Acorn Energy, Inc. (ACFN) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to Acorn Energy Second Quarter 2012 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Heather Mallard, Vice President and General Counsel of Acorn Energy. Please go ahead.

Thank you, and good morning. Please take note that certain of the matters discussed in this presentation contain statements that are forward looking, such as statements relating to the results of operations, financial condition, business development activities and market dynamics. Such forward-looking information involves important risks and uncertainties that could significantly affect the anticipated results in the future, and accordingly, such results may differ materially from those expressed in any forward-looking statements made by or on behalf of Acorn Energy or its subsidiaries. All statements other than statements of historical fact in this presentation regarding Acorn Energy or any of its subsidiaries' future performance, revenues, margins, market share and any future events or prospects are forward-looking statements. For more information regarding risks and uncertainties that could affect Acorn Energy's or any of its subsidiaries results of operations or financial condition, review Acorn Energy's filings with the Securities and Exchange Commission, in particular, its most recently filed Form 10-K and Form 10-Q. Acorn Energy's forward-looking statements are not guarantees of future performance, and the actual results or developments may differ materially from the expectations expressed in the forward-looking statements. As for the forward-looking statements that relate to future financial results and other projections, actual results will be different due to the inherent uncertainties of estimates, forecasts and projections and may be better or worse than projected, and such differences could be material. Acorn Energy undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. I am now very pleased to turn the presentation over to John Moore, CEO and Chairman of Acorn Energy.

