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Ultralife Batteries, Inc. (NASDAQ:ULBI)

Q4 2007 Earnings Call

February 28, 2008 10:00 am ET

Executives

Jody Burfening - Lippert/Heilshorn & Associates, Inc.

John D. Kavazanjian - President, Chief Executive Officer & Director

Robert W. Fishback - Chief Financial Officer, Vice President, Finance, Controller & Treasurer

Julius M. Cirin - Vice President, Corporate Marketing & Technology

William A. Schmitz - Chief Operating Officer

Analysts

Jim McIlree - Collins Stewart

Steve Sanders – Stephens, Inc.

Ted Kundtz - Needham & Company

Walter W. Nasdeo – Ardour Capital Investments

Amit Daryanani – RBC Capital Markets

Colin Rusch - Broadpoint Capital

[John Barr - Bookingham Research]

Operator

Good day everyone and welcome to the Ultralife Batteries’ fourth quarter earnings release conference call. Today’s call is being recorded. At this time for opening remarks and introductions I’d like to turn it over to your host, Miss Jody Burfening. Please go ahead, ma’am.

Jody Burfening

Good morning everyone and thank you for joining us this morning. This is Jody Burfening of Lippert/Heilshorn & Associates. The earnings release was issued earlier this morning and if anyone has not yet received a copy I invite you to visit the Ultralife website at www.UltralifeBatteries.com where you’ll find the release under Investor News under the Investor Relations section. In a minute I will turn the call over to John Kavazanjian, Ultralife’s President and CEO who, along with Bob Fishback, Ultralife’s Chief Financial Officer, will provide their formal remarks. Management will then take questions until 11 o’clock Eastern time.

Before turning the call over to John, I’d like to remind everyone that some statements made during this conference call contain forward-looking statements based on current expectations. Actual results could differ materially from those projected as a result of various risks and uncertainties including continued acceptance of and demand for the company’s products, changes in the company’s products and changes in customers’ purchasing plans. 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, 2006. 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.

John D. Kavazanjian

Good morning and welcome to the Ultralife Batteries’ conference call for the fourth quarter of 2007. Joining me today are Bob Fishback, our Chief Financial Officer; Julius Cirin, our Vice President of Corporate Marketing and Technology; and Bill Schmitz, Chief Operating Officer. Today we reported revenue of $36.8 million for the fourth quarter of 2007 with an operating loss of $2.7 million. These results are in line with the preliminary figures we disclosed on February 15th and include non-cash expenses of about $1.4 million from the amortization of intangible assets and the expensing of stock-based compensation and a $1.3 million inventory adjustment primarily related to the McDowell communications business. Despite the $7.5 million revenue shortfall to guidance we posted a record quarter in our communications systems business of $16.5 million in sales. We expect major increases in revenue for 2008 in this segment with strong orders and prospects in the systems part of this business and in recognition of this trend have renamed this segment in our reporting from Communications Accessories to Communications Systems. Gross margin in this segment was down to 16% due to both the revenue shortfall and the inventory adjustment. With strong order backlog and alleviation of the key parts shortage the continued improvement in deliveries should move us back to a gross margin in the 30% range.

Our rechargeable segment was relatively flat to the third quarter with $3.4 million in sales and gross margin at 17% below our target margin. We expect this segment to resume growth in the first half of the year as we start shipments on our $7 million contract with a prime contractor to the UK military and as we commence sales on additional rechargeable projects. The non-rechargeable battery business was down slightly from the third quarter when sales spiked as we completed shipments of BA-5590 batteries to the UK MOD. Gross margin was down due to unabsorbed overhead on lower volumes and exacerbated by our decision to move a significant part of our workforce over to work in the communications systems area. We have strong order activity from the US Department of Defense and expect this business to also rebound in the first half of the year.

In the fourth quarter we added two new businesses in the area of design and installation services. RedBlack Communications became a part of our company at the start of the fourth quarter. RedBlack had modest sales in the fourth quarter but generated excellent order activity that together with the strong prospects we have will lead to higher sales in the first quarter and continued growth throughout the year. We expect RedBlack to be an important part of our solutions offering and a contributor to revenue and profit. On November 16, 2007 we completed the acquisition of Stationary Power Services of Clearwater, Florida. Stationary Power represents our entry into the standby power market with a full portfolio of design, installation and maintenance services. While Stationary Power contributed about $1.5 million in revenue for the quarter, acquisition accounting rules required that much of the profit on certain orders that were booked prior to acquisition be reflected as increases to the value of the tangible assets rather than through the income statement.

