Ultralife Corp (ULBI) 2009 Q1 法說會逐字稿

Good day, and welcome to this Ultralife Corporation first-quarter earnings release conference call. At this time for opening remarks and introductions, I would like to turn the call over to Ms. Jody Burfening. Please go ahead.

Good morning, everyone. This is Jody Burfening of Lippert/Heilshorn & Associates. Thank you all for joining us this morning for Ultralife Corporation's earnings conference call for the first quarter of fiscal 2009.

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.ulbi.com, where you will find the release under Investor News in the Investor Relations section.

A replay of today's call will be made available starting at one o'clock today through 1 PM on May 7. To access the replay, please dial 800-203-1112, passcode 278-4675.

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

But 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 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, 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. A more detailed description of such 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 ending December 31, 2008.

In addition, on today's call management will refer to certain non-GAAP financial measures that management considers to be useful metrics that 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 and welcome to the Ultralife Corporation conference call for the first quarter of 2009. I have joining me today, 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 $39.8 million for the first quarter of 2009, and an operating loss of $2.3 million. Compared to last year, when we were starting to fulfill more than $100 million in advanced communications systems, revenue declined.

Revenue was also lower than the fourth quarter due to continued delays in contracting associated with funded government programs. Additionally, revenue in Non-Rechargeable Products was down from last quarter.

The significant decrease in revenue in Communications Systems had a negative effect on operating income, and was the primary cause of the quarter's operating loss. In Communication Systems we still expect the award of significant business, particularly in the area of SATCOM-on-the-Move System.

Updating of the DoD fleet, replenishment of worn-out vehicles, and deployment of new platforms is budgeted and proceeding. These vehicles systems are all planned with SATCOM communication. A severe shortage of contracting officers, combined with high levels of new activity, and new working relationships with new civilian leadership, has caused any delay in the issuance of contracts.

We expect this situation to improve, but cannot count on the delays to be caught up by year's end. We do expect that one of the remedies for this will be more multiyear contracts, eliminating the need for annual renewals.

Although our other business segments are relatively stable, in the context of a weakened economy, inventory corrections are restricting growth. In our Standby Power business in particular, price erosion in component parts, driven by inventory liquidations by our competitors, had a negative effect on margins.

In the Design and Installation segment -- the Installation Services Segment, which is primarily driven by Standby Power, gross margin was 8%. While we have continued investment and expenses related to our expansion into a national organization, severe price competition in component parts led to these compressed margins.

During the quarter we made progress toward our model of integrated sales of design, installation and maintenance packages. And we expect to ameliorate a good deal of this in the second quarter.

Non-Rechargeable Products continued to show strong demand, despite a small drop in our 9-Volt business and continued weakness in automotive telematics due to lower vehicle demand. Telematics revenue was down from the previous quarter because of the extended shut down of production at the beginning of the year.

We have started shipments again, and the lower level of production has been factored into our guidance. Although we had a slight drop in revenue of certain military product, this was based on timing of production lot releases, and bookings are strong with almost two full quarters in backlog.

Last Friday we were notified that as a result of a competitive procurement we have been selected as the new battery supplier for the main communication system used by the UK Ministry of Defense. This involves chargers, as well as multiple battery types. And we will commence shipments in the third quarter. The program is managed by a prime contractor, and orders will come through that contractor.

Rechargeable Products sales were still strong at almost $14 million, fueled by strong demand for handheld radio batteries, and from an order for Land Warrior batteries and chargers. With the award of the communications battery business from the UK MOD, we expect continued growth of our Rechargeable segment this year.

As we look forward, we expect that Rechargeable Products will be an area of considerable growth. The economic stimulus package passed by Congress gave considerable weight to alternative energy, with R&D support, implementation funding and tax credits. Much of this represents an opportunity for our Standby Power products and services, but it is tremendously enhanced by our ability to design and deploy advanced lithium ion rechargeable batteries in place of traditional lead acid batteries.

For example, in rural broadband expansion lithium ion can backup infrastructure in remote installations, where longer life remote monitoring, high temperature resilience, and a smaller footprint will make an economic difference.