Thank you, Heather. Welcome friends and fellow Acorn Energy shareholders. I'm excited to tell you about our progress and financial results for the second quarter and our management team's effort to build a base for continuing outstanding shareholder value creation. First, I'm very proud of our strong balance sheet. As of June 30, the company has over $54 million of total current assets; over $45 million of working capital, including approximately $32.8 million in cash and short-term deposits; and $6 million of funds held in escrow and $1.9 million of unrestricted cash. The company expects to receive the funds held in escrow before the end of the quarter. A strong balance sheet is important because we're investing aggressively in our promising businesses, and the #1 thing a business must never do is run out of cash. To expand our balance sheet, we've worked with our management teams to obtain formula-based bank financing. It's always smart to work with banks when you don't need their money. We have also spent a lot of time, some money and effort raising investor awareness. In each of our businesses, I want to give you some sense of how much cash we intend to spend to get the business on a self-sustaining, solid, positive cash flow trajectory. I'm not going to spend any time discussing why pioneering digital energy as a theme is such a compelling opportunity. I invite you to read our recent past shareholder letters to understand what a truly unique time this is for investors. I'd like to take a brief moment to explain our perspective. Anybody who knows me knows I love to send our friends and investors articles and books on why what we are doing matters so much right now. Like many of you, I'm a huge fan of Malcolm Gladwell. And the 3 things he's written helps underscore what we're doing at Acorn and why we think investing our gains from our recent CoaLogix success in our existing 4 businesses makes so much sense for our shareholders. Firstly, Gladwell's first book, Outliers, the Science of Success, talks about how it requires 10,000 hours of dedication to master critical skill. That's what our business has done. We're leveraging your capital against our management team's 10,000 hours with the goal of providing an outsized return on your capital. Whether we're talking about DSIT's sonar brands with the Israeli navy, which lead to the creation of their underwater threat detection business; Jim Andersen as the team's experience at Litton; Kevin Anderson, the inventor of the GridSense Transformer IQ; or the 13 years that OmniMetrix took to create the power generation monitoring industry. These are all fulcrums against which we're investing your capital, and we hope to succeed in a spectacular yet capital-light way because of this profound time-based investment. Second, Gladwell wrote the tipping point about how ideas spread. He focused on the 3 vital personalities: the maven, the salesman and the connector. The maven represents the 10,000 hours that our founders in our team have invested. Acorn is using your capital to address the main issue facing the maven, namely, the fact that it's exclusively product-focused rather than market-focused. I think it's worth pointing out that low small business, high-technology businesses fail because they spend most of their money developing the technology and run out of time and resources to allow the technology to encounter the market, and they change by it so it can become a financial success. Finally, Gladwell wrote how David beats Goliath. And in this article he discusses how relentless effort, not talent or entrenched interest is a critical component of success. We are bringing the full-court press to our customers. This customer focus is why we're so excited about investing in our businesses. Our managements need the people and the resources to grow our businesses to profitability, and profitable growth is our goal. DSIT is our largest and most profitable business. Unfortunately, where there's oil and gas, there's conflict, and there are major tensions in the Middle East, Southeast Asia and Latin America. DSIT helps secure energy terminals from terrorist intrusion. Sales were up 40% versus last year. And the business are into profit of $415,000. We've invested $2 million to date in this business, and we expect to invest another $3 million to expand this profitable company's product line and sales and marketing effort. It was Dan Ben-Dov, DSIT's sales manager, who bumped into Jim Anderson in security tradeshow and called me to urge Acorn to invest in US Seismic. Dan's vision was a DSIT with the leader in active sonar for diver detection and US Seismic at a very interesting passive sonar for diver detection. He believed that the combination would be important for realizing the potential diver detection market by solving 2 big problems: false alarms and environmental concerns in a cost-effective manner. The idea is that active sonar is considered disruptive to marine life and has been banned in some markets. Passive sonar can be coupled with active sonar to detect the potential threat and then wake up the active sonar to verify and track a potential threat. We've acted on Dan's vision by the 2 companies winning a Byrne [ph] grant of $900,000 to co-fund our development of this important project, and we believe it will substantially expand the market to the DSIT leads. We hope that DSIT and US Seismic will expand their cooperation beyond this initial success to land-based perimeter security. The company has growing reputation for innovation and customer satisfaction. We expect continued growth from this terrific management team and their pipeline of opportunities. We're repeatedly hearing from or customers and other vendors that the distribution automation market that we're pioneering is the killer app for the Smart Grid. It's important to review what will likely not be a growth year at GridSense to the length of: one, the rapid growth in trial programs from 1 to over 20; and two, the fact that GridSense last year beat their budget by introducing the Transformer IQ, an entirely new concept to help utilities deal with their aging workforce and Transformer infrastructure. We offer a solution to a major problem for utilities at a compelling price point and we have limited competition. We have always stressed that our business is nonlinear. 2012 is proving an important year in expanding the trials and applications at Transformer IQ. But some of the projected rollouts have moved into 2013. I cannot overstate the challenge faced by distribution utilities in dealing with these 2 problems or the heart that effective work our sales team is doing to exploit this Blue Ocean [ph] opportunity. We've added Alain Steven, Secretary General of the very large grid operators consortium to the GridSense Board and expect to help us expand our credibility and visibility into the large customers internationally. Baltimore Gas & Electric published an article in transmission and distribution world on our work together on Transformer IQ that highlights a very attractive payback of our product. We're excited to play a prominent role in this high profile, $450 million Smart Grid project with BG&E among many others. Lindon Shiao, our CEO, is probably the most excited about our new Grid Insight product that will increase the velocity and scalability of sales by being able to address the fragmented but large coop and municipal markets, as well as adding an important recurring revenue component to our business. Lindon now has over 20 engineers working on expanding our solution suite, and I expect that in 2013 we'll get a glimpse of the true potential of this outstanding company. Our legacy business is a power quality and monitoring instruments at GridSense had a weak first half that led Lindon, who is always quick to make hard decisions, to reorganize the sales function in Australia. In these early stages in the business growth, it's been nice to depend on the regular contribution from these products, but it's not really relevant to the vast opportunity we see. We've invested $12.7 million in GridSense, including $1.9 million in Acorn shares. And we've recently agreed to provide additional $3 million to fund the business through 2013 in what we expect will be positive cash flow. I'd like to remind everyone that GridSense is profitable in the second half of 2011. I've often said that I never want to expand our portfolio of companies unless it's a big fat pitch across home plate. Three years ago, the company that we couldn't resist adding to our portfolio was US Seismic. Earlier this year, it was OmniMetrix. OmniMetrix is our on-site power generation monitoring business. This big opportunity we're addressing was brought home in spades and the recently with the Derecho, a big storm in the Mid-Atlantic taking out power to our nation's capital and other areas for as long as 2 weeks and compromising the 911 service. Washington Post wrote an editorial saying, "The previous night’s storm had shut down commercial power, and emergency batteries were exhausted after a few hours at the key Verizon control offices in Arlington County and Fairfax. Each office had a pair of backup generators, each roughly the size of a walk-in closet. One of the generators failed at each site, and the remaining units weren’t strong enough to keep 911 service up." Ironically, Verizon has made up one of their largest investments in back-up generators of any cell phone provider. This drives home our message. Every generator needs to be monitored in real-time, and we hope to turn this excellent company and their competitors into real customers. Similarly, Amazon data centers that hosted their multibillion cloud service business that hosted Instagram and Facebook lost power when their back-up generators failed to start during the sustained storm. We have a compelling value proposition at OmniMetrix. OmniMetrix created the industry and is the leading brand that ensures thousands of generators start when needed. There are over 2 million generators throughout United States. The business is much larger overseas where on-site power generation is the primary source of power in regions like Africa, South America and Southeast Asia. We acquired OmniMetrix for $8.5 million and intend to invest about $2.5 million, of which $1 million has already been funded to build the support infrastructure in sales and marketing to grow the business from the current 4,200 connections to a 50,000 or more by 2014. To facilitate this growth, we innovated the business model to become a pure subscription-based business charging an annual fee of $400. We have the luxury to invest now. We feel that after 13 years of hard work by the company to perfect the solution, the market is finally ready. There are over 1,000 generator dealers. We are surprised when we did our due diligence that OmniMetrix had only sold 55 units to Generac's entire distribution last year. We recruited an advisor, Andy Briggs, a former generator dealer and past President of Generac's Dealer Council. He developed a very convincing strategy for us to help double the profitability of the dealer service business through the adoption of our Smart Service program, which allows service technicians to review this machine history before climbing into a truck. A better knowledge of the history means a higher first trip success rate. Over 50% of generator faults can also be reset online. This has a big impact on the dealers' bottom line. He's helping us set up pricing policy and salesforce. Some interesting anecdotes that underscore this terrific opportunity is one that -- one large dealer that was buying from a competitor ordered 110 units, and this points out that our Smart Service program is beating our competitor's product and that the momentum of the evolution of remote monitoring is here today. Our dealers are extremely excited about OmniMetrix product both for their existing customers, some of which -- and some of those dealers have thousands of long-term maintenance contracts, as well as new customers. Some examples include one of the world's largest amusement parks, which after testing our OmniMetrix units agreed to install it across the entire base of 140 gen sets, and a well-known big box retailer after testing our box within the dealer's captive region has decided to roll out OmniMetrix box on additional 250 units in 2012 out of a complete installed base of 2,200 units. So we have an exciting growth business ahead of us. There are over 600,000 cell phone towers around the world, tens of thousands of hospitals, fire stations, critical manufacturing, data centers, air traffic control centers, to name just a few targets. Customers who use our products have historically high retention rate, which supports the theme that Acorn's digital energy technologies are addictive. Our shareholders are well aware of the value we can create to this recurring revenue business. Lastly, US Seismic. Since our initial investment in the fourth quarter of 2009, we've invested $14.5 million in cash and Acorn Energy stock in US Seismic, which includes $2.5 million in the last 2 weeks. We have a commitment to invest another $2.5 million before the end of the year. Our use in the proceeds of the most recent $5 million commitment is as follows. $3 million for working capital, $1 million to cost reduce our sensor ray design that takes 90% of the touch labor out of the existing products, $1 million for 2 low-temperature low-pressure rays and as demonstration units. So our field trial and customer updates. Up until recently, we had completed 5, what I tell everyone was imperfect demonstrations. Each imperfect demonstration resulted in an order because, one, customers believe the good parts of our data was hundreds of times better than the data from the legacy seismic tools; and two, our customers believe that our problems were engineering problems, not science problems. We were lucky to have such smart customers. In the past several months, US Seismic has been tested and conducted 2 additional trials and the most recent trial with one of the world's largest oilfield services company. It was a flawless demonstration of the power of our technology. Hats off to Jim and his team. We expect in the next several months to receive several orders from small- the medium-sized seismic services businesses. In the next 6 months, we expect to receive several initial orders from major international oilfield service companies and follow-on orders from our initial small- to medium-sized seismic service customers. In addition, we're working with several major international oil majors to validate our products but ultimately expect that any orders that result from these collaborations will be received from the oilfield service providers. So I'd like to provide a quick product development update. Our investments in product development have 2 primary goals: One, improve the reliability and field readiness of the product; and two, reduce manufacturing cost and delivery times. First, we had to make our custom hardware solution product reliable. Substantial investment of firmware and hardware deliver the product that is reliable and functional and very expensive to produce. Our current hardware product is fine for performing field demonstrations, but it's too onerous and has limited sensor density. The Northrop Grumman license for the interrogator is the central focus of our efforts. We expect to have a demonstration unit complete and debugged by the fourth quarter and a commercial offering in the first quarter. The bend [ph] of 2013. The benefit of the Northrop Grumman license technology is it is primarily software and able to leverage extremely powerful PC-based components resulting in dramatically improved margins and performance. In addition, instead of each box being able to manage 12 sensor channels, each box will be able to handle 300 sensor channels. This is critical as a small footprint is important for the unit to be practical on the field in wireline truck deployments. Lastly, manufacturing and expansion capital update. Substantial investments have been made in automatic production equipment and the quality of processes. US Seismic passed our first ISO 9000 inspection. They hope to achieve certification in the third quarter. They have received significantly, CE, UL and other certification for our products. The SAP ERP systems have been implemented in our daily part of our quality programs. Entering 2013, Jim and the team are preparing US Seismic that $50 million capacity. I want to reiterate, this is not a projection of revenue but a statement of capacity. Acorn expects to invest an additional $5 million next year, and I want to point out this hasn't been presented to or approved by our Board of Directors, but I'm just trying to manage everyone's expectations on how much capital we're going to be investing in the business to support the record scale of implementation inventory working capital. We're very excited about the prospects of US Seismic and feel we back the right team, and to market is desperately in need of low-cost and highly effective tools from improving the productivity and environmental profile of frac-ing and the exploitation of unconventional resources. In conclusion, we expect to eventually have approximately $20 million invested in order to transform what is today a $2 billion industry. In conclusion, we have concrete plans to invest, as I've highlighted, about $15 million of your company's capital over the next year to grow these 4 terrific companies to what we expect to be positive cash flow. Our businesses are all capital-light, high-margin and facing large demand pain on clearly identified pain points for our customers. We are mindful of the challenges of creating new industries, but we are in on the ground floor of solving the largest challenges facing the world's energy needs. I'm happy to now take questions from the shareholders and the analyst community.

