Ultralife Corp (ULBI) 2006 Q3 法說會逐字稿

Good day and welcome to this Ultralife Batteries third-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, ma'am.

Thank you, operator and good morning, everyone. This is Jody Burfening of Lippert/Heilshorn & Associates. Thank you for joining us this morning for the Ultralife Batteries earnings conference call for the third quarter of fiscal 2006.

The earnings press release was issued earlier this morning and if anyone has not yet received a copy, I invite you to visit the Ultralife Web site at www.UltralifeBatteries.com, where you will find the release under "Investor News" in the "Investor Relations" section.

In a minute, I will turn the call over to John Kavazanjian, Ultralife's President and CEO, who all along with Bob Fishback, Ultralife's Chief Financial Officer, will provide their 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 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 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.

Good morning, thank you, Jody. Good morning, everyone, and welcome to the Ultralife Batteries conference call for the third quarter of 2006. Joining me today are Bob Fishback, our Chief Financial Officer, and Bill Schmitz, our Chief Operating Officer.

I am going to ask you all to be a little patient with me because I have a cold today. But I think we'll do just fine here.

Today we reported revenue of $23.7 million for the third quarter of 2006 with an operating loss of $2.1 million. This included non-cash expenses of $500,000 from the amortization of intangible assets associated with the acquisitions of ABLE and McDowell and $400,000 from the expensing of stock option awards.

Revenue and earnings for the quarter were slightly lower than our preliminary guidance and this was based on a final review of McDowell shipments for the quarter. The increase in revenue from quarter two was due primarily to the addition of sales from McDowell, which was acquired on July 3rd.

Activity in military markets continued to be high, even though we only received one order of any magnitude for the BA5390 from the Department of Defense. Although the BA5390 remains our largest selling military battery, and a major growth and market opportunity, its order variability is having a much less pronounced impact on revenues as we further diversify our military business across additional products, channels and geographies.

As an illustration of this diversification, we went and announced two major contract awards from prime contractors in October. Early in the month, our leadership UBI2590 and our McDowell six-day chargers were responsible for an award for almost $11 million for IED jammers. These products were selected for their demonstrated performance and their demonstrated product quality.

Later in the month, we won a $9 million contract for portable military communication kits, the second such order that McDowell has received for this product this year.

Commercial market shipments also remain strong. Shipments in batteries into the telematics market increased again over the previous quarter. Design activity in the automotive market remains strong with many manufactures around the world having automated crash notification products in their future vehicle plans.

We have also seen an increase in medical market opportunities. These include designs in applications such as infusion pumps, oxygen concentrators, and surgical devices. And design activity is translating into orders. Four different products are expected to be shipping in 2007 with two launching in the first half of the year and two in the second half.

We've also seen increased opportunities in RFID and tracking applications, as well as in remote sensing and monitoring devices. There is an important storage tank monitoring system expected to start shipments in the first half of 2007.

Our 9-Volt product had yet another very strong quarter, driven by still growing international demand. We now expect to see this strength well into 2007.

The integration of both acquisitions is progressing. The McDowell acquisition is already showing its power to generate marketplace wins. We are clearly demonstrating the ability to grow revenue with the two recent large awards. And we have only just begun to integrate the activities of the sales forces. The hard work has been in getting McDowell's inventory, production and accounting systems in line with those required of a public company. Much work has been completed and we're working to put in processes to ensure Sarbanes-Oxley compliance, which will be required in 2007.

We are also diligently working on the synergy opportunities on the operational side -- for our leaning-out processes, integrating supply chains, and harmonizing accounting systems. The potential to improve returns at McDowell is becoming increasingly clear to us.

Much of the work at our ABLE operating unit has been involved with the implementation of capital projects designed to augment capacity, ensure production repeatability and enhance product performance. In addition, by linking the ABLE and Ultralife Web sites and with the added coverage from Ultralife's sales force, we're starting to fill the opportunity pipeline with the ABLE suite of products. As part of Ultralife, ABLE's run rate is already double its pre-acquisition rate, and we expect the unified sales model to be an important factor behind the growth of ABLE's products in 2007.

We continue to be impressed by the quality of the people and the products at both operating units. We see many ways to expand their margins and businesses and realize the strategic benefits of acquiring both companies.

For the fourth quarter, we expect revenues in the range of $35 million with a return to profitability. This is based on the strong backlog with only a small part of that revenue waiting for order placements to occur. Even after the non-cash expenses involved with the amortization of intangible assets and stock option expensing expected to be around $900,000, we expect an operating income of between $2.5 and $3 million. As we look into next year, we see a continuation of this level of business with order activity already strong for the first quarter.

