Ultralife Corp (ULBI) 2009 Q2 法說會逐字稿

Good day and welcome to this Ultralife Corporation second-quarter earnings 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, ma'am.

Thank you, operator. Good morning, everyone. This is Jody Burfening of Lippert/Heilshorn & Associates. Thank you for joining us this morning for the Ultralife Corporation earnings conference call for the second quarter of fiscal 2009. With us on today's call are John Kavazanjian, Ultralife's President and Chief Executive Officer, and John Casper, Ultralife's Chief Financial Officer.

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

Before turning the call over to management, 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 ended December 31, 2008.

In addition, on today's call management may 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, John.

Thank you, Jody. Good morning and welcome to the Ultralife Corporation conference call for the second quarter of 2009. Joining me today is John Casper, who I would like to welcome as our new Chief Financial Officer. And also with us today are Julius Cirin, our Corporate Committee Officer, and Bill Schmitz, Chief Operating Officer.

Today we reported revenue of $39.6 million for the second quarter of 2009 and an operating loss of $6.3 million. Revenue decline compared to last year, when we were fulfilling more than $100 million of advanced communication systems orders.

Quarter over quarter, revenue was consistent with the first quarter due to the continued delays in contracting associated with funded government programs. Revenue was virtually zero in automotive telematics due to further inventory corrections in the automotive business and declined in standby power due to deferral of capital spending in the data processing and telecom industries. Revenue was slightly up in all other sectors of the business.

In the second quarter, we booked several nonrecurring charges due to legal action, various operational changes resulting in termination costs, and an increase in inventory provisions. John Casper will take you through these charges in his commentary. Much of this expense was related to our initiatives to get more efficient and drive our operating costs down to a lower level.

While the legal action resulted in a judgment in our favor, defending our position in court cost us higher than normal legal fees. Our operational changes included the closing of our Seattle amplifier operation and the consolidation of it into our newly acquired AMTI unit, and certain severance costs.

The inventory reserves were as a result of an examination of our inventory in the light of a slower economy. Slowdown in economic activity has caused us to reevaluate the parts deemed to be slow-moving and the relationship of their costs to their market value.

We still await the award of the SATCOM-on-the-Move systems for the M-ATV and other programs. While we are still specified as the GFE, or government furnished equipment, in the programs, the government has yet to come to terms on a contract vehicle with a prime contractor to supply these parts. We stand poised with over $8 million in inventory ready to execute on this known demand and still believe that it is not a matter of if, but a matter of when.

Sales in batteries remained strong, with notable weakness only in the automotive sector and in standby power. We're still being designed into new and existing applications, with particular strength in military markets.

Standby power, we've seen the weakness in the capital markets manifest itself with continued deferrals of projects. This has pushed out several significant programs with major customers. It is also exerting pricing pressure on lead acid battery sales as suppliers are fighting to liquidate inventories and generate cash in a tighter market.

We have reduced expenses in this business segment consistent with further consolidation of operations, are remaining poised to execute as we believe that the mission-critical applications that this area addresses can only defer replacements, upgrades and investments in backup power for so long.

In the communications systems business, apart from being ready for the SATCOM-on-the-Move orders, we have now consolidated our amplifier manufacturing under the AMTI business that we purchased last quarter from SAIC. By consolidating our Seattle area operation into the AMTI operation in Virginia Beach, we were able to significantly cut down on overhead while leveraging a strong technical base. This will involve the outsourcing of some of the Seattle production and the relocation of some of the technical talent, along with the closing of a facility that is estimated to save us up to $2 million a year in expenses.

The AMTI business got off to a very strong start in the second quarter. And with sales of amplifiers and their utilization in our advanced communication systems, we will show growth of sales and profits over the next year.

Delays in two major programs have impacted profitability in the first half of the year -- the delay in the SATCOM-on-the-Move orders and the delay in our program with the UK MOD. Regarding the SATCOM orders, we're still specified, as I've said, as the GFE for the MRAP and other programs, including the M-ATV program that has just been awarded to Oshkosh Corporation.

Because we supply this product through one or more prime contractors, our visibility on timing is derived from the information we receive from the primes involved. The government has been in negotiations working through contracting issues now for over nine months. Because the M-ATV program has been awarded and demand for other vehicle programs remains strong, we still expect to receive an order. It is not an issue of whether this will happen, as I've said, but one of when.

As for the second program, we mentioned on last quarter's call that we have been selected as a new battery supplier for the UK MOD for their primary communications radios. The program's start was pushed out one quarter, and we have been making engineering changes requested by the customer for this new set of products.

