Ultralife Corp (ULBI) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ultralife Batteries fourth-quarter earnings release conference call. Just a reminder, 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. Jody, please go ahead.

Thank you, operator, and good morning everyone. Jody Burfening of Lippert/Heilshorn and Associates. Thank you for joining us this morning for the Ultralife Batteries earnings conference call for the fourth 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 website 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 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 would 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 is 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 like to now turn the call over to John. Good morning John.

Good morning. Thank you, Jody. Welcome everybody to the Ultralife conference call for the fourth quarter of 2006. Joining me today are Bob Fishback, our Chief Financial Officer; Julius Cirin, our Vice President of Marketing and Technology; and Bill Schmitz, our Chief Operating Officer, who is on the line from our McDowell operation in Waco, Texas. Jim Evans, formerly the Vice President of Sales and Marketing at McDowell Research is also with us. Jim has just assumed responsibility as Vice President and General Manager of our newly integrated military business unit.

Today we reported revenue of $30.1 million for the fourth quarter of 2006 and an operating loss of $1.5 million. Included in that are non-cash expenses of $700,000 from the amortization of intangible assets and $500,000 from the expensing of stock option awards. These results are consistent with our preliminary review which we announced on February 1.

In addition, we are taking a $24.1 million charge related to the deferred tax asset on our balance sheet. This is in accordance with the relevant accounting standards and does not impair the availability of our tax loss carryforwards.

To recap the reasons for lower-than-expected operating earnings, there were two main operational factors. First, sourcing decisions made in the McDowell operation caused significant unplanned increases in product costs which resulted in approximately $1.1 million in higher expenses. We are now working diligently to remedy this situation by negotiating new purchasing contracts and we expect some modest improvement in the first quarter as we work through existing inventories and commitments with more improvement in the second quarter.

We have also augmented the management of the operation. Andy Naukam has now moved to our Waco operation as Chief Operating Officer, responsible for all manufacturing, purchasing, and engineering operations. Andy is a Corporate Vice President with intensive experience with Ultralife in top management positions in development, engineering, operations, and quality.

Ron Way has also moved to Waco as our Director of Operations. Ron's previous assignment was as Director of Operations for our UK facility. He has already made major strides in leaning out the operation, cutting down lead times, and resourcing product. To ensure the implementation of corporate MRP and financial systems, [David Schusler], formerly of our corporate finance department, has moved to the Waco operation as Controller.

The second issue that we encountered was an excess scrap problem in our 9-volt production at our Newark facility. A key component in the product shifted in its process parameters. While this component was still within specification, this shift caused unanticipated scrap problems amounting to around $600,000 for the quarter. A substitute was found and we qualified that substitute in early January. All indications are that production costs are back on plan.

On the sales and marketing side, order activity in the military business was strong during the quarter and among the awards were two major projects, one for IED jammers and one for portable communication indications systems. On the other hand, we received only one order of any volume on our standard supply contracts from the Defense Department during the fourth quarter. Since then, activity on these standard contract products with the DoD has picked up, as evidenced by the recent announcement of $4.6 million in orders.

Field usage continues to be high consistent with the pace of operations. As military budgets become more clarified, we may see a more regular flow of orders.

We are also seeing increased activity with our international military business for both batteries and communication accessories. We just recently announced the launch and first shipments of our new tactical repeater product to an allied military organization. Extending our productline into military accessories and offering them another military product through to our international distribution is a major area for future growth.

To put this in perspective, there is as many as 100,000 handheld multiband radios in use by military organizations across the world. With a typical range of up to 2 miles, they've initially been used for intrasquad communications but with the addition of sophisticated encryption and the utilization of their multifrequency capabilities, these radios are used more and more for squad level tactical use and to bridge across the disparate communication systems in use in joint land, sea, and air operations.

Our Satcom On-The-Move System, which was the system in the $9.1 million award we announced last quarter, broadens the use of this radios further by adding the power capability to enable their use for satellite communications. The tactical repeater system that I just spoke of is a new offering at our communication system portfolio that further leverages the potential of these radios.

