Ultralife Corp (ULBI) 2008 Q3 法說會逐字稿

Good day and welcome to the Ultralife Corporation 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.

Thank you, operator. Good morning everyone. I'm Jody Burfening of Lippert/Heilshorn & Associates. Thank you for joining us for the Ultralife Corporation earnings conference call for the third quarter of fiscal 2008.

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 that 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 the formal remarks. Management will then take questions until 11:00 Eastern Time.

Before turning the call over John, I would like to remind everyone that some statements made during this conference call contain forward-looking statements based on current expectations. Actual results could differ materially from those projected as a result of various risks and uncertainties. These include worsening global economic conditions, increased competitive environment, and pricing pressures, and disruptions related to restructuring actions and delays.

The Company cautions investors not to place undue reliance on forward-looking statements, which reflect the Company's analysis only as of today's date. The Company undertakes no obligation to publicly update forward-looking statements to reflect subsequent events or circumstances.

More detailed description of the risks and uncertainties is contained in the Company's filings with the Securities and Exchange Commission, such as the Company's annual report on Form 10-K for the period ended December 31, 2007.

In addition, on today's call, Management will refer to certain non-GAAP financial measures that Management considers to be useful metrics and differ from GAAP. These non-GAAP measures should be considered as supplemental to corresponding GAAP figures.

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

Thank you, Jody. Good morning, and welcome to the Ultralife Corporation conference call for the third quarter of 2008. Joining me today are Bob Fishback, our Chief Financial Officer; Julius Cirin, our Vice President of Corporate Marketing and Technology; and Bill Schmitz, our Chief Operating Officer.

Today, we reported revenue of $68 million for the third quarter of 2008. These results put us on track to achieve our guidance of $130 million in revenue for the second half of 2008.

Operating profit was $5.3 million with an adjusted EBITDA of $7.1 million. Adjusted EBITDA is a non-GAAP financial measure for which the reconciliation with GAAP financials is on our website and in our 10-Q report.

The third-quarter revenue includes $41 million in sales in our Communication Systems business. This represents the substantial completion of more than $120 million in orders that we received in the second half of 2007 for advanced communication systems along with sales in other parts of the Communications business.

Gross margin in the segment was 28%, an increase over the second-quarter margin of 27%. We expect similar margins in this segment for the remainder of the year, and improvements next year as we enhance our sourcing agreements and start to reflect in our pricing the materials and logistics cost increases that have occurred since the beginning of year.

Rechargeable Product revenue was $8 million, and gross margin grew slightly from the second quarter to 22%. A worldwide shortage in rechargeable cells has caused significant price increases from suppliers and exerted pressure on margins before we were able to take pricing actions. We expect this segment to grow in revenue for the fourth quarter and next year, and margins to grow toward our target range of 25% to 30% over that time frame.

Non-Rechargeable Products revenue was down from the second quarter to $16 million, and gross margin was down due to costs connected with the refocusing of activities in our UK operation and a product-line transition in our China operation. In the UK, we're in the process of our changeover to an assembly, distribution, and service operation. We expect to see financial improvement from this in the first half of 2009.

In China, we're enhancing our product line and our production operations. While we will incur additional cost for this in the fourth quarter, this is factored into our guidance for the year. We will be introducing new versions of our ABLE thionyl chloride products -- lithium thionyl chloride products in the first half of 2009 with improved performance. Capital improvements in key areas of our process will also result in products that will be more robust with higher performance. These changes will enable significant increases in volume and profit in 2009.

Design and Installation Services accounted for $3.6 million in revenue. Gross margins ran at 19% as we made further investments to grow this business.

We're ready -- I'm sorry. Our Defense and Government business remains strong both domestically and internationally. During the quarter, we sold over $3 million in chargers, solar panels, and rechargeable batteries to the Government of Mexico, and over $1 million in Smart rechargeable batteries to the UK MOD. Both of these are for second half of 2008 delivery.

We sold over $2 million dollars in communications power accessories to a major US prime defense contractor for delivery early next year. And with CERDEC, the R&D arm of the Army Communications Command, we entered a $2.1 million contract to further develop, in conjunction with Mississippi State University, an advanced soldier hybrid portable power system.

In our Standby Power Services business, we entered into a master service agreement with a major commercial account for back-up power systems and services with the potential for a multi-year project for consolidation of their data centers. This contract has the potential to generate as much business over the next 15 months as our Stationary Power Services unit did last year, highlighting the power of our strategy involving our capability of serving national accounts.

We continue to invest in the R&D. At the AUSA conference in the first week of October, we had the worldwide launch of our Tactical Repeater System. With the addition of our Link Repeater System this is the first manned portable system that enables users to build field networks of portable radios. The portability and the Link capability allow radio networks to be built on site, on demand, and as needed, as the situation dictates. We've already made first shipments of the Link product, and there was interest from virtually every defense organization to which it has been shown.