We've had a major engineering commitment in this program for over one year now. We expect the revenue from this to commence in the fourth quarter of this year on a three-year contract.

These programs, coupled with the challenges faced by our standby power business, impacted profitability for first half of the year. In response, we have taken the responsible steps to get expenses down to as low a level as prudent so that the profit from these programs can be as incremental as possible.

2009, we are adjusting our revenue guidance to $180 million to $210 million in recognition of the government contracting delays and our uncertainty about delivery schedules. We still expect contract awards to be made, but with some significant deliveries potentially pushed toward the end of this year, timing issues can cause this uncertainty.

Because of the wide potential range in revenue, we are also forecasting a wide range for operating income, in the range of $1 million to $10 million for the second half of the year. We're still confident in the strength of demand in our markets and the business model of the Company.

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

Thank you, John, and good morning, everyone. I am pleased to be here on my first quarterly earnings conference call as part of the Ultralife management team. As John mentioned, during the quarter we undertook an extensive review of the Company's cost structure at current and projected revenue levels. This study has been my highest priority since joining Ultralife in June. And we're continuing to evaluate areas of savings and cost efficiencies in the business, while also focusing on asset management and working capital improvements.

The outcome of this study was a combination of operational decisions designed to lower the fixed cost basis of the business. Cost reductions, some deferral of discretionary spending and tightening of cost controls was the result. As I go through my prepared remarks this morning, I will detail the expenses associated with the actions that were taken during the quarter.

Starting with the income statement, consolidated revenues totaled $39.6 million for the second quarter, a 55% decline versus revenues of $87.9 million in the same period a year ago. The $48.3 million reduction is attributable to a $55.3 million decrease in communications systems revenue that was partially offset by increases in rechargeable and nonrechargeable products revenue of $5.8 million and $1.2 million, respectively.

Communications systems revenue was impacted by the absence of last year's shipments against the $100 million-plus in orders that were received in the fourth quarter of 2007. The communications systems revenue included the addition of the AMTI-branded amplifier products that we acquired last quarter.

Rechargeable products' revenue grew on strong demand from customer -- both government and defense customers. However, as John mentioned, the automotive telematics sales were down relative to the second quarter last year as customers adjusted current demand levels. Year over year, design and installation services revenue was flat.

Gross margin was $6.8 million for the second quarter compared to $20.6 million for the second quarter last year, a decrease of $13.8 million, primarily on lower sales volumes. As a percentage of total revenues, consolidated gross margin was 17.1% in 2009 versus 23.5% for last year's second quarter, reflecting unfavorable product mix, ongoing pricing pressures in the design and installation services segment, and a $1.8 million increase in an inventory reserves that I will talk about in a moment.

Gross margin for both nonrechargeable and rechargeable products improved year over year due to increased volumes and favorable product mix. Nonrechargeable products' gross margin was 17.7% compared to 12.7% for the second quarter last year. And rechargeable product gross margin was 19.3% versus 18.3% last year.

Gross margin in the communications systems segment declined from 27% to 17.8% on lower sales, unfavorable product mix and the increased inventory reserve. Ongoing intense price competition put pressure on the design and installation services gross margin, which declined from 21.7% last year to 6.9%.

Included in cost of products sold was a $1.8 million increase in the inventory reserve that resulted from an extensive review of inventory levels we began during the quarter. We conducted the review because the working capital cycles have been lengthening over the past several months of economic weakness. The $1.8 million addition to the inventory reserve accounted for 4.6 percentage points of the 6.4 percentage point swing in the gross margin rate.

The Company also implemented a four-day workweek for production personnel in our Newark operation beginning with the third quarter to align inventory and production levels with current sales volumes.

Operating expenses totaled $13.1 million compared with $10.7 million in the same quarter last year, an increase of $2.4 million. This increase reflects the addition of the AMTI brand and the higher sales and marketing expenses related to investments in our standby power business.

Included in operating expenses are some nonrecurring items totaling $1.2 million, which fall into two buckets. First, we incurred charges associated with staff reductions in some parts of the business of approximately $700,000. Second, we incurred $0.5 million in legal expenses related to the litigation matter that was successfully resolved.

Second-quarter noncash operating expenses, namely depreciation, intangible asset amortization and stock compensation expenses, amounted to $2 million compared with $2.2 million a year ago. As a result, we reported an operating loss of $6.3 million compared to operating income of $9.9 million for the same period last year.

Moving down the income statement, net interest expense for the quarter was $350,000 compared to $240,000 last year, reflecting higher average borrowings under our credit revolver. We also recorded $209,000 in miscellaneous expenses related to transactions that were impacted by changes in foreign currencies relative to the US dollar.