[Operator Instructions] The first question comes from William Bremer of Maxim Group.

My first question is on US Seismic. Can you go into a little bit more the 300 sensor channels versus '12? I want a little more color there. And then the 50 million capacity, how long is that going to take you to potentially have that capacity?

Jim Andersen, I'd like to turn that question over to you.

I will. Thank you very much, William. Yes, so on the first one, I'll start out is that our initial, what is called, interrogator technology because we have sensors that are fiber-optic, and light goes down as the sensor comes back, but all of the brains for sending the lights down and looking at the reflected signal to turn it into what the customer wants is in a box we call an interrogator. And up until now, I mean, across the industry, these Interrogators are very, I'll call it, hardware-intensive. Lot of circuit boards and circuitry and things like that to take that signal that's reflecting back and turning it into the data format that the customer wants. What Northrop Grumman had developed and now we license and we are commercializing is rather than having that all done with hardware, it's done via software. So there's a little bit of upfront processing of the signal coming -- reflecting back, but the majority of the horse power and turning that into the format that the customer wants is done via software and via PC. This technology is developed on the order of 10 years ago. It was starting to be developed, and there are 4 patents issued -- actually 3 patents issued and one is pending, and we licensed that recently. And the beauty of it is, is when it was initially being developed, the PC technology was marginal, I'd say, but now, PCs are developed on the order of hundreds to thousands times better. And it's really made, I'm going to call it, software-based demodulation, very, very cost effective. And we believe we'll come out with a very cost-effective interrogator box. And taking account the size that John was talking about, typically right now based on our hardware solution, one of our interrogator boxes, which might fit in, say, a 19-inch equipment rack can handle on the order of a dozen sensor channels. And with the PC-based demodulation technology as the product that first rolls out the door. One box will be able -- a similar-sized box that we have now will be able to handle 300 sensor channels. And as we progress, we intend to triple that future introductions of the product. So that's with respect to the size difference. And I forgot, what was the second question?

Next question is really on -- oh, I'd like to add, what's the timing on this ramp-up to 300?

Oh. We are -- by the end of this quarter, Q3, we'll have first prototype up, and and running, and we'll be testing it, taking it out to different deal locations, and we're working all the bugs out through Q4 and introducing it as commercial product in Q1 of next year.

Okay. And then the ramp-up to the 50 million capacity, if all goes well, what's the timing on that?

Well, we're setting up to -- for handling capacity of $50 million next year. And beauty of it is, is it really isn't taking a lot of capital equipment. Some of the things that we've already done is we're setting up to have an ERP system. We used SAP Business One, the biggest software solution fiber in the world, tracks all the POs, inventory, work in progress and all that. So that's getting in place. We're having -- we're expecting the approved ISO supplier, ISO 9001. We're having our final audit in about 7 or 8 days and expect to get the certificate within a couple of weeks after that. And that's important because it's being imposed top down from our major customers when they start buying production equipment and when we transition from prototype test equipment and production. They imposed it upon us, and we're making sure that, that's in place to handle it. So that's all happening in the background. And then we looked at the things we make here versus the things that are made outside of USSI. And pretty much all the heavy intensive capital equipment -- I mean, things that need capital equipment are being done outside. Example being the fiber optic lead cables, the cables that have to be armored, high-temperature, 20,000 pound breaking strength, all these things, we design them here, but they're completely manufactured outside our plants and shipped to us, and then we cut into the cable at certain locations to install our sensor -- fiber-optic sensors. So very little capital is involved in that. The places where capital expenditure is required at some of the automation, that is our fiber-optic Geophones consist of wound coils of fiber. And we've purchased our first automated station, which has increased our, I'm going to call it, output per shift by -- on a factor of 50 to 100. And we envisioned that in order to handle $50 million in revenue next year. We need 2 of those stations, and the stations are fairly inexpensive, like $35,000 now that we've developed, so not very capital-intensive. And then there are some other stations that we're developing for automated testing of equipment, when as is being put together because we have to remove the touch labor, so think of it as like when -- as the things getting built, you do a quick hookup to something and test it out all automated, and we're setting all that up. Again, not really capital-intensive. These stations aren't that expensive, so internal capital-wise, it's pretty capital-light but pretty much in our plan based on the investment we're already getting from Acorn Energy, that, I'll call it, capacity to be able to handle 50 million will be in place in Q1 of next year.