We also formally launched RPS Power Systems in October, our brand of back-up power hardware solutions for mission-critical power needs in the telecommunications, utility, financial, and information services industries. RPS provides comprehensive hardware solutions incorporating energy storage and electronics for critical-power applications and renewable energy needs.

RPS will offer our customers an extensive range of market-competitive products including lead acid batteries, racks, cabinet systems, and accessories, as well as uninterruptible power supply systems, telecom inverters, and power distribution units. This launch is directly in support of our position as a key player in the standby-power marketplace.

Earlier this month, we also participated in the much heralded Wearable Power Competition held by the DoD. This competition involves both batteries and fuel cells, and started with almost 170 entrants. While the criteria included real operational metrics, it was also biased toward lower weight and did not include environmental stress testing, all of which gave great advantage to fuel cells. Even with all of this, we were one of three systems to make it through the entire competition, and only two fuel cells outperformed our system, and only because of 100 grams of weight difference.

Not only were we the top battery entrant by a large margin, we were also the only one that made it through all of the testing. And our system was still operating when the fuel cells stopped working, and it was the only product that finished that could be practically packaged in its current form for use today in the field. The technology that we used keeps us at the top of the pack in deployable performance, and we are already getting interest from advanced projects looking for state-of-the-art power sources.

We're reiterating our revenue forecast of $130 million and our operating income forecast of $10 million for the first half -- second half of 2008. And we're reiterating the preliminary revenue base for 2009 that we affirmed last quarter of at least $250 million.

The current economic situation has the entire world concerned. Even though today we have a profitable, growing, and vibrant business, we would be remiss if we didn't position ourselves to weather a slowdown. We've taken pains to keep our fixed overheads low and run lean operations, which means we're flexible and we can react to downturns in volumes.

In the US, we have handled this year's spike in Communication Systems volumes with the help of a flexible contract work force. Our UK operation is trimmed down, and our China operation has significant flexibility as well in its workforce. We have portions of our R&D work, production work, and services that are outsourced and can be brought in-house if necessary.

While we are prepared, we're also optimistic. Our business is founded on bringing value to important functions and mission-critical applications. Our products increase the capability of these applications and drive economies. And we believe, that in difficult economic times, we are a place that our customers turn when they want efficiency and value.

The steps we've taken in the past couple of years to diversify our customer base, broaden our product offering, expand our geographic coverage, and leverage our engineering expertise to enter new, high-growth markets, place us in a stronger position to not only handle a downturn, but to mitigate against one.

Our Standby Power business is strong, and even if there are market delays in implementation, we can grow it through gains in market share.

Our telematics business is expanding across car models, and we're implementing new designs that significantly reduce costs and that should provide growth, even in a market where overall car purchases are expected to decrease.

Our Defense business is growing very fast internationally, and our solutions bring expanded capability in power and communications in a world where the threats to security continue.

We have a solid balance sheet and are generating a significant flow of cash. As a result, the Board has authorized a share-repurchase program of up to $10 million of our stock. With our stock trading at a very low multiple of our cash flow, the imputed cost of that equity capital is far above our costed debt, even in our most pessimistic scenarios of the cost of borrowing. It is our firm belief that at our current stock price, it is in the best interest of our shareholders to repurchase stock from those who would like to sell at these prices.

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

Thank you, John, and the morning.

Earlier this morning, we released our third-quarter results for our fiscal quarter ended September 27, 2008. Consolidated revenues totaled $68 million, a $34.7 million increase, or more than double last year's third-quarter revenue. This growth was driven by sales of advanced communication systems in addition to higher sales of rechargeable batteries and chargers, and added revenues related to the 2000 acquisitions of Stationery Power and RedBlack Communications. Sales of Non-Rechargeable products were lower in comparison to last year, when we shipped a portion of a large order to an international customer.

Gross profit amounted to $15.7 million, an increase of $8.8 million from the prior year. As a percentage of total revenues, consolidated gross margins were 23% in 2008 compared with 21% in last year's third quarter. The overall gross margin improvement was led by our Communications Systems segment, which reached 28% compared with 24% last year on significantly higher sales volumes.

In our Rechargeable Products segment we reported 22% gross margins in the quarter, consistent with the same quarter a year ago.

Margins in our Design and Installation Services segment were 19% in the third quarter of 2008. As a reminder, this segment is relatively new as a result of the acquisitions of RedBlack and Stationery Power only a year ago.

The margins in our Non-Rechargeable segment declined from 19% to 12%, mainly as a result of an unfavorable sales mix and the transition at our UK operation from a manufacturing center to a distribution and service center.

Operating expenses totaled $10.4 million versus $6.7 million in 2007, an increase of $3.7 million. Approximately $1.4 million of this increase related to incremental costs acquired with RedBlack and Stationery Power, and $700,000 related to a greater investment in R&D. The remaining $1.6 million of the overall increase was attributable to higher sales commissions tied to the increased revenue, and generally higher marketing and administrative costs associated with running a more diverse organization.

Included in our total operating expenses in 2008 are approximately $1 million of non-cash expenses related to intangible asset amortization and stock compensation expenses compared to $1.1 million a year ago.