Income taxes amounted to $95,000, reflecting a tax provision related to book tax timing differences pertaining to goodwill and intangible assets. The net loss for the quarter was $7 million or $0.41 per share compared to net income of $6.4 million or $0.36 per share last year.

Turning now to the balance sheet and cash flow, we continued to draw on the revolving credit facility this quarter, primarily to fund inventory balances. As of June 28, the outstanding revolver balance was $23.9 million, an increase of $7.3 million from the first quarter of 2009. Inventories stood at $51.2 million compared to $48.1 million as of March 29 of this year. Accounts receivable at $30.6 million were down slightly from the end of first quarter.

DSOs for the quarter were 67 days. CapEx for the quarter was $900,000. We ended the quarter with cash and cash equivalents of $1.2 million compared to $900,000 at the end of Q1.

As I said at the beginning, we are continuing to analyze the Company's operations, cost structure and working capital management in an effort to extract additional cost savings and improve operational efficiencies. In the second half of the year, we will continue to lower the cost basis of the business. We have identified actions to reduce manufacturing costs and to lower operating expenses by approximately $1 million. These operating expense savings, combined with the absence of the second quarter's $1.2 million in nonrecurring items, is expected to reduce quarterly operating expenses from approximately $13 million to $11 million by the end of the year.

We are keenly focused on strengthening our business model and lowering the cost basis of the business without jeopardizing near- and long-term initiatives to drive revenue and earnings growth. Back to you, John.

Thank you, John. Operator, I would now like to open it up for questions.

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

This is actually Trey for Steve. First, if we could start with the revised guidance, I know you mentioned the UK MOD and a couple of other things in the comms business. Aside from that, can you talk a little bit about what has changed from your perspective, given the new range, and if you could quantify the downside between comms and the backup power market?

Well, real straight -- the real issue is in comms. MRAP ATVs are starting to be produced. We actually know that because in this phase of the program, we're going to be shipping and selling the cables directly to the equipment manufacturer so that they are ready for installation of the rest of the system.

We already had our cable orders. The problem is that we supply the system part through primes, and we don't have that yet. It is going to happen, but we don't want to get pushed. Last year and the year before, when we were supplying this program, we ran into supply issues with our supply chain of turning them on real fast, trying to ramp them up real fast.

One of the reasons why we have a substantial amount of inventory ready for this program is because we really wanted to keep our supply chain going. We didn't want to start them on this start-stop. We are a little frustrated by how long it has taken. But it is going to happen. We just don't know how we are going to get crunched at the end of the year. And we don't want to get into a situation like we got into at the end of 2007, when at the end of the year we had a substantial amount of product waiting for one part, which didn't show up, which caused us to move revenue from that year, December, into the January quarter.

So we don't want that to happen again. It is the reason for the large range. And frankly, it is the reason for us dropping our guidance, is that -- it's not that we don't expect somebody's going to demand delivery of these things. But we are in August right now. And we want to make sure that when we do this, we do it efficiently and the right way and that we don't try to kill ourselves to make some artificial number, but we try to kill ourselves to help do what the customer wants.

One thing I will add to that is that the range is a function of the anticipated timing of the orders, the two large programs that John referred to. So it's that uncertainty on timing that drives the range.

So it is really a timing, not a volume issue. It is a timing issue.

So I guess, then, the difference between the high end and the low end of the range is almost solely on the comms side of the business?

Yes.

It is just the timing? It is not more I guess broad-based from other segments?

No, it really isn't. It really isn't. We have some, on the UK MOD program, we have some engineering changes there, that we thought we would be shipping that this quarter. But they wanted some engineering changes to make the product better. And we are doing those now. So we expect that to be a fourth-quarter shipment. We don't think there is any problem with that.

Okay. So we should be looking, then, at the second-half guidance as more 4Q-weighted as opposed to I guess more even split?

Yes.

Okay. That was helpful. And then, kind of moving to the rechargeable business, I know this is an area that you've previously expected to provide some growth. Can you give a little more color on what triggered the sequential drop-off in the quarter?

Purely timing on shipments. We produce product for a number of people, people like Harris Corporation and others. And we do a lot of acceptances, and it really did turn out to be a timing problem or a timing issue of lots were ready at the end of the quarter that kind of sucked the pipeline dry. And then we had to start it up again. And we got to the end of this quarter, and some lots weren't ready for acceptance. Really it's a timing issue. There is no change in run rates in particular that I know of.