Now I'd like to turn over to Bob Fishback, who will cover some of the financial highlights, after which I will return with some comments and we'll open it up for the Q&A.

Thank you, John, and good morning, everyone. Early this morning, we released our third-quarter results for the period ended September 30, '06. Consolidated revenues were $23.7 million, an $8 million increase over the same quarter a year ago, reflecting added sales from the ABLE and McDowell acquisitions, strong 9-Volt shipments, and higher sales to commercial customers, mainly in the automotive telematics market.

Revenue came in roughly $700,000 lower than our preliminary figure after a final review of revenues at McDowell identified a sizable shipment that had not yet completed the revenue cycle. We expect to recognize revenue from this shipment in the fourth quarter.

Gross margin was $4 million, up $1.6 million from the $2.4 million reported in the same period last year. This increase was mainly related to higher sales volumes plus the added contribution from ABLE and McDowell acquisitions. As a percentage of total revenues, gross margins were 17% in '06 versus 15% in '05.

During this year's third quarter we had a number of items that adversely impacted our overall margins. We booked a $350,000 reserve for a potential liability that pertains to a workers' compensation trust in which we participated during the past few years, $200,000 of which was recorded in cost of sales. We also recorded a $100,000 non-cash charge for the write-off of certain fixed assets that were deemed to be no longer productive. In addition, we realized higher scrap than usual and we experienced higher than expected electricity bills.

The gross margin in our nonrechargeable operations was 14% this quarter, consistent with last year. While nonrechargeable revenues increased 33%, margin improvements were hampered by the aforementioned items as well as an unfavorable product mix.

Our rechargeable segment reported an 11% gross margin for the quarter versus 20% last year, again reflecting an unfavorable sales mix.

Finally I want to point out that this quarter we added a communications accessory segment to reflect a portion of McDowell's product line. The margin in this segment was 36% on sales of $3 million.

In the third quarter, operating expenses totaled $6.1 million versus $3.9 million a year ago. Most of the $2.2 million increase is due to the acquisitions of ABLE and McDowell. Added operating expenses from these companies accounted for $1.4 million and the amortization of intangible assets, a non-cash expense, accounted for $500,000, $200,000 higher than our preliminary estimate. In addition, non-cash stock compensation expense was $400,000 this year compared to $0.00 last year. Absent these expense increases, operating expenses in our core operations were essentially flat.

As a result, we are reporting an operating loss of $2.1 million compared with an operating loss of $1.5 million for the same period a year ago. After interest expense of $400,000 and an income tax benefit, our net loss was $1.7 million or $0.11 per share. Comparatively, we reported a net loss for the third quarter last year of $1.3 million, or $0.09 per share. Average shares outstanding for the third quarter of '06 were 15 million shares, up 300,000 from last year due to stock option and warrant exercises and new shares issued for the ABLE acquisition.

With respect to cash flows, EBITDA, excluding non-cash expenses related to stock-based compensation, was a slight negative of $300,000. Cash used for working capital during the quarter was approximately $200,000 as receivables and payables both increased due to timing of customer collections and payments to vendors. We used $400,000 for capital expenditures during the quarter in addition to $5.1 million for the acquisition of McDowell.

Financing activities included cash inflows of $3 million from a drawdown on our revolver and $500,000 from the exercise of stock options and warrants, offset by cash outflows of $500,000 for debt principal payment. Overall, these cash flow activities resulted in a $2.9 million decrease in cash from the end of Q2 resulting in an ending cash balance of $1.3 million. The outstanding balance on our revolving credit facility was $3 million at the end of September. Our additional borrowing capacity on the revolver at the end of the quarter was approximately $15 million.

The two new orders that we recently announced in October totaling $20 million may cause us to increase our revolver borrowings a bit before the end of the year, but we expect the revolver balance will diminish after the first of the year as deliveries under these contracts are fulfilled and receivables are collected.

Following the closing of the McDowell acquisition on July 3, we have been spending a great deal of time and effort improving the financial controls and processes of that operation. To keep things in perspective, prior to the acquisition, McDowell was a successful, closely-held private company with basic reporting systems in place to inform management of the business's progress, but not the rigorous financial systems and processes required of a public company. We're in the process of implementing the necessary policies and controls to manage this business much more effectively, including working together to implement a new ERP system, improving the accounting of manufacturing costs, and developing the application of consistently applied accounting principals at a level required of a public company.