As a result of higher margins and the benefit of leveraging operating costs over a broader revenue base, we reported $5.3 million in operating income for the third quarter of '08 compared with $200,000 last year.

Operating margins were 8% for the quarter versus 1% in '07.

Below operating earnings, net interest expense for the quarter was a $200,000 increase -- was a $200,000 decrease from $500,000 last year on lower outstanding balances of debt and lower interest rates.

Our third-quarter income tax provision amounted to $200,000, reflecting mainly the alternative minimum tax on US taxable income after applying our applicable net operating loss carryforwards. We continue to carry a full valuation allowance against our deferred tax asset, so our income tax provision for the quarter was nominal.

Every quarter in accordance with GAAP, we review the valuation allowance against our deferred tax asset, and in this quarter we once again determined that an adjustment was not necessary. The important message to conclude from this is that our cash taxes this year will be very nominal as we utilize our NOLs.

In future years, we will be limited annually as to the amount of NOLs that can be utilized, in accordance with the Internal Revenue Code Section 382 limitation that we have spoken of the past. This limitation will not impact us in 2008, but the use of our NOLs after this year is estimated to be a minimum of approximately $12 million per year plus any unused NOL limitation from prior years. Taxable income above this limit will be taxed at a more normal rate in the range of 35%.

We reported net income of $4.7 million, or $0.27 per common share, compared with a net loss of $200,000, or $0.01 per share, last year.

Average diluted shares outstanding were $17.7 million, up from $15.2 million a year ago. This 2.5 million share increase is mainly the result of a 1 million shares issued in our limited public offering completed in November of '07, and 700,000 shares issued from the conversion of our $10.5 million convertible note in January 2008 that pertained to the financing of the McDowell acquisition.

In addition, stock option and warrant exercises during the period, as well as the potentially dilutive impact of unexercised options, warrants, and convertible notes had an impact on the overall increase in average shares.

Now moving over to cash flows. Adjusted EBITDA, defined as EBITDA excluding non-cash stock-based compensation expense, amounted to $7.1 million.

We generated approximately $5.5 million in cash from changes in working capital, as inventory levels and receivable balances declined, offset in part by lower accounts payable balances. We continue to show improved working capital metrics, as inventory turnover amounted to five turns per year on a year-to-date basis versus three turns for all of 2007. And our DSOs were 52 days cumulatively for the year compared with 55 days for the full year of '07.

With respect to our investing activities during the third quarter, we used approximately $700,000 of cash for capital expenditures and $300,000 on contingent earnouts related to prior acquisitions.

Our financing activities included a $6.5 million paydown on our revolving credit facility and $500,000 of payments to reduce our bank term loan. As we have forecasted, we ended the quarter with a zero balance outstanding on our revolving credit facility, and we had $5.5 million in cash. This compares to a revolver balance net of cash at the end of Q2 of $5.7 million, reflecting an overall change in our net cash revolver position of more than $11 million over the three-month period.

Looking toward the rest of 2008, we are reiterating our previous guidance of generating roughly $10 million in operating earnings on about $130 million in revenue for the second half of the year. This implies that our fourth-quarter outlook is approximately $4.7 million in operating income on revenue in the range of $62 million, based on our current backlog and anticipated order activity.

We expect to see revenue in our Communications Systems segment come down somewhat from Q3 as we complete deliveries on the sizable advanced communications orders we received in the second half of '07. However, we expect to see increases in Non-Rechargeable and Rechargeable product sales in addition to growth in our Design and Installation Services.

For the full year of '08, then, our total revenues are projected to reach nearly $270 million, practically double the $138 million in sales that we achieved in 2007, and our operating income for the full year is projected to be roughly $22 million compared with a $200,000 operating loss in 2007.

Our total adjusted EBITDA for 2008 will be in the range of $30 million.

For 2009, we are reiterating our guidance of generating a base of -- a base level of revenue in the range of at least $250 million.

Our balance sheet is strong. As I noted earlier, we have minimal debt on the books. Our debt-to-total-capitalization ratio was only 7% as of the end of our third quarter. Now, while we monitor the global financial crisis and how it may impact us, we believe we have put ourselves in a position to maintain sufficient liquidity as we continue to grow the business.

We've maintained a very strong relationship with our banks, JPMorgan Chase and M&T Bank. We're presently in the midst of working on a new credit facility as our current revolving facility is scheduled to expire at the end of January. As we go through this process, we realistically are expecting a slight increase in our cost of borrowing, but with our recent performance and our favorable outlook, we have put ourselves in good standing. We anticipate no issues with the banks in finalizing a new agreement, which we're targeting to have completed before we enter the new year.

We are -- as we disclosed in the earnings release, our Board has approved a plan to repurchase up to $10 million of our own stock, as we have seen the value of our shares decline over the past few months, similar to virtually all other public companies. We believe that our stock is a very good value at the moment, and we intend to take a structured approach to buyback, abiding by all the relevant restrictions in connection with the SEC Safe Harbor provisions.