Each lot has to be certified by the government prior to shipment, and that takes time. We usually try to make those happen on the quarter. But as John said, the timing of which is often a function of when the government can come in and bless the lot for shipment.

It happens in our nonrechargeable business also because of the lot sizes sometimes.

Okay, so should we expect a catch-up in this quarter?

You'll see pretty -- I think -- I haven't looked at the numbers necessary by segment this quarter, but I think rechargeables will be pretty consistent.

It's going to be a big growth in the fourth quarter again.

Fourth quarter will be a good-size growth because the UK program is rechargeable.

And Land Warrior is popping back in.

Okay. And then on standby power, you noted in the release and commented that you're still seeing the pricing competition in the market, which is impacting your margins. Do you see this abating anytime soon, and if not, how can you respond?

I wish I knew the answer to that. It's a very good question. It's a question we ask ourselves about every day. Our thrust in that market has been to -- with national accounts. And they are the people we service the best and have the best proposition for. And a lot of people are just plain old delaying capital expenditures, whether they are upgrades or added facilities, capacity and such, to add more battery backup time in their facilities. Facility moves and things like that that were anticipated people are delaying, because of the capital markets not wanting to commit capital.

We are seeing some loosening of that, but I think it is going to go with the general economy. And it is not just us. Everybody is seeing it. And what has happened is that we have gone from kind of a real broom in battery sales in that marketplace, because there are a lot of buildouts in communications business going on still, to one where it is restricted a little. People were building a lot of inventory. And it's really, really affected prices and inventory. Sooner or later, inventory corrects itself. We're not really to predict that that is going to happen in the second half of the year, but we have our eye on it. So I don't know if I have any better judgment than you would have on that, Trey.

The only thing I would add to that -- this is John -- is that we are keenly focused on that segment during the second half. We have expectations for it that we are watching closely. And we've opportunities with national accounts that I won't go into here but that we're keenly focused on to continue to strengthen that business.

We've done a lot of work to get our cost structure down in that business as well in next quarter.

Okay. And then lastly, could you give us an update on your cash flow outlook for the second half and your current liquidity position?

I would be happy to. We have maintained a long-standing successful relationship with both Morgan Chase and M&T, who are both on our revolver. I've had some positive discussions with them in the last week, actually in the last couple of days. We're actively working the relationship so that we can address any questions or concerns they may have as we continue to fund the Company operations and the growth in SATCOM.

But they know on a cash flow basis, we've probably got $10 million in inventory that will turn pretty fast into receivables and then cash on one side of the equation. Like I said, we had some lots that didn't get finished yet to get through acceptance that started to go out this quarter that caused another strain on inventory that gets out.

And then return to profitability -- we've got about $4 million a quarter -- $2 million a quarter in noncash expenses, which, as we get profitable, add to the profitability. We expect to generate cash in the second half of the year.

So we are not -- we're in pretty good stead with our banks, and I don't see any problems. I think we're going to -- we'll make some major strides in getting the cash flow in shape this quarter. But of course, receivables then have to flow through. So it will probably be till the end of -- be by the end of the year before you see really substantial decreases in that revolving credit facility.

Great. Thanks, guys.

Walter Nasdeo, Ardour Capital.

We have been looking at the timing of the government contract, and obviously these are things that are out of your control, and they do have a major effect on not just the results, but the perception of what is going on.

If we can maybe extrapolate out a little bit and say, okay, there's some other things going on contract-wise through the government bidding process that may be appealing to Ultralife to be involved with and assume that you get another opportunity to try to fulfill a contract there, on the inventory side as you are trying to get somewhat of a balance between the government side and a more commercial exposure, obviously through years and years we have been looking at the pendulum swinging. And as soon as you kind of get a little closer to a better mix of commercial, a big government order comes in and swings you back over and ties you up that way.

As you are planning out, what steps are you taking to kind of help smooth out some of this? Because as John mentioned, it's not -- this has happened for years now, where a quarter has kind of been help up or a half a year has been kind of held up, through no fault of your own, but through the government side of getting the bid out or getting the award out. And really, it causes a lot of upheaval in your quarter.

What can you do? How can you manage this better and make this a little bit smoother process going forward? Because now what is happening is these numbers are just getting bigger and having the same type of effect as when three or four years ago, when the numbers were smaller, but still had a major effect on what was going on in the Company.