Used as a central hub for a dispersed force with handheld radios, a portable or mountable repeater unit can extend their effective range by receiving, amplifying, and resending their signals. The unit operates either with our UBI-2590 batteries packaged with it or by using vehicle or generator power and comes packaged in a rugged case suitable for dropping in a central location or transporting in a vehicle. With the large and growing numbers of handheld radios fielded across the world, we expect this product to be quite popular.

We've also launched our first alternative energy product in this market with our new small portable solar charging system that can charge handheld radio batteries in three to six hours. We've developed the technology to utilize solar power, a primary for supplemental charging with the ability to both tune the panel to the charge current and to convert the solar energy efficiently to optimize charging. We expect to further develop and field more variance of this productline in the future.

Commercial markets continue to show steady growth. Automotive telematics is still strong. We anticipate several new models to start [taking] product during 2007 for the 2008 model year. This year we have already confirmed design-ins for three new vehicle platforms. One will start shipments early this summer and the other two will commence in the fall. Design interest has indicated that [CEF] recovery systems are another opportunity area for our automotive systems back-up batteries.

Work that we have done in the medical market continues to result in orders. This quarter will see first shipments from a new infusion pump product and shipments are growing for other applications such as defribulators and hospital medical apartment.

Our 9-volt productline continues to be quite strong, fueled by growing domestic and international demand. With a healthy backlog we have enough visibility to forecast we will continue this trend for at least the first half of the year.

While we segmented our market approach between government and commercial markets, many of our development projects span across these markets. In conjunction with a major wireless communications equipment supplier, we are developing a large-scale battery and charging system that currently will scale to over 2 kilowatts in power. Initial plans call for its use to power a portable cellular site that can be rapidly deployed for military communications in remote locations. It is also planned to be used for commercial emergency services. This is a flexible configuration that we can scale for many other high-power stationery applications.

Looking forward, we expect a very good year in 2007. We have a solid and growing base of commercial business. Added to the space we have a solid core business in communications accessories. Our overall military business is now diversified so that we can better withstand the ups and downs in procurement cycles. We have a strong and growing international military business, a diverse and growing business through prime military contractors, and a widening portfolio of standard products sold worldwide.

There is no question that we underestimated the task of integrating two acquisitions at one time. On top of the usual integration issues, we pushed the business to grow and as a result we've been playing catch-up to ensure we have the right infrastructure in place to handle both current activity and future growth. We are fixing the operational problems and will return margins to where they should be.

We understand the issues and we have the personnel and the vendor base to realize the full promise of this business. We have the advantage of having successfully tackled problems like this before and the benefit of strong and growing demand from a great customer base.

For the first quarter, we expect revenues in the range of $28 million to $30 million and we expect to be between $1 million loss and breakeven on operating revenue. This anticipates that we will still have the full impact of the material cost issues at McDowell as we work through the premium material cost inventory. It also includes an assumption of around $1.1 million in non-cash expenses associated with stock option expensing and intangible amortization.

At this point, our strong base of revenue and robust portfolio of opportunities lead us to believe that we will continue to grow revenue as well as improve margins and that we will return to profitability by the second half of the year.

Now I would like to turn it over to Bob, after which we'll open it up for questions.

Thank you, John, and good morning everyone. Early this morning we released our fourth-quarter results for the period ended December 31, 2006. While our independent accountants are in the process of concluding their year-end audit work particularly with respect to inventory valuation and related cost of goods sold at McDowell, I want to remind everyone that final audited results to be included in our Form 10-K filing in a few weeks may differ from the results we are releasing today.

Consolidated revenues rose to an all-time quarterly record of $30.1 million, a $12.2 million increase or 69% over the same quarter a year ago. This increase in revenue was driven mainly by impressive growth in rechargeable sales, additional revenue attributable to the ABLE and McDowell acquisitions, strong 9-volt shipments, and higher sales to telematics customers.

Specific to our reporting segments, nonrechargeable revenue increased $1.5 million from higher 9-volt and telematics battery sales and the addition of ABLE to the mix, offset in part by a decrease in direct sales to the U.S. Defense Department.

Rechargeable segment sales reached a record $9.1 million compared with just $2.4 million a year ago. This increase was the result of rising sales of 2590 batteries and charging systems. Communications accessories, which comprises integrated kits and systems, mounts, cables, and power supplies contributed revenue of $4.4 million in the quarter.

