Ultralife Corp (ULBI) 2003 Q4 法說會逐字稿

Good morning, and welcome, ladies and gentlemen, to the Ultralife Batteries, Inc. fourth-quarter financial results. At this time, I would like to inform you that this conference is being recorded, and all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers after the presentation.

I will now turn the conference ever to Jody Burfening with Lippert/Heilshorn, who will read the Safe Harbor statement. Jody will then turn the conference over to John D. Kavazanjian. Please go ahead.

Thank you. Good morning, everyone. Jody Burfening of Lippert/Heilshorn & Associates. Thank you for joining us this morning for Ultralife Batteries' earnings conference call for the fourth quarter of fiscal 2003. The earnings press release was issued earlier this morning, and if anyone has not yet received a copy, I invite you to visit the Ultralife Website at www.UltralifeBatteries.com. You can find the release under Investor News in the Investor Relations section.

In a minute, I will turn the call over to John Kavazanjian, Ultralife's President and CEO, who, along with Bob Fishback, Ultralife's Chief Financial Officer, will provide their prepared remarks. Management will then take questions until 11:00 Eastern Time.

Before turning the call over to John, I would like to remind everyone that some statements made during this conference call that contain references to a number of matters, including Ultralife Batteries' future plans and objectives, are forward-looking statements. These statements represent the current views of management with respect to future events, and are subject to certain risks and uncertainties which could cause actual results to differ materially from those contemplated in the forward-looking statements. A more detailed description of these risks is contained in the Company's filings with the Securities and Exchange Commission.

With that, I would now like to turn the call over to John. Good morning, John.

Thank you, Jody. Good morning, and welcome to the Ultralife Batteries conference call for the fourth quarter of 2003. With me today are Bob Fishback, who's our Chief Financial Officer, and Bill Schmitz, our Chief Operating Officer. Nancy Naigle, our Vice President of Sales and Marketing, is traveling today on Company business, and will not be joining us.

Today, we reported operating income of $2.3 million, on record revenue of $24 million, and net income of $2.2 million or 15 cents per diluted share. This significant increase reflects continued strong demand for our products, both sequentially and over last year's fourth quarter. It also shows the operating leverage in our business model. These factors also produce better-than-expected revenues and operating income for the quarter, with an incremental operating margin of 30 percent that was consistent with our expectations.

Revenue growth continued to be led by increased sales of our BA-5390 battery to the U.S. military. Revenue from our nine-volt product was also strong,, and we saw growth in revenue from our HiRate sales and battery pack products. Rechargeable revenue doubled, as well, as we had forecasted. Through the end of 2003, we have received five consecutive exigent buy contracts for the BA-5390. In the fourth quarter, we completed shipments on our third exigent buy contract, we started shipments on the fourth contract, and were awarded a fifth contract valued at $13 million, which extended our order coverage for that product further out into 2004. Just recently, we also announced a sixth contract, for $12 million, for this product. Demand for this product continues at a very high level, and this order extends our scheduled backlog out into the third quarter of this year.

We're close to finalizing per-unit pricing on both the fourth and fifth contracts, and we expect it to be in line with the pricing on the third contract, which was finalized just days before last quarter's conference call. While we have incorporated some learning-curve improvements in our operations into the agreed-on pricing, we think we have the opportunity to beat these goals and exceed the margins implied in our guidance.

In both our U.S. and our UK operations, we made major improvements in operational capability and capacity. In the U.S., we are almost finished with the capacity expansion program for assembly in our large cylindrical HiRate products. By the end of this month, we expect to be at full capability, which will enable us to meet the requirements of the Army's facilitization program, which puts some of this capacity in place.

We also plan to more than double our cathode manufacturing capability, a critical process step for us, by completing the installation of another cathode line in the U.S. during the second quarter.

We have also made significant improvements to our cathode capability in the UK. In addition, we started a program of lean manufacturing in our UK operation. We expect to both increase capacity and decrease cycle time, due to the implementation of these lean teams over the next several quarters.

During the first half of this year, we'll use our improved processes to provide improvements in the performance of our UK product, and to unify its design with our U.S.-produce product. This will cut down the number of model numbers that we produce, giving us greater purchasing efficiencies, and will offer us flexibility in scheduling, and a dual source for all of our major cylindrical HiRate products.