As we’ve already started to aggressively grow our footprint in this market with the opening of sales and service locations in Atlanta and Dallas, we expect to expand in markets where Stationary Power Services has seen strong demand and expect to be able to increase our design and installation activity as well as secure more service contracts to an expanded local presence. In 2008 we expect Stationary Power to be a contributor to sales and profit and we expect this contribution to grow significantly through 2009 and beyond with the addition of new technology and service offerings.

Through development work going on today we expect to start to introduce smart lithium ion batteries into this market in 2009. The growth of small distributed hubs for wireless, fiber and cable communications presents a maintenance challenge that our smart circuit technology with remote monitoring can help to solve. Over time we will expand this capability to larger applications and installations. We’re also studying the feasibility of establishing these services in international locations where we have a presence and where these services are in demand. Government and defense markets are fueling much of our sales growth in 2008. As we are at a cyclical high in US defense spending there’s always a concern that this is not sustainable. The growth we’re projecting for 2008 is as a result of our product development in the area of communications systems products. We intend to continue this development work. The trend is for these systems to require extended ranges, more power and more complex systems integration. Our work with SATCOM Systems, our tactical repeater product, our growing line of RF amplifiers, our high capacity smart batteries and chargers and our work with fuel cells for remote power are all directed at these trends. The addition of RedBlack Communications gives us industry leading systems integration capability and a high level security cleared operation as well.

In 2007 we made significant strides in growing our international defense business, particularly in our battery product lines. For the first time we sold more batteries directly to overseas military organizations than we did directly to the US Defense Department. We intend to make similar inroads with our world class communications systems products. We firmly believe that our enhanced capabilities and international reach will allow us to grow our share of domestic and international defense spending. Our goal is to sustain if not grow revenues even in a declining total market through these moves. Based on a strong backlog and known demand we expect to reach revenue of at least $238 million in 2008. This includes making up the $7.5 million in revenue that’s moved from quarter 4 of 2007 into 2008. For the first quarter we expect an operating profit of between $2.5 and $5 million on sales between $50 and $60 million. While these projections are still highly dependent on parts flow we believe we have the commitments from our suppliers and the plans to ensure that last quarter’s problems do not reoccur.

Now I’d like to turn it over to Bob who will give a financial commentary after which we’ll open it up for questions.

Robert W. Fishback

Good morning. Earlier this morning we released our fourth quarter results for the period ended December 31, 2007. Before I get into the specific results for the quarter let me first summarize a number of items that occurred during the quarter which had an impact on the business and our overall financial results.

First in mid-November we completed the acquisitions of Stationary Power Services and Reserve Power Systems, giving us half a quarter’s worth of financial results in Q4. In addition we added a full quarter’s worth of results from Innovative Solutions Consulting, now RedBlack Communications which we acquired at the very end of Q3. To reflect our expanded services business we have renamed our Technology Contract segment to Design and Installation Services. This segment will now include the results of Stationary Power and RedBlack as well as technology contracts. The reserve power business which mainly consists of sales of rechargeable lead acid batteries will be folded into our rechargeable product segment. Currently this business has a very impact on the financials. We have also renamed our Communications Accessories segment to Communications Systems to reflect the significantly increased focus in this segment on integrated communications systems as opposed to individual accessories.

Second, in early October we announced that we had negotiated a $7.9 million reduction in the overall purchase price for McDowell Research. This settlement agreement was consummated in mid-November with a $3.5 million prepayment on the convertible notes we had with the sellers. In the end, we recorded a one time non-operating gain on the McDowell settlement in Q4 of $7.6 million and subsequent to the end of the year the holders of the convertible notes exercised their rights to convert the remaining $10.5 million principal balance on the notes into 700,000 shares of common stock.

Third, in order to provide financing to the recent acquisitions and the payment on the McDowell notes we completed a limited public offering in mid-November where we issued 1 million new shares of common stock raising gross proceeds of $13.5 million. These significant items added to the complexity of our year end closing process causing us to report a little later than we otherwise would have liked.

Turning now to the financial results for our fourth quarter of 07 consolidated revenues totaled a record $36.8 million a $6.7 million increase or 22% over the same quarter last year. This revenue increase was the result of significantly higher sales of communications systems as well as the added contribution from RedBlack and Stationary Power. Offsetting these increases in part were lower revenues in our rechargeable segment compared to a strong prior year when we shipped a large order of 2590 batteries and chargers for an IED jammer application. Gross margin in the fourth quarter of 07 was $5.7 million an increase of $600,000 from the prior year. As a percentage of total revenue however gross margins declined from 17% last year to 16% this year mainly due to lower margins in our rechargeable business relating to the decline in sales volume. Our fourth quarter 2007 results were adversely impacted a charged inventory of approximately $1.3 million primarily related to the integration of the McDowell business into our Newark operations as we completed the relocation of that business and conducted a year end physical inventory.

