Ultralife Corp (ULBI) 2004 Q1 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Ultralife Batteries first-quarter financial results. (OPERATOR INSTRUCTIONS). I will now turn the conference over to Jody Burfening of Lippert/Heilshorn, who will read the Safe Harbor, and then turn the conference over to John Kavazanjian. Please go ahead, ma'am.

Thank you, operator, and good morning everyone. The earnings press release was issued earlier this morning, and if anyone has not yet received a copy, I invite you to visit Ultralife's 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 Chief Executive Officer, who along with Bob Fishback, Ultralife's Chief Financial Officer, will provide the formal remarks. Management will then take questions until 11:00 Eastern time.

Before I turn the call over to John, I would like to remind everyone that some statements made during this conference call that contain references to the number of matters, including Ultralife future plans and objectives, are forward-looking statements. These statements represent the current values 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 these 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 first quarter of 2004. Joining me today are Bob Fishback, as Jody said, our Chief Financial Officer; Bill Schmitz, our Chief Operating Officer, and Nancy Naigle, our Vice President of Sales and Marketing. Today we reported operating income of $3.4 million on record revenue of $27 million and net income of $3.2 million or 22 cents per diluted share.

To put this quarter's results in perspective, last quarter we produced $2.3 million in operating income on $24 million in revenue. A year ago we reported $600,000 in operating income on $15.4 million in revenue.

This quarter we also exceeded our revenue targets in both our rechargeable and military businesses. The leverage of our business model, along with continued improvements in operating efficiency, was the major reasons for strong operating margin improvement.

Demand for our BA-5390 battery continues be strong. During the quarter, we successfully demonstrated the capability required in meeting the terms of the capacity facilitization agreement that we have with the U.S. Army. This added production capability has enabled us to get back to a normal work week and minimize over time in most of our operation. Over the next four to six weeks, we will be commissioning our newest cathode line. This will eliminate a major constraint in our operations, more than doubling our production capability in this critical area.

We are extremely pleased with the rate of growth in our rechargeable business and our growing customer base both for military and commercial use. This quarter we sold products to almost 100 different customers, most of whom have the potential to continue to grow their business with us. Gross margin for the rechargeable segment was slightly down as we did take a charge for reserves connected with some rechargeable business inventory that has become obsolete. We expect this business to continue to grow next quarter and gross margin to expand as this one-time charge is behind us.

We are also quite confident that we will exceed our initial target of $5 million in revenue for the year in this product line. One of the new applications for which we are now supplying products in volume is the digital camera battery for a major consumer electronics company. We were able to coordinate engineering, design and manufacturing capability between our customer and Ultralife Taiwan, ensuring top-quality customer service and the capability they could not get elsewhere. In this case, we decided to accept lower gross margin in favor of gaining entry into a prestigious new customer with whom we hope to do additional business. This move also further expands our product portfolio.

This past quarter we were notified that we did not receive the Large Cylindrical Battery Award, the smallest of the next NexGen II awards. Although we were disappointed, we have no reason to believe that our prospects for winning business in any other solicitation is in any way diminished. As in aside, our full-year guidance did not include any estimated revenue or profit from this award.

We did, however, complete our bid submission for the next phase of NexGen II, the rectangular family, along with the separate small business set-aside bid for the BA-5347 thermal weapons site battery. Since we are the only company currently producing the BA-5390 in volume -- the major part of this procurement -- we are very hopeful of success. As much as we would like to be able to predict when this award will be made, the past has taught us that it is difficult to do so, and therefore, this award is not built into our 2004 guidance.

Also during the quarter, we were awarded a $2.7 million contract by General Dynamics to continue as the developer of batteries and chargers for the Land Warrior Stryker program. This award will cover 18 months of development, as well as initial shipments of some product. A short time ago we announced a $1.5 million award from Cubic Defense Systems for batteries and chargers for use in their advanced compact training system. And earlier this week, we also announced another release. This one for $6 million against the NexGen II small cylindrical contract.

On the commercial side, we maintained a very high level of activity this quarter. Thin Cell design and sampling work continues to grow for a wide variety of applications including medical devices, smartcards and active RFID tags. Cylindrical cell design activity continues in medical, search and rescue and automotive telematics market. We continue to expect to begin producing meaningful revenue from these product lines in early 2005. Our commercial business is now growing as fast as our military business, and this activity should result in it growing even faster as we enter 2005.