The next Next Gen II solicitation for Phase IV is finally moving forward. These packages have been released for both the large rectangular family, which is the fourth phase of this process, and for a part that was carved out for a small business set-aside procurement for the BA-5347 thermal site battery. We're qualified for both of these, and these bids are due in sometime in March. And it's our hope that awards would occur sometime this year, although past experience has taught us not to attempt to predict just how long this will take. Activity continues to grow in our commercial business, as well. Sampling activity for our thin cell product line is high in our targets, such as medical devices and asset tracking. Our rechargeable business, although a small part of our revenue, doubled from the third to the fourth quarter, and is poised for continued growth in 2004, with us projecting revenue of over $1 million in this product line in this quarter.

The applications that we are addressing are wide and varied -- some from our target markets and some from new applications and markets. In the security market, they range from active asset tags to access cards for environmental -- and access cards to environmental measuring and monitoring devices. In the medical area, these applications involve wearable devices and new generations of portable defibrillators. We have at least three active projects, involving a new generation of search and rescue beacons, as well. There were projects involving backup batteries not just for automotive telematics, but for enterprise storage systems and industrial robots. And there is a resurgence of products in portable and consumer electronics, including digital cameras, specialty PDAs and specialty computing devices.

Looking ahead, we anticipate revenues for the first quarter to be in the range of $26 million, with operating income of approximately $3 million, based on the order schedule we see coming into 2004, based on our ongoing order flow and based on the level that we are seeing of design activity. For these reasons, and because we will be operating with our full D-cell assembly capability online coming out of the first quarter, we are expecting sequential revenue growth for the second quarter, as well.

In the second half of the year, we are maintaining a prudent outlook, taking into account the possibility that military demand may level off, and we may return to normal hold times, which would flow one month of additional production to inventory. Therefore, we are comfortable today adjusting our full-year guidance upward to around $104 million in revenue and $12 million in operating income, based on the strong order flow for the first half of the year. This represents a 31 percent increase in revenue and a doubling of operating income over 2003.

This year, we plan to spend over $5 million in capital equipment once again. The difference this year is that, instead of spending most of it on capacity improvements, we are now at a point where we can apply resources to cost reductions. $3 million of this capital is earmarked for projects that will improve yield, will decrease labor content and/or will cut down on cycle time. Most of these programs will start to pay off in the second half of the year and into 2005, but this represents a great opportunity for us. Our goal is to continue growing, while reducing costs and controlling inventory, without major increases in our employment level.

As our dedicated workforce continues to mature and add to their skills, this combination will allow us to use our operational excellence to generate additional bottom-line improvements, at the same time that we continue to grow the top line. This is a major focus for us this year, as we move the Company toward our near-term goal of 15 percent operating margin.

Part of continuing to build the Company is the efforts of our Board of Directors to continually upgrade its composition. I am very happy to welcome Anthony J. Cavanna to our Board of Directors. Tony has just retired as the CFO of Trex, the building products company that he helped to form and build. His background as a businessman, financial manager, manufacturing executive and chemical engineer is a great match for our Company, and an exciting addition to our Board.

I'd now like to turn it over to Bob Fishback to cover some of the financial highlights.

Thank you, John, and good morning. This morning, we reported the results for our fourth quarter of 2003. Consolidated revenues were $24 million, $1 million higher than the $23 million guidance that we had provided during last quarter's conference call. This will. This quarterly revenue record was nearly three times the $8.8 million figure reported in the same quarter last year. This $15.3 million increase resulted mainly from the growth in shipments of our HiRate battery products, most significantly our BA-5390 batteries sold to the military, as well as higher sales of nine-volt batteries and rechargeable products.

Gross margin for the 2003 quarter, December, was $5.3 million or 22 percent of sales, an improvement of $4.5 million from the $800,000 or 9 percent margin reported a year ago. The majority of the improvement in the gross margin was realized in our primary battery operations, where the margin for the December 2003 quarter was $5.6 million, or 24 percent of revenues, compared with 13 percent in the prior year. Higher volumes of sales and production were the key factors for the improvement, along with gains in manufacturing efficiencies.

Operating expenses for the December 2003 quarter totaled nearly $3 million, up from the 2.5 million reported in the same quarter last year. Generally, these costs have risen somewhat to support the growth in our business, costs related to additional system support and customer service and sales, as well as higher legal and professional fees. As a percentage of revenues, operating costs have declined from 29 percent last year to 12 percent this year.

Operating income for the December 2003 quarter was a record $2.3 million, the fourth consecutive profitable quarter for Ultralife. This was approximately $300,000 higher than our $2 million guidance, mainly due to higher sales than we had projected. In comparison to the same period a year ago, where we reported an operating loss of $1.7 million, the year-over-year change amounted to an improvement of $4 million. Included in other income and expense for last year's results, but not in 2003, was a $1.4 million gain related to the sale of a portion of our investment in Ultralife Taiwan.