Along with solar generation and standby power installations, lithium ion batteries can store energy and deliver it back when needed over deep discharge cycles 100 times better than lead acid batteries, without the cost of air-conditioning.

While we got off to an exceptionally slow start to the year in our Communication Systems business, we took further steps to grow our capability when we acquired the assets of the tactical communications products business of SAIC.

Headquartered in Virginia Beach, Virginia and producing under the brand name of AMTI, this business designs, develops and manufactures amplifiers and accessories targeted at the handheld radio business. Its customers include militaries, law enforcement, and the ISR -- that is intelligence, surveillance and reconnaissance -- community worldwide.

This business gives us a more complete product line with which to address the handheld radio market, which is the mainstay of many of the international military organizations with whom we work.

For 2009 we are adjusting our revenue guidance to $230 million, in recognition of the contracting delays that we are assuming will not be totally recovered this year. We still expect contract awards to be made this quarter.

We also are adjusting our operating profit number to $13 million, in recognition of the slow start that we have had in Q1. We are still confident in the strength of demand in our markets and the business model of our Company.

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

Good morning everyone. Earlier this morning we released our first-quarter results for the fiscal period ended March 29, 2009. Consolidated revenues totaled $39.8 million for the first quarter, a 20% decline over the $49.6 million of revenue reported in the same period a year ago. The $9.8 million decrease resulted primarily from lower Communication System sales versus last year's results, which were driven by three large orders we received in the latter part of 2007 for SATCOM-on-the-Move and other advanced communications systems.

Offsetting the $19.8 million decrease in Communication Systems, in part was a $7.1 million increase in Rechargeable Product revenues, due to strong demand for batteries and charging systems from US defense customers. Non-Rechargeable revenues rose $1 million as a result of higher shipments of BA-5390 batteries, offset in part by a decline in sales to automotive telematics customers, most notably General Motors.

Revenue in our Design and Installation Services segment rose $2 million, mainly driven by the added revenue base provided from the acquisition of U.S. Energy Systems in the fourth quarter of 2008.

Gross profit amounted to $7.8 million in the first quarter of '09, a decrease of $3.1 million from 2008, primarily related to the decrease in consolidated revenue. As a percentage of total revenue, consolidated gross margins were approximately 20% in Q1 2009 compared with 22% in last year's first quarter.

While quarterly margins improved in our Rechargeable Products segment from 18% last year to 25% in 2009 as a result of higher sales volumes and favorable product mix, margins in our other three segments declined.

Non-Rechargeable gross margins declined from 20% to 18%, due generally to lower production volumes that resulted in unfavorable overhead absorption.

Our Communications Systems margins for the first quarter of '09 were 25%, down slightly from 26% last year, mainly related to the decrease in sales in this segment.

Margins in the Design and Installation Services segment where 8%, down from 12% last year, and well below where we had been anticipating. This segment's margins were weaker than expected due to price competition with component suppliers, relatively low margin jobs that carried over from year-end, and ongoing integration efforts related to the U.S. Energy acquisition.

We expect to be able to significantly improve margins in this segment over the next quarter or two, as we focus on selling the value we provide to our customers, encompassing not only the products we sell, but also the service component that is so critical to the end users.

Operating expenses for the quarter totaled $10 million compared with $8.5 million in 2008, an increase of $1.5 million. This increase was mainly attributable to higher R&D costs associated with the development of new products, higher selling and marketing expenses related to the development of the Standby Power business, and generally higher administrative costs.

Overall, we reported an operating loss of $2.3 million for the first quarter of '09, compared with operating income of $2.4 million in 2008. Below operating earnings, net interest expense for the quarter was $200,000, a decrease from $300,000 a year ago, due to lower levels of debt and lower interest rates.

Our first-quarter income tax provision was nominal, amounting to $100,000 in deferred taxes, as we continue to carry a full valuation allowance against our net deferred tax asset in accordance with GAAP.