We're in the final phase of an exceptional year for Ultralife. We continue to focus on growing our topline, improving our gross margins, and leveraging our operating cost structure to enhance our profitability. In addition, we will continue to diversify our products, services, customer base, and geographic presence to smooth out the variability in our revenue going forward.

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

Thank you, Bob. Now, operator, we would like to turn it over and open it up for question-and-answer.

(Operator Instructions) Ted Kundtz, Needham & Company.

A couple of questions for you. John, your talk -- I know last time we spoke, the last conference call -- was you were looking at the Communication Systems business really sort of in the range of $160 million in total this year, and then dropping down to the $110 million, reflecting the completion of that large contract. A, do you still feel that's the right number? I guess that's part of your $250 million goal.

And secondly, what kind of visibility do you have on that so far? And what do you expect the mix would be between the US and the international side of that business?

Okay. Some good questions. First, we haven't changed our outlook on that. I think if anything, because of the Repeater products, we're a little more optimistic about that segment.

In terms of SATCOM, there are -- there's still a multi-year SATCOM project going on. We know that it's funded in the supplemental, which has passed and passed out to all the services. We are expecting -- most of the contracting action is kind of quiet in October as the Pentagon dispenses the budget money to people and before it gets down to the different commands. So we are expecting -- I hate to always predict when the government is going to let contract. But we are expecting them to start letting contracts for that in the next few months. So we think that business for next year is in pretty good shape.

Internationally, there are some prospects for the SATCOM systems. Whether they happen -- but we're not counting on them in 2009. Whether they happen in '09 or 2010, I think some of the other people in the world who have manpack radios and vehicle-based systems -- allies that we have -- are looking at SATCOM-On-The-Move, and they are coming to us to look at our systems. So I think that's a potential for us doing better in that segment next year then we've projected.

On the Tactical Repeater side, we have some -- some of that is in our forecast for next year. But it's a huge opportunity. Outside of the US military, which does use handheld radios -- but outside of the US military, in a lot of the services in the world, it really is the predominant method of communication.

And there is -- like I said, there's virtually nobody we've talked to who isn't interested immediately in a portable repeater. Repeaters predominantly used to be big ground station installations, and then the portable ones really weren't transportable except from the back of a vehicle. And this is basically a suitcase. And so we're pretty optimistic about it. So I think there's a real opportunity there.

I think the work we did to do the Link Repeater, which let's us build networks of these, and both the SATCOM systems and stuff, right from a ground radio just makes it a pretty good value proposition to people.

So I think next year, I think we're pretty confident in our plan, and if parts of it don't happen the way we expect it, there's other parts we can make up with, because we have a pretty solid business there.

Okay. So more visibility or more confidence on the US side of the business than the international side, but hopeful on the international. Is that -- but with less visibility? Is that the (multiple speakers)

On the SATCOM -- on SATCOM systems I would say we're more confident on the US. But the Tactical Repeater, as I was saying, is -- that will be -- that's going to be more -- we're more optimistic internationally on that.

Okay. Another question. Just how much of your business is auto-related? What percent of revenue is that?

About 5% of our business is auto-related.

Where do you see that going next year? Is that -- with the designs you're getting, is that a possible increase, even despite this kind of anemic environment? (multiple speakers)

Well, we're expecting -- yes. We're expecting two things to happen. Number one, we're going to expand over more platforms. We see a big platform growth in terms of the number of vehicles that we're planned to go into. So the back-up batteries for our customers, which is a small percentage of vehicles, we expect that percentage to go up significantly, at a much higher percentage than anybody's most pessimistic predictions about where auto sales will fall. So we're not -- we don't have any huge number in it for next year, and I think we're feeling like it's okay. We're in pretty good shape there.

And the other thing we're doing is, with some of our customers we're doing some redesign. We've learned a lot about this business, and most of the customers came to us after they designed to systems, and so we had to come in after the fact. We've been working with almost all of them to say, gee, as you get to your next generation, here's how we can reduce your costs and the cost of the back-up, and also help ourselves, as well, but really bring them a little bit of value and help our margins as well. So we think that there's at least one customer where we'll be able to do that next year. So, yes, we are feeling pretty good about that. (multiple speakers)

Okay. It should be a growth business (multiple speakers)

I think we have a real -- very prudent number in there.

Okay. Great. One last question. Just on the -- and, Bob, it's probably for you. Just given your guidance for the fourth quarter on revenues of I think you said $62 million -- which doesn't quite get you to the 270, but -- and then looking at the operating income guidance, it would imply gross margins kind of moving up fairly nicely from the Q4 levels. But yet your comments indicated that you didn't expect to see much gross margin improvement until next year. So I'm just wondering if you could reconcile those two?

Yes. We would expect as we go into the fourth quarter we will see some improvement over Q3 in gross margins. Our operating costs we think will come down a little bit from the Q3 levels.

Oh, they will? Okay. Okay. That's how you get there.

Yes.

Okay. So gross margins up a little bit and costs coming down. Okay. Great.