Gross margin was $5.1 million, up $1.4 million from the same period last year; however as a percentage of total revenue, gross margins were 17% in '06 versus 21% in '05. This decline in the margin percent was mainly related to issues at McDowell that resulted from purchasing and outsourcing decisions that proved to be costly.

The gross margin in our nonrechargeable operations was 15% this quarter, down from 23% in the same quarter last year related to the 9-volt scrap issue and change in sales mix. Our rechargeable segment reported 21% gross margin for the quarter, an improvement over the 15% reported last year, reflecting higher volumes and a more favorable sales mix.

Our communication accessories segment generated a 15% margin, reflecting higher than normal products costs incurred as a result the purchasing decisions we've talked about.

In the fourth quarter, operating expenses totaled $6.6 million versus $3.5 million a year ago. As was the case in Q3, most of this $3.1 million increase is attributable to the acquisitions of ABLE and McDowell. Added operating expenses from these companies accounted for $1.7 million and amortization of intangible assets accounted for $700,000.

In addition, non-cash stock compensation expense was $500,000 this year compared to zero last year. Absent these items, operating expenses in our core operations increased modestly.

The above-mentioned items resulted in an operating loss of $1.5 million for the fourth quarter of '06 compared with an operating profit of $100,000 for the same period a year ago. Net interest expense amounted to $0.5 million for the quarter, up $300,000 over last year related to higher levels of debt.

As we close the year, we reviewed the carrying value of our deferred tax asset that we had initially established on our books at the end of 2004 after a period where we had generated positive taxable earnings. In our evaluation of this asset at the end of 2006, we concluded in consultation with our independent accountants that it would be most appropriate at this time to re-establish full reserves against the tax asset for the time being. In accordance with GAAP, this non-cash accounting adjustment resulted in a $24.1 million income tax charge to the P&L.

As in the past, we will continue to assess the appropriateness of the reserves related to this deferred tax asset and will make adjustments accordingly in the future. By no means does this adjustment impair our ability to utilize our NOLs at this time. In other words, it will still be quite some time before we expect to pay any meaningful income taxes in the U.S.

Including the charge for the deferred tax asset adjustment, net loss for the fourth quarter was $26 million or $1.73 per common share. Comparatively we reported a $40,000 net loss for the same quarter last year or $0.00 per share. Average shares outstanding for the fourth 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 positive $600,000. Cash used for working capital during the quarter was approximately $4.3 million as we increased manufacturing activity to fulfill year-end orders. We also used $500,000 for capital expenditures. Financing activities included cash inflows of $4 million from a draw down on our revolver and $100,000 from the exercise of stock options and warrants, offset by cash outflows of $500,000 for debt principal payments.

Overall these cash flow activities resulted in a $600,000 decrease in cash from the end of Q3 resulting in an ending cash balance of $700,000. The outstanding balance on our revolving credit facility was $7 million at the end of December.

At the end of the year, the combination of our trade receivables and inventory totaled approximately $52 million. This was higher than previous balances due to the fact that we've ramped up our operations to fulfill orders that we had received during the quarter. As one would expect, we used our credit facility to finance this growth in the business.

In closing our books for the quarter, we understood that with our lower-than-expected results we would likely violate a couple of financial covenants in the credit facility. As we bring down our inventory levels and collect on receivables, we will improve liquidity and decrease our borrowing levels.

While we have more than sufficient assets to secure our outstanding borrowings with the banks, the banks have agreed to readdress the terms of this facility with us by March 23 this year and we will be filing an 8-K containing the terms of this agreement early next week.

As we look ahead to the first quarter of 2007, we are forecasting consolidated revenues in the range of $28 million to $30 million, largely based on existing backlog and our current pipeline of orders. Based on this revenue range, we anticipate reporting an operating loss in the range of $1 million to break even. The expected increase in operating margin over the fourth quarter results reflects a reduction in scrap in our 9-volt operations in Newark and general improvements in gross margins.

In the projection that we are anticipating only slight improvement in McDowell's operating results in the first quarter but we do plan to work through the high-cost materials during the quarter and bring down the levels of inventory for the high-cost parts.

Before turning the call back to John, I would like to take a moment and share our current thinking about our target business model in light of last year's acquisitions of ABLE and McDowell. There are really three key components to our target model.