Okay, great. Let's say, with US Seismic, hey, John, Jim, how do you guys see US Seismic's revenue in the back half of this year, similar to this last quarter the second quarter or a steady little ramp-up?

You want me to take that, John?

Well, I guess to the -- Bill, I appreciate that question. And it's -- we're -- the business is so small at this stage. And we are really dependent upon -- each one of these orders that we're talking about is $1.5 million, $2 million. And it's a question mark when we've got a big pipeline, but it's sort of a question as to when we can -- when those orders land. And that's really -- well, it alot of times depends on these big service companies. Jim, is there anything else you'd want to add to that?

Yes, and I'd just say that we're expecting to have over the next 30 to 60 days, plan some of these follow-on contracts we've had for first article systems. So, this would be like the single systems like John's talking about that cost over [ph] $1 million, $1.5 million. And then it comes down to how many of these systems we could deliver in Q4.

Yes, and we're really trying to get people not to be focused on quarter-to-quarter revenue. And the hardest thing is that we think it's important we land these orders. When we ship them out, is it third quarters, fourth quarters, first quarter, I don't know. But each one of these potential orders, particularly with larger oilfield service companies could lead to much, much larger company-transforming opportunities. So we're really hesitant to -- and Jim -- I know, Bill, that's your job is to forecast, but we really are not giving any projections on that.

Okay, gentlemen. And you called out GridSense a little bit in terms of year-over-year numbers, can you give us a sense of what you're seeing there back half of this year, as well, as we head into the first half of the year?

Well, I mean, what we're seeing is, is that the communications companies are saying that, really, AMI is not as hot as everybody thought it was going to be, but really the killer app for the Smart Grid is distribution optimization, which is what we do. And as far as I know, we, and one other company, Elster, have got these transformational products. And once again, huge utilities, huge potential deployments and very limited visibility. Even the biggest companies have problems scheduling when they're going to land these deployments. And so I want to limit the amount of time that we take to talk about that right now because I don't really have much insight other than the fact that based upon the number of pilots that we have, it's -- there should be dramatic growth ahead of us. When that growth occurs, what quarter, we can't predict.

The next question comes from Rudy Hokanson of Barrington Research.

I have 4 questions I'll lay out, and then you could address them in the order you want. One is I just wanted to double check that the footnote about DSIT becoming involved in Seismic is indeed related to the grant that was given to USSI and DSIT, or if there's something else that is happening right now. Second, you make reference in the press release to OmniMetrix working on its business model, and I was wondering if you could give more detail on that. Three, if you could speak to expectations for R&D in the second half of the year for Acorn in total, perhaps in some for each one. I know that you've been adding to engineers and others that come under that classification in the P&L, but I was just wondering in terms of looking at that line item, if you can maybe express it a little bit more. And then going back to the USSI question, that was asked before, and without a forecast specifically of revenue, if you could -- I just want to make sure I understand, when you say that you're doing some small proof-of-concept sales or large proof-of-concept sales and what we just saw announced at the end of June and early July, were items 2 different situations, one was 700,000, one was 800,000, but now you're talking about 1.5 million. I just want to make sure I understand the size of what these orders are likely to entail when you say smaller or large, please.

Great. Thank you, Rudy. So Jim, would you mind taking the last question?

Okay. Yes, first I'll compare to when you say size of orders, our target market is the microseismic monitoring. And there's -- several of the areas where you have to monitor our high temperature, which require a more expensive equipment, and I'd say that's probably on the order of maybe 30% of fuels being hydrofrac-ed or high-temperature. These are fields like Haynesville in Texas and Eagle Ford and they're places -- some places in California and then maybe a little internationally, but those require a little bit more expensive systems. So the conventional technology required to monitor these areas is cost on the order for a typical system [ph] $7 million. We're coming out with the fiber optic technology that actually is superior, and we're sort of testing the price point. But we're coming out with the early adopters for -- to address that market with some things on the order of between $1 million and $1.5 million. And then for the lower-temperature systems, those will run on the order of $500,000 to $700,000, maybe $750,000, which are sort of some of those initial orders that you talked about.

I'm sorry -- Thank you so much, Jim. Deena, do you want to talk briefly about how we've changed the business model at DSIT -- I'm sorry, at OmniMetrix?

Sure. Historically, the business model for OmniMetrix has been to sell the hardware and also charge for the monitoring fees for the ongoing service that we provide to the customers. The cost of the hardware has dictated that it's been a barrier to entry for the -- for our customers to connect with us. So with the Acorn investment, we have removed that barrier entry and basically done the Razor-Razorblade model and are giving away the hardware in exchange for the connection. The connections is the value of the business in moving forward in recurring revenue stream. And we believe that our data and our deliverable to the customers are so strong that they will become addicted to the data therefore, or churn rate is historically always been extremely low. And the future of the company is in gaining the number of connections. And then in the future, we will expand the services to them to actually increase the offering and add services to the customer -- to our existing customer base.

Could you perhaps give a bit of perspective in terms of what the equipment used to cost upfront, and then also and I may be mistaken on this, I thought part of the business model in the past involved charging for a full year of service upfront and then every subsequent month that a customer was charged was really for a month 1 year out, or did I misunderstand that?

To answer the first part of your question, historically in the past, we had charged approximately $1,000 for the hardware. And then the second part of your question, we do -- we did historically and are currently charging a year's worth of monitoring in advance. And then at renewal, we will charge the year's worth monitoring in advance on every renewal year. So if that part of the model hasn't changed, we're just taking away the hardware cost.

Okay. So if I just understand it, there's only a charge once a year for the next 12 months?

That's correct.

Great. And Benny Sela, would you mind commenting on the DSIT seismic expertise?