We reported a net loss for the quarter of $2.5 million or $0.15 per common share, compared with net income of $2.4 million or $0.14 per share last year. Average diluted shares outstanding were 17.1 million shares, down slightly from 17.4 million shares a year ago, due to the share repurchase program that we initiated six months ago.

Moving over to cash flows, adjusted EBITDA, defined as EBITDA excluding non-cash stock-based compensation expense, amounted to a negative $400,000 for the first quarter. Included in EBITDA was $900,000 in non-cash expenses related to intangible asset amortization and stock compensation expenses, in addition to $900,000 for depreciation.

Changes in working capital resulted in a use of cash of approximately $6.3 million, mainly due to the buildup of inventory as we prepared to deliver on anticipated contract awards. As a result, our working capital metrics experienced declines, as inventory turnover amounted to 2.6 turns for the first quarter, versus an average of 4.6 turns for all of 2008. And our DSOs were 63 days for the first quarter, compared with 53 days for the full year of '08, as we have seen a slowdown in payments from customers due to the general economic conditions.

With respect to our investing activities during the first quarter, we spent $5.7 million in cash for the assets associated with the AMTI brand that we acquired from SAIC in late March. In addition, we spent $1 million related to the final incentive earnout payment tied to the performance of RedBlack Communications, and approximately $400,000 for capital expenditures.

Our financing activities included an outflow of $3.3 million for cash used to repurchase 416,000 shares of our common stock, in connection with our share repurchase program that was authorized by our Board from October 2008 through the end of April 2009. In total, during the six-month period we have spent $5.1 million to buy back a total of 628,000 shares of our stock at an average price of about $8.15 per share.

In addition, financing activities during the quarter included $600,000 of payments to reduce outstanding debt, offset in part by $200,000 of cash received from exercises of stock options and warrants.

Overall, we borrowed $16.6 million from our revolving credit facility during the quarter to finance our overall cash needs. As debt is relatively inexpensive when compared with the cost of equity, we believe that incurring debt in the short term is a prudent approach to financing our growth at the present time. As a result, our cash balance at the end of March was $900,000 compared to $1.9 million at the end of December.

As we progress into the second quarter of 2009, we are lowering our first year our full-year guidance for consolidated revenue from $250 million to approximately $230 million, due to the delays in government contracting in the first quarter.

We expect that our consolidated gross margins will improve throughout the year, as sales volumes rise and we are able to take advantage of sales of higher margin products, as well as improving margins through better manufacturing efficiencies and procurement opportunities.

We are working diligently to control spending across the board; however, our operating expenses are currently projected to increase somewhat over the Q1 level as we absorb the operations of AMTI.

As a result of the foregoing, we have revised our outlook for full year 2009 operating income to be approximately $13 million, down from our previous guidance of $20 million.

As we have addressed in the past, our involvement in the government defense business subjects us to revenue and earnings fluctuations from quarter to quarter. This first quarter was clear evidence of this. And we work with our customers every day to anticipate their needs and to put ourselves in a position to maintain a competitive advantage by being able to deliver our products and services to meet stringent delivery schedules.

In spite of the short-term setback we saw with order delays in Q1; however, we remain optimistic about our prospects for the remainder of 2009 and beyond.

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

Now I would like to turn back to Ben and ask him to open it up for questions.

(Operator Instructions). Steve Sanders, Stephens, Inc.

This is Trey for Steve. I was hoping you could help us connect the dots on the revised $230 million in revenue guidance coming off the $40 million quarter. How does that growth come in in the various segments, and what visibility do you have on that?

It is pretty straightforward. We expect this year to be around $60 million in SATCOM systems. And that came out about $15 million a quarter, and it didn't happen. It didn't happen because of delays. It is still budgeted, planned. We have -- it is a little frustrating in terms of the control over it, because we do this through a prime, and the prime has got to get the contract award in place with the government before we can start shipping product.

So we have had a couple of false starts here. We did not want to get our supply lines messed up. We had problems last year when we got some relatively large orders, and it took us a good six months to get supply lines in shape. So we have kind of absorbed that -- the shock to our supply lines by continuing supply.