First, we have talked in the past about being operating breakeven in our core Ultralife operations, that is our Newark and UK facilities, at a quarterly revenue figure of $18 million. This model had assumed no impact from non-cash expenses for stock-based compensation and intangible asset amortization which combined now amounts to about $1.1 million per quarter. So our modified operating breakeven for our core operations including these non-cash expenses is in the range of about $22 million in revenue per quarter.

The second key component relates to our base expectations for operating results at ABLE and McDowell. Based on their historical operating performance prior to acquisition, we had an expectation of generating approximately $800,000 in operating profit on approximately $6 million in sales per quarter. The combination of these two key components suggest that we would generate about $800,000 in operating profit and approximately $2.5 million to $3 million in EBITDA on a base of about $28 million in quarterly sales.

The third component to our target business model is our expectation that we should be able to generate 30% operating margins on incremental revenues above the base. While actual results will obviously deviate from this figure each quarter, we believe that the 30% margins are a reasonable, achievable market as we grow the business over time. This is how we approach the business in our planning, budgeting, and every day in how we try to run the business.

We are at a pivotal time right now. While we have some operational issues we are resolving, we have significantly diversified our product portfolio and customer base in just the last year. We've become much less dependent on orders from the U.S. Department of Defense and have begun to establish a solid base of consistent business that we can count on from quarter to quarter. As a management team, we are committed to working through our short-term challenges so that we can reach the business model objectives we have set for ourselves.

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

Thank you, Bob. Now I would like to turn it back to Debbie and ask her to open it up for questions.

(OPERATOR INSTRUCTIONS) Walter Nasdeo, Ardour Capital.

I have a question about last year's military defense revenues. What was the percentage of revenues for 2005 -- Department of Defense revenues please?

Department of Defense revenues meaning sales directly to the Department of Defense I believe were about 19%. I'm going to ask Julius. 19?

Yes, it was in the 15% to 20% range.

15% to 20%. Sometimes it gets to how do you classify it? In '05 it was about -- do you remember? (multiple speakers) I think it was 24%.

You are catching me a little off guard.

I think it was 24%.

24% down to 19%. (multiple speakers). Okay, okay, that's what I was trying to get to.

And it was about 4% in the fourth quarter.

Okay. How are the issues of delivery to those guys and timing of these contracts has always been kind of a headache for you. Are you getting any ability or divining some way of smoothing that out a little bit so it doesn't cause hiccups as often as it has?

Well we try to smooth it out. We try to smooth it out on what we're told in terms of what to expect for run rates. But to be frank with you, about a year ago they changed their policy and did not -- would not give us consumption rates on a regular basis. So we get it occasionally, but not on a regular basis. So I guess the answer is we try to stay close, understand what the consumption rates are. We do get some guidance on it and we try to plan to that.

Okay, and then looking over at the balance sheet, your cash position is pretty thin right now. What are you -- are you looking at that? Are you addressing that? Have you have any plans to bulk that up a little bit going forward as far as any other acquisitions maybe out on the horizon or just to strengthen it up a little bit?

I can't comment on other acquisitions, but we have a core business that should be generating cash. Bob's comment about -- is exactly on target, at $24 million, $25 million in revenue on a quarterly basis even though we say that's $800,000 profit, it is over $2.5 million in EBITDA. We should be cash generating.

Even last quarter if you look, we have $52 million in inventory and receivables. Some of that is inventory because we had some shipments that held over, but some of it is from product transition and some of it is because quite frankly we positioned ourselves for DLA orders we thought would come in the fourth quarter. So now this quarter with those orders we're basically going to turn that inventory into cash. So we ought to be out of our facility by turning that inventory and receivable into cash and we should be a cash generating enterprise, Walter.

Soon?

Yes, soon.

Okay because this number is pretty thin. That's the only thing -- I mean it just kind of jumps off the page at you. And assuming that you don't have any issues or hiccups along the way to deal with because you are kind of exposed to other people's decision taking there is the only thing I was getting at. So, okay, if you're comfortable that you're going to turn some of that into cash relatively quick, that will give me a little bit more (multiple speakers).

