Ultralife Corp (ULBI) 2005 Q4 法說會逐字稿

Good day and welcome to the Ultralife Batteries fourth quarter earnings release conference call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Ms. Jody Burfening. Please go ahead.

Thank you and good morning, everyone, and thank you for joining us this morning for the Ultralife Batteries earnings conference call for the fourth quarter of fiscal 2005. The earnings press release was issued earlier this morning. If anyone has not yet received a copy I invite you to visit Ultralife's Website at www.UltralifeBatteries.com, where 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 turning the call over to John I'd like to remind everyone that some statements made during this conference call contain forward-looking statements including references to Ultralife Batteries' future plans and objectives. These statements status 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. Welcome everybody to the Ultralife Batteries conference call for the fourth quarter of 2005.

I have joining me today Bob Fishback, our Chief Financial Officer, Bill Schmitz, our Chief Operating Officer and Julius Cirin, our Vice President of Corporate Marketing.

Today we reported revenues for the fourth quarter of 2005 of $17.8 million. That was virtually breakeven on net income with an operating income of around $130,000. Our latest guidance was for revenue of 19 million and an operating loss of $500,000. Revenue was driven by continued strong growth in our commercial business which was highlighted by the commencement of telematic backup battery shipments to General Motors Corporation. The revenue related to GM in our guidance was slightly lower due only to a later start than expected and a hiatus in the production schedule over Christmas. We did not ship any BA-5390s under contract during the quarter. An extremely strong operational performance in both our U.S. and our UK operations gave us an operating profit, despite lower than forecasted revenue.

In late September and early October, we took actions to lower our operating breakeven to approximately $18 million, given an expected sales mix. These cost production measures along with the effects of our automation project for lean manufacturing programs and our quality initiatives lead to a very strong gross margin performance. In addition we were helped by exceptional performance through implementation of the same programs in our UK operations and by continued migration to a higher value product mix.

In early January, we announced the qualification of the BA-5390, the first product qualified under Phase IV of the Next Gen II contract and the first-ever manganese dioxide battery qualified with a now mandatory state of charge indicator or SOCI. We expect the latest award of the older version of the BA-5390 announced last week to be the last significant order for that version. The only possible exception would be an add-on order related to the exercise of the option under that award for another $1.7 million, which could potentially occur in the first half of this year. Future orders will be for the 5398 and we announced the first of these orders for $2.7 million just this past Monday.

In addition, in late December we completed qualification of the BA-5347 thermal weapon site battery. This was part of a 60% award of the five-year contract for this fast-growing product. Last week, we received our first order under this contract valued at $1.6 million.

Over the course of the year we expect to qualify additional batteries under the next Gen II, Phase IV award, both in the U.S. and the UK, as demand migrates from the old SO2 versions to our new MNO-2 versions. Field usage for the BA-5390 continues to be strong and growing. And continued reaffirmation by the Department of Defense of their strategy to migrate rapidly to new technologies should push this along.

Our newly approved version is the benchmark for SOCI implementation and performance. This gives Ultralife a competitive advantage since the U.S. military has now declared that all future batteries will have an SOCI on them.

This quarter, we've commenced first production shipments of the Land Warrior products under contract to General Dynamics. This is part of the first fielding of this system that is expected late in the spring.

Our commercial market growth continues. As I've mentioned we commenced shipments to General Motors in the fourth quarter. We expect to achieve around $10 million in revenues across our three telematic customers in 2006, with the prospect of added platforms coming online later in the year for model year 2007 from several different customers.

Rechargeable revenue grew slightly from quarter 3 to quarter 4 to $2.4 million with a very slight decrease in gross margin purely attributable to mix. We expect to see growth in our rechargeable business in 2006 as we continue to burden our product offerings and our customer base. Applications for virtually all of our products continue to expand. We are seeing increasing demand for our lighter and higher energy density rechargeable offerings as applications evolve to be lighter and more affordable.

An example of this is in medical applications where laboratory and diagnostic equipment is using our larger scale batteries in place of older lead acid batteries for more portability and longer life, and where smaller scale offerings are used to make oxygen pumps and blood analyzers smaller and more affordable. Portability also extends to industrial applications such as geophysical measuring equipment and infrastructure diagnostic equipment to the oil and gas exploration industry, whereby devices are now being made more portable with use of our products.