You will notice in my remarks we have not made a distinction between our business in the U.S. and our business in our UK facility. This month we completed our product harmonization program, resulting in a common cell design across our Company. We now have products of identical form and function and the flexibility to manufacture them in either facility as operational demands require.

As a result, we will be able to realize additional leverage on manufacturing costs and increase our ability to service our customers as the Company grows. We have also made the decision to make additional investments in product development. Opportunities have started to outstrip the resources we have to field -- a good problem to have. While we have been able to meet all current opportunities, we believe that we will do a better job of servicing prospective customers if we have the resources to be proactive. These investments are modest but strategically important and are incorporated in our guidance and our business model.

Last quarter we told you we expected $26 million in first quarter revenue with some growth into the second quarter. We have exceeded our first-quarter target by $1 million, and we expect the second quarter to be around $28 million in revenue. We expect to operating margin to improve to $3.5 million, including provisions for the added resources in product development. In the second half of the year, we are still maintaining a prudent outlook, taking into account the possibility that military demand may level off and we may return to normal hold time, which would flow one month of production into inventory. We are adjusting our full-year guidance upward to $106 million in revenue and 12.5 million in operating income based on the first-quarter's results and the improvements in margins.

Financially we are sound. We now have a growing, profitable, cash generating business, and we are in the last stages of negotiating a new financing agreement. This will give us the financing flexibility that will enable us to grow at very competitive rates. Bob will have more to say about this in his comments.

Now I would like to turn it over to Bob Fishback who will cover some of the financial highlights.

Thank you, John, and good morning everyone. Earlier today we reported the results for our first quarter of 2004. Consolidated revenues reached a quarterly record $27 million, $1 million higher than the guidance we had discussed during last quarter's conference call. Compared to the same quarter last year, revenues gross $11.6 million or 75 percent. The key driver for this increase was strong growth in sales of HiRate battery products to the military, particularly our BA-5390 batteries.

In addition, sales to commercial customers have begun to increase as evidenced by $1 million year-over-year increase in rechargeable battery sales from $400,000 last year to 1.4 million this year. These revenue increases were offset in part by lower 9-Volt battery shipments versus last year's strong performance, which included the delivery on a sizable order from the UK Ministry of Defense.

Gross margin for the March 2004 quarter was $6.3 million or 23 percent of sales, an improvement in dollar terms of approximately $3.2 million over the comparable quarter last year, and as a percentage of sales, a 300 basis point improvement. The improvement in gross margin was led by our primary battery operations where margins increased from 22 percent last year to 27 percent this year. Higher sales and production volumes were the key factors for this improvement in addition to gains in manufacturing efficiencies. Gross margins for our rechargeable battery operations declined from a loss of 200,000 last year to a loss of approximately 500,000 in 2004 in spite of the increase in sales. The margins in 2004 were negatively impacted by a $250,000 increase in reserves for obsolete inventory, while the margins in 2003 were favorably impacted by early termination fees associated with a closeout of a certain production contract. In addition, product mix somewhat impacted the rechargeable margins as well.

Operating expenses for the first quarter of 2004 totaled $3 million, an increase of approximately 400,000 over the same period last year. Generally these costs have risen to support the growth in our business, including higher investments in customer service and sales and additional system support, as well as higher insurance costs and professional fees. The R&D line item reflects a decrease of $100,000 from the same period last year as resources during the first quarter of 2004 were shifted to support the requirements for our recently announced to $2.7 million development contract with General Dynamics.

As a percentage of revenues, operating costs have declined from 17 percent last year to 11 percent this year. Operating income for the March 2004 quarter reached a record 3.4 million. This was approximately $400,000 higher than the $3 million guidance we provided last quarter, mainly due to the higher than projected sales. As sales increased 75 percent, operating income improved more than five times from the $600,000 reported a year ago, demonstrating the high amount of operating leverage we have as we grow the Company.

Income taxes for the first quarter were less than $100,000. This current tax provision relates to the alternative minimum tax computation that only allows us to offset 90 percent of our taxable earnings with the NOLs we have. At the time of our earnings call last quarter, I discussed the issue of whether there may be an annual limitation on our ability to utilize our U.S. net operating loss carry-forwards based on internal revenue code section 382.

At that time, the analysis indicated we were not subject to any limitation. However, shortly after the call, we became aware of changes in the holdings of some of our more significant shareholders, which triggered a change in ownership limiting the annual use of our NOLs. We included this updated information and our Form 10-K report.