Yes, we have gained a lot of experience in the advanced signal processing of acoustic underwater signal classification and detection. And it turns out that this expertise and technology is applicable to seismic systems, which has similar sound waves that propagate in the ground versus underwater. And that's where we compliment with USSI. They have the advanced front-end sensors, and we complement them by adding the advanced signal processing providing detection and classification program, and that's where we tie together. We -- our Ministry of Defense has also given us couple of context like this lately. Regarding land-based security projects, we can't talk too much about them, but applying the acoustic knowledge that we gained for seismic application. And from that point of view, it's a very good match with USSI, and that is an expansion on top of the BIRD projects we'll be, as John explained, we'll be jointly doing for underwater active -- our active and USSI passive sensor -- a diver detection sensor.

So, again, maybe to reiterate what John was saying earlier, and why this grant, the BIRD project, is so important is that this way neither one of you has to reinvent the wheel but you can complement, I think, where you hadn't been in the seismic market now, you can take the knowledge and the connections USSI has to some degree and see how you can be complementary on Seismic. And on the perimeter security that USSI, I believe that's the way it's called, has been working on that you can take your more naval application and work with them on those markets. Is that correct?

Yes, exactly. That's what the synergy is all about, 1 plus 1 is 3 and not only 2.

Thank you, Rudy. And Rudy, I think the -- I can't break the numbers down for you on the R&D, but the one point I want to be very clear about was that we have a little less than $40 million of cash. We have $15 million of money for direct investment and our operating cost, including our dividend, is about $8 million a year at the corporate level. And so we've got 2 years of cash with all of the foreseen investments in the operating businesses. And that's sort of an enviable position to be in, and probably 25% of that capital will be invested, if I were to guess, in R&D, with 75% being spent on sales and marketing and getting the products into the marketplace.

Can I -- just for the sake of the mundane as we try to build this financial models, can you just give me -- is it possible to give a rough run rate of what would be called R&D in the second half of the year? Accounting all the capital spending but just R&D, would it be good to look at first half of this year and say, it's likely to repeat or is it likely to maybe trend down because you have -- of what you've done in the first half, or is best just to [indiscernible] it flat?

I don't know that I can comment on that, Rudy. I'll give that some thought and get back to you.

Next question comes from Jim McIlree for Dominick & Dominick.

John, a few things. First on OmniMetrix, just a contemplated monthly or annual charge for the service.

Deena?

It will be dictated by volume. Obviously we're trying to partner with dealers, so the concept for the dealers is the more customers they create connections with, then the lower the cost of the monthly monitoring. But it's anywhere from $25 a month to $45 a month is the range depending on the volume.

Great. And how long is it reasonable to think that the distribution channels will be, let's say, completely built and you can start going after the end users?

We are in parallel going after the large volume end users currently, and we typically try to work with these dealers because it benefits their business to have these large volume customers as their service dealers as well. But there's nothing stopping us currently from going after end users. We're just obviously looking for the low-hanging fruit currently, and the volume accounts are what those are. And these dealers represent the connections to the customers that typically we don't have. So that's the real main driver behind letting the distribution on the dealer levels help us with the volume connection.

And the dealers are the OEMs or the...

They are the service dealers to the OEMs. Service dealers to the manufacturers, correct.

Great. And then John, on both GridSense as well as US Seismic, can you lay out what a typical timeline would be from beta trial, trial lasts x many weeks or months, evaluation period of a certain time, get the order, another evaluation then you get the big one. Just I'm trying to kind of map out the time period before both GridSense and US Seismic for that.

Great. I'd like to hand that one over to Jim Anderson. Jim, would you mind sort of giving your experience to date?

Yes, so what happens is you have the initial -- we go out and do some kind of demonstration with the client, and sometimes it's a funded demonstration and sometimes we make decision it's worth to go out there because we have the part -- the equipment to go out and do the test. Sometimes we do it gratis for them. Typically, once we do a demonstration, within a month's time, they give us an indication that they want to place an order for a larger system. A lot of times though that -- them stating they have the -- they plan to do it, and when they do it, sometimes months go by, but they always come through. So they have the date, and then once we build up a system and deliver it, which we've done -- example, one, we've delivered a system at June 31, end of Q2, to one of our clients. And they're getting ready to go test it in the field sometime in the middle of this month. So we shipped it to them, installed it in their truck. They're doing some integration work with their own equipment, they're going to go test it so that time from when we delivered to when they test it was on the order of a couple of months. And then based on this testing that they're going to do, if they're happy with how everything works, some time this quarter, we would expect a follow-on order. So sometimes, when you deliver it, it's a couple of months so they actually can schedule a test. And like for this client, we're talking about they're going out to a high-temperature field, shale field in Haynesville field in Texas. So it sort of varies. But I'd say from one step to the next, the decision is typically made quickly in the order of few weeks to 30 days. But sometimes, it takes 60 days from that decision to get us the actual order.

And as these -- I'm sorry, Jim, but as these systems are potentially deployed, is it likely that an operator would deploy in the one in one field, and then it's working so he deploys multiple more? Or is it more likely that it was -- we do one in one field and then you kind of sprinkle it in other fields to see if it also has applicability there?

Yes, what we're hearing from our clients that we're making systems for is the biggest thing we've gone out, we've tested it with a small-scale system on the order of few levels and they're happy with the performance on that. So then they order a system that's full scale and they want to see how that performs in an actual monitoring. And some customers say that they'd go out and do one monitoring job, and that's enough to convince them and they'll turn around and order multiple systems. And some have said they want to do -- use that initial system in 2 or 3 tests before they are ready to order multiple systems. So I don't know. Is that sort of the answer to question?

Yes, that's helpful.

And then I'd say, I think things happen faster at US Seismic than they do at GridSense because GridSense really is creating a category where there's never been any pool at the price points that we have that monitors the cable temperature and underground infrastructure. And so unfortunately, what you do is you show up at these, you sort of get this pioneering customers who are willing to adopt the product and try it out, do a pilot, maybe they have some side pocket money to fund it. And then if they're very happy with it, then they have to put it in budget for the next year. And that's one of the big things that's sort of been slowing down the progress at GridSense. The good news is that, that there are literally thousands of utilities out there that are our target customers. And we think that Grid Insight is going to, which is a software package that allows the pilot -- the user of the pilot to be able to instantaneously be able to monitor and get immediate feedback from the sensors. They don't have to ask permission from their IT department. And across any business we've ever dealt with, the IT department is usually the enemy of any innovation in the energy networks. So it's good news for GridSense, and I think it's going to shorten the cycle there.

The next question comes from Ted Lu [ph] of Valley Financial Group.