Automotive telematic's design activity is growing both in the U.S. and in Europe. We continue to expand the number of prospective customers and vehicle platforms and have the potential this summer and next fall to be adding both manufacturers' and model lines to our telematic backup battery business with a prospect of significant growth over the next five years.

Interest also continues to grow in our Thin Cell product. Most of these Thin Cell products -- projects are for product design that would not be feasible without this unique packaging. Hence, development leadtimes are longer but it is still one of our most sampled products.

In this quarter, we again expanded our offerings of power accessories. They now range from EMI shielded cable to sales of individual modules of our Smart Charger technology for use by others in their chargers; and the hybrid charging model module which now allow a second power source such as a fuel cell or a primary battery to be used as an input to our multibased Smart Chargers.

Two weeks ago we were very excited to announce an agreement to purchase Able New Energy of Shenzhen, China. We hope to close on this purchase and welcome them officially to the Ultralife Batteries family sometime next quarter. Able is a young and very fast-growing manufacturer of lithium (indiscernible) chloride batteries and some small lithium manganese dioxide products. They have primarily focused on markets in China, but have started making inroads in Asia and Europe. As part of Ultralife, our plan is to grow this product line even faster by expanding the distribution of their products, improving their performance to create and Ultralife branded version of their products and by utilizing their capability in volume manufacturing to address markets and product spaces that we currently do not address.

Some examples of these markets include asset tracking, RFID and safety and security -- markets that we currently cover but where we will now have a fuller product portfolio with much broader application coverage. With an operation in China, we will also have improved access to the low-cost sources and materials and access to low-cost labor for labor-intensive production.

For 2006, we are very optimistic. We believe that we're back on track with regular orders, production, and shipments of the BA-5390. In addition to getting this core production back, we expect growth in virtually every other part of our business. Our rate of growth may range, depending on the assumptions we make for 5390 market share gains and introduction rates of other next-gen products. As the year progresses, should we have better visibility, we will be able to provide more clarity on the revenue growth trends for the year.

Looking forward to the first quarter, we do expect revenue in the range of $21 million and an operating profit in the range of $750,000, excluding stock option expense which we will now be capturing. Stock option expense is expected to be around $250,000 for the quarter. Overall, we are in a very good position with an expanding market mix, a growing arsenal of products and ever-more efficient operational capability.

Our plans call for annual revenues in excess of $90 million for 2006. While we believe we have a good assessment of our base demand, as I've explained, it is still early for us to gauge the magnitude of the market share gains we expect for MnO2 in the military market over the year. And while we're still adding more and more opportunities in our commercial market, it is also hard to forecast how fast those will mature into our revenue streams.

None of this includes the effect of the Able acquisition which we expect to conclude next quarter.

Opportunities have never been greater. Quarter by quarter we have built and will continue to build our base business. 2006 is off to a great start and we expect it to be a great year.

Now I'd like to turn it over to Bob Fishback who will cover some of the financial highlights after which we will come back and open it up for the questions and answers.

Thank you, John, and good morning everyone. This morning we released the results for our fourth fiscal quarter that ended on December 31, 2005. Consolidated revenues for the quarter amounted to $17.8 million. Compared to last year's fourth quarter, sales were down $500,000 related to lower revenues from our development contract with General Dynamics as that contract is now in transition from development to production. Increased sales of HiRate and small clinical products were offset by lower shipments of BA-5390s to the U.S. military.

Gross margin for the fourth quarter of 2005 was $3.7 million or 21% of sales. This compares with last year's fourth quarter margin of 2 million or 11% of sales. This improvement reflects significantly better operating results from our UK operation as well as the benefit from cost savings measures that we initiated during the latter part of the third quarter.

Our nonrechargeable operations reported a 23% margin this quarter versus 13% last year. Our rechargeable operations reflected a 15% gross margin compared with breakeven a year ago, as a result of an improving product mix. Our margins for technology contracts reflected a modest loss to an adjustment -- due to an adjustment from projected overall profit margins on uncertain contracts as these begin to wind down.