During our recent earnings calls, we have discussed the analysis we were conducting with respect to our net operating loss carryforwards, and whether there may possibly be a limitation on our ability to utilize these NOLs in the future, based upon Internal Revenue Code Section 382. This work has now been completed, and the good news is that to date, we have not triggered a limitation in the utilization of our NOLs against our future income. However, due to rules for alternative minimum tax, we did end up with a small income tax provision for 2003, just slightly more than $100,000, or approximately 2 percent of taxable income.

On another note pertaining to taxes, in conjunction with our tax accountants, we have accessed the appropriateness of recording a deferred tax asset on our books as of December 2003. Although we have a lot of optimism about our future, we have concluded that we will not record a deferred tax asset at this time, since we have not yet built the profitability track record to conclude that it is "more likely than not" we will be able to utilize these NOLs. We plan to evaluate this issue again at the end of 2004.

Net income for the December 2003 quarter was $2.2 million, or 15 cents per diluted common share, compared with a net loss of $400,000 last year, or a 3 cent per share loss. Average diluted shares outstanding for the quarter were 14.5 million shares, higher than the 12.8 million figure reported last year, due to the impact of stock options and warrants, and a couple of small equity transactions that were completed during this time horizon.

I will now shift the focus of my remarks to discuss a sequential comparison of the December quarter's results versus the September quarter. Consolidated revenues rose $4.2 million from the 19.9 million reported in the third quarter, an increase of 21 percent. Consolidated gross margins increased 1.4 million, from 3.9 million to 5.3 million. As a percentage of sales, the margins improved from 20 percent in the third quarter to 22 percent in the fourth quarter. This change resulted from our ability to leverage our cost infrastructure with increased revenues, in addition to improving our manufacturing efficiencies during the quarter.

Operating expenses increased $200,000 from quarter to quarter, due to higher legal and professional fees, as well as increased investments in sales and marketing. Operating income increased $1.2 million, from 1.1 million in the September quarter, due to the improvement in gross margins. As a percentage of sales, operating income amounted to 10 percent in the December quarter, compared with 6 percent in the September quarter. With respect to cash flows, EBITDA in the December quarter was $3.2 million, including depreciation of approximately $800,000. For the full year, we generated positive EBITDA of approximately $9.1 million, an impressive turnaround from past years. While we generated positive EBITDA in the fourth quarter, we used cash to continue to grow the business, mainly in working capital. We used approximately $4.5 million of our cash in the fourth quarter to fund changes in working capital, primarily due to higher levels of inventory and accounts receivable balances. We also spent approximately $1 million on capital equipment additions, as we continue to increase our production capacity for our HiRate batteries. We financed these activities by utilizing our revolving credit facilities, where the outstanding balance increased $2.1 million during the fourth quarter.

Turning to the balance sheet at the end of December, the Company continues to strengthen its financial position. In addition to our ending cash balance of approximately $900,000, we also had additional borrowing capacity of approximately $3 million under our revolving credit facilities, providing us with total cash and credit availability of nearly $4 million. It's also important to note here that we self-financed $5.5 million of capital equipment additions during 2003 internally. We continue to have a relatively small amount of debt on the balance sheet, $8.4 million, most of which is related to short-term revolving credit to support our working capital needs. Our total debt, as a percentage of total capitalization, was only 20 percent, and we continue to improve our cash position by managing assets effectively.

DSOs during the fourth quarter averaged 47 days, compared with 57 days a year ago. We are turning our inventory 6 to 7 times a year, compared with approximately 5 times a year ago, and we are working to improve this even further. We are in the process of evaluating our refinancing alternatives for our current credit facility, which is scheduled to expire in June of this year. We currently have multiple proposals in hand, which would lower our cost of borrowing while improving our overall flexibility. We will be providing more information on this within the next few months.

Looking ahead into 2004, we see continued growth. We project that our consolidated revenues for the first quarter of 2004 will be in the range of $26 million, an increase of approximately $2 million from the December quarter. We are also projecting that gross margins will increase from $5.3 million to 6 million, and that operating income will increase from 2.3 million to $3 million in the March quarter, as sales grow and as we add to our production capacity. Operating expenses are expected to remain in the $3 million per quarter range.