Over the past couple of months, additional work has been done to frame the magnitude of this limitation, and we now estimate that the use of our NOLs will be subject to a limitation in the range of approximately $14 to $18 million per year. What this means for 2004 financial results is that we only expect to accrue and pay taxes based on the AMT rules, a fairly nominal amount for 2004.

Net income for the March 2004 quarter was $3.2 million or 22 cents per diluted common share compared with net income of $300,000 last year or 2 cents per share. Average diluted shares outstanding for the quarter were 14.9 million shares, an increase of nearly 2 million shares over 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 my focus to discuss the sequential comparison of the March quarterly results versus the December quarter. Consolidated revenues rose almost $3 million from the 24 million recorded in the fourth quarter, reflecting a 12 percent increase. This resulted primarily from greater shipments of HiRate batteries mainly to the military, as well as an increase in sales of rechargeable products.

Consolidated gross margins increased $1 million from 5.3 million to 6.3 million. As a percentage of sales, the margins improved from 22 percent in the fourth quarter to 23 percent in the first quarter. Higher revenues and related increases in production volumes, as well as continuing improvements in manufacturing efficiencies, were the main reasons for this improvement.

Operating expenses were consistent from quarter to quarter at $3 million. While R&D costs declined modestly as resources were devoted to our new General Dynamics project, SG&A costs rose slightly as general costs to support our growing business increased.

Operating income increased more than $1 million from 2.3 million to 3.4 million. As a percentage of sales, operating income amounted to 12 percent in the March quarter compared with 10 percent in the December quarter.

Turning to cash flows. Our EBITDA in the March quarter amounted to $4.2 million, including depreciation of approximately $900,000. During the quarter, our need for working capital increased, primarily reflected in higher receivables and inventories based on the timing of production and shipments, and we used approximately $3.8 million in cash. We also spent approximately $500,000 on capital equipment additions as we continued to invest in our plant capacity and began certain cost reduction projects.

During the quarter, we generated $2.7 million in cash from the exercise of stock options, and we reduced our outstanding debt by approximately $2.4 million, primarily related to our revolving credit facility.

Our balance sheet at the end of March continues to improve. In addition to our ending cash balance of approximately $1.1 million, we also had additional borrowing capacity of approximately $5.7 million under our revolving credit facility, providing us with total cash and credit availability of almost $7 million. This compares with 4 million as of the end of December. The amount of debt outstanding at the end of March was only $6 million, mainly revolving credit supporting our short-term working capital needs. Total debt as a percentage of total capitalization was only 13 percent compared with 20 percent at the end of December.

We are in the final stages of deciding how we are going to refinance our current credit facility, which is scheduled to expire at the end of June this year. We have multiple proposals to provide us with much greater financing flexibility and also reduce our overall cost of borrowing. We expect to have a new facility in place within the next several weeks.

Looking ahead, we are projecting revenues for the second quarter of 2004 to be approximately $28 million, mainly due to the demand we have experienced from the military and in our rechargeable business. We are also projecting operating income to reach approximately 3.5 million for the second quarter. During the quarter, we expected operating expenses will increase somewhat as we devoted additional resources in R&D and various support functions to ensure that we stay ahead of a growing list of development opportunities, mainly for commercial customers. EBITDA for the second quarter is expected to be in the range of $4.4 million, and capital expenditures are expected to be approximately 2 to 2.5 million as the capacity enhancement programs reach their final stages of qualification.

For the full year 2004, we are increasing our previous guidance to reflect the higher than expected results for the first quarter, while continuing to be prudent about revenues in the second half of the year. Our revised outlook is for approximately $106 million in revenues with operating income in the range of $12.5 million. EBITDA for the year is now expected to be approximately $16 million.

We continue to expect that capital expenditures for the full year will amount to approximately $5 to $6 million with as much as half of this investment to be dedicated toward cost reduction programs. We remain focused on driving our target financial model -- on driving toward our financial model for the Company with near-term gross margins in a range of 26 to 27 percent and pretax operating margins in the range of 15 percent. Longer-term we have a target of reaching gross margins of 30 percent or more, generating a 20 percent pretax operating margin.

The financial results for the first quarter of 2004 keep us on course toward achieving our goals. It was a solid quarter, and we are working to stay in front of the great number of opportunities that will help us grow the business. We are very confident about our ability to succeed, and we look forward to reflecting ongoing improvements throughout the rest of this year.

That concludes my remarks. Now I will turn it over to John.

Thank you, Bob. It has been another record quarter. We continue to increase revenue and achieve the operational improvements that will help us make progress toward our operating income target in the near-term of 15 percent. Later today we will be filing our proxy statement in preparation for our annual shareholders meeting, which is on June 10th. The proxy includes several important proposals, including the nomination to our Board of a new independent director and a broadening of our stock option plan.