But I think it is pretty straightforward. You contribute about $15 million of that. We were down a couple of million dollars in delays because the slow startup of the auto industry. And then we had a couple of timing issues in terms of lot acceptances on shipments. 9-Volt was a little lower, maybe $500,000 lower. That is the best I can bridge it.

I will also say that we were -- in terms of the UK MOT program, we were probably a quarter later than we were told that was going to happen also. That solicitation was done in the fall. It was supposed to have been awarded in January. So that was a good three or four months behind.

I guess assuming that sales are going to trend up in some steady level for the remainder of the year, could you talk about how you see revenue and margin in 2Q versus Q1, or the second half versus the first half?

I think last year we went to annual revenue guidance purely for this reason. If we get contract issues in place for the SATCOM systems, depending on when they get in place, and the ability of ourselves to get these things out, QA'ed and shipped -- because there are government Q&A requirements to any shipments.

The thing even in battery shipments. One of the reasons we were down a little bit is because we do lot acceptance. And if a full lot is not ready to be tested by the government, then it spills over to the next quarter.

We believe we will do that $190 million over the next three quarters. It won't necessarily be total level, but our assumptions are it is reasonably level. The fluctuations are going to be more from timing than anything.

Then on the spares order then, relating to your commentary there, is that something that, I guess there wouldn't be the delay or lag to ship out once that finally goes through, whatever the process is?

The government contracting office made a decision back in the fall to -- instead of placing a separate order for spares, to put that under a total multiyear contract. And that is what we have to wait for. And again, that is not with us, that is a contract between the government and the prime, who is managing the program for them, and we have to wait for that to happen. So that is all under the same multiyear IDIQ contract.

And then just to clarify the comment in the release and on the call around component suppliers, you're talking about your actual competition and not the components that you use. So -- because that would be a little counterintuitive if obviously your suppliers are having competition, you would think that would drive price down, and therefore it would benefit your margins.

Yes, it has been in our competition. When we go into semi-power installations, the parts components to those is anywhere from 50 -- they could be as high as 75%, if it is just a plain battery swap out, of the initial installation work.

And everybody is getting compressed in cash flows from suppliers to distributors to the installer's themselves, who may hold some inventory. And we saw a tremendous, tremendous flushing of inventories. People selling -- we had people selling batteries that we buy from other suppliers -- known suppliers, they are selling them below our cost. And sometimes we think below their own costs, purely to get cash.

It can't go on forever, but it is just something we face out there in the marketplace. We have moved more to a model of not selling parts, but selling parts bundled with service. As we do that, we are able to handle that a lot better over time.

We embarked on that program sometime in February and March when it became apparent to us what was going on. It is a little early, but April results have showed a marked improvement, just because of the way we package things for people. Things that we can do that others can't, which is bundling services together with our product.

It is going to help, but until this stops -- there are still people with inventory out there who need to get into cash who are pushing it through. This is, like I said, manufacturers, distributors, everybody in the chain.

That was helpful. Thanks, guys.

Ted Kundtz, Needham.

Could you just go back over -- John, you said the SATCOM was really the -- there was no business in the quarter for that? You were expecting $15 million and you got nothing?

There was zero.

Zero, okay. I guess the question really is -- and this is a follow-up on a prior one -- discussion, what is your confidence level of that really ramping back up in this quarter? And -- or does everything just kind of get pushed out?

What we have done is assume everything gets pushed out. All I can tell you -- I don't know what the production levels on existing contracts are. I can tell you a few things. First, when we have an IDIQ contract in place, like we do for certain of the battery types, we get good, predictable flow of orders. We can plan them; we can do them.

Last year in the SATCOM systems we got one big order that we scrambled to get done first. And it was done as a sole source procurement, urgent need, go get it. Now they are trying to put in place a multiyear contract vehicle, so we don't have that happen again.

But on the front end of it, it is just taking an extraordinarily long time for the government and the prime to get this put in place. I can't even speculate about what it takes. I know the pressures though that are on contracting officers, both internally and just plain old workload, that is pushing this.