That is a really good question, Walter, and I will answer it with two things. First thing I will say is, we are keenly aware of the large swings. It is really hard for us. When we are making large investments, we probably have, of our $2.5 million a quarter in R&D, there is a good $2 million of it probably, 60% to 80% of it but as high as $2 million of it is dedicated to three or four programs that are really driving large volumes but are lumpy in nature. Whether it is large energy battery storage; whether it is the UK MOD program, which we spent a lot of money and development on because we are paying for the development costs; whether it is future SATCOM programs and now amplifier development, we have a lot of expenses that are coming in whether we get that stuff or not.

And so we are very cognizant of it. And I would say we have two initiatives -- the two biggest initiatives we have are in commercial areas. One of them is in standby power, where we need to build a services sector. And it is our biggest opportunity to do that, is in that marketplace.

It is going to take some time. We had a model which is making money, selling batteries and services and picking up the service contract, which is what wasn't happening with the people before. So I think that that is an important part of it. I think we're making inroads into that. But batteries sales are down in that sector because of delayed programs, and the margins are hurt.

It is going to come back. It is not a permanent thing. In fact, we're seeing competition lessening in the services side of that because a lot of people are having problems there. And again, that is where we're after national accounts, because we are uniquely positioned to be able to do that in an industry that is very local typically. So building the services sector is fundamental to that.

Second, in alignment with that is energy storage using lithium-ion batteries for energy storage. Standby power is the biggest use of energy storage. It is lead acid batteries. There's a great value proposition for lithium-ion batteries, but it goes beyond that. It goes to microgrid activity of solar and wind, where energy storage is fundamental to them being successful and economical. And it goes to larger energy storage projects. And I think that that is the, as you watch us develop, that is where we have a lot of R&D effort. There's a lot of investment, a lot of work that is trying to change that.

Now, once we do that, we're still going to have ups and downs in the military business, but you are right. Paying for that base R&D to get into these higher-margin businesses that are more service, more engineering oriented, right now what pays for that are these large, lumpy programs. And that is a function of the way kind of the US government works.

The last thing I would say is the other things we're doing in the military markets is taking things internationally. More than half of our battery business in military markets we developed as an international business. It may have swung a little bit back now, but with UK MOD it will be back to more than half being international.

And I think we're doing the same things with our communications products. We've talked a lot about our tactical repeater. That is the product -- because international military organizations use hand-held radios like the Thales MBITR or the Falcon from Harris. That is the biggest opportunity there, because that is really the SATCOM analogy, range extender technology for the hand-held radios is the tactical repeater.

So that's -- actually, our problem is we're investing in these areas, whether it is energy storage, whether it is tactical repeater, whether it's standby power, we're investing in building these areas now. And when we get these hiatuses, which is -- we're going to go from famine, believe me, to feast, where it's going to be, hurry up, we need these things right away, even though it took us nine months to get it in place. That is what we cope with every day. That is the challenge of our business. But those are really the three initiatives we have there to do that.

Okay. If I can just follow that up real briefly, because as you said, going from famine to feast and saying, okay, we need this stuff the day after tomorrow kind of thing, how do you, because of your other initiatives that you've got in place, how do you allocate capacity? How do you prepare? Obviously, in this one, you've already got your inventory built up. But assume going forward, and some of these other initiatives really start to take root, how do you allocate relatively scarce resources to say, okay, we can now fulfill a $100 million or $150 million government contract in the next 60 or 90 or 120 days?

To be honest with you, that was part of our motivation. As we get into some of these businesses, we are much more picky about what we do ourselves. In nonrechargeable batteries, we make everything ourselves. But in the communications products area, we don't stuff our own printed circuitboards. We were making our own amplifiers up in Seattle for the Seattle line. We're now outsourcing that. That product is mature. It can be done at a vendor.

So we have taken a lot of steps to go do more things with outside resources. But we cause them problems with feast or famine, which is why we have inventory right now, because we have had to keep them at a decent level as well so that we don't shut them off and then shut them back on.

One thing to keep in mind as well is that our manufacturing operations have been built to be scalable. We've got a temporary workforce. We have lines that can be lit up and greenlighted when the time comes at a moment's notice. But we can flex that very dramatically when -- as need be. And we continue to design products that cross multiple prime opportunities. They aren't designed for just one solution. They're products that can be sold through more than one prime, be it a Raytheon or a Harris or others.

So we have grown the base business from $30 million to $40 million. We continue to do that, as John said. Services will help us start to benefit from the law of large numbers over time to take out some of the lumpiness of this. But it is an issue that we are attentive to as we deal with this seasonality, if you will.

But we are aware of the issue. When we ramped up last time in the SATCOM line, internally we had to do training to get people online. But we had to get our vendors going also. And most of our problems end up with our vendors.