Through this transition, we are identifying significant opportunities to improve McDowell's operations, from leaning out assembly lines, to improving purchasing procedures, to managing working capital much more effectively. Our 10-Q filing will include some discussion in Item 4, "Controls and Procedures," about areas of deficiency at McDowell regarding internal control processes and procedures. Based on our timetable of activities, we expect McDowell to achieve significant improvements in its internal control over financial reporting by the first quarter of '07 in order to be compliant with Sarbanes-Oxley standards by the end of 2007 as required.

As we look ahead to the fourth quarter, we're projecting the consolidated revenues will be in the range of $35 million. We expect to report positive operating earnings in the range of $2.5 to $3 million. This projection generally assumes operating income break even on our base business at a revenue level of $18 million per quarter, excluding non-cash stock compensation expense and intangible amortization, with incremental revenues contributing approximately 30% to operating earnings. As we work through the integration process of the acquisitions, the addition of McDowell and ABLE may cause us to change our overall break even assumptions a bit but at this time we expect incremental revenues from these acquisitions to generate operating contributions at least in a similar range of 30%.

As we refine our understanding of these new businesses we will be able to have a more informed discussion of our business model early in '07.

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

Thank you, Bob. The addition of McDowell and ABLE have significantly widened our opportunities for growth and profit in the fourth quarter and beyond, and we're working hard to complete the integration of both of these operating units. We're enhancing those operations and with strong bookings and revenue growth, we will return to profitability and put the issues that hit us in the third quarter behind us.

Now I'd like to open it up for questions, and Matt, I'll ask you to open up to Q&A.

(OPERATOR INSTRUCTIONS). Steve Sanders, Stephens, Inc.

Bob, I want to see if you can walk us through your last comment again there. I think you said ex the incremental amortization and the option expense, your core business is operating income break even at $18 million. Later on $17 million over that to get to the $35 million. And then you use 30% incremental margin. I'm not getting 2.5% to 3%. Can you just help me again with that?

The base business that we've said in the past -- our basic business model is a break even at the operating income level at $18 million. So let's call it -- the base really -- what we talked about for sometime really is the Newark, New York, and the UK operations. And the incremental revenues for those operations we expect -- we talked about in the range of 30% contribution margins.

We have layered on top of that now a new incremental base, call it, with ABLE and McDowell. So those additional revenues from what we had disclosed in the past, as far as what their revenues were -- they would have added about $6 million a quarter or something like that, with an operating earnings in the range of say, $600,000 a quarter -- or right in that range. So that is a new base that now we're working to understand how much we can improve upon that. But now from that incremental growth on that new base, we will add 30% we expect (multiple speakers)

Let me help you with that, again a little more. You will notice that even with a, kind of a light quarter, McDowell gross margin was pretty good. These businesses have very different models. McDowell has a little higher -- has a higher gross margin but also higher operating costs -- a little higher on the sales side and maybe in some of the applications and engineering they do.

ABLE is a different model. They have a decent gross margin and pretty low operating costs. That's just the way their cost structure is. When you fold that stuff all in together, it probably gives us a little higher break even but probably a little more leverage. But we are trying to -- we just want to make sure we get this all right and get the classifications of manufacturing expenses and understand the variable and fixed parts of those a little better before we comment anymore.

And then I think the quote you used in the release was the third-quarter issues are substantially behind us. You have given us quite a bit of additional color. But can you talk a little bit more about that? If those issues were fully behind you, do we have another couple points of margin in there?

I think the answer to that is yes.

Yes. First of all, there were the couple of one time, I guess we can refer to them as one time items with the recognition of the liability for the workers' comp trust issue, which was $350,000 in the quarter. We don't expect that to recur. We think we have got a reasonable estimate of what our potential liability is there.

The write-off of the fixed assets of $100,000 that we don't expect that to recur. The operational issues we're dealing with, the fact that we had some scrap issues that we're dealing with effectively, we don't expect that to recur. The higher engine costs, we're working to deal with that, to look at some different suppliers -- so we're working on that. That probably is one issue that is not totally behind us but we're working with that. So those are the key issues.

And then John, I think you characterized the rest of the fourth-quarter guidance as relatively small. That it was based on pretty good visibility at this point. Again, any additional color there would be helpful.

Yes we are in the best --

The 90 that we are sort of waiting on or are there a few other things that --?

We are in the best position we have ever been in terms of solid book backlog in a quarter. It's almost all there. And we also are in the best position we have ever been in terms of pipeline that we believe is coming along that will get us whatever the rest of the way is. We've got two months to go here -- a month and a half to go here. We've never been in a better position. In fact, we've never been in a better position in the quarter we're going into than we are for quarter one. We're booked pretty solidly. And it is in multiple different areas.

