization and helping us identify and execute on meaningful acquisition targets.

Lastly, after a very successful four plus year expatriate assignment running our Ultralife China operations, upon repatriation to the United States, our current general manager of China is being appointed to a newly created position of Vice President of Global Primary Battery Sales. He is a battery chemistry expert and, given his intimate involvement with some of our core cell manufacturing technologies and facilities, we view him as uniquely qualified to help us drive application solutions and the global sales growth of all of our primary batteries, not just those produced in China.

All three of the aforementioned newly appointed senior executives -- the EVP Global Sales, the Vice President Corporate Development and the VP of Global Primary Battery Sales are direct reports to me.

Now that we have discussed the focus, targets, resource allocation and leadership to help us drive growth, I would like to briefly update you on some of our new product development activity. To better control our destiny for organic revenue growth we embarked on a new product development mission to respond to identified needs before clearly defined customer specifications, working with the customers to tailor the product solutions to their specific applications.

In November 2012, the Company completed a very successful demonstration of the Ultralife GenSet Eliminator at the US military network integration evaluation 13.1 at Fort Bliss, Texas. The proof-of-concept was fully vetted and on our website you will find links to a third-party newspaper article and DoD communication video discussing the GSE's benefits to the military.

We have received some terrific feedback on the product, and have incorporated all of the user suggestions into our current offering. Also, as we speak, we are participating in a GSE demonstration with a force provider company at the US Army's Expeditionary Warrior Experiment, or AEWE, at Fort Benning, Georgia. To date we have received GSE purchase orders for applications within two different US military service branches, and interest continues to grow rapidly with both US and international customers.

With respect to the MKM large-format battery itself, separate to the GSE, we have received small quantity purchase orders for both application-specific and test units now from over 15 different customers, both in the US and internationally.

Applications range from medical carts and emergency response systems to full UPS and standby power applications in both the commercial and military spaces. Although the MKM is a modular energy storage building block, each forms the part of an integrated system subject to rigorous and time-consuming testing. That said, we are very encouraged by the broad scale of applications interest and the potential implications for future MKM revenue streams.

Regarding our brand-new high-capacity 5390 and 2590 batteries, we received very favorable feedback from the recent field testing NI3 13.1, and to date we have received small quantity orders from over a dozen different customers and have shipped over 500 units. Though still shipping in relatively small quantities, the number of inquiries and purchases for these new batteries continue to accelerate.

In summary, regarding the new B&E products mentioned today, the quantities and dollar volumes are still small. However, we are seeing broad scale initial penetration of our new products and on a global basis. To put it in perspective, in 2012, 35% of our total B&E products revenue came from products that are less than or equal to three-years-old. In 2013, we expect that number to be closer to 40%, demonstrating the continued importance of new product development on the vitality of our product line.

At Communications Systems, they have developed a lightweight portable amplification system, or LPAS, which is valued at approximately $10,000 per unit and utilizes the industry standard A-320 amplifier and an integrated rechargeable power supply. To date we have shipped small quantity orders to both US and international customers.

In addition to international opportunities for several thousands of units over the next three years, we are working with the USSOCOM command for initial fielding in support of tactical vehicle programs as a pilot program, with similar multiphase purchases to integrate into traditional vehicles in the future.

Throughout 2012, the Communications Systems group has captured sales with multiple early adopters of the new A-320 Handheld Vehicle Adapter, or HVA, both domestically and internationally, with volumes increasing steadily. The system is undergoing thorough testing with one international customer for a multiyear contract for several thousand systems. Additionally, US special forces continue to integrate the HVA into multiple vehicle platforms. The A-320 HVA, without the 20 watt amplifier, has a list price of around $4000 per unit.

We also continue to gain momentum with our A-301-150 satellite radio combiner within US and NATO special forces. The product's versatile use in vehicle platforms, aerial platforms and maritime craft has had the immediate appeal to multiple special forces groups. We are currently pursuing a contract with a major OEM for multiple purchases over 2013/2014 for systems to be integrated into air platforms, and each of these has a standard list price of approximately $20,000 per unit.