Well I'll just make a comment about -- we have gotten a lot of messages from investors and analysts like yourself about -- we are embarrassed by this and don't give us numbers you can't beat. We have a very healthy backlog for this quarter.

When we give a revenue range, we're giving you what we think we have booked that we're getting out and most of that stuff is built or in inventory and we expect to turn the cash -- we have a very healthy set of receivable balances that we are collecting on now. We had a lot of late in the quarter shipments, because a couple of the big orders that we got we had to ramp up for in the quarter. The IED jammer project, for example, substantially went out in the month of December and really in the second half of the month of December. So we are pretty confident that we're going to turn this stuff into cash.

Okay, thank you very much.

Mike French, Kaufman Brothers.

I was wondering if you could provide us a little more detail. What happened at McDowell in terms of the purchasing decisions? It seems like $1.1 million of additional expense was more than just went to the wrong store.

Before we bought McDowell in the spring when we started working together with those guys, they had a very healthy and growing business. Jim and his guys did a great job of selling product, growing and expanding. They ran into their own operational problems and lead times going out and turnaround and they went out to source the products. They did not have a good -- to outsource products that they had been building in house and moving vendors to vendors who could meet their production goals.

They did not have a good system for tracking costs and doing it. And just plain and simple went out and sourced products with people where they paid multiples of what they were paying to get product -- to get it. And especially with joining with us in July and August, saw a big upswing and then the big IED jammer order we got which resulted in a big set of chargers; we paid almost $0.5 million in extra charges to get those chargers out.

Now if we did it -- doing it in a little more orderly fashion and being able to track this stuff as you go along, which is the way we do it because we're used to handling that volume business, we watch where we go and we use volume to drive costs down. It was not done. It actually drove costs up to go get product and we have product -- we have part by part detail. We've spent the last month working with vendors to drive costs down, to find other vendors and to bring products in house and we have pretty excruciating detail on this thing internally to convince ourselves that -- just bad decisions were made.

Even the people who did it will sit there and tell you today they just made some bad decisions and panicked to try to meet the customer requirements. It is great to meet the customer needs, but you can't do it and hamper yourself and it literally was that much money. We actually -- we're going to get that back. We're going to get back to those numbers. We have some inventory to work through and to some extent it is a matter of when you assume which inventory is going out, in other words look at your mix of product, what's going to go out with inventory that was bought at premium versus new vendors or inventory that -- where we didn't have that issue. But we are going to work through that stuff.

The good news is we have a very healthy order backlog and that stuff will pretty much all be gone in the first half of the year. We are going to get a lot of it out in the first quarter. It is not bad product. We just paid a lot of money for it, more than we should have. It is as simple as that.

We get back -- I think there is not just the opportunity to get back to where we were in terms of costs, which made McDowell a very profitable operation, but with the volume that we're driving there, we can do better. And there is evidence already -- it's anecdotal to show that. Without full systems in place, we're doing a lot of manual tracking. But that is fine. We are tracking it now. We'll have our systems implemented -- in our Ultralife operations we can tell every day every week how we buy against standards, how we're doing a purchase price variance, what it costs us to make product. We're not at that stage with McDowell but we have manual systems in place to do that now. David has put them in along with Andy and Ron. And so we are watching it every day. That is where we are.

It sounds like you have your hands around that now. I had a couple of question about new products. First on the tactical repeater, what do you think the market opportunity is for that device?

Well, there's literally hundreds of thousands of radios out there. I don't know, Jim, do you want to comment on that?

If you just talk over the next year, we've got prospects identified of probably up to 500 of those units which would work out to probably $10 million or greater just in the tactical repeaters in the international market.

Now that's not a forecast that we're going to get to. But he is just saying if you look (multiple speakers) market was, we didn't say we were going to win all of those, but that's kind of the magnitude of the market out there.

And that's just international, not including the U.S.?

That does not include the U.S.

What would it be if you included the U.S.?

The number would be huge.

It would be bigger than that.

Okay. And on this other one that you mentioned that you could use for cell sites, can you describe -- also the same question, what is the market opportunity, what is the ASP on this?

We haven't really -- we haven't priced it yet. We priced it to the one customer. We have not priced it to the market yet but as you might guess there's a lot of engineering that goes in a product like this. So these are nice margin products because they have a lot of engineering content.