Operating expenses in the fourth quarter of '05 totaled $3.5 million, a decrease of $100,000 over the same quarter last year, excluding the $1.8 million impairment charge that was included in last year's results related to the write off of certain rechargeable manufacturing equipment. Overall, we reported operating income for the fourth quarter of '05 of $100,000 compared with a reported operating loss last year of 3.4 million. Excluding the onetime impairment charge, last year's loss would have been $1.6 million, reflective of a significant improvement in operating results from a year ago.

This quarter's operating income came in better than the $500,000 loss we envisioned last quarter as we succeeded in taking cost out of the business to right-size the model to breakeven at the operating income level on quarterly revenues of approximately $18 million. We also realized better than expected manufacturing efficiencies at our UK operations.

We have put in place an operating plan for 2006 that allows us to leverage our existing infrastructure; and should the pace of revenue growth accelerate faster than we currently anticipate we will add resources judiciously. On the bottom line we reported a modest net loss for the fourth quarter of $40,000 or essentially breakeven, compared with reported net income of 18.1 million or $1.20 per diluted common share a year ago.

Last year's results included a onetime $21.1 million non-cash income tax benefit related to the recognition of a deferred tax asset for the Company's cumulative net operating loss carryforward. Average shares outstanding for the fourth quarter of '05 were 14.7 million shares up about 400,000 shares from last year, related to stock option exercises.

Shifting to cash flows for the fourth quarter, EBITDA amounted to approximately $900,000. Cash used for working capital during the quarter was negligible as inventories and receivable balances remained relatively consistent. We spent only $100,000 in the fourth quarter for capital asset additions. Financing activities during the quarter included cash inflows of $200,000 from the exercise of stock options and cash outflows of approximately $500,000 for debt principal payments.

Overall the cash flow activities resulted in a modest increase in cash during the quarter of $200,000 and we ended the quarter with total cash investments of $3.2 million. The balance sheet at the end of the year remains solid. We took actions during the second half of '05 to better match our production with specific orders and leaned out areas where we determined we could be more efficient, focusing on establishing a breakeven operating earnings model at $18 million in revenue per quarter.

Inventory balances at year-end were higher than where we wanted them to be, due to a buildup of inventory during the year in anticipation of BA-5390 orders from the U.S. military. As we fulfilled the military orders we now have received during the past few weeks, we should see our inventory balances decline in the range of $4 to $5 million during the first half of the year. Also we expect production levels to be slightly below shipment levels during the first half of the year as we convert inventory into cash, which may compress our gross margins a bit.

Our credit facility remains intact and we have successfully met the revised debt covenants that were put in place at the end of the third quarter with our banks. Although we have no current intention of accessing our revolving credit facility, we have borrowing availability of approximately $8.5 million. Overall, total outstanding bank debt at the end of the year was $7.7 million, and total debt as a percentage of total capitalization was only 11%.

Looking ahead, we are projecting revenues for the first quarter of '06 will be in the range of $21 million. This outlook takes into account the favorable impact from the recently announced orders we have received including the restart of the BA-5390 shipments. Operating income is expected to be in the range of $750,000 for the quarter, excluding any impact from accessing stock options. And as John said, we currently expect that the impact in Q1 related to stock option expensing will be approximately $250,000, primarily affecting the Company's operating expenses although there will also be an impact on gross margins.

For the full year of 2006 we are optimistic about our growth prospects. With the orders received to date from the U.S. military and the qualification of BA-5390 (indiscernible) behind us we believe that we should begin to see a more steady flow of orders going forward. Our commercial business continues to strengthen and the level of product development activity is higher than ever.

Against this backdrop, our goal is to build the quarterly revenue base throughout the year to a range of $23 to $25 million, providing us with the opportunity to achieve and even exceed 90 million in revenues for the year. As was previously announced, the addition of Able New Energy to the Ultralife family will require a $2 million cash payment at the time of closing, which we fully expect to be able to finance from internally generated funds. We still anticipate closing this transaction in the second quarter.

We continue to be very upbeat about our future. We remain confident that we can continue to build a solid long-term growth company by continuing to stay the course with our focus on key markets and applications. Now I'll turn it back to John. Thank you.

Thank you, Bob. Operator, I think now at this time we would like to open it up for questions and answers.

(OPERATOR INSTRUCTIONS) Steve Sanders of Stephens Inc.