Yes. Some of the work we've done in taking overhead out in some operations -- UK is an example. It takes some time before you start seeing that, and so that will happen.

And then the other effect is that we've moved our sales force to a little more of a variable comp plan over time here. So as volumes come down, commissions come down also.

Okay. Got it. And then just on your gross-margin target for next year, I know your longer-term goals. What do you think kind of improvement you could see -- if you could comment on that or not. I'm not (multiple speakers)

Yes. We're (multiple speakers)

Specifically.

Yes, Ted. We're not shy about it. Our goal -- we think it's very achievable to get gross margins up to the 27%, 28% level.

By next -- in next year?

I would say by the end of next year. We're putting a lot of investment now into, for example, growing our infrastructure in Standby Power, which is why the margins there are where they are. We think there's just a lot of headroom there.

A lot of the adjustments we're making in -- when we were primarily a non-rechargeable battery company, we've had 28% -- 27%, 28% gross margin there. And the things we're doing to restructure ourselves to get ourselves back to there in both the UK operation and in our China operation, we're making investments now that will pay back.

Jim McIlree, Collins Stewart.

Can you help me understand the tax issue again? If your pretax income is greater than $12 million, then you start paying a statutory rate on that incremental amount. Is that correct? Or is it, you feel $10 million, $12 million of taxes?

The latest calculation (multiple speakers)

And then you --

Says, first of all, that our Section 382 limitation is around 12. It might be a little higher than that. As you get into the detailed calculation, it could be as high as 13 maybe. Somewhere in that range.

Yes, 13 to 14; correct.

All right. And so above that, you pay taxes. If you don't use it in a particular year, you get a carryover. So for example, last year we didn't use it all, and we had a carryover to this year.

We didn't use it at all. Last year we had a loss.

We didn't use it at all. So it's $24 million then this year.

Yes. And based on some of the incremental calculations, that number in 2008 is somewhere in the range of about $30 million that's in a sense tax sheltered for 2008. And then anything above the taxable income that we report in 2008 that gets up to that limit will carry over to 2009, and so that added onto the base of a $12 million or $14 million minimum limitation for 2009 will shelter us for taxes initially in 2009.

And this is US taxes.

Correct.

So (multiple speakers)

And that applies to the pretax income?

Correct. Correct. We have some substantial carryover. We're making money in the UK, and we have the taxable carryforward in the UK, which we will utilize against those profits that accrue to that operation, and a similar situation to China as we -- when we start making money in China, we will have some carryforwards there as well.

That's very helpful. Can you give either in detailed or general parameters, what percent of your business in Q3, as well as all of '08, as well as all of what you expect -- or what you expect in all of '09 to come from military? And when I think of military, I am taking direct to DoD, direct to UK MOD, and all of your international customers, as well as to prime contractors, who then sell to US and international armed forces.

I can just tell you in kind of round numbers, we've been probably 70% would you say this year, Bob?

Yes. It's been heavy because of Communications Systems.

Yes. Military sales have been about 70% this year. Next year it will probably be -- our plans probably would put it in about the 60% range.

Yes, probably two-thirds.

Probably 60% or two-thirds depending on kind of the mix there.

Right. So that remaining piece would be the telematics, the 9-volts --?

Design and Installation Services.

Right. And then whatever portion of rechargers goes to the Commercial segment?

Right.

Then lastly, on the buyback, are you intending to borrow money in order to buy back stocks? Or is the intention to take excess cash and use that to buy back stocks?

Well if necessary, we would borrow money. Right now we have $5.5 million in cash at the end of the quarter. We would anticipate being close to $9 million to $10 million at the end of the fourth quarter. Unless we made some big capital expenditures or spent money for an acquisition or something, which I wouldn't comment on right now, we wouldn't -- we probably wouldn't be able to buy that much stock before the end of the year.

So unless we did something different in terms of other big expenditures, we likely wouldn't be able to -- we wouldn't likely go into our borrowing line. I don't know -- it kind of depends on the price of the stock we buy it at, and we -- as you know -- or Mike should know -- there's a limitation on how much we can buy -- 25% of the average trading volume over a period of time and stuff, so -- per day. We can't buy -- we don't -- during self-imposed blackout periods we don't intend to buy, and we wouldn't buy -- stuff like that.

So in a practical since we wouldn't end up borrowing. Is it possible we would? Yes, it's possible. But in a practical sense we likely would not end of borrowing to do it. But it's -- and like I said, unless we had some other major expenditure that came up.

But take that to mean we're not against borrowing to buy back the stock.

But it's not necessarily the plan right now.

Exactly.

Okay. That's helpful. Thank you very much.

Richard Baxter, Ardour Capital.

I guess with regard to the economic environment, can you talk a little bit about your visibility into -- your sales visibility into some of the different segments? I know they are different depending on contracts and such.

And then I guess the follow-up to the second one would be, is your growth into the RPS Power solutions -- sort of the difference that strategy is with some of the other stationary power targets you have? Or other businesses you have?