We actually -- we didn't go into this level of detail, but we spent between $100,000 and $200,000 in the last quarter, a little over and above in engineering to get this product to do engineering on it because it was such a promising product. We use the same technology of control, charge control, smart SM bus -- smarts that we use in our 2590 product but it is almost equivalent to 12 2590s in power. And we can do it and we can scale it down and we hope we can scale it up.

Right now 2 kilowatts is pretty ambitious but we have this product going and I think it's going to be a $10,000 order of magnitude type of product. And it kind of depends on -- it is an OEM business. It depends on where our customer sells it, but it is not just military. When you have a Hurricane Katrina type event where they lose power and lose cell service, this is something they can put in right away and have cell service for emergency responders and such. And as such we think it is a pretty interesting product.

We have other markets that we want to apply it to but I don't want to give away our marketing strategy quite yet.

Okay, besides the tactical repeater on this product, are there other devices you're working on where you're taking some of what McDowell has and what Ultralife has and adding engineering capability?

I think when we look at those markets we really look at trends. Handheld radio is one when I talked about the solar charger. As we go to bigger systems for solar charger, that's part of it. All the different systems we look at that are looking for a battery and a charger and then power conversion so you can run it off of different currents, we now have more integrated solutions and I think the Satcom On-The-Move -- what we call Satcom On-The-Move is a real good example of that. Where you might have something hooked up to a vehicle to use your handheld radio running off a vehicle power, while its charging batteries and then you may go away from that vehicle and take it with you. So then we give you an antenna and you run off of battery power. Those are the kinds of things that we're doing together.

You had really healthy sales in your rechargeable line this quarter. Do you think it's sustainable at the almost $10 million a quarter level or was this --?

That's driven by -- that really was drive a lot by the IED jammer program, which is pretty interesting. If you would have asked me a couple of years ago would they ever deploy rechargeable batteries in combat active deployment situations, I would have said no. But this is a project where you just can't get enough. It uses so much energy to do what it needs to do you just can't get enough nonrechargeable batteries out there.

So I don't know the word sustainable, I don't think -- until there will be follow-ons to that program there will replacement batteries and stuff like that -- I don't know if sustainable is the right word but I think there is a trend there. You're going to see more and more high-power utilization programs in the military that can't use -- could use nonrechargeables but just logistically they use so much power that you can't sustain that kind of flow of supply to the front line with them. So, yes, I think we're seeing a trend there I would say.

Okay, I'll turn the floor over to the next analyst.

(OPERATOR INSTRUCTIONS) Jim McIlree, Unterberg, Towbin.

I just want to make sure the incremental margins you're talking about are 30% once you get above that $28 million revenue level you talked about?

Yes Jim. Except for some products -- except the 9-volt, which has to compete with a substitutable product, an alkaline product, and some products that we just supply on a pass-through basis to some people of distribution products, there is hardly a product I can think of that we don't get a 30% margin on. So on an incremental basis that is the case.

Now we supply some polymer cells to some distributors. It's a small business. If somebody came in for a big buy of those or if we sold another 0.5 million 9-volts a quarter, our 9-volt margin is kind of low to mid-20s, so that might be a different case. In general where we see the growth, which is the other products, especially as we move to higher engineered products, there's hardly a product we have that doesn't give us that kind of return.

And at what sales level would you need to expand your facilities? Another way to say it is what is your capacity utilization now?

Good question. In the accessories productline, we are an integrator. Except for chargers, we are an integrator. We design all our circuit boards and DC converters and AC converters but we have them all made outside. So we're very heavily material supplier materials driven which back to Mike's question about cost, that is why we (indiscernible) buying it. We didn't control those costs. They were really purchased cost stuff.

And so ramping up that operation is not that hard. We really have made huge strides in weaning that operation to do more with fewer people. We were doing 100 to 200 chargers a week in the McDowell operation and probably more than that toward the end of the quarter when they were doing 1/10 of that and doing it with the same amount of people. So I don't think we have a capacity utilization issue there because there's not capital equipment and stuff in place.