But this is one of these things that we have been on the edge of our seats day-to-day ready to move on since -- literally since the fourth quarter. Because we know the demand is there. Because we know the Commands -- people who are assembling parts need what we have.

But you also see some of the other programs sliding. There is a program that hasn't been awarded yet for the MATV, they are calling it. It has had a protest. It has been delayed. Things are getting delayed because there is a little -- there is a contracting bottleneck going on in the military right now that -- again, I can't speculate as why, except to say, I think there is a heavy load. And I know that they are down a significant number of contract officers right now.

The reason we adjusted our guidance is not because we don't believe we are going to get an order, but we think -- I can tell you, if we get an order, we can catch up the rest of the year. That is not the issue. The issue now is, gee, are -- some of the vehicle programs moving a little slower, because if it is affecting us, it is affecting others. We talk to others in the industry. We go to industry consortias and stuff. Nobody is confused about the budget. Nobody is confused about the needs, but things are taking longer.

I guess the risk is that if this doesn't come in in this quarter and it just gets delayed into -- and there is another shortfall in the second quarter, because it gets pushed over into the third quarter -- so that is a possibility. Because you don't have the order yet, and you don't really know when it is coming.

It is always a possibility until we get it. We are very cognizant of it. All I can tell you is we know what the demand from the Commands is for this, and it is becoming reasonably urgent. All we can hope is that that spurs people to come together and get this done faster.

To some extent -- and again, I don't know what the loads on particular individual people in the contracting community are, but I know across the board they are heavy. And to some extent then they may to raise to an urgent need to become the priority for the contracting group. I don't know, because unfortunately we have to work through a prime on this. This is the way we do it. This is the way we run this business. And we have to wait for them to get through that.

It is always a possibility. It is not our belief that it will take that long, but it is always a possibility.

And that is the biggest risk to the balance of the year, it sounds like. The other things you feel like you're fairly comfortable with -- all the other programs that -- the UK -- the international business as well?

Yes, the rest of our business is really doing pretty well. Again, we have seen some softness in businesses like 9-Volt. We really believe that is -- and that is a small -- that is about 10% of our business. We believe that people are cutting their inventories down. There is no question about it.

We know that some of the shortfall in telematics is that the auto manufacturers have cut their inventories down. They don't have the luxury of having any buffer stock anymore, because cash is very dear out there in the market.

So that is happening. It can't happen forever, right? You can't take your -- you can't negative inventory. But we are seeing that. But despite that, we still see pretty strong demand out there for what we are doing, and nothing strange.

Now will you make a press release when you do get the SATCOM business? Are you able to do that?

Yes, we will. We believe it will be of magnitude that it will be -- and it is certainly important enough that we would do that.

It seems that a lot of the year is really contingent on that. If it is that much business out there -- $60 million of business.

The other thing is, could you just remind us what the -- you had talked about pricing in Standby Power, how difficult that is. And a lot of the excess inventories -- or the selling going on there. How big a business is that for you right now? What was that in the quarter? It is not a huge business, I know, but it --

Design and Installation Services were about $6 million. And the majority, 90%, of that was Standby Power.

Okay, 90%. Okay. Now does that situation -- that could -- it sounds like that could extend for a bit as well, the pressure there.

Yes, our goal has been to get that to a 30% margin. We think we can, but right now our near-term goal is to pick up another -- there is 10 points to be had by just getting ourselves in shape to sell product in a bundled way. And we think we are on a path to do that. That is $500,000 right there just on the volume we have. But it may take a little longer to get to the 30%, as long as this extreme price pressure is there. It can't be there forever.

Just looking at your -- you had talked about your goals for the operating income, and just kind of backing into it on the back of the envelope thing, it seemed like the margins have to average like 24% in the year -- gross margins. That is quite a big increase to kind of expect in the balance of the year. Does that sound pretty -- how do you plan to get there, if that number is correct?

You have to understand that the business that has been delayed is -- pretty much 25% of our business is our systems business, which really pulls the best margins. That business is a minimum 30% gross margin business. And when you start looking at how much overhead it pulls, on an incremental basis it is probably 35% to 40% on an incremental basis.