On a connected note, you will notice in the proxy that Joseph Abeles will not be standing for reelection as he has informed us of his desire to retire from the board. Joe Abeles has been one of the pillars of the board and of the Company since its founding. He was instrumental in the financing of the Company at its inception and in every equity offering that the Company has done. He has functioned as the Treasurer of the Company in the past.

When I came to Ultralife five years ago, Joe had been working as the acting President and CEO for six months. Of course, at that point show, Joe was only 84 years old and had been retired from the active management of any company for 20 years. There is not a single person connected with Ultralife who has not been touched by Joe. We will miss his counsel and sage advice, but we are glad to count him as one of the Company's best friends, most loyal supporter and most dedicated shareholder.

Now I would like to turn it back and open it up for questions and answers.

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

Good morning, folks. I have got a bunch of questions. Let me to start with the commercial market development. You talked a little bit about on the rechargeable side you have seen some applications in digital cameras. But I also want to get a sense in the nonrechargeable, nonmilitary primary side. Where do you see the ramp in the latest quarter, and what do you see on the docket for the second quarter?

David, let me see if I can take these things in order. First, we have numerous development projects onboard. Because we are in the designing business, there is some lead time associated. For example, I think we said in automotive telematics we right now have two or three active programs besides Volvo, who we are already producing for, two or three active programs going forward where we have done designs, and we are waiting for programs to be committed to.

Our guess and our planning assumptions are that some of this will affect us in 2005 and then some more in 2006. I cannot tell you who the customers are because we have confidentiality agreements with them. But there are two or three in automotive telematics, mostly for starting at the high end of the vehicle, and I think that is what we are seeing. If you will look at who has backup batteries today backing up the telematics product, they are people like Volvo, they are people like Lexus in the high end of the product line.

In the medical field, we have done we told you we have one product with a revel medical device that is coming to market this year. We have been very prudent about projecting revenue for that because it is a new product in the marketplace. We think it is exciting and innovative. We have got literally more than a dozen designs in terms of sampling in the Thin Cell marketplace. Of course, not just medical, revel (ph) medical monitors and pumps, but RFID is a very hot market for us, as well as most smartcard projects.

These again are projects that have to develop and come forward. And while maybe you might see something in '04, right now our plan is that stuff is '05 type of business.

Really you do not have very much built-in if anything from the commercial primary side for '04? Is that how I should hear that?

Yes. The way you should hear is we have very modest numbers built in for some of these projects. Let's call it initial production and market entry for some of them. We have got I think three or four (inaudible) beacon projects going in search and rescue. So maybe three or four products where we are doing designs in news beacons in search and rescue.

We have at least one in the defibrillator marketplace, a project that is in customer survey and FDA approval loop. We don't have a lot of experience with how long those approvals take, but we are guessing that -- our best knowledge, I should not say guess -- our best knowledge is that while it might be some volume in '04, there is none built in our plan. It is '05 volume.

In the rechargeable business, that is a tough one to predict. We have one project -- the (inaudible) camera project -- which we started on six or nine months ago I think that is getting the volumes and, if we look at the forecast, fairly substantial volumes this year. We have another project which we have just literally 100 different applications. We have another one of these projects that we have just been notified is looking like it is coming to volume next quarter, and that is built into our growth assumptions for that business.

But again, we have to be prudent. If we believe everything our customers tell us in terms of volumes, we have to mitigate that a little bit.

The other thing I will say is in rechargeables, about a third of our business is from some of the more standard products that we put out. We have some high-end products we did for the military, notably the Land Warrior battery and the rechargeable version 5390, which is 2590 which we put up -- we started marketing through our Website and through our salesforce to commercial customers for replacing lead acid batteries and things like portable instrumentations and large, large asset tracking and other applications. And I think we shipped to 25 different customers 2590s last quarter. That has been a rousing success.

25 2590s you said?

I said we shipped 2590s to 22 different customers last quarter.

I see. Shipped to 22 different customers. So not all of those were military I assume?

No. About half was commercial and half was military.

That leads me on to my second question, and then I will hop back in queue. A client asked me a fabulous question I did not know how to answer, which was -- let's say we go back to peace time -- let's say the military really does start adopting the BA-2590s. How does this change your revenue and margin assumptions for the military? And in a way, I guess I am asking how long do the BA-2590s last?