I know we used to hang on what is going to happen with the 5390, but the 5390 -- I mean total DLA standard battery business is now about 15% of our business. It was 60% of our business a couple of years ago. And in addition to that 15%, I would say that is those product classes -- most of those products, including the 90, we have additional sales through primes and direct to bases. We also have additional sales internationally now that is kicking in, in those areas. So thermal imaging, for example, our thermal imager products, all of our sales were through -- to DoD through DLA in the past. Now we're selling it to about four or five different countries. And we're selling to special ops and direct to bases. So we're much more diversified even inside of that 15%, which represents that product class. So we're not hanging on -- it's not this, oh, gosh, they are going to order more 5390's, but it's not that we're hanging on that revenue plan anymore, Steve.

That's helpful. And a final question -- I know it's too early to really provide guidance for '07, but we've got this $35 million number in the fourth quarter. You guys obviously have a pretty good idea of what the buckets are. How should we think about that as the starting point going into '07? What are sort of broadly the pluses and minuses going into '07 relative to that $35 million?

Well McDowell and ABLE operating units represent, oh, I don't know -- probably 30% of our business between them. And they are pretty -- 25%, 30% -- and they are in pretty solid shape with products and backlog. They're not dependent on DLA ordering patterns, things we have had in the past. And we think we will continue to grow those businesses, as we've said. Especially ABLE -- it's a low number right now but it's got a -- we have doubled it and it's got a real opportunity for growth in this year.

Of the rest of our business, about half of that now is military -- UK battery businesses, about half is military and about half is commercial now. And the project, what we see in our military business -- we have been in the standard battery types we've been selling on contract, we have been real light, and quite honestly, things like the 5390. But we have diversified that base and -- I hate to say this -- but it can only go up.

In terms of the prime contractor business, there is more and more of that out there. We have only just started to scratch the surface. If I look at our pipeline of opportunities they are out there. We believe that for example the land warrior project, which we had shipments earlier in the year for trials and stuff, we believe that is something that will get fielded next year, along with numerous other projects -- in-ground sensors and other projects that are going to happen.

We get asked -- what are you going to do if Iraq goes away? Well, the fact is that the change in usage of portable power has just been very, very significant over the last year. And the trends are going to continue. Because we don't have the manpower. And you're going to do it with sensors, you're going to do it with forced multipliers like Land Warrior. You're going to do it to defeat electronic measures that the enemy is using -- things like IED jamming is a permanent part of the arsenal, and all this stuff requires portable power. So even with a lower pace of operations, the demand is going up.

And one last question -- the problems that you saw this quarter around the processes and controls, particularly at McDowell, weren't fully recognized until arguably, four to five weeks after the quarter ended. I realize there's still work to do, but are you far enough along so that if there are similar issues in this quarter or over the next few months, you feel like you'll identify them earlier? Have a chance to address them? Just speak to that sort of control and process a little bit.

Well McDowell -- we are working very hard with them on their systems, on their accounting process and procedures. We think over the next quarter we will substantially improve what they're doing down the (technical difficulty). And certainly as we go into '07 we'll have much better control down there.

To put it into perspective, Steve, these guys had a great business. But as a private company they only had to worry about a yearly accounting period to be able to file their taxes. And so now, getting to -- getting to where, all right, we get quarters lined up and then getting the months and weeks to really understand that will only have a benefit. And they are finding a benefit in that they are starting to see a little more -- finally how to manage their workloads and maybe do a little better match of expenses to revenues on a more specific product by product basis that may -- will actually inform our decisions about pricing and about how we go forward with where the money is, where the profit is.

Mark Grzymski, Needham & Co.

I think Steve touched on, most of my questions here, but just kind of following up with what you touched on in the end there, John, was related our efforts in Iraq. With everything that has kind of changed in the last two days, I am wondering what -- well I heard what your impression is -- but I'm just curious, any -- how that might change the environment for the overall -- for the military and then how that might relate to your products?

Again, I will go back and say we represent, in power, to the military maybe 20% -- maybe 20%. 15% to 20% probably of their power requirements come from us. So first of all, that's huge market share to be had. In the rest of the world we are probably a lower market share than that. While we have a good operation in the UK, we are still a very low percentage of what they buy. And so there's a huge opportunity of market share to be had. So that is the first dynamic that we see, regardless of where anybody is deployed.