Couple of questions. First on the guidance for at least 90 million in '06. What have you assumed for the 5390 beyond the 4.4 million that you have already received?

Between the 5390, 5347 and the kind of bundle of products that we have on contract now, Steve, we've assumed -- we kind of do it probablistically. We have a product mix which we have assumed is about what we know the run rates to be and, unfortunately, we are not allowed to give you the run rates -- but pretty close to what the field run rates are. Now the good news about that is -- there's two pieces of good news about that. No. 1, we think the run rates are increasing as we increase market share. We haven't really accounted for that.

And the second thing is that we believe that the inventory levels are down and ultimately there will have to be a correction for inventory levels since they've gone into reserves. So we think it's kind of -- it's a prudent way to look at it, so the best I could tell you is we've accounted for run rates. I don't know if we -- .

Is it fair to say that the 2.7 or 4.4 million, however, you want to look at it, that you are expecting for the 5390 in the first half is lower than the run rate you expect for the year? I know you are not going to let us pin you down but I am just trying to sort of gauge the level of conservatism around the 5390.

They're using -- of the 5390, 5590 product the current consumption rate is 50,000 units a month plus or minus sometimes a little less, a little higher. So we are within running anywhere from around 20% of that to higher, sometimes, 25% of that. So that's kind of what we -- that's kind of the way we've done it.

And then on the Able acquisition, a general comment on what you would expect their '06 revenue run rate to be. I realize it's early but of the 2 million or so they did it in '05 is it 3, 4, 5? What are you comparable with at this point?

The answer is kind of yes. They've done -- they did about 2, 3, 2, 4 last year. It's somewhere -- they are going to grow again. They could just -- we know what their prospects look like. And we would assume that with us, with Ultralife instead of it being another small battery company in China being owned by Ultralife -- and this is one of their motivations -- they believe they will close more business because there's not another battery company in China. They're part of an international company now.

So, 3 to 5 million is kind of what we've assumed for '06. We really haven't focused as much on '06 because that 3 to 5 million -- while it's interesting and we want it and we want it to be as big as possible, we're really focused on '07. And that is where we think we can really jump the growth rate up for that company. They are selling it to a big market. The market they are into is kind of $50 to $100 million a year and parts of that market are growing very fast. Things like automated meter reading and RFID.

So I -- it's penalty-free for me to say that now because we don't own the company but we would be -- we'd say they are kind of in the 3 to 5 million range this year. But we are much more concerned with how -- what position we are in with them going out of this year, what we -- how we've done with new products and what we are in for some of the bigger opportunities there.

Let me ask a couple of follow-ups and I will do them all at once and then I will hop back in. Continuing with Able, can you just drill down a little bit on applications that are more suited for the final chloride versus your manganese dioxide sort of complementary versus competitive pressure. Also comment, and I assume based on what you just said, that '07 may be the real focus. But are there any material sourcing benefits that you see beginning in the second half?

And then two quick questions beyond that. Just update on the 9-volt and the competition that you are seeing on the automotive telematic side? If you want me to repeat any of those, I will.

That's okay. I think I got it. On Able and (indiscernible) chloride the markets for those are pretty well understood. RFID tags and toll tags, the easy pass system which we have in New York, it's called a fast pass in some states. I think it's in over 30 states that uses a half AA final chloride cell so that is a pretty good-sized market. RFID, also, where you have extreme temperature environments. That's a half AA final chloride or other types of final chloride market.

Every slot machine I think actually has a half AA final chloride cell or a cell like that. Automated meter reading for both gas and water meters. These are prepaid or the automated meter reading is a big application for the final chloride. Another big market that Able is engaged in is tire pressure monitors, where every tire has the have a monitor on it monitoring pressure and reporting back to central stations on a lot of vehicles now in the U.S. and I believe it is beginning to be mandated by a certain point.

So one on each tire and one on the spare, kind of 5 per car of tire pressure gauges is a final chloride market as well. Julius, is there -- Is there anything I've forgotten, Julius, in there?

No. That covers the majority of the final chloride type applications.

So it's really applications where there's a wide temperature range variation. One other is the Macintosh computer uses it as a memory backup of final chloride cell. So that's really where we see that. Your second question, remind me again, Steve.