EBITDA for the first quarter is expected to be approximately $3.8 million, with $800,000 of depreciation, and capital expenditures are expected to be in the range of $2 million during the quarter. For the full year of 2004, we are increasing our previous guidance to reflect expected strong demand for our products in the first half of the year. On the basis of our current outlook for approximately 104 million in revenues, we expect to generate a gross margin in the range of $24 million, and operating income of $12 million. EBITDA is expected to exceed $15 million.

Capital expenditures for the full year are projected to be in the range of $5 to $6 million, much of which will be used to improve manufacturing efficiencies and reduce costs.

We continue to focus on a very straightforward financial model for this Company. Our near-term target is to drive gross margins to a range of 26 to 27 percent. And as we do this, by leveraging our infrastructure and becoming more efficient, we plan to drive our operating expenses as a percentage of sales down below 12 percent, resulting in a pretax operating profit margin in the range of 15 percent. Longer term, we have our sights set on driving our gross margins toward 30 percent or more, with a 10 percent operating expense ratio, generating a 20 percent pretax operating margin.

2003 was truly an exceptional year for this Company. It was a year that was successful in many respects. But 2003 is now in the past, and there is still much work to be done in order to achieve the goals we have set. We are confident that our strategic course will lead us to continued success in the future. We remain committed to our mission of sustainable, profitable growth, and we are looking forward to another successful year in 2004.

That concludes my remarks, and I'll turn it back to John.

Thank you, Bob. Before I open up the Q&A session, I'd like to add a few comments. As Bob said, this has been a great year for Ultralife Batteries. Everyone has worked long and hard to bring the Company to where it is today. We have been fortunate to have our improved performance performance reflected in the Company's valuation. Still, we know that especially when the Company stock has moved as much as ours, there is a real focus on watching for insider stock transactions. We have a very sound strategy, focused on promising markets and operational excellence, and I am proud to say, a cohesive management team with a breadth and depth of experience. We are only at the cusp of realizing the Company's long-term growth potential. I know I speak for the entire management team in saying that this entire group is committed to taking Ultralife to the next level. It's just beginning for us. Until now, there have been very few insider stock transactions, but that may start to change. Many of the options were granted between three and five years ago, and they have expiration dates coming in the next year or two. These options were granted because the Board and I wanted to reward the management team's dedication through the lean years with non-cash compensation. And this was during a time of salary freezes and cutbacks. I do not know what anyone's individual plans are, but I would not be surprised to see some insiders exercising some options during the appropriate trading windows.

On a personal note, I have a similar issue. Virtually all of the options that I have are ones that I received when I joined the Company almost five years ago. If I had any choice in the matter, I wouldn't touch a single share. But unfortunately, these options are also due to expire in around 17 months. Given the number of shares involved, combined with the trading restrictions and the time left to do something, it's fair to say that I will expect to start exercising some of these options over the next year. If I do so, be assured it is my intention to hold onto a significant portion of the stock, although whenever I do any exercises I'll have to sell some of the shares to pay for the exercise and the taxes that will be due.

As I said before, we're not even close to being finished with what we intend to do with this Company. I am committed, and this management team is committed to this enterprise. I would be more than happy to answer any questions about this during the Q&A session.

And now, I'd like to open it up for questions, and turn it back to Laila to do that.

(OPERATOR INSTRUCTIONS). David Kurzman, Needham & Co.

Good morning, folks. I have a plethora of questions, but I will try to limit myself to two so everyone else can get in line here. Let me start with the SG&A for Q1. I would expect that after many years of not paying bonuses, that perhaps you might be paying some bonuses for 2003 in the first quarter, yet the guidance you're giving suggests that that might be more modest than what I'm imagining in my head. Can you talk me through how to think about that?

Yes. David, we've had a small bonus program in place for the top, I'd say, 12 or so executives, 12 or 15 -- I don't know, maybe 12 executives of the Company, during this year. It's not big; the range is, I don't know, 5 to 7 percent, kind of ballpark. It could be as high as 15, but it's all based on overachievement of plan. And that's the philosophy we've had, together with the Board, going into 2004. I don't see any change to that happening. We have a little bit of a luxury, because we have significant stock options in the money for people, and that's why I have to say that people kind of count on that as part of their revenue stream, as the Company does better.

That seems fair.

Yes, so that's kind of that story. Now, another year or two out, that may change -- only because we will then face, eventually, salary compression down into the organization, probably. But we don't have that situation now.

And then sort of as a follow-up to that, and then I'll hop back in queue -- can I get a sense from you -- I mean, if I sort of run the numbers here, 26 million topline, 3 million operating income -- that suggests that it's about a 6 million gross-ish profit, give or take hundreds of thousands here and there. Should I expect total R&D and SG&A combined to be below 12 percent in the first quarter, as it was pretty close to doing in the fourth quarter?