So market share is really -- your focus now is market share not the --

It is market share, but it is also new applications. The IED jammers are a really good example of where -- I mean the power requirements to be able to do what you need to do -- IED's are a fact of life forever now in the world for any soldier who is deployed anywhere, even peace-keeping duty. So the energy that you need in a portable way, I would have told you a year ago, and I probably did tell you a year ago that I think that rechargeable batteries wouldn't necessarily be what people would use in combat. But the fact is you need so much energy in that application that you can't physically get enough nonrechargeable batteries out there for that application. So it's got to be rechargeable. And with that comes logistics of chargers and batteries and how do you run chargers and stuff. Those markets are expanding. Just as I said, I think there are new applications that are really expanding the use of power, portable power out there. [So it's both.]

And also you're not just focused on the US military, either, so.

Yes. And just -- I am not an expert on politics, but I think experience shows that the hawks are never as much a hawk as you think they are and the doves are never as much a dove as you think they are. I don't think anybody is advocating abandoning either the fighting men and women we have in Iraq or leaving the place in -- leaving in a disorganized way and not trying to make the country better before we eventually are able to get our people out of there.

Just going to the $35 million for Q4, I know that is a ballpark number and it's a give-and-take. How do you -- since now that you are showing us a little bit more color here on the revenues with the acquisitions, what is the breakout on that $35 million? When you guys are giving us this number, I'm just curious what the rechargeable, with the communication accessories, how that is built in there?

I think it is running -- Bill, why don't you --? (multiple speakers) sliding it to me, you tell them.

In commercial, business has grown, and in the commercial business it's a lot easier to do a trend analysis. So we have really good information there. And to John's earlier point, we have a much higher booking than we have ever had. It's easy to say both ABLE and McDowell are fully booked out and we're just looking to write a fairly small percentage of orders to finish out the booking for the quarter. And then it is really going to be up to our collective operations to get everything done for the quarter and we're well on our way to do that.

So to John's earlier point, we are -- and we have such a diverse mix now that we are a lot more confident as far as going into this quarter and into next year. And to John's earlier point, Q1 -- we have pretty good bookings going into Q1. And a lot of that has helped with the two orders that we announced -- we've got $20 million on the books right now and it's a matter of that and the commercial -- and that's not counting the commercial business. So we've got a couple more orders to write but we are looking pretty good.

I think we are about -- I'll say, I think we're about 50% nonrechargeable, about 30% rechargeable, and I think about 20% accessories is kind of the ballpark for the quarter.

Remember, McDowell has -- the chargers they do are part of the rechargeable segment. But the other communications accessories, amplifiers, repeaters, antennas, kits, speakers, are the accessories part.

So just roughly speaking here -- that communication -- all that accessories that you're talking about -- that's a pretty good incremental increase quarter-over-quarter, correct?

Yes, it is.

Yes, we did $3 million in Q3. We will probably -- we will be in the range of 15% to 20% maybe of total revenue in Q4.

And regards to rechargeable, that's also a huge step-up there and it looks like nonrechargeable has some growth built in. But it's fair to say that rechargeable and the accessories business is really going to drive the incremental -- the $12 million addition here from quarter-over-quarter?

No question about it.

Walter Nasdeo, Ardour Capital.

I just have a brief question. And it is more perceptually what's going on or what your take is on all the lithium ION issues that have been in the news lately. And we're hearing things where they may be banned --batteries may be banned on aircraft and things like that. What is your take on that right now?

Well, it is humbling to every -- we deal with power every day. Our job is to get as much power in a small space as possible. Safety is -- 6:00 to 7:00 this morning I did communications meetings with our third and second -- first shift employees and we do them in the afternoon. And the first thing we lead with is safety. It's all about safety. It's safety in the factory and it's safety of the product. It is humbling to all of us when Sony, as great a company as Sony -- has a problem. We deal with power. And safety is always an issue. We are lucky a little bit -- or whether it's luck or by design, we are not in consumer applications. And most of the applications we're in, we'll pay to have the extra safety of testing, source selection, circuits -- lithium ION batteries need to be protected with a good circuit, and need all those things. And so the markets -- our attitude is we won't ship anything unless it has gone through all that -- kind of mili-spec testing and submersion and shaking and with really good, robust safety mechanisms in the design.

Unfortunately, consumer products don't always want -- they want cheap sometimes. And so people are working hard to get their costs down. From what I read about Sony, they had a crimping problem that was part of automated production and they were working hard to get their costs down, and I can't comment on whether they could have or should have found it or whatever. But all I would say is that the lesson I get is you've really got to -- you can't ignore safety. Plain and simple.

The other thing I would say about circuitry -- we do our own circuitry by and large for our products because we believe that's the key on rechargeable batteries. Most of the time if your cell phone battery dies, it is not the cell; it is usually the circuit. That's where you got to put your money because that is what protects the packs.