Good question. They literally get hundreds of charges off of it. But 500 cycles is the rated capacity of it.

There are a couple of answers to that question. Number one, we know that they were under trained, that there is more and more devices -- there is probably at least two maybe three kinds of number devices that use the product that were fielded as a result of the Iraq war that are now permanent parts of the arsenal that people had not been getting trained on.

So in one sense, the demand has gone up. This will allow -- the shortage of batteries in the past and the cost of them really hurt them in the training side. So this will allow them to do more training. That is what they are going to use them for. When they train in real deployments, whether they are doing things at the National Training Center or going out in Fort Polk in the swamps for a few days, they are not using rechargeable batteries. They are still going to use primary for that part of the training.

So I would say that the demand is growing. Part of that demand will be filled by rechargeable batteries that will be more economical for them, and part will be done by primary batteries where they will have to train because it will simulate combat situations where logistics and (inaudible) supply are important.

In terms of if we go from -- and this is just round numbers; tell me if I am way off base. If we go from the average soldier might use 20 BA-5390s a year, but now they are going to go to two or three rechargeables so there is always in the charger charging while you are out in the field, is that a reasonable way to think about it? What does that do to your margins then?

I don't know what the numbers are. It is as simple as that. The way to think about it I think is there is demand for additional training and for additional applications that economically it was tough to justify going to a three or four active demand of primary batteries. The idea is to fill that demand with rechargeable.

Really going to rechargeable opens up new markets that didn't exist?

Yes. In fact, we have seen it. When you look at the Stryker program with GD, you look at the Stryker program, that is really -- the gist of that is that the battery usage is so intensive they have to use a mix of the two. The demand per average soldier would just go up so much that it is not just -- cost and logistics would be much complicated for both deployment and training.

So I think we are being pretty prudent in terms of our numbers and estimates for some of these things. And we remain firm in thinking that this is at least a $200 million year type of business that our target is to be 50 percent of. The way to think of it is we are about 60 of it this year, so there is room for growth.

James McIlree, Unterberg Towbin.

Can you talk about the Exigen pricing on the contracts that you have remaining for the rest of the year if those have been settled yet?

Yes. We have settled. This year we have gotten Exigen pricing settled at the beginning of the contract. We are about to start another contract I believe. I am looking at Bob. Bob, why don't you answer? You know the most about this.

Within the next few weeks, we will start shipping under one of the new contracts. We are putting the final touches on the definitization of the pricing right now, and we expect it to be done prior to when we start shipping under that new contract.

What we have done in our guidance is we have been very prudent about the numbers we are assuming in there so that we don't get any more surprises.

Okay. I want to make sure that the pricing has been set for all of the Exigen contracts that are expected to be delivered upon this year?

They are not. There is one more -- two more to be set, and we are on the final touches of that. It might be -- we are hoping to get it done next week.

And that puts you through what time period, the September quarter?

We get into September with that.

Great. Can you break out the revenues by military, Thin Cell and 9-Volt? You have already done that for rechargeable.

I don't think anything has really changed. I think 9-Volt -- the military is running about 60 percent. 9-Volt is running about 25 percent, and the rest is commercial business. Thin Cell is not what I would call significant in terms of percentage at this point in time.

If you were to ask us what are we counting on for Thin Cell for the year, it is in the ballpark of 1 percent, so it is noise. Like I said, it is not that we are not trying to get this thing going, it is just that we are trying to be very prudent about forecasting how fast some things will takeoff. So the surprises are on the upside, not the downside.

I understand. The guidance for the year suggests a second half that is flattish to down with the first half. Is this solely related to your caution on the potential military inventory -- I don't know what we should call that? Rebalancing?

Yes. We are not permitted to go into details of what we know about military inventory. All I can tell you is we have assumed that we are going -- let's make the assumption there we are going to flatten out in demand and that an assumption that they go back to a normal contractor hold period. As we said before, if they don't do it before the end of the year, if demand stays so high that they need to keep taking deliveries after a couple weeks hold, it will happen at some point in time where they will go back to a six-week hold. That maybe the end of '05 for all we know, but it could be the end of '04. So we baked that in as an assumption to our numbers just because we have to be cautious.

The one other factor that is involved is that we do need -- they do need to put out another procurement. Whether they will do that before or after they award the large rectangular family of products, the rectangular battery products, that is anyone's guess. We don't know that. We know that there is a budget issue in that. The Pentagon is looking for a supplemental budget, but because of the election year, they probably won't go back for it until after the election is what we are hearing, but that is in the realm of politics. There is money there, a lot of money. It does not take a lot of money to buy the batteries. They need them. Plain and simple, we know the demand is still there.