One of the reasons why we have gone to a four-day workweek instead of laying people off is we need these people when the orders come back. So we have taken advantage of the ability to do that, and our people can draw unemployment for that fifth day under some of the new programs out there, because we know in short order we're going to have to bring them back.

All right. Well, listen, I appreciate that, guys. Thank you very much.

James McIlree, Collins Stewart.

John, can you talk about the -- I'm sorry -- can you talk about the UK radio order? Who is the prime on that? And are you getting the engineering changes from the MOD or are you getting it from the prime?

We work through a prime contractor who manages all their batteries in the UK. I'm not sure we have permission to say --

No, it's not -- we haven't announced the prime.

We haven't gotten their permission to announce it.

We are working on the wording of that announcement, so it should be coming out very shortly.

But the prime and the UK MOD, we work directly with the MOD people on it, but also with the prime, because they are integrating the batteries into the communications systems that they supply. So a lot of the changes have to do with some of our electronic signaling for things like state of charge or state of health, which is a new addition. Some of it is cosmetic to makes it easier to maintain -- put it on the radio or put it on the charger.

Okay. And then on the satellite on the --

So you know, we're not trying to be evasive. We just need permission before we say.

No, no, I understand that. That's fine. And then on the M-ATV -- or excuse me, on the satellite-on-the-move, do you have an explicit dollar amount that is in the guidance for the second half? I know you have talked about ranges, and there's all sorts of possibilities. But if you hit the midpoint of your revenue guidance, what does that imply about satellite-on-the-move revenues?

The best way for me to say it is if you say we are running at $40 million a quarter -- although we are growing that segment, too. Bill keeps pointing out to me, that non-SATCOM, non-this, non-that was about $30 million a quarter at one point in time, this time last year. We are growing that part of the business.

But if you assume that that is flat, then that's $160 million of it. So there is $20 million to $50 million tied up in the other programs before the end of the year. The MOD program is probably in the ballpark of $10 million. But we have to do a little probabilistic analysis here about what we can get out of what, but that is pretty round numbers.

Okay. And I'm sorry, I missed -- what did you say on the MOD amount?

It is about $10 million for this year. Will that be 12 and SATCOM will be 28, or that would be 8 and -- it's in the (multiple speakers).

Right, right. And I recognize that's one of the issues here. Okay. And then finally, on the M-ATV specific --

You know real well that Oshkosh, it was in The Wall Street Journal the other day -- they have to deliver 2200 vehicles by the end of the year. So that is the number of SATCOM systems somebody needs. It's a question of what is the order going to look like and when are we going to get it, and how many can we get out?

Right. And so on the M-ATV specifically, are you assuming that your share of that is going to be 100% or something less than that?

Well, all we know is that they're putting their cables in 100% of them so far. You know that they have the orders for 2200, so we are shipping -- we have orders for cables and [release kits for] cables for those units. Okay? There is another 3000 they are expecting to get. We will let you know if we get the cable orders for those. But right now, our cables are going into all the units. So if they can figure out how to make somebody else's system work with our cables, great.

That was my next question. Is there something about your cables that would suggest that only your systems are going to be supplied?

Pretty much, yes, because they match the RF signatures and all the shielding and the connectors. So yes.

Will you -- do you think that the orders for the satellite-on-the-move kits for the M-ATV procurement, will those come from Oshkosh or will those come from the government, who then takes delivery and gives them to Oshkosh?

That comm kit will come through -- no -- the cables now under this program are getting there by Oshkosh. The rest of the equipment will come through a prime. The government has to pick who that prime is. Last time, it was a couple of different people we sold them to. This time, the government has got to decide. And that is kind of what we're waiting for.

So that prime is going to be some electronic systems integrator? It might be Oshkosh, it might be somebody else?

Exactly. And I can't even speculate because it's gone -- they are doing their thing about it. But I will even say, we know there is demand for other systems and other vehicles and other things that people would like to get this in an ID/IQ so they can buy it. Right now it is on GSA. We get some GSA orders, but they're onesie-twosies. Because of the dollar limitations on GSA orders, you can only get so much.

We've talked about spare parts before. We know they like to order spare parts. But the order -- what they need in spare parts, they've been ordering onesie-twosie, or for GSA, because there are dollar limitations. We get this thing on an ID/IQ contract, then that lets all those other things happen.

Great.

In Afghanistan, there is no line of sight. And we know people would like to put these systems on things like Bradleys and other vehicles, but right now there is not a vehicle.

Right, okay. Very good Thanks a lot.

Ted Kundtz, Needham.