Yes. It will run around 3 million, pretty close. I don't know, Bob, do you have any --

That's about right, where we have commented that it would be in the range of about $3 million on the revenue in the first quarter of 26.

Is that coming, then, out of R&D? Or is that coming out of -- the reason why I'm pressing on this is because it was right around 3 million in Q4, and I don't see why it's not growing.

Well, first of all, Q4 -- because it's the end of the year, we do accrue for a little higher accounting fees.

Oh, good point.

And we did have one or two small items; they are not big enough to call out, but when you add them up, they added up to a little bit. So one or two small items of some legal expenses, the termination of a contract and little things like that.

That's what I was missing. All right, I'll hop back in the queue. Thanks.

Steven Gish, Roth Capital Partners.

John, you had put out a press release recently talking about two new products on the thin cell line. At this point, you had mentioned that you are still putting out samples in the market to the medical area, other areas as well. Currently, are you billing any or capturing any revenue from the thin cell?

I think, yes, we are capturing some. We have a very, very modest assumption in the (technical difficulty) 2004. I guess that's the important thing for it. Bill, do you want to add to that at all?

In the fourth quarter, we began commercial shipments of the new thin cell that we introduced, the U-1004 (ph), which was really the first time we have shipped that many quantities. And we continue to ramp up the line. As John said earlier, we are sampling a wide range of customers in a wide range of applications. So we're forecasted to grow that business pretty modestly. But we stick with the capability of the cell that it might be a sleeper hit for us.

Okay. Then your CapEx projections for this year -- are you anticipating receiving any additional financing from CECOM to subsidize that?

No, not at all. We don't anticipate that at all.

And what about -- in October, you issued shares, about $2.5 million worth, as basically a bridge loan to Ultralife Taiwan. And if that's the time where (ph) that by March or so of this year, that would either convert to equity or you would be paid back. What's your thoughts on that, at this point?

That's still the case. UTI is in a phase right now where they're doing some refinancing and restructuring financially, and one of the two things will happen.

And last question. On your outlook goal of becoming a $200 million company over the next couple of years, is that primarily driven by organic growth, or do you see acquisitions?

That's exclusive of acquisitions. That's organic growth. I think we have been pretty consistent in saying we see this as a 20 to 30 percent a year kind of growth rate business.

George Nooney, LAR Management.

Mr. Nooney, your line is live.

Jim McIlree, C.E. Unterberg Towbin.

A couple of times, you guys have said you have a near-term pre-tax margin goal of 15 percent. Can you tell us what near-term is? 12 months, 18 months, 6 months?

Jim, our goal is to get there within the next couple of years. We're going to shoot to get there earlier than that, but we are putting out a target to get there within a couple of years.

Okay, so certainly not by the end of the fourth quarter of this year?

I'd say it depends. We're going to shoot to get there as fast as possible.

I think part of the issue for us is it's very mix-sensitive, in terms of the product line and products that we're making. And it kind of depends where we go grow. Right now, I would say based on the model for next year, we don't get there by the end of the year. But certainly, we would hope that with some of the programs we have going for manufacturing efficiencies, that if we can get them to kick in a little sooner, that we could get there. That's really kind of the bottom line.

And if we take 26 million, and add in some increase for Q2, then it looks like you're suggesting second half as kind of flattish with the first half. It also sounds like you're expecting the military to drop. So am I right? What is increasing to keep total revenues flat, if the military is dropping?

Let me explain. The way the military contracts work, they typically have a hold period, during which we hold the batteries and they sample, to make sure there's no latent defects. They've been on the path of cutting that whole period down to get the product into the system because they needed it. We have to -- I don't know another way to say it, but the prudent way to approach this is to assume that eventually, we're going to go back to that contractual hold period, which will increase our inventory by three or four weeks, and flow product that would ordinarily go right out the door, in today's state, we flow it into inventory. So it's not necessarily that demand is going down, it's that they go back to the normal hold period. That's the first thing.

Second, growth -- we certainly think that we're going to grow some in our rechargeable business, and some of our other commercial business will grow to take it up if it flattens out. But we see that growing through the year. We're just, in the military business, kind of being a little careful about the second half of the year. Someday, we'll go back to the hold period. I don't know when; we've just built in our assumptions it's going to happen in the second half of the year. If it doesn't happen in the second half of the year, then we have to look at the first half of 2005, as when they go back to it, because that's the normal course of operation.