And, Bob, the DSOs were up sequentially and also year-over-year, and the inventory turns were down substantially. Can you go into that?

Our DSOs -- I saw your report this morning. We do an exhausted method on our DSOs. We have got a number of 48 days for DSOs, which is basically flat with the fourth quarter which was about 47. For all of last year, it was I think 50. And on the inventory turns -- so the DSOs I think we are still managing our receivables very well, and we don't see a significant change in the way we are looking at things at our end.

With respect to inventory turns, inventory turns have declined a little bit from the fourth quarter, which I think -- we were in the high 6s in the fourth quarter. This quarter we are in the low 6s, about 6.1. Part of the reason for that is some of the inventory buildup due to timing issues and production and shipments.

Most of the military stuff was produced in production lots. So it depends when the lot -- the two-week production lot or whatever -- is ready. At the end of last quarter, the lot was ready at the end of the quarter. If the lot is not ready until the week after the quarter is over, then you have a little (inaudible) there sometimes. That is all it was. There was nothing abnormal about the way we manage inventory.

Steven Gish, Roth Capital Partners.

Actually it is Rich Yen (ph). I am sitting in for Steve Gish. A couple of questions. First of all, you had mentioned about your cathode section line. Can you give us an update on the progress in both the U.S. and the UK?

In terms of capacity?

Yes. That is correct.

Our U.S. capacity has been, as we said last quarter when we put in the last of the winding and filling equipment that is in our D cell line, U.S. capacity has been in pretty good shape in those areas. Our only constraint was in the area of cathode production where we were -- so we were able to get back to normal workweek, five-day workweek with if we had a little overage to do, we could work a day on the weekend. But in cathode we have been running seven days. We have two cathode lines, and they have been running full out.

So the new cathode line will get us in shape there. The reason we don't give out actual production numbers is because it depends what kind of cell you are making. But we can line to make upwards or over 40,000 cells a day. It is just we were limited by our ability to make cathodes in our large cylindrical operations.

The UK operation is very capable. It is probably running right now at about -- what did say, Bill, 30 or 40 percent of capacity maybe? We are running about 30 to 40 percent of capacity in the UK. Our business there has been good. There has been a little downturn in our UK MOD business just because of fiscal year budget issues, but that is just a perturbation. As they move to a new fiscal year, I think their appropriations go April 1st or something to April 1st.

But we have capacity there. We're meeting customer deliveries, and we are actually putting some other products like the 2590 where we need productive capacity into the UK.

In terms of the rectangular contract, from our understanding, it is a little more difficult manufacturing these types of batteries. We are wondering if you could comment on that and where would you see gross margins?

The largest part of the rectangular contract, I mean by far the overwhelming part of it is the 5390. We have been making that all along, and our gross margins in that product are in the high 20s in terms of percentage. So it is what it is. We are the mass producer of that product, and it has been a great producing product.

The other product inside that contract are basically derivatives of that product, plus one rectangular battery that is a pilot survival radio battery that we have submitted good samples for.

The other product, which is a 5247 which was pulled out as a small business set-aside, we are the only maker of the cells for that product. We have been making the cells all along in our UK operation, shipping them to a battery assembler who develops the full products, and they assemble the batteries.

So we have bid that contract ourselves directly to do the whole battery. We have also supplied cell quotes to some of the assemblers who are seeking to also get that business as an assembler. So most of those contracts we are already in production on.

Finally in regards to the NexGen (inaudible) loss, have you been briefed by CECOM on that, and what were the circumstances?

Go ahead, Bill.

The only information we have is we have quarterly reviews with CECOM on that, and they are expecting to make an award by the end of summer.

No. This was on the large cylindrical. (multiple speakers)

I am sorry. The large cylindrical, yes, we had a post-briefing on it and went over it, and again at this point, we thought we offered a great value to the CECOM in this regard, but they decided to go a different way with it. So we are happy with our bids samples and the quality of them. But at this point in time, they decided to go to a different supplier.

All we can figure from it to be honest with you is that the two people who got it -- (inaudible) -- the only other two bidders, have been making that product already for CECOM with a sulfur dioxide cell. It maybe that it is a low-volume product, and they just did not want to go through the effort of qualifying somebody else in it, and they went with those guys. We felt we offered a very competitive bid.

So there is some subjective judgment that goes into any of these, and that is where they were on it. But I will just say if their criteria is to have more comfortable people who are producing it already, that makes us feel pretty good about the rectangular family.