John, questions for you would be on, what kind of visibility do you have for the balance? You say the $100 million, the low end of your range, which really kind of excludes the SATCOM business, I guess, and some of the UK -- well, probably some of the UK MODs in there. But what is your confidence level in that number?

It is very high. I won't tell you every dollar is booked, but we have very good visibility on that.

Okay, that is good to hear. Another question --

Things that are under contract with the government, things we have in the commercial business, flow really, really well. It is just these -- kind of the lumpy business that is really tough. Our hope is that when they do award a contract, and I can't speculate, I'd really like to -- we are hoping that they award a five-year procurement vehicle, not like a one-year. And I think that is what we would like to see, and that will just make life so much easier.

True. And hopefully, that is going to be the trend. Do you have any comfort in that, that is going to happen?

We have heard that that is what they're trying to do, because it is getting harder and harder to do contracting because of new regulations and new disciplines that are being put in place. The only way of dealing with that with the limited contracting force that they have there of contract officers is to do multiyear contracts. So we suspect that that is what is going to happen. That is our hope. The UK MOD contract is -- the bid was done as a three-year procurement. So that is certainly in that category.

Can you say how big that business is?

All I can tell you is that their original -- the quotations that were done that we entered was three years, 110 --

$120 million.

$120 million, three years.

Okay, that's what you quoted?

(multiple speakers) That is [the quantities] and their procurement tender.

For you? Okay.

For anybody.

For anybody who's -- right. That is the total bid, right.

Just to be clear, the low end of the range does presume some modest unit shipments of SATCOM late in the year. It presumes that the order is received late.

Okay, great. Another question would be regarding the nonrechargeable business. The revenues went up fairly nicely in the quarter, though the margins went down, gross margins. And I know they are well below where your target ranges are on that. Could you explain what happened there?

Well, we took about $1.8 million of inventory provisions. And that is spread out across some of those different product lines. And we had a private-label agreement for the 9-volt product, which was a unique product, for somebody else that we discontinued. Our volume hasn't gone down because we're selling it direct to people now. But we discontinued it earlier in the year. And we have looked at that inventory. It is salable. It is good product, but it is to a different spec. And we have taken some reserves on that product.

We also had some, as part of a qualification process, we used to build and have the capability still to build our D cells in the UK. And we built some of our D cells in our UK operation. And while they are not certified now for certain applications, they are certainly usable in others. But because that is a slow-moving inventory, given the economic conditions, we reevaluated our carrying cost for that and we took some reserves for things like that. So you would see that in the nonrechargeables (multiple speakers) think of, Bill right?

That was it.

That was it, I think.

Where do you expect those margins to rebound to? Because I assume that the charge you took was not all there, but you just described some of it being there. Probably some of it's in the rechargeable side, too, because those margins also went down.

We typically run, with the kind of odds -- we're running in the low 20s in the nonrechargeable business. The biggest reason for that is that our 9-volt product carries below 20% gross margin right now. We are in the middle of a redesign of that that will take significant costs out of it. But it is a 10-year battery, so it will be next year before we can get that out.

Just to be clear as well, because you mentioned nonrechargeable -- this is Casper -- we posted 17.7% as the margin -- right? -- in my remarks for nonrechargeable. That was up from 12.7% in the second quarter last year.

Yes, but I look sequentially. I think everybody is looking at you guys sequentially because you have really sort of laid out your margin goals here going forward. And a sequential improvement was kind of in the model, and we are not seeing that. So it is the -- that is what we are all kind of focused on.

What you're seeing there is reserves that were taken.

Yes, and also in the rechargeable side as well, I assume?

I'll also tell you, I don't think we took any reserves. I think GM, we're getting paid for everything.

Thus far.

At this point in time, just in case you were wondering about that.

I'm sorry, what?

General Motors receivables, they're paying their receivables on a regular basis. So there was nothing in -- no reserves for that that were required.

Right, yes. Okay, okay. The other one, you really talked about a target operating expense line, John, of $11 million by the fourth quarter, which really assumes your G&A probably has to get down to about -- your SG&A has to get down to about $8.5 million. Is that a realistic -- because your R&D, I assume, is going to be running around $2.5 million.

Sales, marketing and admin, that SG&A, about $8.2 million is predicated in the $11 million number we're aiming for at year and.

Okay. That is a big drop.

Yes. And the only caveat there, as you might expect, is if we hit meaningful sales above and beyond, then there's commissions that go along with that.

Right, yes. Okay. But that is a pretty realistic objective to reach?

We believe we can get there.

Okay, that's it. Thank you.