John, I just wondered if you're getting an adequate flow of opportunities for potential acquisitions in the future.

Ted, that's a great question. Whenever I -- we're intellectually curious, but we always measure, is what we're looking at as alternative opportunities as good as what we have right now? And I would have to say that probably for the first time in my life, I felt like I have enough to say grace over, providing capital to the 4 management teams that we have, and we really want to keep our powder dry to fund the growth of these 4 terrific companies. Thank you very much for asking that question.

Next question comes from Ricky Salomon [ph] of Verizon [ph].

A question I guess first for Jim. I've been hearing talk of maybe some competitive technologies, distributed acoustic sensors or DAS, and also HP and Shell was working on a MEMS-based solution. Can you talk about your technology and how it might stock up against potential competition?

Sure. I guess I'll talk about the MEMS first. For people that might not know, there was a -- Shell and HP announced a joint venture where they're going to develop MEMS, which is a miniature mechanical sensor technology. And they came out with some reports -- bottom line right now, I think they're struggling, and I haven't heard of any progress in probably in the order of maybe 6 or 8 months. But from the latest stuff I've seen, I'll talk a little bit about it. They published a paper on the order of 18 months ago with where they want to be on performance on the MEMS system. At the time they said they're at a noise floor, and this is a typical measurement of performance. I'm going to throw a couple of numbers out, but they mentioned a 70 nanogy per route hertz [ph]. It's a noise floor measurement that they were able to achieve in the lab, and they are trying to develop something that would be similar to -- and which they haven't tested at all outside labs and the fields. And they also felt that they were going to develop a, what is called, an ASIC, which is an application-specific integrated circuit, to couple with that MEMS sensor that increase the floor performance down to somewhere in the order of what is called the 10 nanogy level. But that -- where they try to demonstrate that in the lab and not sure when they would take it into the field. Just to give a comparison, we just shipped the system to a customer that had a noise floor that was already better than what they are trying to get. And we're shipping it. And so I think we're already there. And when it comes to cost, we are targeting to be able to be less expensive than the conventional technologies being used now, which is the coil Geophone. I mentioned that there are several companies that have developed MEMS sensors outside of the HP, Shell-HP joint venture. They're on the market. They've been on the market for almost on the order of 5, 6 years. They've never been able to achieve the performance of the even the traditional Geophone, but they're much more expensive. So I think, to date, the MEMS entry into the oil and gas has been disappointing to the companies that have tried to do it. One last thing -- what value of this you hear this up systems, they called, LinkedIn. The lead researcher on that MEMS project via his LinkedIn thing left that project and went to work for Apple. I'm trying to remember where it was, left maybe 6 or 8 months ago. So my impression is since we haven't been hearing anything on that -- that it just -- and the lead researcher leaving and then how the level of success the other MEMS supplier have had in their market. And I don't feel threatened by it, especially because we already have a product. We already shipped it. That performs better than what they're trying to attain. So that's MEMS stuff. And before I move on to DAS, I want to make sure that, that answered your question.

Yes, that's great. It sounds like we're less expensive and more sensitive. [Indiscernible]

Absolutely, yes. And the other part which they're making with this is called the application-specific integrated circuits. And if they want to make that and put it downhole, there's no technology out there now for that, that you can make an IC survive at the temperatures needed for downhole. So it probably would end up being something that might be used on the surface but not downhole. So then it comes to the DAS, which is really, really interesting. And DAS stands for distributed acoustic sensing. And I'll equate it to on the order of a decade ago. There was a system that came out. It was called distributed temperature sensing, which I'll say that 2 are sort of analogous. And what is distributed temperature sensing was you take a single fiber, put it in some kind of cable, but you put it in a well. And just the fiber itself will give you a temperature profile along the fiber of the entire length of the well. Trying to build upon that, there's been several companies that have tried to pick up on some technologies. It's been around for a long time, called Rayleigh backscatter. I'm going into a lot technical detail on it, but it's a technology that's been around for probably 15 years, which where the DTS gave you distributed temperature profile. This takes a single fiber and allows it to give you a distributed acoustic sensing where you can sense noise along the fiber. And it's just a bare fiber of the sensor. I mean, it's in a cable to protect it, but the fiber itself is the entire sensor. So people look at that, that would be beautiful. It's inexpensive, which I agree with all of those things. But now we start talking about reality. Let's say, you want to measure seismic. I have -- there I have to go back to, okay, what's the requirement for seismic sensor and typically, the biggest one is noise floor. That's #1 most important criteria, noise floor. And that means -- like noise floor means, how quiet of a signal can you detect. And if you take the standard Geophone that's use to date, and say, "okay, let's compare the noise floor of that compared to the MEMS." Distributor acoustic sensing, That distributed acoustic sensing is at least 100x higher noise, so it's not even close to the conventional Geophone. And if would you compare to us, it's on the order of 1,000 to 10,000x less sensitive. So I do think I see some value in it. You can put it in a well and you can listen to things like valves closing, maybe flow coming in from different areas, but I don't think anybody with any kind of seismic expertise would say that it would be used, can be used for detecting seismic activity, as far as vertical seismic profiling or microseismic events like we would detect. So where I think that would go, DTS ended up having on the order of maybe after a decade out in the field a $50 million sort of like a market size. There's applications for it, but they're limited. I think this DAS technology will also have a similar kind of market size as DTS because it's not really seismic. It would just be another tool that can listen to things. So when we're going after the seismic market, which the existing market for seismic equipment is on the order of $1.5 billion market. And we're looking to increase that by coming out with a better product that more than meets the needs. And then last thing I'll just say is that we went through a similar kind of, I'm going to call it, process that happened on the order of about 10, 12 years ago when I was running the fiber optics group at Litton, some companies came out and wanted to use this, what is called, similar DAS technology. They said this will take over all the stuff that was going on at Litton and the navy or the fiber-optic sensors we are developing because this single-fiber sensor is -- would make it so much easier and cheaper and more reliable, same kind of things we're talking about right now. The navy went through a 2-year study. And after 2 years of studying it, came out and said this technology will never have the sensitivity needed for a high-performance Navy sonar system and just dropped it. So some of the -- so I think that's trying to find the home somewhere else. And this is one of them, but I think eventually, they'll come to the same conclusion. What I like about it is the industry now has really a lot more interest going on with fiber, which is pointing a lot more people to us. And we just did a demonstration with a large -- very large oilfield service company where they wanted to put a DAS system downhole with us just as a comparison. And without going in a lot of detail, I guess, they ended up feeling like that system was deaf compared to ours. A few hours of comparison they didn't bother looking at what data that DAS system was getting because it barely picked up anything as compared to what we are doing. So in general, I think it's good for us, but I don't ever think -- I think most people in the industry don't think that it can ever be used for seismic measurements. I hope that answers your questions.