Sir, does that answer your question?

Yes.

Mike Huffman, Fraser Management.

Good morning. You made a comment that you were going to be investing more in product development. Is that in terms of personnel or testing or marketing?

Yes, yes, yes. Okay. First of all, Mike, our marketing job -- I hate to say this with Nancy here -- but our marketing group has done too good a job. The amount of leads coming in, the amount of opportunities coming to us is overwhelming our ability to number one, have that interchange with the customer to clarify exactly what they want; number two, to be able to design a solution to it, and number three, to be able to produce prototypes. So we are going to put resource in each of those three areas. We actually as a management team sat down and said all right, how do we want to attack this problem? And we viewed that we had a golden opportunity that we did not want to let go past to really accelerate our entries into these marketplaces by doing that.

So we are going to add some people on the front-end. We are not talking about armies of people -- we are talking about a couple -- to handle the front-end of the product interface with customers to clarify what they want and qualify opportunities. Number two, to add some design capability, and three, to add the ability to do very fast prototyping.

What is really great is we are already better we think than anybody else out there in terms of customer response in these types of opportunities. We are being told that by our sales force and by our customers. But we are not -- we want to be better. It is simple as that.

Along those lines, can you give me a little more depth without naming names on the camera company you're doing business with? How long it has taken to get to where you are and where you see this sort of thing going?

This was kind of an interesting project. You have been with us for a long time, and you know that we talk about looking for high-value applications. I would not necessarily call this one of those. But the customer came to us and had a real need for this battery. It is actually a battery that is used in multiple digital cameras, but everybody has a little difference spec for it.

We went to Ultralife Taiwan, and we actually said to the customer you can deal directly with Ultralife Taiwan. And the customer said no, we are not good at that. We want you to do it. We want you to source it for us. So that was part of the customer service agreement, and that is what we did.

UT is producing the whole thing. They make the cell. They made it up with what is called a PTC safety strip and a circuit board and they mold it. And they ship it directly to the assembler who is assembling the battery for that customer. And what we provide is really the project management. We participated in the original design, and we participated in assuring the quality of it.

That is what they wanted, and they are happy, we are happy, Ultralife Taiwan is happy, and it is turning out to be an interesting model. If this became -- I will tell you that this is not a 30 percent gross margin business. This is 10 to 15 percent gross margin business. But our cost of servicing this customer also is much lower than what you would traditionally assign to it. And so that is why we decided to take it.

In a company, you need to be able to handle multiple business models. But we just have to have our eye open to make sure that our cost of servicing is not high if our gross margins are. It just makes sense to do. If this became a very big part of our product line, a lot of people ask us for this. We talked about this. We owe it to all of you to split that out as a distribution type business so we identified it as a different type of business model. It is not big enough for that now. But if it got to that, that is what we would do. Did I answer your question?

Yes, you did. Any update or further comments on stock sales by insiders?

No. All of our stock sales are posted on a regular basis on there. On a personal note, I have owned 80,000 shares of stock in the Company. Most of what I exercised that I could afford to keep I kept. I have 300,000 shares of options that expire a year from July.

So sometime over the next year I have to do something with them. I will just put in one other plug because I testified in front of a Senate committee yesterday about this, if FASB decides to go through with this idea of expensing stock options, which will further obscure the operational performance of the Company for you the investors, then it might be in the best interests of the Company for me to exercise all of those options this year because it starts next January 1st.

But in any case, that is the biggest overhang out there is mine, and I have been very clear that my objective is to exercise the options and hold as much as stock as I can afford to hold in making sure I don't get my own personal finances totally out of whack. Everybody else is -- I don't know what their plans are, but it will all be disclosed and filed it anybody does anything.

David Kurzman, Needham & Co..

Thank you. Would it make sense to switch from an option plan to a restricted stock grant program?

I don't know, David. We will decide to go. You know all I can tell you is, we have been steadfast in ensuring we did what makes the most sense to our shareholders, which means optimizing the value of this firm. So we are not going to play accounting games. We are going to do what makes sense to optimize the value of the firm, to optimize the value to our shareholders, to grow the business and become more profitable in a real sense, which is the value of future discounted cash flows as you know. And if there is some artificial accounting concerns -- if accounting requires us to do certain things, we're going to do them, and we're going to give you all the data that we can give you so that you can evaluate the Company properly.