In the battery operations, we really have the capability to do easy $200 million. That is the non McDowell part. Any way you slice it, we've got capacity in almost every area. The 9-volt is probably the tightest. We are probably 80% utilized in our 9-volt area but we are 50, 60% utilized in the other areas and the places where we have real barriers, which is drier room capacity, heat treating, and cathode, we are probably 30% utilized. So those other areas we can add capital it's kind of a 90 to 120 days to add the capital at most to ramp those up. So we are in good shape with capital.

In terms of sales force, we have an embarrassment of riches there. We've acquired a very good, solid sales and marketing group from McDowell operation. We have a very good, solid one from ABLE. We have a good distributor base. I think we have more than ample sales and marketing and in some ways that is why we're driving sales so well, sales and marketing resources. And by putting it altogether under Jim, the military stuff, we're going to get some real synergies there.

I think the same thing by focusing development by market, we have picked up a lot of there. So I think we have the infrastructure we need for a while.

Okay, and on the telematics business, kind of ballpark where you are now and then whether or not these three design wins are of equal size to your prior design wins? So what it can get to on a run rate basis by the end of next year or this year, I'm sorry?

We're probably running $2 million to $2.5 million a quarter in that --. Bill, I don't know -- are you on the line?

Yes I am.

We're running about $2 million, $2.5 million a quarter now in telematics?

Yes, we expect that with any luck, it depends on how these new models do to double on that by the end of the year.

Soak kind of $4 million to $5 million a quarter by the end of the year in the telematics business.

Okay, terrific. Thank you.

Steve Sanders, Stephens Inc.

A couple of questions. Can you just drill down a little bit more on the 9-volt scrap issue? It sounds like you pretty much have it resolved, but can you provide some additional detail on what's going on there?

Yes, I'll give you detail. We buy a separator material on the 9-volt that is a single -- every product we use, we use what is called a trilayer separator where the center layer melts at a certain temperature and shuts it down. Our 9-volt product uses a single layer separator which is more of a commodity product, very large volume worldwide, it's used in all kinds of products.

And we use a wax coating to shut that down because we wanted to do it at a different temperature. It was designed a long time ago by Kodak. I don't know, Julius was there, 15 years ago probably by Kodak Corporation. We adapted the design and you really don't -- once you have something that works you don't like to change it because you have UL approval and all kinds of safety testing and stuff to go through. That separator was -- if you look at the way it's made, it is made to a spec of thickness and we test in a laboratory to make sure that anywhere in the range of thickness test it works just fine.

We don't run volume manufacturing at every corner of the design. Maybe we should, but it's pretty costly. And for years and years and years that product was shipping kind of at the middle to high-end of the thickness and that is really what we worry about because if it is a little too thick you can't get it in the can.

It started shipping toward the low end of the spec on thickness, a little thinner and an unanticipated thing happened, which was we started getting some punctures because we have a metal grid in there on the cathode, it's a stainless-steel grid. It can have some little burrs or bends in it and usually that is not a problem, but we started picking up -- not a high-volume but if you have these problems they can really, really hurt you --we started having a higher number of shorts.

It started in the third quarter, but we did not understand what it was from. We started thinking our winders were out of alignment. We did a lot of work to try to fix that -- you remember we're running at very high volumes. This was a 2 million unit a quarter type of product and thought we had it licked and it just kept going. Finally in about October/November, we realized what it was and embarked on a program. There were all (indiscernible) to the separators but we just didn't want to go -- we had something that worked, didn't want to go through all the work of -- you never know what is going to happen when you do a substitute.

Well, we did the substitute and it just literally took us 60 days to get through all the testing in UL and safety and ten-year warranty and stuff and on January 11th we passed it all and on the 12th we covered the new separator and the lines have never run better. So we already proved it to ourselves beforehand that this would work and now it has proven out.

Okay, and beyond McDowell, overall quality of your inventory. Do you have any issues there as you scrub it at the end of the year?

Not a bit. I will be honest; we've gotten some orders for [5390s As]. We had them in inventory because we were building to what we felt was a consumption rate at the end of the year in the fourth quarter. So we have absolutely no concerns at all about that stuff.

We're going to have -- at $28 million in the quarter, our material content if you take McDowell into account is going to be at least $20 million material content that we're going to -- we'll leave inventory -- and we even as we look at the McDowell inventory, another issue we had was the balance of it. There's a lot of it there and we're like one part short of a charger or one part short of a DC converter board. So it is not going to take much to add to that to turn that into a goods that we get out.