We are also currently working with a major US Army prime contractor to supply systems capable of supporting the newly released Rifleman Radio. When fully fielded, the U.S. Army expects over 200,000 of these radio systems to be in service. This new, vehicle-integrated, power-enhanced Rifleman, or VIPER, system enables the operator to use the same radio in a vehicle or during dismounted operations. We are on schedule to release the system in Q2 with initial fielding in Q3.

Lastly, regarding our Company revenue growth plan, now that our business model is defined and validated, our portfolio adjustments are completed, we fill our strong balance sheet, no long-term debt and improving EBITDA rate, position us to more seriously pursue acquisition opportunities that may make sense for either of our two business units. Our goal would be to add key technology, capability, market access reach or brand recognition, such that we could supplement the expected modest organic growth rate and reap the operating leverage benefits from our business model faster.

As we look at our third priority, and that is to leverage our China operations for global commercial business growth and improved cost competitiveness, our Ultralife China team completed several important operational projects in 2012 that will position us well in 2013 for both improved profitability and growth. You may recall in the beginning of this year, we said that in conjunction with our Lean efforts, in 2012 we expected to continue to invest in our China operations to increase productivity and throughput without expanding our manufacturing footprint, and that is exactly what they have done.

First, they completed what was a lengthy internal transition to become the sole manufacturing location for our 9 volt battery. As a result, having one facility versus two for relatively the same number of units produced, the product line gross margin has improved, and this is contributing over 100 basis points in overall company gross margin improvement.

Also, as mentioned last quarter, they completed a small investment in our facility in Shenzhen to significantly improve the manufacturing capability for our Thionyl Chloride Lithium battery used by our electric metering customers. This project increased labor productivity, decreased cost and resulted in less variation in the tested battery capacity.

While we continue to aggressively pursue operational productivity improvement projects in China in 2013, we will be equally focused on taking our China-produced primary battery products to the global markets under leadership of our new Vice President of Global Primary Battery Sales. Given that our products are developed and tested by our own global technology teams and manufactured at our wholly-owned facilities, we feel that we have a competitive advantage and unique value proposition to provide the highest quality, properly applied products that our customers can use with confidence, knowing they will meet their application reliability requirements.

Simply stated, with the fewest supply-chain levels from the factory door to the customer door, we feel we are in a better position to ensure that the technical, manufacturing and quality standards are met to deliver on the performance and reliability commitments we make to our customers.

Regarding the financial outlook for 2013, we expect to see low to mid-single-digit year-over-year organic revenue growth, reflecting solid growth in our Communications Systems business, offset somewhat by modest gains in the Battery & Energy Products business. With ongoing operational productivity improvements and plans to continue prudent investment in new product development, we expect to increase year-over-year operating profitability and achieve an operating margin rate in the mid-single-digit range.

As we now view the uncertainty in DoD spending as the norm, in are 2013 operating plan we have taken a conservative outlook for revenue built mostly around specific opportunities we expect to materialize with any upside creating the opportunity for further operating leverage. Early in the year we expect spending as a percentage of revenue to be higher than our business model targets, as we ramp up completion of several new products that support some significant upcoming project opportunities. We expect a spending to revenue ratio to improve as the year progresses.

Our pending business opportunity funnels remain particular strong in Communications Systems in China and the pipeline of future market opportunities from our new B&E products continues to widen and grow. Though we are doing our best to achieve more consistent quarter-to-quarter revenue levels, identify customer buying patterns and pending projects timing would suggest a softer first half followed by a stronger second half in 2013.

For Communications Systems, in 2012 we had anticipated and achieved a solid rebound to positive growth rates in 2012 versus 2011 based on the high activity level we saw in broad participation in both domestic and international projects. For 2013, we remain optimistic for continued growth and would expect Communications Systems revenues to increase by high-single to low-double-digits over 2012, as several large projects, new product development-driven opportunities with multiyear shipments continue to move forward in our funnel. Depending on budget constraints, we could see some meaningful awards later this year or early next year.