And, Bob, can you refresh my memory on how the CECOM -- what do we call it, the money that CECOM is putting in for their capital equipment -- how do you account for that, and where is that on the balance sheet? And how does that all work out in the end?

We refer to that as the facilitization, is what we called it, which is a strange term, but that's what it's referred to as. It was $3.1 million. We're basically acting as an administrator of the funds, and what we do is -- the title of those assets are not on our balance sheet or are not ours. The title goes to the U.S. Army and CECOM, and those assets are not in our fixed assets at all. We do tend to pay for these items in advance, and that goes into a prepaid account on our balance sheet, kind of as a receivable, in a sense, a miscellaneous receivable. And then we'll turn around and bill the Army for those funds. So what we have outstanding or, actually, what we have billed so far and received to date through December, is approximately $2.1 million. So that has flushed its way through the balance sheet, so nothing is on the balance sheet with respect to that. There's about $250,000 or $300,000 that actually is sitting in our prepaid and other receivables line item on the balance sheet that we have billed to the Army for that program.

Great. That's tremendous. And finally, is it possible to break down the revenues either -- well, actually, both -- both quarter and year, by, let's say, military, nine-volt, thin cell, UK, rechargeable?

I think we have been pretty consistently saying that we're running right now about 60 percent military, about 25 percent nine-volt. And of what remains, the rest of it is commercial business. Thin cell is a very small number right now, and rechargeable for the year was maybe $1 million.

Let me clarify that. For the quarter, rechargeable was -- will end up to be about $600,000 -- yes, for the quarter, $600,000; for the year, total rechargeable line (ph) will be about 1.5 million.

Larry Baker, Legg Mason.

Can you just talk a little bit about the Next Generation? I know you were deliberately circumspect about the timing on that. But can you just talk about the size and the potential timing, without a commitment to it?

Yes. First of all, the bid packages are due in at this point in time, unless some change is made in the middle of the process, early in March. An award could be anywhere from 60 days to more than a year off. These awards have been delayed in the past because the people who are working real hard to evaluate them in the government have been trying to keep soldiers supplied in Iraq with product. So that's why we are a little circumspect, because we're trying to get out of the business of predicting something we don't have control over. The large cylindrical, which is the pending award, that bid was done -- I don't know, a year and a half ago, I think. And we are extending the validity of the bid. We were doing it months at a time. Now we're down to weeks at a time. So we feel like it's imminent, but it's even hard to predict that.

Really, we put a dollar value on those, because they are awarded with a dollar value. But that dollar value -- what that dollar value means is it's a prudent estimate of a five-year demand. And basically, it's set in a range. It isn't set too low, because they have to represent the contract fairly. It isn't set too high, because if they don't make the minimums -- if they don't buy the minimum in the contract, you can come back with recourse and say, "Gee, we should have gotten a higher price, because you didn't buy enough." All that really guarantees you, though, is it guarantees you a fixed price for five years for the product, and it guarantees you that you will have a chance to supply either 60 percent or 40 percent of the demand. That's all it guarantees you. Now, you can get more -- if you get 60 or 40, and other person can't supply enough to demand, you can actually get more of that, as has happened to us in the past with some of the product. But the real only -- we will put a dollar value on it, because that's the Army's estimate of the five-year purchase that the quote is based on. But all that really guarantees you is a percentage of the demand and the price for that period of time.

Now, having said that, Bill, do you know what is the valuation that was put on the Phase IV?

I think the large rectangular was on the order of 240 million.

So the Phase IV large rectangular is about $240 million over five years. That's the value of it. And you can do the 60 and the 40 percent of that, to see (ph) what it's worth. That's what that's about. And I'll give you some examples. The sulfur dioxide contract actually -- they are going back out (ph) to bid on it, because they bought the maximum. They give you an average, and then there's a maximum. And when they see the maximum, they have to go to bid gain. They've actually exceeded the maximum on that already, within two years of the five-year procurement.

Can you talk a little bit about the military approach on the rechargeable, sort of what volume that might be, or (multiple speakers) standards? Is there a shift in outlook there?

A lot of work is being done by the military on rechargeable batteries, and the reason is, obviously, disposable batteries are not the most efficient way to do things all the time. Now, having said that, I will tell you that rechargeable batteries have a number of problems. Number one, they don't last as long. They last about half the amount of time, in general, although there are improvements being made. The second problem with them is that they don't perform very well at low temperature, and there are some very cold places in the world. The third thing is that if you warehouse them, you have to regularly refresh the energy in them. You can just slam them in the warehouse in a war reserve and come back five years later. They have to regularly be refreshed. And then the last thing is that high temperature causes irreversible capacity losses on rechargeable batteries.