Yes, I'd say. But I also have another couple of questions for you. Let's say, by some chance, you get an influx of large orders, you say it's not capital-intensive. Could you ramp beyond, and you're going to be $50 million by the first quarter? You can easily ramp to more than that if you had to, right?

Yes, and here we're talking about capital and infrastructure in place, and so we're setting up -- we need to be ready because there's been several clients who come to us mentioning this is the kind of requirement they have, and their biggest issue they say with working is they go, "You know what, we don't want 10 of anything, a dozen of anything, we need hundreds of thousands. We want to make sure you can do this." So we are setting up to do that with the capital equipment -- of course, we'll have to bring in more people and all that stuff but the capital equipment will be in place to handle it. And I feel that we have some of these large customers come out to show them what we're doing, talk about capacity, and they've walked away -- and plus our quality program, and they walk away satisfied. So I think we're on the right path. But we do -- we would have to increase some of the staffing as these come in, but capital equipment-wise we'll be fine. But the beauty I think John mentioned is, we're going through a process right now to reduce the touch labor to -- believe on the order of 90% reduction in touch labor be on this automation and upgraded designs we're doing right now.

Okay, great. And that leads me to my next question. So you have a new interrogator coming in. You're taking out human touch from the process. What's that going to do to your gross margin on systems, that are going to be going out in the door, say, in the middle of 2013? How does that look?

That is exactly why we're doing this. Because our intent is always to have greater than 50%. We envision -- when you look at the competing technologies, there's so much room in there for us with a better product, much less costly to make, and we need to sort of test it. But we see with these advances we're making in removing the touch labor and the PC-based interrogator, we see the possibility of much bigger than a 50% gross margin in 2013.

Okay. Terrific. And on the OmniMetrix side, this is my last question. You mentioned you wanted to get the 50,000 connections by the end of 2014. And just to go briefly over that model, so you're going to be collecting 425,000 -- I'm sorry, $425 per connection at a high gross margin -- what are the costs are going to be associated -- how is that business model going to look exiting 2014?

The first year, whenever we're absorbing the cost of the hardware initially, obviously the gross margin will be a lot lower. But in years 2 and beyond, that marginal -- that margin is phenomenal. We have very, very low cost associated with those additional years of the revenue. So that's what's so exciting about the business is obviously the churn rate is important and historically, we have a very low churn rate? So having that big margin and also as we move forward, adding services that we can also create additional revenue sources through automated systems should prove that this model looks very good.

It really is just a question of how much money do we want to invest in sales and marketing, and what we see sort of this really terrific Blue Ocean. I mean, every time you turn over, you find another application. Like there's 3,000 large-scale aquariums. I mean, just to sort of show how sort of niche these applications are in the major cities like Philadelphia, Atlanta have of these aquariums and they all have backup generators. And if they lose power, whales die. So there's a lot of stuff out there, and so we're really, really excited to see -- be able to put this money to work.

Next question comes from Frank Barresi of Ameriprise Financial.

I have a couple of questions. The first one, which is beyond OmniMetrix, how many dealers have you signed up already on -- to do this? The next one was on -- I'm sure it's in the 10-Q, but how large is DSIT's backlog, how are current sales going? Then the third one was, if there are problems in developing this PC-based system for U.S. sensor, is the 12 channel system good enough to -- I mean, would you think you'll be selling that for a while? Or I guess it really comes down to how likely is it? Because it sounds like you have a pretty ambitious schedule to commercialize the PC-based system. So I was just wondering if the 12 channel would be a viable commercial product if it takes a lot longer than you think. And then just the fourth question, you said something about Elster, I had to leave for a second I didn't quite -- relation to GridSense.

Good. I'll follow up on that one. So, Benny, are you still on the line? It's Friday. It's Sabbath in Israel, so we may have lost -- I know we lost Michael. Did we lose Benny?

He is no longer on the call, sir.

I apologize. So I don't actually know the number. If I were to guess it's probably around $8.5 million of backlog at DSIT. But I'll get you an answer on that, Frank. And then Jim, do you want to answer the question about potential delays or how the progress is going on the interrogator?

Oh, yes. Here's the big benefit -- or the approach we're taking is that I think most of you know, I used to work at Northrop -- Litton that became Northrop Grumman. And this is a technology we developed there. And we actually after I left, several actual systems there were actually built and operated. So we know it works, and we licensed technology. But the beauty of it is, is that people are actually listed as the inventors of the patents or the people we hired in here to take the technology forward. So they've already done it once before for a military system, and it's really ending up being an adaptation. So I feel the risk is pretty low. I mean, we've already built several pieces of -- there are circuit boards that we have to make, minimal amounts and -- but the algorithms that we used, through the PC, we're pretty much using similar algorithms that was used at Northrop Grumman that is part of the license. So I feel very, very confident that we're going to have the same operational and ready to sell in Q1 of 2013. Is the existing 12 channel viable? Yes, but the margins are low. And that's what we're trying to improve upon.

Great, thank you so much, Jim. Yes, so at the end of the day this is all about driving our businesses towards cash flow positive. And we like high-margin businesses like we have in the portfolio. The last question was about a Elster. Ed Woolard, our advisor, former CEO of DuPont, always challenges me. Is it really possible that you guys have so little competition? I think that's true in the case of US Seismic. DSIT has a very good competitor in a company called, Sonardyne. And GridSense, really nobody else is out there offering products at the price points that we offer. There are some -- there is one terrific company called Elster, one of our former top converge guys is now running the North American Electric business. And if the extent that they get $100 million deployment of their meters, it's sometimes difficult for us to sell against them because they can adapt a product or something like that, but nobody has the same vision that GridSense has. So I just wanted to mention it because I feel it's very important for us to be balanced about how big these opportunities are and what's the pace of adoption.

Okay, John. And I also was wondering about how many on the OmniMetrix have you signed up dealers or at this point in time?