Have you guys had any catastrophic failures?

Have we had catastrophic failures? Not in the field. We stress our products in the factory. We have had -- in our testing, in our shake testing and stuff like that, we have uncovered design issues and stuff. But our goal is to find them here, not at the customer. So we have not had that problem.

James McIlree, Unterberg, Towbin.

John, the $35 million you are talking in Q4, do you need to get any DLA 5390 orders to make that?

Do we need to? It would be nice. But we sell 5390's now not just to DLA. We sell them to bases, we sell them to primes and we sell them to several overseas militaries now. And so we have a mix in the pipeline that based on probabilities of certain things happening, we think we are pretty well covered for the incremental we have to have, but some element of that would -- do we have to have it? No. Would we like to? Sure.

So 5390 is some percent and you're assuming that some will come from the bases primes, maybe DLA, but some combination of those end users by some percent of 5390's?

We have it at a reasonable level -- at a reasonable percentage chance. We kind of do -- we try to do a probabilistic analysis when we look at these things and be real careful about predicting what the chances of something happening are.

So it is not based on the guys at DLA have said, hey, John, the order is right around the corner, hang in there?

Some of our -- when we look at what we still have to book, some of it is based on people saying yes, you are going to get an order. But I can't comment on specifics of that.

You made a comment early that you think the Q4 levels I think you said could be sustained or would be sustained in 2007.

Yes.

At least the way I am reading that, it sounds like a base case for '07 is $140 million. Am I reading too much into your statement?

Well, we have to go to our Board in a couple of weeks to get approved for Q4. So I wouldn't say that yet. But we really think that at least in the Q1 into next year we are going to sustain this level. So if you take this level times 4, yes, you get 140. But I am not ready to stand up and say yes, that is the number for the year. We need to work through some more things.

And could you just -- sometimes you give indications about how much 9-Volts and military were as a percent of revenues in the quarter. Could you do that again?

9-Volt was about 25% of the quarter, ballpark. And military represented -- Bill, what was military do you think this quarter? About 40%, probably? We're about 40% military, maybe 45%.

And that includes some of the accessories that --?

That includes McDowell, yes, for the accessories.

The other -- part of next year, Jim, there's very little that is going away. But we do depend on programs getting funded on a continuing basis. So for example, the IED jammer program, there's plans for that to extend out. We just needed to make sure that that funding flows through. Part of the issue this quarter with DLA, and we knew it ahead of time, are how fast does the budget get past the Pentagon, the Pentagon gives it to services and such. So we just have to make sure in the next chance, some of the things are staying. On the other hand, we have other parts of our business, telematics, the ABLE product line that are definitely growing next year. So we just need to get a little more comfort around a couple of big projects. But most of the stuff is either growing or sustainable.

And you have made reference a couple of times to things being booked out for Q4. You are just talking about specific units when you say that, right? McDowell and ABLE? You're not talking about Q4 as booked out for the $35 million? There is still some work to do; you guys can't go on vacation yet.

No. We still have to produce and ship things too. And we still have to fill up Q1. But there is a fairly -- we are in the best shape we have ever been in, solid, book backlog going into the quarter. And we are in the best shape we've ever been for the rest of it in terms of the opportunities, pipeline of opportunities. People saying, hey, this is coming. We need this. We are just waiting on the order.

And I think lastly, if we took $3 million at the top end of operating income and $35 as the revenues, obviously, you're coming in less than 10% operating margins. Is it reasonable to assume that even after you fold in McDowell and ABLE that -- and get all your studies done and what their contribution could be, that 10% is a really low end goal; it should go higher than that?

Yes, it should go higher than that.

I think in times past, you guys have talked about 15% to 20%. Is there any reason to believe that with McDowell and ABLE in there you can't reach those again?

There's no reason to believe we can't. We talked about 15%, but that was before we had to expense stock options and before we had the intangible amortization. So if you look at the quarter -- look at it in that sense, we are up between 10 and 15%. If you look at it on a cash generation, on an EBITDA -- I don't know; there's no EBITDA without stock options. I know some of you guys do that in your models. But if you look at it like sort of an operating cash number, that's the way we look at our business, to be honest with you. There's no reason we can't -- we won't be up there. And if you look at the gross margins of ABLE and McDowell, even at the levels today, they have real good gross margins. We are growing the revenue. We just have to leverage on the operational side. And we have a really good track record of doing that. We did it with the Ultralife business and we've just got to do the blocking and tackling and do it with their businesses.

Mike Huffman, Rock Point Advisors.