Sure. In terms of visibility, in the battery world, both the commercial and the military battery world give us pretty good visibility. We've had our ups and downs with visibility from defense logistics agencies, but that mostly goes around their procurement cycles and when money is appropriated, but we're pretty much booked out through the first quarter for them. So we have pretty decent visibility in the beginning of the year, and run rates have been fairly stable over the last few years there. So I think our predictability is good.

Same thing with our other commercial business and our telematics business. It's been very predictable for us and very smooth. If it goes up, it goes up. It goes down, but it's smooth. And on kind of a running average, we've been able to plan and predict that pretty well.

In the military defense business for communications products, I think our normal communications sales run -- kind of our base business, $30-million-plus-a-year business runs very, very predictably. A lot of that is on the GSA Price List. I can't always predict what parts we're going to sell. But it seems to be a very good, steady volume. It's a lot of replacement business. It's enhancement business. It runs pretty well.

The big project stuff, notably this year SATCOM. We were blessed. We got -- we booked an entire year the beginning of last year. I'm not sure that that's going to happen that way again. But I expect to have a pretty -- we have pretty good visibility of what's in the budget. We know what's going through contract cycles.

Can something be interested and changed? Yes, absolutely it can if priorities change. But we're involved in so many different parts of that business now that if we would had told you a year ago that there would be another tranche of -- fielding of IED jammers, that threat went down. Instead, SATCOM systems became the important procurement. And we play a part in both of those. So one went down and the other one went up.

But I would tell you that I think we have pretty good visibility. We know what -- the vehicle plans are pretty solid. We know what communications products are going in them. We know that they're going to use SATCOMs for them.

So again, do I have a ton of backlog? No, because we've run through defense budget cycles, but I think once -- with the money dispensed and once normal contracting processes go through, we're going to be in pretty good shape with visibility for next year.

On the power side, we generally book out -- our fourth quarter that we're in right now and part of our first quarter is already booked. We book out three to six months, because crews have to be scheduled and people plans mostly rotate around facilities plans and stuff. So we have very good predictability in that business, and our customers generally share their plans past that with us. So like I said, I think we're in a mode now where we have very diverse business with pretty good visibility there.

In terms of RPS, that's merely a recognition of the fact that in our Standby Power business we use component parts, and we buy those from people outside. But like almost everybody else in that business, we're also -- can operate as the distributor for those parts.

One of the differences between us and some of the people -- and some of the other companies in the business is, we buy direct. We are a battery company. We buy direct. A lot of the people who do installation of these kinds of systems buy through distribution, which puts another profit center and another step in the process. We generally buy direct, our products direct.

So if we have products in inventory that we buy direct, and we can do that, and there's people there who are looking for somebody to distribute through, we also can be a distribution channel to that marketplace. So RPS for us is a recognition that we buy batteries direct from some people. And there is another tier of distribution in that marketplace that other people buy from. Why shouldn't we be that also? And that's why we've done that.

Colin Rusch, Broadpoint AmTech.

Congratulations on the quarter. Can you give us an update on your plans to expand the technology portfolio?

Yes. I think you usually ask me about Standby Power; right?

Well, Standby Power in particular, and then any other areas would be great.

Well first, I will just go quickly through a couple of things. First, in the battery world, we have access we believe to leadership technology in rechargeable cells. So we're bringing new versions of different products we have. For example, the 2590 is the rechargeable version of the BA-5390 used all over the place. We now have -- we must have -- what, Bill? Six or seven different versions of it?

Yes.

We have versions with 2.6 amp power cells, with 2.9 amp power cells, with 2.4 amp power cells, Smart, not-Smart, Smart and submersible (multiple speakers)

Different pinouts.

Different pinout versions for people. So we keep expanding to match what people need in their applications.

We're also -- you will also see us take the Smart technology and put it into non-rechargeable batteries. There applications out there -- things like unattended ground sensors -- that are asking for it, and we're starting to do that now. So that's a whole new expansion in that battery world, as well as starting to put our 13.5 amp-hour D cells into products as well, to push the technology capacity-wise in non-rechargeable. So in the battery world we just keep pushing the limits of technology and packaging.

In the communications world, I think the Tactical Repeater and the Link Repeater are our real focus here. And people have some particular needs. The Link Repeater actually has some really interesting ways to connect -- it's the way -- instead of going radio-to-radio, you can go to the Link Repeater and go outside of that radio network to a SATCOM link or to some other kinds of dedicated local network links, and so we're getting some really interesting queries on those. And as we start getting that product out there, I think you'll see us customize that.

And one of the things we did when we bought RedBlack Communications is we acquired a first-class capability for communication systems software and hardware, and they did the Link Repeater product, and they are participating in doing some of these systems, which involve actually some software capability on top of the hardware. So you will see us push more into more complex systems, maybe customized for some particular needs for people in that area.