I know you commented on the lower labor cost. That's obviously an opportunity over time, but on the sourcing side, what's the initial focus?

We've been sourcing some of our raw materials over there. Electrolyte. We get some lithium from China. There's other opportunities but where we really haven't done a lot is in mechanical parts. Where there are they're smaller value but there are big cost savings opportunities there in mechanical parts, whether they be plastic or metal parts and such. With an operation over there it just gives you an edge up on doing that. So that's really where we see it.

You had one other question.

Then just update us on 9-volt outlook, sales and margins and last question was you sound pretty optimistic on the auto telematic side. I was just wanted to see if you could update us on what kind of competition you're seeing there?

On 9-volt -- we're -- 9-volt business has been -- I think last year we did somewhere in the ballpark of about one-third of our revenue was the 9-volt productline. It's kind of anywhere from a 2 to 5% growth rate for us. There are some opportunities where we think we can do better; but there are new channels that we're working on. And 9-volt is just a good solid performer for us. It's been running in the low 20s gross margin.

The only thing I'd just tell you about gross margin is a lot of it has to do with how you spread overhead. So we start the beginning of the year with assumption of volumes and put our overheads in place. So I don't want to fool ourselves on our standard cost system. Sometimes it can run 20% sometimes it looks like 24, 25% overhead. But it's low 20s.

I think there are prospects with sourcing for doing better there but also for utilizing our factory better of course, will get better gross margins across the board so -- which is where we put a lot of work in.

And then on the competition on the auto telematic. Just an update there?

We, really, you know, the real -- I don't want to say we see no competition. I think people have been trying. We have seen competition there but I think people have -- the automakers are learning that telematic's batteries are really limited to using MnO2. There's no other chemistry that has the safety that is required for automotive -- that we know of right now -- that you can produce in any kind of volume. And we are a head-on performance and we intend to keep maintaining that lead on performance and quality and staying ahead there.

So while we've seen competition I think that we -- let's put it this way. We haven't lost anything. And we don't anticipate losing anything in telematic. I think we have a unique offering there. We're going to keep making it better because we assume that everybody else is going to be trying to make theirs better.

Mark Grzymski of Needham & Co.

Can you -- I think you mentioned option expense for the quarter. What's it looking like for the year?

Say that again. What's the question?

(MULTIPLE SPEAKERS) It's going to be in the range of $1 million right now is what we are projecting.

Secondly can you break down -- ?

We're not trying to be cagey about it but we have to calculate it every quarter and when, if the interest rate changes or other assumptions change or volatility in the stock changes then that expense changes. So it's a nondeterministic number until the day you calculate it.

No, understood, but ballpark obviously -- .

Can you break down revenue in '05 from 9-volt you did to about a third of revenue. What was the Military contribution in '05?

You want to take that, Bob?

Yes. In '05, it was about a little less than 20 million as far as the Military contribution. Like John said 9-volt made up about a third of the overall revenue.

Then the rest of it was other commercial which was about 50-50 rechargeable nonrechargeable maybe a little more nonrechargeable. Let me make a comment about that. We've referred to Military before and the way we've done that is we've made that direct, we sent that direct sales to the U.S. Military. That's been 95% of what we've sold in the Military market.

With some of the work we're doing with General Dynamics where we don't sell directly to the Department of Defense, we sell through a subcontractor or a private contractor, some of the increasing sales overseas, we are most likely -- and we will talk about probably on the next call -- we're really looking at redefining that as kind of military, government, and homeland security as one area distinct from commercial.

So we find now with more channels to markets that look like that where we are going to have to put a little more rigor into it. Not that's it wasn't rigorous. We're giving you the real numbers. But there's other channels we have to take into account so we will probably have to take a shot at redefining that.

Now with the telematic, you mentioned that '07 models -- if you are getting into '07 models you'll be shipping at the end of the current calendar year. Does that mean we're not you are not going to get any additional orders in the first half of the year because of that?

Generally the way the model year works is that, as you know. '07 models will start showing up anytime from the summertime through the fall and in depends on the car manufacturers. Some car manufacturers bring them out early or some bring out a limited amount early and then mass production later. Some wait until late in the year. It just depends on the strategy of the manufacturer.