So in combat situations, while occasionally they may use them, they are not really the preferred battery. Now, for training, they are great. But there's a lot of work going on, and we're doing a lot of work for the military, both in rechargeable batteries and charging systems themselves, under contract for the government. We're doing work for them that shows up in our technology contract line, where we are helping to try to develop those kinds of products for them, and see about their applicability out there in future applications.

I don't think this is something that's going to change markedly in the next year or two. I don't know when, but I think over time, we will see more and more of them used in training. The Europeans use a lot of rechargeables in training, but in actual combat and peacekeeping, combat, people out there in the field, it's a little tough because they aren't a lot of plugs to charge batteries in Iraq and Afghanistan.

I don't know -- Bill, did you want to add something?

The only other thing I'd add is, with the charging capability right now, it provides a heat signature. So they're really not the preferred -- to John's point, there's an awful lot of technical work that's got to be done to really field these products in large numbers. But the rechargeable training applications are growing at a very large rate, at the moment.

And then just rechargeable on the commercial market -- I think you said first-quarter sales expected to be in excess of 1 million. Does that accelerate during the year? Do you expect somewhere between 5 and 10 million in sales?

We have about 5 million, 5 to 6 million, built into our assumptions. But it could be between 5 and 10. We think it will grow.

Mike Huffman, Fraser Management.

Could you give me a little more on the implications of lean manufacturing in the UK, and what product lines are going to be dropping, what you expect to come of that?

Yes. Most of what we make in the UK are HiRate cylindrical cell line, and then a pretty good number of battery assemblies based on those cells. Our inventories in the UK -- the UK is about 10 percent of our business, Bill?

Yes.

10 percent. It could be a little higher as it grows, 10 to 15 percent of our business. So you don't see it necessarily as some big inventory, but the inventory is running too high. And it's running too high because it's a little too high in the work in process, and it's a little too high in our raw materials. And the UK guys know this, too, but it hasn't really been a big priority because it's been a small number, when we're making 700 or 1,000 cells a day. But when you start making 5,000 cells a day, it becomes noticeable and important. Not that it wasn't important before, but as we focused on things, we were more focused on getting the capacity of our product up, and just growing our business there. So it's now become important. I don't know. And getting cycle times down and getting inventory out is critical.

Bill? Bill has been intimately involved in this.

The issue is we're trying to reduce the number of SKUs. UK makes some really specific SKUs to their own market that we can reduce by having the same similar cell made in both places. So that increases our flexibility and able to respond to customers. Plus their assembly leadtime for specific battery packs was very long, on the order of three to four weeks. And with just some simple lean manufacturing, we are training the folks in that assembly operation, we are reducing it to one to two days. So it's just that type of ability to really respond to customer requests for our product a lot quicker.

George Nooney, LAR management.

Let me call you right back.

Hi, guys. Larry Radar for George. Question -- as you come out of '04 and start into '05, what percentage will commercial non-military (indiscernible) be in your view?

I think we've said in the past, and I'll reiterate, I don't think our view has changed that for '04, we think the military will continue to be about 60 percent of our business. So, as we grow, that military and the commercial business will grow about the same in '04. Toward the end of the year, we think we'll start to grow our commercial business faster than that. And so, our preliminary look -- and I want to stress this, preliminary look -- at '05 says that we'll be more like 50/50 in '05.

But military -- we think that the market, the adjustable market for us in military for primary batteries is about $200 million a year. We'd like to have half of that, which means 100 million. So we still can grow there.

What will that mix shift do to your margin?

It will be good for our gross margins, in general, although you have to look at specific products. We do have some of our rechargeable product line as product that comes directly out of Ophalek (ph), Taiwan and goes right to customers. So if that was something that exploded, that's not a 30 percent gross margin product line. On the other hand, it doesn't have a lot of expenses that get dragged with it, either. But in general, based on the mix that we're anticipating, it would improve our gross margins.

David Kurzman, Needham & Co.

Right now, international sales represent a very, very small portion of your revenues. With the dollar weak compared to foreign currencies, do you see any expansion near or mid-term in international sales?

Let's see. First, we've been very active in increasing our distribution channels internationally. We've been strong in Europe with our UK operation, but in the Asia-Pacific area, we've been pretty active. We think Japan is an area that has a lot of promise, and several other of the areas in Asia -- Australia, et cetera -- are going to be promising areas for us. I would not say that it's going to be big enough in '04 to notice -- to say that, gee, there's a huge impact from growth in international. It takes some time in some of these markets. Do we have opportunities in these markets? Yes, we do.