For Battery & Energy Products, we now have the focused target resources, new products and leadership in place to help us drive growth. That said, much of our B&E US government defense business is dependent upon the volume from some very large DoD and OEM prime customers, and they themselves have stated that they expect their volumes to be lower in the foreseeable future. As such, our growth guidance for B&E and hence total Company revenue in 2013, considers the possibility that B&E volume for new products, new market segments and new customers may not be able to fully offset the US government defense revenue decline.

We continue to be pleased with the growing new international and commercial business opportunities. You can be assured that our corporate executive and B&E management team is game tackling the challenge head on as we know the rewards of meaningful operating leverage and profitability await in a hint of B&E revenue growth.

Finally, with respect to operating profit, we were pleased with the achievement of our second-half 2012 low- to mid-single operating margin guidance by delivering an 8% operating margin rate in the fourth quarter, on top of the reported 6.7% operating margin in the third quarter. In 2013, we plan to take the next steps towards our interim 10% operating margin goal by achieving profitability improvement each quarter year over year and achieving a mid-single-digit operating margin rate for the entire year.

In closing, in the fourth quarter we were pleased to deliver our second consecutive quarter of total Company profitability despite flat volume. The validation of our business model provides a strong platform on which to grow earnings as we achieve topline growth. Though market challenges remain, particularly in the US government defense sector, we feel we are well positioned to capture several new revenue growth opportunities, and that we have the right business model in place to deliver attractive leveraged earnings growth in the coming year.

Operator, this concludes my prepared remarks, and we would be happy to open up the call for questions.

(Operator Instructions). Walter Nasdeo, Ardour Capital.

I wanted to just circle back to the defense spending. I know it is pulling back and it has been a challenging area for you for the last number of quarters. Are you seeing -- and maybe it is both, but are you seeing a -- the order size getting smaller or the order volume getting smaller, or both?

Maybe even different than that. Right now in our operating plan, we have funded, approved, and we are the winner projects that are just being held, given some of the overall uncertainty of the budgeting cycle. So that is certainly influencing and maybe making as little timid about our revenue projections in the case -- and that as relates to Communications Systems primarily.

In the case of B&E products, there were really no orders last year from DOA as the troop withdrawals occurred. And with some of our new products we are very optimistic about the opportunity to continue to provide battery packs in the future, but there is open IDIQs that there aren't orders being placed against. The overall orders activity is just a lot slower and so I don't look at it as being a bunch of small orders versus a bunch of large orders. It is just an overall sluggishness of demand.

Are you seeing that in some of the European defense partners that you are working with also?

Somewhat, but in most of the international activities, rather than just try to be everything to everyone, I think the teams have done a really good job on focusing on projects where we have some type of a competitive advantage, and that the project is actually funded. So, there may not be as many different opportunities we are looking at, but the ones we are looking at have a higher probability of actually going through.

Okay, thanks a lot.

(Operator Instructions). Jim McIlree, Dominick & Dominick.

Can you help me understand why the operating margin in 2013 is expected to go down versus the second-half operating margin? It looks like volumes are up modestly, so why would margins contract?

We still see a pretty reasonable front half to back half revenue trend, and even though our spending for selling expense and, most notably now in the first half of 2013, for new product development and completing some of our projects that we are trying to get completed into production, are ahead of the revenues that we had expect to achieve for those projects. So, when you look at the overall 2012, there was actually a loss in the first and second quarter, improvement on higher volumes in the third and fourth quarter.

As I indicated in my comments, we are expecting a little bit softer in the first half of next year, but we would still be at the spending rates associated with new product development. And overall, when you look at the total year and you look at the operating margin impact, that would suggest that the fourth quarter 8% operating margin target isn't something that is sustainable for every quarter through next year.

And are you willing to put a split on the first half versus the second half revenues? In terms of what percent?

I think it has been more like 45/55.

And you think that will be roundabout the same area in 2013?

Yes, that would be roundabout. So, we are at anticipating a little bit better revenue second half, in the back half, and a little bit less rich spending than we are in the first half.

Okay. And can you provide the depreciation and amortization, as well as CapEx for the quarter?

Sure, we will be happy to. We have been running historically around $900,000 to $1 million in depreciation. And that has been pretty consistent, and that is what we see in the fourth quarter. CapEx is approximately the same in the fourth quarter. CapEx for the total year will be slightly less than $3 million.