After the McDowell acquisition, you were explaining that they had a contract or relationship with GSA. You were hoping to have Ultralife's product offering included under that agreement.

With GSA.

With GSA.

Yes.

And did you have any update on that or is that a factor in the business -- the book of business you're (multiple speakers)?

We actually now have the 9-Volt on the GSA price list. Because it is now being bought for what I would call quasi-commercial applications -- smoke detectors and military housing. It's also being bought for some sensor applications, to power them. So we have got the 9-Volt on it. And we're looking at what other products might make sense to get on there. The ABLE product line is one that might be prime for that. So yes, that is something we're actively looking at right now. But we did get the 9-Volt on and we're looking at some of the other products.

Great, and regarding the 90, I think a lot of us have just been waiting for the order flow to pick up again. I think you made a small amount of reference to that, both this quarter and last quarter. But do you have any further comment, just in terms of the state of charge indicator and when order flow will pick up again?

They are using them, Mike. They are using them at a pretty steady clip. We know what the usage numbers are. They have been leaning out their own inventory and taking down some level -- a lot of it has been tied up with budgets. We expect to get another order. We would expect to get one for this quarter, but we're not counting on it. But I expect it to start picking up again now that the budget is given out and stuff. It has taken a long time for budgets to get down to the units into the operating people in the military this quarter. I don't know if that has anything to do with the election or what -- but we're starting to see movement and we're told that things are starting to move now. So we would expect to get an order. But I can't tell you -- I don't know I have it till I have it.

(OPERATOR INSTRUCTIONS). Michael French, Kaufman Brothers.

I had a couple of quick questions on McDowell. Do you have an estimate for what the ERP system will cost?

Yes, it is going to be -- it is something that they -- we currently have in place there. It is the implementation process right now. So I would expect it is going to be less than $100,000 over time here, when you talk about the license fees, the consulting fees and so forth.

They've had a couple of interesting contract wins since you closed the deal. Are they bidding on anything else of that size in that $10 million or over that you are aware of?

Well, we don't usually comment on what we're bidding on. But suffice it to say there's lots of opportunities out there that they are involved in. A lot of what they do is involved with a special ops community, who doesn't particularly like it advertised what they're looking at. But there's a fair amount of business out there, Michael.

I think that -- two things to point out in terms of the business [models] of McDowell. One is that together with us, going in charge your batteries together and to operations like that -- it really -- the IED jammer is an example of a contract that kind of cinched it that we were together. Communication accessories award they got really was a product that they've done before that was a very interesting packaging with some of their products that really fit a need there. And they've gotten a repeat order for it. I think that by doing more -- they are pretty well used to doing customization and a lot of one-offs that are particularly tailored to what the customer wants. We do not want to stop that.

On the other hand, there is an ability to kind of productize some of these higher level products and maybe sell more of them instead of the individual units across a couple of commands. And so I'd like to think there's some of those opportunities there. But yes, there's a fair amount of business out there. Special ops is the fastest growing part of the military budget.

It seems like this acquisition is really working out.

Well, it is on the revenue line. And we're getting the operations act together. It's just taking us -- we are guilty of being a little more optimistic than we probably deserve to -- how fast we could get all this stuff together just purely on an operational basis. But it is really coming together. We know what the issues are. They are really good people, and we are working together real well.

Well, I have confidence. I agree with what you said. You have a good track record for [continuing] operations.

Thank you.

The last question here on the war reserve, if you could just generally discuss what you think is going on there and what is likely to happen in the future in terms of possibility for backfill.

I don't know that I ever made any comments on the war reserve. I know when I say reserve level, they keep a fairly significant pipeline of inventory between depots and shipping points and pre-positioned stocks in different places. So we are not privy to exactly what reserve levels are and what counts as "war reserve" versus pre-positioned stock versus whatever. But we know that they've tried to take reserve levels down of the old battery, meaning the 5390 without the state-of-charge indicator so that they can get the newest battery stocked in. Those reserve levels fluctuate from time to time. We are not privy to the numbers but there's a lot of evidence that the usage rates has been higher than our production rate. That is all I can tell you.

Steve Sanders, Stephens, Inc.

Bob, on the operating expenses Q4 versus Q3, I guess you essentially told us that the amortization in the 123 would be flat. I guess there was also a little bit of noise in those numbers. But should we think about this as a pretty reasonable run rate going forward and if not, why not?

That is a good assessment. I think we would expect it to be relatively the same, plus or minus a little margin for error. But, yes, it is going to be a basic run rate.