The other thing I will sign say is that some of our sales in Europe have been sold as U.S. dollar sales, as well. So when we do that, we don't benefit. Of course, when the dollar gets weak, we complain. When the dollar gets strong, we don't mind it. So it doesn't does balance out over the long run. I would not describe any great kicker to that, in his current year.

So basically, you really have not had any tailwind from currency in 2003, or any expectation in 2004, even?

No, not a big one.

Great. Let me follow up quickly. Can you quantify -- and maybe this is a question for Bob and Bill -- can you quantify the cost savings from your efforts in CapEx? It sounds like you did 5.5 million in CapEx in 2003. Can you quantify how much of that was for cost savings, how much of that was for capacity additions? And I don't know if you're willing to say how much you actually saved on that incremental expenditure.

Bill is looking at me right now. I think the number we spent in 2003 for cost savings -- I wouldn't say it's zero, but it's more like zero than it is any other number. We were just going all out to increase our capacity.

Should I read into that that there's still room for cost savings?

Oh, there's tremendous room. That's why we are spending $3 million -- more than half of our CapEx this year is dedicated to cost reduction type programs, to reduce inventory, to take labor out of process and improve our yield.

And a lot of those projects that we have got on the plate right now are very quick payback projects.

So here's my thinking. I look at what you are telling us for '04 in the way of margins. I hear what you're saying about the opportunities, and that you are going to make efforts, $3 million or more, just for CapEx to try to get those margins higher. I am seeing very good margin improvement going towards what looks like 11 to 12 percent -- 12 percent, probably -- in operating margins for '04. I would expect, actually, even a little more -- or are you guys just being conservative, because $3 million, I would assume, would give you at least 100 percent, if not more than that, return on your incremental dollar?

We're trying to be very careful about how fast we can implement these projects, and how fast we'll get payback with them. It's prudent; it's prudent to not count on savings, day one. Stuff happens in a manufacturing operation. You put something in that's supposed to get you payback, and people have to get trained and bugs have to be worked out. So we are being careful. Is there opportunity? Yes, there's opportunity.

Steven Gish, Roth Capital Partners.

Bob, what is the total credit line? And how much availability do you have on that currently?

The total credit facility is $15 million. We've got a $3.6 million holdback line of credit that takes away from our availability under that. We have about 1.2 or 1.3 million that relates to a term loan supported by fixed assets under that facility. If you get down to it, when you get down to the availability under the revolver the way it is today, it really comes out to about $9.5 million of potential availability under the facility the way it is today. And what we had outstanding -- and we have also a small facility also in the UK that gives us about $700,000 or so of potential borrowing capacity. And we have utilized that pretty extensively in the UK. The facility we have with Congress financial in the U.S. outstanding -- as of the end of December, we had about $7 million or so outstanding under the revolver. So that gave us an extra $2.5 million of potential available borrowing capacity at the end of the year.

And then you had mentioned in Q4 there was some alternative minimum tax? Do you expect to see a similar situation in '04?

Yes. Now that we are in this profitability mode, we're going to see -- what happens is we go through and determine what taxable income is. Alternative minimum tax says we can only use up to 90 percent of the taxable income, and offset that with NOLs. So 10 percent of that taxable income -- if the taxable income becomes taxable at a rate of 20 percent for alternative minimum tax. So it gets down to about 2 percent of taxable income, is what we're going to see as actually current taxes payable.

(OPERATOR INSTRUCTIONS). David Kurzman.

Near term, you guys are thinking in the next couple of years -- you know what? Actually, I think my questions have been answered. Thank you.

At this time, I show no further questions.

Well, thank you, everybody, and thank you all for listening. It's been another record quarter, and a record year for Ultralife in both revenue and profitability. We plan to do it again this quarter, and again this year, as we continue to execute on our focus on key markets, operational excellence and financial control. We have a business model that's only starting to develop to its potential. We have the prospect of growth in revenue, profits and returns to our shareholders for years to come. For our long-term shareholders, we're thrilled to be able to reward your faith and patience. To our newer shareholders, we get up every day to work hard to reward the confidence you have shown in us by investing in our Company. I look forward to sharing our results with you again next quarter. Thank you.

Ladies and gentlemen, this concludes our conference for today. Thank you all for participating, and have a nice day. All parties may now disconnect