It also depends on how they run their supply lines. In some cases we will ship the unit to the telematics person who makes the electronics. They will integrated and they will ship it and in some cases its integrated as part of the final assembly. So, again it really does depend on who it is and they really have weekly production and delivery schedules. I think the auto industry, I think we believe they're pretty good on their annual requirements. It's just week to week, things can vary.

For example we had a straight line demand, but with General Motors they shut down at Christmas time. That's no surprise to anybody but we should have realized that. We get weekly releases against delivery schedules, so it really does depend on the manufacturers. But our assumption has been that anything for the '07 model year would start in the fourth quarter. I think that's a pretty good assumption. There might be some that start sometime in the third quarter but for everyone of those there's one that starts late in the fourth quarter.

So that implies then that announcements would come earlier in the year and shipments would begin in the later in the back half of the year.

Yes and, again, again it depends on the manufacturer. People we are working with already where it can add onto the contract where they add a model, that's different. That probably would be earlier rather than later. Our experience though is, with new customers, that it does take a little time to negotiate contracts. And that until we have a signed contract and in fact we have kind of a principle that until we have a signed contract and a delivery order -- because we have had this before, where we had a contract with a manufacturer and good news is we said, "You know we're not going to announce this until we are really delivering."

And when it came time to deliver they decided not to put it in the model that year. So we want to be very careful about this and just make sure -- again it's a subjective decision -- make sure that it's something solid before we tell you all about it.

Walter Nasdeo of Ardour Capital.

I was wondering if you could give me a little more color or clarity on some of the cost reduction measures that you've taken? And are these systematic? Are they going to continue on or were they like one-time events?

First of all, they are systematic. They are structural and systematic and I will ask Bill, Bill, you want to talk a little bit on the manufacturing sites?

Yes. From an operational standpoint we have been doing leans for quite some time and on a lean you do a lot of Six Sigma projects to reduce scrap in the process. And we've also automated a number of our operations, too. So over, we've basically reinvested a lot of money over the last couple of years to do that and we're much better positioned now going forward as far as reducing our labor content, our material content and doing a better job with new products and some of the margins we are getting a lot of new products. So, operationally, we are a lot stronger than we've been.

On the expense side, we've taken the approach of putting process improvements in place. We've done -- we continue to make investments in IT and using IT, or information technology, to improve our process so that we can't increase our sales without increasing our infrastructure has been a big savings for us. So we did some redeployment of indirect labor people. Purely because we were able to handle more with less, using our IT systems.

Can you kind of give me what your current manufacturing capacity is and do you think you are going to be banging up against that anytime soon?

I think we've been pretty clear in the past unless there was some huge change in mix we have capacity to do about $200 million in revenue in this place. We've got -- we're running probably in our cathode area which is probably the longest leadtime, most critical area -- what would you say, Bill? We're running about half capacity right now?

Correct.

So we are running about half capacity and we haven't even -- we still have the opportunity to speed up some lines and code wider so we can increase our capacity -- without buying more equipment, just increasing our capability there.

In our winding area we'll probably -- with these new orders, we will probably get up to be about half capacity there as well. In our large cells and our small cell winding, I would have told you we were pretty close to capacity. But we just doubled our automated -- we added automated winding over the last six months and we now doubled that again just in the last couple of weeks with the addition of some new winders we are bringing online.

So we are running probably 75% capacity on automated winding but we could still go back to manual winding if we need to. So we are in good shape there.

One briefly, just on the Able acquisition. Are you envisioning any Administrative Synergies going forward or is that just basically going to be run as a freestanding business over there?

I'm not sure. Let's see, Administrative Synergies. They're an overseas corporation. They run fairly lean. The one area I think they have sufficient staff administratively. We probably have to put a little IT in there because we have to comply with Section 404 internal controls of the Sarbanes-Oxley Act. That's not going to be overwhelming. Still, the place where there is some synergy is in the market coverage where they have a sales force which is selling into areas that we cover already. So people in China trying to sell into Europe is pretty tough. But we have good coverage in Europe. We have good distributors in other parts of the world.

So we will be -- they will be representing and selling the Able product. Additionally they have good coverage in China and we do not. So adding to their portfolio of China. The thing to work out that Nancy Naigle, our VP of Sales and Marketing and Julius will be working out is the kind of the coverage strategy in the market and product marketing strategy but that's where there is synergy in the administrative side. I think, otherwise, it is pretty straightforward.