So if you do the math of a shortfall it holds -- we triangulate this five different ways just to make sure that we have our model right. It really does hold together.

James McIlree, Collins Stewart.

Can you tell me kind of rough numbers how you get to the $230 million for the year? If you broke that down into the major -- into the four major reporting categories, how would you roughly get to the $230 million?

I think it is fairly simple. If you look at what our business is right now, without any Communication Systems product, is $40 million -- was $40 million a quarter. And that is with historically low numbers -- recently historically low numbers of 9-Volt communications accessories and automotive. What we would consider a bottom. That is about $120 million minimum for the next three quarters.

We are short -- there is about $60 million in Communication Systems to go. And with growth in some of the businesses, and new business that we have won overseas in the UK, that easily makes another $10 million of that.

So it is really hinging on the Comm system orders.

Oh, yes, that was a -- that was $110 million of our revenue last year, SATCOM. It has been assumed to be in the $50 million to $60 million range, probably about $60 million this year, because that is -- we know that is there.

And this spares order, I guess I'm a little bit confused by the difference between the $60 million Comm Systems total, and then the spares order that you spoke about last quarter. I thought that was more like a $10 million to $15 million-ish kind of number.

Yes, it is about $50 million in systems, and about $10 million in spares.

So the $50 million in systems would be for the variety of vehicle programs out there, like Humvees, MATV, possibly MRAP spares or replacements, things like that?

Humvees and MRAP. There is still MRAPs being produced.

Is the spares business, is that part of the same IDIQ that you referred to, or is that something different?

The issue we ran into in the fall was that the decision was made, instead of making that a separate order under the previous vehicle, which was a sole source procurement -- I believe the new administration is not thrilled with sole source procurements. It wants it to be as competitive as possible -- and asked that that be put under the new IDIQ contract. That is a guess on my part, but a pretty good one. So that decision was made to do that, and that is part of that.

So the IDIQ itself has not been let, is that correct?

That is correct.

So the first step is going to be, you're going to have to get to be part of the IDIQ, and then the task orders under it.

The prime will get the IDIQ contract, which then will allow the programs to order again. All we know is what the prime tells us, number one. Number two, what we get asked for for price quotes to be able to be put into that contact. And then third, what we know from the programs asking us what we are in a position to deliver when the contract vehicle gets put in place.

I hate to be a pest about it. So the IDIQ relates to the prime's IDIQ. And then they are -- as part of that, then they are tasking you to supply to that.

Exactly. The IDIQ is done by the Central Command, ECOM. And then the orders against that get placed by the programs.

Right. Okay, great. I will circle back. Thank you very much.

(Operator Instructions). Richard Baxter, Ardour Capital.

I guess just to continue on with the pricing pressure questions. Were you seeing sort of the pricing pressures in both the batteries and the power electronics for this, or just mainly the batteries or --?

We have seen some in power electronics, but it is mainly in the battery area.

For something different, can you talk a little bit about integrating the AMTI into your Communication business?

I just want to clarify, we were talking about in Standby Power (multiple speakers).

Correct.

And AMTI will be rolled into our Communications business. We already have an amplifier part of that business -- a small group that we acquired a couple of years ago in Seattle. They do more of the amplifiers for the higher-end systems. AMTI gives us the handheld radio, smaller portable system component to that.

Are the amplifiers some of the more higher-margin components of these things that you are going for?

Yes, amplifiers are higher-margin components, because there's a whole lot more engineering work that goes into them. They are multiband amplifiers to enable frequency hopping. And they have very uniform performance across those bands. You have to manage heat. And there is a fair amount of software in them as well, because they have to handle all the different waveforms.

James McIlree, Collins Stewart.

Just on the gross margin side. For the non-rechargeable batteries you had a pretty good gross margin improvement quarter-to-quarter -- excuse me, for the rechargeable batteries, a pretty good gross margin improvement. Is that a sustainable level going forward?