Are there any cash closing costs for the UK facility?

Outside of what we discussed with the remediation project that would be a cash outflow.

Okay.

$950,000.

All right, perfect. Thanks a lot.

(Operator Instructions). Gary Siperstein, Eliot Rose Asset Management.

Congratulations on the wonderful progress. Mike, can you give us some color on -- you mentioned starting to look for M&A activities. With cash at $10 million now and a debt-free balance sheet, what is your thinking on that? For the first potential acquisition? Are you going to start small and see if you can do them successfully and then go from there? And what size maximum would be the first potential deal?

I don't know if I can bound it specifically, but in the 13 or so successful integration acquisitions that I have done, I have learned that small ones are as much work as big ones. And so we would want to make sure that even though the first one we don't want to bite off more than we can chew, that it would still have a meaningful impact in our overall revenue increase.

So, does that mean there is a minimum of $10 million of revenue? Perhaps. If there was unique technology that there was a fantastic opportunity for long-term revenue growth, we would maybe do something smaller than that. But for an existing, ongoing operation I would like to make sure we are at least at $10 million. And then when I look at that relative to our overall revenue base at least we get some meaningful topline growth associated with it.

And what I have done in the past is done a reasonably smaller strategic acquisition, make sure that we learn and can do a good job integrating it and build some confidence there, and then usually take a second bite at it and go much bigger.

Okay, that is fair. Thank you. And, Phil, great job on the inventory reduction in the quarter and the corresponding increase in cash. With the ability to move revenues forward as you forecast this year, is that about it on inventory, in terms of reduction? Or do you feel there is more room there?

Gary, my answer to your question is an adamant no. There is more room there. And that is our best opportunity for further financing.

Could you -- not to pin you down, but could you get another $5 million out of inventory over the next 12 months?

Yes.

Super. Okay, thank you. And, Mike, in your formal remarks you mentioned a lot of new product activity. You mentioned penetration into the medical space actually coming to fruition. I know you have been working on it for a long time. That was a very long list and very exciting with the potential. Is that finally the fruits of the sales force? I know it has been tweaked each year for the past few years. Do you feel you got the right people now and it is starting to bear fruit?

I look at it holistically. Gary, when I look at the organic revenue growth dials I feel that people and products -- we spent a lot of time making sure we had the right people in place and we could leverage that. We spent time developing the right tools, and we talked a little bit less call about the targeting. I think we were missing some go-to-market, especially for new product leadership. Now we filled that, so with the people, the products, the tools, targets and leadership, I feel pretty good about our ability to maximize the opportunities that are out there. And by adding some layer of acquisition activity on top of that, I feel good about our growth prospects.

And you guys, during this transition and restructuring and government freeze on the military side, certainly for the last maybe two or three years, you guys have gone dark in terms of IR. With the last two profitable quarters and your forecast for this year, with cash doubling, book around $4.20, selling at half revenue, are you guys getting ready now to go out and tell the story to the Street?

It is always a balance, Gary. We try to make ourselves available, if not in large audiences, in small audiences, as you're well aware, especially after the earnings call. And most of our investors -- it is interesting -- they like for us to be out there selling the story and receive the benefits of that, but we get an equal amount of pushback from some of those same investors, like don't waste your time with me; go and fix the business and get it to grow, and good things will come.

So, we are always trying to balance that. And at this point we are probably erring on the side of trying to get the business fixed and getting revenue growth and probably a little bit underwhelming some of the IR/PR activities.

Okay, that is fair. Thanks, guys. Congratulations. Looking forward to further progress.

(Operator Instructions). There are no additional questions in the queue. I would like to turn the call back over, sir, for any additional remarks.

Great, thank you. Thank you once again, everybody, for joining us for a fourth-quarter 2012 earnings call. Once again, I look forward to meeting up with several of you over the next couple weeks or so and to sharing with you our quarterly progress on each quarter's conference call in the future. Thanks again for participating and happy Valentine's Day.

Thank you, ladies and gentlemen. That will conclude today's presentation.