We are not going to be driven by strange tax strategies or playing games with subsidiaries. We really try to keep -- I don't want to get sued for this -- but this is the no spin zone. I would fair and balanced, but I know I would get sued. We're really trying to keep this as simple as possible for us, for our owners, for everybody.

If the accounting rules require us to do something, we will do it. But we are not going to let accounting rules influence what we do operationally.

Let me throw a tax-related question at you. You guys provided a very broadband on the section 803 issue of $14 to $18 million. First of all, can you explain why the range is so broad? Second of all, what are going to be the triggers that are going to cause that range to narrow?

This is Bob. What we have done -- there are certain computations that we have to go through, and some of the key criteria in those computations have to do with the date on which we had a change in ownership. We know that there was a change in ownership sometime during the fourth quarter of 2003 based on the 13F filings. But if we can fine-tune that to determine a specific date, it may help us increase that limitation because dependent upon the value of the company and the date of the change in ownership.

So the stock price at the end of the year was around 12.5. If we determine the change happens somewhere where the stock price was I don't know $14 a share during the quarter, that helps us out. So that could increase the possible limitation.

Who decides that?

We are working through that analysis.

Price Waterhouse Coopers does our tax work, and they do the computation.

Along with us. (multiple speakers)

You understand we are faced with going back to some of our larger shareholders and asking them what day they bought the stock, and they are not under any obligation to tell us that.

The other key factor in this has to do with a more aggressive view by the Internal Revenue Service, which has given us a little bit more flexibility we think in the limitation, and it has to do with determining what the fair market value of our assets is. So we need to determine whether we need to go through an appraisal process, a fair market value appraisal process, to value the assets which then will have an impact on that number without trying to get into too much detail.

Wouldn't your banks, the banks that are looking to do your future credit lines, wouldn't they have already done that? Could you use that, or can you use just what your accounts put together for your 10-K?

No. That would be a different type of an appraisal.

And then finally in terms of the BA-5347, the thermal site, can you give a little more color? Can you give a size of the market? Can you give what kind of thermal site this is? What do you know?

What we know is that this was a product that was developed about two years ago. It is the next generation of NightVision if you will. It operates -- NightVision only works when there is limited -- a little bit of moonlight. Thermal sites work in the daytime even and even through rain and possibly even sandstorms. So they are very advanced thermal imaging that look at infrared radiation which bodies give off, for example, and enable you to create an image.

It is used on the M-16 rifle, which is the most advanced weapon out there. The derivation of the M-16 is the (inaudible). It is our understanding that it will eventually go to the (inaudible). That is more widely used by servicemen. It was first fielded an Iraq.

It is raging hit. Everybody loves it. Anybody who has ever had one wants it. And demand has grown very fast.

Do you know how many M-16s and M4 carbides are out there, or is that just too big a number?

It is too big a number, and the actual number of batteries shipped is a classified piece of data.

Let me perhaps overstep my bounds and just ask one more question. What would a Kerry presidency do to your outlook? Have you guys sat down and really thought about that?

You know personally we all think about it. Our guess from history is that in the short run, it would not affect a whole lot. We have people deployed worldwide. They need to be supplied and taken care off. Anybody who is President is going to have to worry about protecting the interest of the United States and security. You know it is hard to see that anything major would change in the short run. In the long run, I don't have the slightest idea.

Larry Radar, LAR Management.

My questions have been answered. Thanks again.

David Kurzman, Needham & Co.

In terms of expenses should we expect cash bonuses to rise in both the fourth quarter might have slightly higher SG&A?

Our cash bonus plan is very small, very modest. It is for the top Directors and Officers. It is like a 5 or a 10 percent on a quarterly basis at most -- at most 15 percent, which we have never achieved. It is based on over achievement of plan. So our numbers we give you are based on our plan. If we over achieve our plans it is a very small -- it is in the noise of the consideration of the business model.

So it was in the first quarter so there isn't going to be any huge swings that we should expect?

No, we accrued for it in the quarter. What we look at the numbers -- in fact, our bonus plan also says that if the over achievement based on the plan and accounting for the bonus.

(OPERATOR INSTRUCTIONS). I am showing no further questions.

I want to thank you all for joining us today. I want to remind everybody that Ultralife's shareholders meeting will be on June 10th in New York City. You can get all the information on the website, and it will be in the proxy. We hope that all our shareholders are going attend either in person or by listing in over the Internet. In any case we urge all shareholders to carefully consider all the proposals and make sure that they vote on them. We look forward to sharing further progress with you at that time, at our shareholders meeting on June 10. Thank you all for participating.

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