Yes, it really is because in the rechargeable battery area, we were hurt last year by cell pricing. We couldn't reprice our contracts, and cell pricing went up significantly. There was a shortage out there. They were a couple of fires. We have started recovering that. We had to work through some old inventory. We got through most of it last year. We got through some of it this year. But the answer is, yes. It is sustainable as we move forward.

The other thing is, as we deploy more programs there we get a better mix of both smart batteries, which are with our SmartCircuit capability in it, which have a lot more value, and we can get a better margin on. And chargers -- smart chargers and chargers, which also do better for us. Yes, I think it is very sustainable.

I think a few years ago you got -- you almost hit 30% gross margin in that business. Is that possible again?

I think we have said 25% to 30% is what we would like to be in gross margin.

Yes, where we want to be is up in the 30% area.

We may pop above that time to time, because of mix and stuff, but 25% to 30% is where we are heading there.

Then on the Non-Rechargeables it seems to be flattish quarter-to-quarter. And I think you also want to be 25%, 30% there, right?

We said we want to be about 25% there, mid-20s. The issue here is that with our 9-Volt product, which is a big chunk of that, we compete against fairly commoditized alkaline and other products there. So there is only -- while we believe we create a lot of value, it is pretty hard to capture a lot of it in consumer markets, or in markets that compete with the consumer type of product. So that is why that pulls us down a little bit.

So better margins would await either a mix shift and/or a better economy, so you don't have the pricing pressures.

Exactly.

Is that a fair enough assumption?

That is a very fair assumption. Certainly, volume helps in that area, because we have a lot of our depreciation and overhead equipment is tied up in that area.

Right, Great. Thanks again.

Jill Mastoloni, Catapult Capital.

Thank you for opening the call up. Can you go through your line of credit and any debt covenants that you may have? And your balance sheet is a little bit worrisome. Sort of where you stand regarding potentially raising cash? If the buyback is potentially, or if anything is remaining, if that would be put on hold, given the balance sheet concerns?

First, I would tell you the buyback expired on 30 April.

That program is over. So we are done with that at the moment. On the debt covenant question, we have two debt covenants, two financial covenants that we need to comply with. One is a debt-to-EBITDA covenant, and one is a fixed charge coverage ratio that we are in compliance with at the end of the quarter.

What are those -- what is the debt-to-EBITDA and fixed charge coverage ratios?

What are the ratios themselves, the numbers?

Yes.

I don't have them right off the top of my head, but we are (multiple speakers).

They are filed with all of our documents.

No, part of the document, or the document itself as far as the credit facility is filed. We don't disclose the calculations on what we provide to the banks. But we are within the numbers.

We are within our covenants. The other thing I would mention to you is we've got about $7 million in inventory right now tied up from awaiting these orders, so that we can execute on that program. We probably have another couple of million dollars in inventory, because we have started increasing our production of non-rechargeable, because we are quoting lead times of kind of six months now on some of our military and non-rechargeable batteries, which we think is unacceptable.

On top of that, we acquired a significant set of inventory with the AMTI acquisition, probably a couple -- $2 million or $3 million worth of inventory there that was too much. But they only had two salespeople. Now we have a whole sales force selling it. So just inventory alone, we probably have about $10 million that we would hope to turn into receivables in the next quarter or two.

So it sounds like you are fairly comfortable with the balance sheet as it sits at this point, with the ability to turn the inventory over.

Yes, we are real comfortable with it.

Thank you, guys.

A significant conversation between us and the Board when we embarked on the buyback plan. And I think we are still comfortable with it.

(Operator Instructions). There appear to be no further questions at this time. I would like to turn the conference back over to John Kavazanjian for any closing or additional comments.

Thanks everybody for participating. We still have a fundamentally very strong business, while we certainly would have liked to have had a stronger start to the year. We see continued demand in the defense business. And we are going to get through these contracting delays.

Our commercial business, though slightly affected by some of the conditions we have talked about, really does have expanding opportunities, because of the new value we bring in the applications that we participate, and really through some of the new initiatives in alternative energy and energy storage.

We really do look forward to updating you again on our progress next quarter. Thank you all for participating.

This concludes today's conference. Thank you for joining us. And have a wonderful day.