And then John, I wanted to come back to the automotive telematics -- I think the target at the beginning of the year was ballpark $10 million. I just wanted to see if you think that is going to turn out to be a pretty good number. And then directionally, it certainly sounds like you signaled some upside in '07 and beyond. How should we think about that?

The 10 -- we might have run around 9 ballpark. But having said that, it is not over yet and we're getting pretty healthy demand this quarter. Our overseas customer seems to bounce around a little bit. And GM had a dip at one point in time that might have been -- they are back up again -- there might have been an inventory correction. You know how they work is, they order what they need for the week. And we get -- our visibility is -- we get a forecast but our visibility is only two, three weeks out. So it might be more in the ballpark of 9 to 9 -- maybe a little more than that for the year.

For next year we are bringing on additional models, and it is going to increase. That is what we can tell you. We have some that are coming on now as they get into the model year. There's some that we are being told are going to be brought in kind of the April/May/June/July time frame -- kind of midyear.

And then for the overseas customers, a lot of them are talking about -- there is an initiative in Europe called the eCall initiative that we might have talked about before, which is to put emergency call capability in automobiles -- all the automobiles in Europe. And we're doing a lot of design activity. People have talked about '08 being the year, which would mean production starting second half of '07. But with the auto guys, we have learned to not count our chickens until they are hatched. Because things can move from year to year. But there's a lot of steam behind it -- more than we have seen before for doing that.

And then just two quick follow-ups. You mentioned a couple of medical device wins that were going to kick in I think two first half, two second half. A little more color on those. And then finally, on the 9-Volt, it sounds like we're seeing some good momentum there. It also sounded like your commentary around '07 was pretty encouraging. Any detail there would be helpful.

Yes. On the medical side, medical has been for us kind of -- let's see -- $5 million a year kind of business, order of magnitude. I think we are going to get it up to be -- when something is 10% -- 5% of the business is one thing, I think 10% of the business is where I would like to get it to. In the 20% range. I don't know if we will get that this year. I would say we might be around $10 million in medical. But it depends on product introductions. And the medical stuff is long lead-time. We have been working on some of these for a bunch of years. We have batteries that need to be able to be autoclaved and survive. We have batteries that have to go through different levels of FDA trials. It just takes time. It's just gratifying to see finally that we've got some pretty good sized projects coming to market.

So I would say next year -- my goal -- and I am doing this based on not having any empirical data in front of me -- but my goal would be to get up in the $10 million a year range in that business for next year. We are kind of around about 5 this year.

Is the margin profile on that business consistent? A little better? A little worse? Starts slow, gets better? How do I think about that?

It start slow but it gets better. Put a lot of design work in on the front end. But ultimately it's a pretty good business. It has longer -- the good news about the medical business is it has longer product cycles. Because once a product gets out there, people don't want to have to go through testing and approvals and all. So it is nice in that [that tend] to groove with some of these products.

Our defibrillator customer, our AED customer -- it was a lot of work up front. We were working on it for three years but we're now starting to get the pretty decent volumes. And we have a good experience and we just know how to do it. And we are actually -- telematics is a similar type of business in terms of, it took a lot on the front end -- a lot of work to get the processes in place, but we know how to be an automotive supplier now. Sometimes it is a little frightening. We actually know how to deal with the forecast and the releases and the computer system work we have to do.

On the 9-Volt, we're extending the business. And it really is driven by international pretty heavily. The domestic business has been driven -- we have done very well in medical there with our distribution channels and work we do for people like Energizer. But in the smoke detector market, it is always driven by kind of retail cycles of every so often somebody competes to knock somebody else out of Home Depot or Target or something, and it is usually based on the cheapest units you can produce, which is not the one with a ten-year battery in it. So we go through cycles there. But the overseas market is really developing. There's a lot of smoke detector legislation occurring in Europe and in Asia. Japan has been the latest.

Just as a side note, part of our scrap issue was not anything to do with our processes. We had a customer in Japan who took their first shipment and stored the batteries improperly. And we took them back as a goodwill customer gesture, thinking -- we usually have a pretty good recovery rate on those batteries, we can repackage them. But we did not get a good recovery rate and we took a write-off. But it was in the right spirit of customer service.

But Japan has been very strong for us. And we see that growing and doing better, and Europe as well. We've seen that market expand there. And that is really where the increases have been.

That does conclude our question and answer session. I'd like to turn the call back over to John Kavazanjian for any additional or closing remarks.

I would like to thank you all for participating today. I hope we have been able to answer your questions. We really look forward to sharing our progress with you next quarter. Thank you very much.

That does conclude today's conference call. Thank you for your participation. You may disconnect at this time.