We're running really without an MRP system which means it's very easy to get out of balance on inventory. With some pretty simple tools we're going to get that back in balance and be much more efficient with it.

Okay, then in the telematics business you talked about the good growth opportunities there over the course of the year. What about pricing and margins in that business? How is that playing out relative to your model?

It's okay. Even with a unique product, the automotive business is a tough business. They are all having problems. The U.S. automakers -- with the data on Chrysler yesterday, but we are able to hold pricing pretty well. We do have some learning curve efficiencies, but we have some learning curve price changes. But as we go through it we're getting better and better every day and we are getting decent margins from that product.

I think that as we go forward with those guys there is a real opportunity we think to use some of our more advanced technology products which will give them an advantage and us an advantage and improve margins on a more advanced technology basis with denser products that we have now that we will get out there.

Okay, and then you have obviously talked a lot about McDowell. Can you just give us a quick update on how the margins and the growth are in the ABLE business?

Oh, ABLE. Bill, do you want to take that one?

Sure. The ABLE business has grown nicely. This quarter is going to be a little bit softer because of Chinese New Year, but we have had some really nice penetration with the ABLE product into our U.S. distribution, so we have had some favorable pricing. We have used a lot of the capital as John said earlier from Newark and used that in the product to really differentiate it. So we are very optimistic about ABLE going forward.

We did about in the ballpark of $4 million I think this year, Bob, in ABLE.

On a run rate, yes. We ended the fourth quarter on a run rate of about $4 million.

Run rate about $4 million. The year before they'd done about $2.2 million. Coming into this year, we're hoping to double that run rate by the end of this year. That is the ballpark of what our numbers say.

Okay, then just to make sure I understood this, it sounds like most of the issues with McDowell get resolved in the first quarter. They probably carry into the second quarter somewhat and then it's third quarter before we should really expect your target margin model to deliver? Is that fair?

Yes, and we know that. We're not bringing in a single unit of additional premium product. And so we really can bound with what we have in inventory. And the timing between -- we right now do not have a projection yet of time between the first and second quarter. We're taking the sales orders. We have to do this manually to some extent because we don't have an MRP system running down there. And to understand the timing between first and second quarter -- we are assuming in the first quarter the full impact and then if we do better than that, great. We will let you know.

Okay, and then the changes you've made operationally there from the management side, how does the sales and marketing side of that business look?

Jim, go ahead.

That side of it is stable. We anticipate growth. We had maintained the same salesforce now for approximately four years who demonstrated growth each year through McDowell. So I think that that's the most stable thing we have right now at McDowell is the salesforce.

Just to make a comment is that salesforce, they will only do better when we start cutting down lead times and being more responsive there and I think they are seeing it already. They will only do better.

The second thing Jim is doing is he is integrating -- there is no reason why a battery guy and an accessory guy has to go call on Fort Hood. He is integrating the salesforces under a guy we had running the battery side, Mark Matthews, in sales and marketing. Mark is now working for Jim integrating both McDowell and the (indiscernible) salesforce. From here on out you'll hear McDowell as a brand, not as an operation. We have really integrated it. On the business side under Jim and the operations side under Andy and under Bill.

Okay, thanks.

(OPERATOR INSTRUCTIONS). Having no further signals in queue, Mr. Kavazanjian, I turn it back to you for closing remarks.

Thank you, Debbie. I just want to say it has been and it remains our goal to be as transparent as possible and to indicate to you as accurately as possible what our business outlook is. We've heard from, as I said, we've heard from our shareholders and analysts and we are resolved to be much more prudent in our projections.

In the past we've tried to give you the most likely estimate including orders that we were probably less certain about receiving, so going forward our resolve is to guide you to our base numbers backed by orders in hand and we will let you know what the upside is to our forecast. Nothing in business is guaranteed, but we have heard the message and we are acting accordingly.

Nothing however is changing in our resolve to build this strong company and reward you, our shareholders, and build a company we can all be proud of. So I would like to thank you all for participating today and we really look forward to sharing results with you again next quarter. Thank you.

Ladies and gentlemen, thank you so much for your participation. This does conclude the conference and you may now disconnect.