Yes, Deena, do you want to answer that question?

Sure. Historically, Frank, we have approximately 50 dealers that have bought from us for the past 12 years. What we've done over the past 2 months is develop the Smart Service program where we're launching a new sales effort to go to these dealers and explain the benefit of our products as opposed to the historical way of selling it. If the customer asked for monitoring, then they would call us. So we're trying to drive sales from the dealers to show them how it will benefit their business and create more business in the service industry for them, and have them actually out there helping us sell the product as opposed to being a pull. So over the past couple of months, we have taken the existing 50 dealers that have been historical customers of ours and turned them into ordering -- the customers that actually order from us. And John gave you an example of, we had one that bought 0 from us last year, and they've already bought 110 in the past 60 days from us this year based on this new program. So we are slowly trying out this new program that we're implementing to see how -- what the reception is going to be. And it's been phenomenal. So now we're taking it to all the other dealers that are existing customers of ours, and then try to grow that from there.

Great. And then -- thank you so much, Deena. And then lastly just to circle back on the DSIT backlog question in the 10-Q it says that we have $9.5 million of backlog at DSIT. So we're -- the company is in great shape, and I think they've got a great pipeline. Thank you so much, Frank.

Next question comes from Charlie Sloan of MCC.

Charlie Sloan. My questions are as follows. The -- you tried to solve the pain points of energy, right? The existing grid and all these other issues that are very difficult. With GridSense and USSI, are you reaching the pain points of making the sale? I mean, you talked about -- there's no question that in big organizations like utilities or health care or some of these other companies, IT is simply part of the sale. They are the buyer at some point. And it's almost as much not selling to the engineer as much of selling to the C-Suite and also through the IT area. Do you have the right people in place at both those organizations to do that?

Charlie, great question. So first of all, I was crushed by my effort to be able to sell to IT to the -- with the Coreworx business. That was a hard and difficult lesson. I'll defer the question to Jim as far as the level of people he talks to and the sales process there, and then I'll quickly respond on GridSense.

Charlie, as presently, I feel we do. And here's how it's been operating for us up to now. The pull is really coming from the major oil companies, and so they are trying -- of course, they want to improve their efficiency but the problem they seem to be having in this frac-ing industry, there's a bad public relations related the hydrofracing. People hate to admit they're doing it, but you can see on like the television commercials like the Chevron, the Exxon Mobils, BPs, they're all coming out and say how they're trying to do this in a environmentally friendly way. And one of the big ways they want to improve their image not only just improve their efficiency is show that they're good stewards and they monitor what they do. And so that's also becoming a big pull from the oil companies. So what happens is we initially get some contacted via the major oil companies. They call for some kind of demonstration. And then once they seem pleased with it, which has already happened in one and about to happen in another, they don't end up buying the system, they direct us to their service company because the oil companies don't buy the hardware, they buy the service from their service companies. These are the Halliburton, the Schlumberger [ph], those kind of guys. So that's sort of happening, and so what we end up do is the service company likes us because all of a sudden their customer calls and say, "Go call USSI and set up some kind of relationship with them and go out and do some kind of demonstration and qualification." So that's sort of how it's going. And I think with the staff we have up to now, we'll be able handle that. But we're also right now looking at expanding, bringing on oil guy on our board and looking at the possibility of hiring a salesperson in Houston area. And we think it's about time to start expanding that.

Well that's my other -- with USSI, it doesn't sound to me, John and Jim, like it's a capital question per se. But because John, you've laid out the capital vision for the company and you have 2 years of capital, and many of these businesses -- DSIT is one of the best businesses I've ever seen in terms of running at. And so many of these businesses will be cash flow-positive by then. But capital, what you said Jim, regarding capital is that if -- and it's not a capital question because everything is pretty capital-light. But is it a question of your size, and does it make sense to get capital at some point from some JV partner that takes away that major hurdle that some people may have in buying it?

Well, I mean, what we've been able to show the people is that we are relatively capital-light because they see these huge systems that are needed to go out in the field. And we say, "Well, the huge part of the system is the cable." And we just buy it -- we specify it and buy it and they deliver it here. And we cut into the cable at certain locations, hook our sensors up. So that part, we're taking all of the touch labor out of it or a majority of it out so...

I think Charlie's is basically saying...

I'm asking a different -- probably a different question, John. Capital as a question of accelerating the business, how do you accelerate the business to make sure that you stay ahead of competition? And whether it's capital per se or whether it's a joint venture partner that you accept part, you share part of the surplus of acceleration of the business?

That's a good question. We haven't had an objection. We hadn't had any objections based upon our capital structure. And so that's one of the things that has not been a problem so far. And we think who collaborate the best wins and I'm reluctant to -- I haven't seen a problem on our side yet or the customer's side that would indicate that we have to do that.

But some of the objections you may see are just lack of orders, right? Sometimes it's the question of omission. If the customer says, "Yes, that's neat, that's great eye candy, that's awesome." And then they say, "Well, it's a small company. We'll wait for a couple of years." Right?

I'd just say stay tuned.

Yes, and that -- I mean, yes, that's a concern. And that has actually happened in a couple of occasions. We said, you want to come out and visit and explain to us how you're going to be able to meet this huge requirement we have. And I think they've walked away satisfied because we showed that on the areas that like acquiring all the capital equipment stuff, that's all done outside we are mainly integration and we have a specific part of the product that we make -- that we keep close control over such that IP and stuff doesn't get out there. But that is definitely -- it's always bought up but large customers and they want to come out and visit. And that's one of the things they told us. They said, "Well, one of the things we require is you to have on ISO 90001." And we heard it and we're doing it. And so absolutely that is a concern and question. And we are doing our best to address it but ...

It's a higher-level question probably about how best to address this huge market before competition true or not really comes in and drives down price points even further. Because there will be competition. Competition is good.

Oh, absolutely.

I think you guys are doing the right things and that goes across all the different portfolio companies, John, and just keep up the hard work.

I think we'll take one last question, and then we'll wrap up. Thank you for being so patient, everybody. We have 88 people on the call. So I'm really grateful for all the attention from our shareholders.

Okay, currently there are no more questions, sir.

Okay, I'm not that grateful anymore. That was -- thank you very much, everybody. That concludes our presentation. And thank you so much. We're looking forward to the future of each one of our 4 companies. Thank you very much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.