They have an accounting and process engineering and all. They really have unique products. The one product they do have that we have is their manganese oxide smaller cell like a two thirds A cell; and in that area we are going to add our cathode to that and help them with the chemistry. And we ought to just do nothing but make the product better. Plain and simple. Julius, is anything you would add on the marketing sell side?

No. I think you explained it well. We see a lot of synergy possibilities moving forward. Obviously we are much stronger in the overall sales and marketing, just from a staffing perspective. But as John said they bring us access into, certainly, China and certain parts of Asia where we don't necessarily have as much coverage.

One of the things they give us for China and other parts of Asia, once tole me there is always a market for the best and there is always a market for the cheapest but we've made the best and we've made the best of good economics. But there is a market for products that sometimes don't have all the bells and whistles, high low temperatures that the customer doesn't necessarily need -- especially in developing countries there are markets like that -- where a low-cost product makes sense. And we will maintain the Able brand because they've done a very good job of that.

(OPERATOR INSTRUCTIONS) Jim McIlree of Unterberg, Towbin.

Are you expecting to pay taxes in 2006 and if so at what rate?

We will continue to book taxes on our U.S. income, generally, at an effective rate of around 35%, say, but most of that is going to be non-cash. We've got plenty of NOLs. There may be a modest cash payment for taxes required but because of AMT penalties, very modest.

So for financial reporting purposes, a 35% tax rate is reasonable?

Yes and I will qualify that because it gets difficult. We are reporting taxes, we are reflecting taxes on the P&L for our U.S. operations. It gets a little bit dicey because of our UK operation but generally speaking, a 35 to 40% rate is in the ballpark.

What Bob's trying to say is if you make money in the U.S., we have a 35% tax rate. In the UK if we lose money then you -- and because we haven't booked the (MULTIPLE SPEAKERS) asset there you can end up with a blended rate of 37% sometimes and something like that you've seen.

In some of the financial filings, you've indicated what gross margin levels you would expect to achieve at 35 million [over] 50 million in revenues and what kind of OpEx you might expect also. It sounds like that has changed with the lower breakeven. Can you help us out understanding what kind of gross margin level you could achieve, let's say 25 million 30 million in revenues per quarter?

I don't think we are going to change our forecast there. I think we've been pretty steadfast in saying we will return 30 to 35% of incremental revenues to the bottom-line and if you do the math on that, that gets you to -- that gets you there. Now. Do we think, do we hope we can do it sooner? You know, yes. I'd like to be able to tell you I can right now but it's really dependent on mix.

We are moving, we think, to a higher value mix in our products. We're doing more engineering-intensive stuff, more complex assemblies, etc. But we are not ready to call that a trend yet. If that becomes a trend we will do better. I think if you look at the numbers, when you get to about $35 million in revenue we should be able to turn about $5, $5.5 million in operating profit. If we get to the high end of that range, yes, then we will say, "35% part of that range? Yes, we will do better than that. We'll get there at maybe somewhere between 30 and 35."

But we would rather be prudent about this in the way we've forecasted because it just so mix-dependent. I mean you saw it, just on a small-scale you saw it in our rechargeable business. Where from quarter 2 to quarter 3 we actually went down in revenue and up in gross margin.

Absolute dollars and in quarter 3 to -- so if I were to call that a trend quarter 3 to 4, we went up a little bit. I would have said we went up a little, and we went down a little bit. It is very -- it can be mix-dependent. So we just want to careful until we have a real good handle on that.

Is there any chance that the inventory of 5390 that you built up is unused or is it -- is it all finished, 5390s you have an inventory? Or is it more like parts that might be able to be used on the 5390As that (MULTIPLE SPEAKERS) order?

We have finished 5390s. There are no -- there is no chance that we won't use them. In fact there are some overseas militaries who buy the 5390 without the stated charge indicator. We've sold to Canada. We've sold to the UK. The Australians buy them from their own militaries, of course but so we actually have ordered from time to time that we will stock out of the old ones and we will have to build them.