In Standby Power, besides expanding our footprint to serve the customers that we're attracting, you are going to see us start to move lithium-ion batteries next year into that field. It will be -- first targets will be things like maybe central office applications in telco, where there's a real need to save space and get more back-up time, mandated by the post-Katrina FCC ruling -- which is expected to really hit in 2009 -- mandating people to double their capability. And these people have installations where they don't have more space, and it's not just a more robust solution that you can monitor and it will last longer, but save a significant amount of space with it.

But also a lot of -- some of the unattended applications, not just in -- we've talked a lot about unattended things like muxes, multiplexes that are out there for cable installations, or fiber hubs. But also monitoring for water supply. We've seen a lot with petroleum pipeline, water supply, where there is monitoring, and where systems -- mission-critical systems for those kinds of utilities have to be backed up. So you will see us move lithium batteries into there, and we have some active design work going on there as well. So I think that's where you'll see it the most.

We are also looking at a lot bigger things to work at. But we're also looking at larger-format energy storage. And we have access to some technology that we think is pretty interesting for those kinds of things. And wind and solar farm solutions -- initially, we've targeted kind of the micro-grid applications of those, not the real huge installations, megawatts. But they're getting our attention because people are calling us. They are really not getting good solutions.

People do a sizing of a back-up energy storage for wind power. Wind power can't exist without energy storage, as you know. And they look at lead-acid batteries, and they find out that they can really only discharge them halfway. So with the capacity they have, they really have to double it. And then they look at the footprint and the cost and the weight, and trailer trucks full of these things. So long term, I think you are seeing it, and we will look at that.

And then the other thing that you will see us do is in portable power. We showed it at our annual shareholder meeting. Our Analyst Day we'll show it also. We had it at AUSA. We have a fuel-cell-based charger. And our partner is finishing off the design of the product there, and the fuel-cell component of it.

We will have that in the market. It's basically a charger unplugged -- same charger box that everybody is used to, but there's no plug in it, and it charges batteries. And it does it because it's got a fuel cell with a replaceable chlorohydride pack. We think that -- we will have that in the market next year, as well as, we're doing a lot of work, as I said, with the project with Mississippi State on hybrid fuel cells.

And we're doing some work on solid oxide. I think we have a real interest in solid oxide as a way to get two to three times the capability -- I'm sorry -- efficiency of using fossil fuels as a diesel generator, as something that's going to be real important in the future, because the oil price may be down, but we all know, in the long term, it's going up. It's as simple as that.

Okay. Great. And then, how should we think about the potential for lower material prices flowing into the income statement? And could you just help get me up to speed on the supply chain management and the rate at which you contract prices for materials?

Yes. I think we've said we've seen some increases over the year, and we've probably been -- between freight and materials prices, we've probably seen increases in the 1% to 2% of effect on our P&L from those. And we're just now getting to pass along some of those costs because of contracts that we've had.

So we're really not seeing decreases in prices of basic materials. If we get them -- we're obviously keeping our eye on this, because it's abated and we all know commodities prices have come down. It's a question of will we see that in our numbers?

We buy aluminum, we buy manganese dioxide. We buy lithium metal. It's a question of whether -- can we get that reflected in those. We've had some slight increases. Can we roll them back? We haven't anticipated that yet, Colin.

Where we do have some real opportunity is in some of our communication systems that use a lot of transformed products. So some of the metal frames we have, the cost of the metal is only 15% maybe of the total cost of the product. So commodity price changes aren't going to affect it that much. But that says that there's a lot of value-add in there, so there's opportunities to really look at different sourcing for those products.

And our electronics product. In our amplifier line we're looking at some new technologies in transistors that can help us. And certainly the more we have electronics-based products, the more we can take advantage of what people are really used to, which is prices coming down, costs coming down in electronics.

So right now, we have planned in next year to get some price help -- cost help -- price help with people. We haven't planned -- we've planned some very small price increases in our business plan. If we can hold those back or drive those down, that will help us. We do have some plans, as I said, in communications products. We are going to improve those margins with some different sourcing on of some of the electronic components and some of the heavy metal transformed parts. So that 28% -- our goal is to get that over 30%, and we think we can do that next year.

[Jimmy Kim], RBC Capital Markets.

Kind of related to the last question, you talked about managing your fixed costs -- or keeping your fixed costs low. I was just wondering what percent of your COGS are fixed costs and what percent are variable?

Probably -- I do know. Bill, what were there, about 25% of overhead in our product costs?

Yes. Because typically we run the model at 25% overhead, 25% labor, 50% (multiple speakers)

And I would say probably half of that is -- I would call fixed, and half of that is variable.

I'm sorry -- so overall, 50/50?

No, no. 25% of our cost of goods is overhead. And of that 25%, about half is fixed and half is variable.

Most of the fixed is true fixed. It's not like a step-fixed cost. It's true fixed. It's infrastructure.

I see. Thank you very much. That was my only question.

Steve Sanders, Stephens, Inc.

Good quarter. John, could you come back to the MSA agreement that you talked about? I think you made some comments about the revenue potential there over 15 months being comparable to what Stationary Power did in '07. What was that number in '07? And what are the milestones to get visibility on that contract?