(Operator Instructions). Jamie Sullivan, RBC Capital Markets.

Just to make sure I got the right number, you said 12.7% for the gross margins in nonrechargeable, is that right, in the quarter?

Nonrechargeable in the quarter was 17.7%. It was 12.7% same quarter last year.

Okay. All right, great. And that is where the bulk of that inventory charge was taken?

Not necessarily. The inventory charge was across the board. We looked at each segment. It was pretty evenly split across comm segment and the battery business.

Okay. All right. And if we think about the [COS] programs and the long-term margin targets that you have laid out in the past, are there any changes to those targets? Are you thinking about the business differently at this point in terms of the margin profile?

It has been fundamental to the investments we are making to move to higher engineered content or higher service content types of businesses. The battery -- in standby power, for example, the battery business is kind of 20s gross margin in the past, and services business is 30-plus. Unfortunately, the battery business, that gross margin has plummeted significantly in the last few quarters -- the price competition in that business.

And we do not -- we have not built our -- we are building our services segment. It probably started at 5%. It's between 10% and 15%. But we would like that to be 30% to 40% of our business in that sector, and we're just not there yet. So that is part of it.

In the communications area, these are vast communications systems, whether it is SATCOM or the MRC-200 tactical repeater program. That is fundamental. And then to get any -- because those margins are well over 30%. And that is fundamental, too. We don't have those this quarter.

And then lastly, rechargeable battery systems, because they are chargers and smart batteries and state of charge and state of health and stuff we do there, that's a highly engineered product, that carries really good margins. And we did not have that this quarter.

So you want to look at where we are unhappy about where we expected to be right now. The programs we have gotten kind of whacked onto at this point have been the higher-margin products. They are going to be there. They are coming. We're still spending the money on the engineering on them. The customers are there. They're committed. They need them. They are happening. But it is just -- it's longer than we thought it would be.

Right. Okay. I guess if we look at the end markets and some of the soft areas like standby power and auto, if I guess in standby power, if you think of kind of the current run rate, when do you foresee a restocking starting to be necessary in those customers?

Good question. I think we have taken a lot of the restructuring work we have done and cutting back on activity in that area to get that thing right-sized. Our assumption is that it will be soft through the end of the year. I think we're going to maintain the revenue in pretty good shape, but the margins are going to be tough in that business until we grow -- we will grow our percentage of service there as we pick up new accounts. And our goal is to not just sell product and installation, but pick up the service. We're doing that pretty successfully. But it takes some time before that is a more meaningful percentage.

So our assumption is we will do okay on the revenue side, and we will bring back the margins slowly. But it is going to be next year before that market recovers. I think there is a lot of reticence in that marketplace, even though there's more and more buildouts and things going on, a lot of reticence for people to spend money. We are actually -- we actually think we are gaining market share there. But that doesn't give us any solace in a tough market.

In other areas, automotive, I think automotive, we've made the correction in kind of the absolute volumes of cars that we go into. I think this quarter and to some extent last quarter has been an inventory correction. I think there is a massive one going on across that whole industry.

You guys would know better than us how long that takes to shake out, but I think we would have expected to do kind of $12 million to $15 million in that business this year. It is probably going to be more like $6 million. And Bill just said if that, so maybe $4 million or $5 million. But we do have orders and see shipments resuming in the third quarter at some level and in the fourth, because we are actually going in additional platforms. We're actually going in more vehicles. So I would say that business is back, but it is still going to be soft. That is built into our numbers as well.

And the other businesses we have, we still see pretty good demand. Our 9-volt business is in pretty good shape. It is not raging, but we had some inventory correction, but it is still in pretty good shape there. And then our other businesses, our military business and some of the other things, whether it is medical or pipeline inspections and things like that, some fringe markets, are doing pretty well. Nothing great shakes, but nothing lower than expectations. We're doing pretty well there.

Okay, thanks a lot.

(Operator Instructions). It appears there are no further questions at this time. Mr. Kavazanjian, I would like to turn the conference back over to you for any closing remarks.

Thank you. We have a really strong company here focused still on growing markets and applications. We are frustrated with contract delays. But ultimately, we are going to have those orders and have those business.

And while the economic downturn has delayed some of the progress, we continue to grow our business while staying lean, and we're still making the investments we need to capitalize on the markets as the business climate improves. We think that the strong companies are the ones that in these kind of markets can stay the course and stay lean and grow market share and really come out stronger.

We look forward to sharing with you the progress of these initiatives on the next call. And we would like to thank you all for participating.

This concludes today's conference. Thank you for your participation.