Having said that, the component commonality there is pretty high. I think the only part's go, the circuit board and the case. Just the bare circuit board. The case is a new charge and the mold for the window for the charge indicator. So it's really just the circuit board. Everything else is common. So really on the parts, there's no issue. We have an inventory of both D cells as we build out our D cell line and we have an inventory of 5390s.

But there's no chance that those are going to be -- have any problem at all and as Bob said, we have $4 to $5 million worth of between the 5390s we built and the cells that we are going to turn into cash in the first half of the year. A good part of that this quarter.

Finally, Bob, the 3.5 million of OpEx. Is that a good rate going forward or would that ramp at the same rate as cells ramp during the year?

I would say our projection right now is in that range; but I think it will ramp to some degree as sales go up but not -- we are going to leverage what we've got pretty much.

One other thing. John ,I know you're reluctant to talk about the specific 5390 revenues. Are you also reluctant to talk about what your overall Military revenues might be for 2006?

It was about 20 million last year. This year it's going to be -- it's not going to be 50. It's probably going to be in the 30 to 40 range and the best I can do is tell you range only because -- the way we forecast we run up against all kind of --

The way we forecast is we look at our portfolio of what we have. We look at trying to do a probablistic. Here's what our probabilities are and assess it that way. So it's going to be in the 30 to 40 range.

If it's 30 to 40, then, it doesn't look like commercial is growing that much.

No. Commercial is growing.

Well, if it was 20 in '05 then commercial is what. 50? And if you're doing 30 or 40 in '06 --

When you look at commercial you have to separate out the part of the commercial business that is 9-volt. That is really a zero to kind of a 5% growth rate at this point in time. And then you have to look at the rest of the commercial. Our rechargeable business is growing, yes, so the rest of that stuff is growing at a pretty good rate. It's been growing kind of any 30, 40%. It grew 50% one year and then this year -- last year to this year, I think we grew between 30 and 40%. Something like that, Bob?

Right.

So nearly 40%. So it's pretty healthy.

(OPERATOR INSTRUCTIONS) J. D. Abouchar. Pacific Edge Investments.

I had two questions for you. One, with the new -- getting the breakeven down to 18 million a quarter as revenue ramps how is OpEx going to grow or not grow with that? In other words, can we hold the line or are there some variables in there that are going to grow with the revenues?

Hold the line is our approach. There are some things that grow as you grow your company whether it's DNO insurance or liability insurance are things like that. But in terms of headcount, manpower, those kinds of things, we believe we are sufficiently staffed right now. Where we had one or two people as we have to do things like Section 404 work over in Able or will our audit fees go up a little bit? I wouldn't bet our audit fees will hold the line. They never have.

Okay, but there's no like commissions or things like that that are done in scale with revenues?

No. Not at all.

Second question is obviously your net cash balance doesn't look too good. You do have cash but you have the debt. Are we concerned at all there that, if you grow revenues say beyond the 90% that we are going to get into working capital crunch? In other words, talk me though how you're thinking about cash for this year and growth and paying for the acquisition and that sort of thing?

First of all we've got about $4 to $5 million that's going to float a cash out of inventory over the next -- at least over the next six months. Most of this quarter. That's the first thing. Second, if you take a look at our balance sheet, our Accounts Receivable is about $6 million more than our Accounts Payable. So right there is a trove that you get back in the balance. You end up in better shape for cash.

Then if we grow fast, that's what the working capital line is there for. The working capital line, we had $8.5 million on the line. The revolver I should say. The revolver is there for that very reason. The revolver is not there to finance capital. The revolver is not there to make acquisitions. The revolver is there to finance growth.

Okay and then, what was depreciation for this quarter? Depreciation and amortization?

That's 750, Bob?

Yes it was about $800,000.

Then for '06 sort of ballpark CapEx and what depreciation should look like?

In '06 CapEx we are expecting to be in the 2.5 to 3 million range and depreciation will be in the 3 to 3.3 range. Something like that.

It appears there are no further questions at this time. Mr. Kavazanjian, I'd like to turn the conference back over to you for any additional or closer remarks.

I'd like to thank everybody for joining us today. We believe that 2006 is starting strong and we really expect it to be a good year of growth and profitability. We look forward to reporting our progress to you again next quarter. Thanks, all, for participating and take care.

And ladies and gentlemen, that does conclude today's call. Thank you for your participation.