The master service agreement project I talked about?

Yes.

It's really -- it's pretty straightforward. We're seeing a lot of people consolidating data centers. Data centers -- people who have nine data centers wanting to go to three. And what they're realizing is they can consolidate operations. They are realizing that they can do better on energy, infrastructure, things like air conditioning and such, and that the associated increase in cost of communications isn't going to really -- it isn't going to be that much.

So we have one customer, who doesn't care to be told who they -- just doesn't want us to say who they are, who has asked us to participate in their consolidation of data centers, and we're doing one of them in the fourth quarter. And with all of these things, the revenue -- in the Standby Power business, revenue sometimes is tough to predict quarter-to-quarter in that we have completion criteria, and we very studiously watch the revenue recognition there. So what we may do a lot of work in the fourth quarter on one part of a project, and because there is acceptance criteria, may not be able to take the revenue in the first quarter. That's why I kind of had to say over a 15-month period time.

But we will probably do $2 million, $3 million -- $2 million worth of business with them in the fourth quarter, and that potential is there over the -- per quarter -- over the next year. So you do the math, and it's kind of $8 million, $10 million worth of business there on stuff that's planned out, that we have visibility on, that -- as long as we perform, it's pretty much our business.

And Stationary Power services in 2007 did $9 million in business. This is just one account, and it's a model and the kind of account that we have an eye to doing more of. And there's other people out there doing a similar thing. And for us, it's being able to match up -- this just happened to be one where they were in the territory that we already serve. And there are other territories that they are in, that this will prompt us actually to be able to plan to expand into some other geographies, to be able to serve this particular customer.

We have similar discussions with other customers about what they're trying to do, and then to serve them, where we would have to be. And that's really driving our strategy of where we expand, as well.

Then, Bob, I think you talked about the year-over-year weakness in the primary business, being tied to a particular project, basically a comp. But year-to-date, can you talk a little bit more about the trends in that business and how we think about that going into 2009?

Yes. Overall, we've seen some decrease in overall sales in that business. We -- that business, the Non-Rechargeable business, tends to carry a lot of our overhead infrastructure. So how we allocate those costs going forward is something we are taking a hard look at.

But we had some significant projects last year that had -- that carried some high margins on it with some -- particularly international sales -- that have not recurred, at least at this time this year. So we've had some incremental material costs with higher energy and so forth. And that's driven our current gross margins down a bit.

Looking ahead into 2009, as we make some changes with our UK operation in that transition, shore up some of the product line issues at China, we expect those numbers will come back into the 20-plus-percent range.

Bob is being kind of nice about it, certainly nicer than I would be about it. We have some contracts with some auto companies, and we have contracts with the government that's been the majority of this business this year. And our 9-volt customers that -- those contracts primarily expire at the end of this year, and then with the government in the first half of next year, where we couldn't pass along cost increases as price increases to them. That is a big chunk of it, Steve.

Then we are flowing -- as we transition to UK, there are some costs still there that have to go somewhere. And because we were assembling non-rechargeable batteries, they have to go into that product line right now. And so we are burdened by that a little bit, as well as in China, we're making -- we're holding back some things and making some investments because we're doing this whole new product line. It's as simple as that. So this is the time to do it. We have strong business in other areas. And we've got to take those expenses now.

And as we think about 2009 -- and I know you don't want to get real specific at this point, but based on what you see right now, how does the first half versus the second half look?

We don't -- I wish I could tell you we had visibility of that. If you ask us right now how we would plan it, we would pretty much say it's pretty flat. We don't -- (multiple speakers)

Okay, and obviously the question is (multiple speakers)

We're not going to start at $50 million a quarter and go to $70 million a quarter.

Okay. So the $110 million on Communications and some of the other businesses feel like they get off to a pretty solid start in 2009?

Oh, yes.

Without you having to win any major contracts here in the next month or so?

No. We need the next tranche of SATCOM systems, for example. If those contracts got delayed until February, that would be -- that would have an effect on us, but it wouldn't be anywhere near the effective of this year, and then there would be a lot of vehicles getting produced that wouldn't have radios in them. So we don't -- we're pretty confident that that's not going to happen, but we need a few -- we need people to place orders for things. But in the other areas, we're pretty well booked.

That's it. Thanks very much.

There appears to be no further questions from the phone lines at this time.

Well, thank you everybody.

Some closing comments. We feel that the prospects for this Company have never been brighter. We have virtually no debt. We are generating cash, and we really see long-term growth in our products, markets, revenue, and profits.

While there's concern about the general state of the world economy, we think the strength that we have and really being focused in our customers' applications, and bringing them products and services that make them more efficient is what's going to enable us to grow and prosper.

I want to remind everybody, on November 13 we're holding an Analyst Day at our New York, New York headquarters. And for those of you who won't be attending in person, or for other interested parties, it will be web cast, and details will get posted on our website.

So thank you, and we look forward to talking with you again next quarter.

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may disconnect at this time.