In addition we experienced unanticipated manufacturing inefficiencies during the quarter as we ramped up our assembly operations. While we added $2.2 million in revenue during the quarter from our new acquisitions the margins associated with these operations were much lower than our 30% target due to the requirements of purchase accounting where inventory as of the date of acquisition is marked up to fair value and current volumes are not at levels to be able to adequately absorb current overhead costs. Operating expenses in the fourth quarter totaled $8.4 million versus $6.6 million in 06 an increase of $1.8 million. Of this total R&D costs accounted for $400,000 of the increase as we accelerated spending on certain new product development programs during the quarter. Approximately $500,000 of the increase was related to the added SG&A costs associated with RedBlack and Stationary Power. In addition other SG&A costs rose $900,000 due to higher professional fees associated with the integration of our new businesses in addition to generally higher costs required to support a broader organization. Included in total operating costs in 07 are approximately $1.3 million of non-cash expenses related to intangible asset amortization and stock compensation expenses compared with $1.2 million a year ago.

As a result of the above we reported operating loss for Q4 07 of $2.7 million compared with an operating loss of $1.5 million last year reflecting the lower gross profit and higher operating expenses below gross profit margin. Below the operating line net interest expense for the quarter was $500,000 down $100,000 from last year due mainly to the reduction of the outstanding principal on convertible debt. As mentioned earlier we recorded a one time gain of $7.6 million on the negotiated settlement for the McDowell acquisition. Income taxes were nominal in the fourth quarter of 07 as a result of our decision in the fourth quarter of 06 to fully reserve for our deferred tax asset due to the uncertainty at that time of our ability to fully utilize our existing net operating loss carry forward. We continue to monitor this situation each quarter. On the bottom line we reported net income of $4.4 million or $0.27 per diluted common share compared with a net loss of $26 million last year or a loss of $1.73 per share. Average diluted shares outstanding were 17.3 million shares up 2.2 million shares from last year due mainly to the impact from the limited public offering during the quarter, convertible notes outstanding and unexercised stock options.

With respect to cash flows for the fourth quarter adjusted EBITDA was relatively neutral as adjusted for the add back of non-cash stock-based compensation expense and the one time non-operating gain on the McDowell settlement. During the quarter we used approximately $4 million of cash for working capital needs as inventory levels and receivables increased offset in part by an increase in accounts payable balances. With respect to investing activities we spent approximately $700,000 on additions to property, plant and equipment and $6.2 million on acquisitions. With respect to financing activities during the quarter we raised $12.6 million net from the limited public offering. In addition we generated $800,000 from stock option exercises and we drew down $2.3 million more from our revolving credit facility. We used $500,000 of cash to reduce the principal balance on our term loan, $1.2 million to extinguish debt that we assumed in the Stationary Power acquisition and $3.5 million to make the prepayment and retire a portion of the McDowell convertible notes. As a result we ended the year with an outstanding balance on our revolving credit facility net of cash of approximately $9 million up $1 million from the end of September.

Inventory levels rose $5.2 million during the quarter due mainly to the ramp up of production for SATCOM-On-The-Move and other communications systems as shipments to our customers were delayed. As we work through our supply chain issues we expect to be able to bring our overall inventory levels down during the first half of 08 which will help us to eliminate our need for borrowing under our revolver.

As we look ahead to the full year for 08 we expect to generate revenues of at least $238 million with very strong sales of advanced communications systems and accessories. Specific to the first quarter of 2008 we expect revenues in the range of $50 to $60 million due primarily to higher shipments of communications systems. Our ability to achieve this projection is highly depended upon the parts flow from our supplier for a key component in our advanced communications systems. We are currently forecasting operating income in the range of $2.5 million to $5 million for the first quarter based on the range in revenues.

Our fourth quarter results were certainly disappointing but we remain very upbeat. 2008 is looking to be a record breaking year as we see increasing demands for our products and services particularly communications systems and our recent entry into the standby power market is opening new growth opportunities in the commercial marketplace. We remain very optimistic about our ability to sustain long term growth while delivering profitable results.

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

John D. Kavazanjian

While we’re not happy about the issues we faced in the fourth quarter our supply lines are intact and we believe we have all the elements to make up for this with a very strong first quarter and a great 2008. We also think we’re making the investments in products, services, markets and applications that will keep the company growing in 2009.

Now I’d like to ask Darrell to open it up for questions.

Question-And-Answer Session

Operator

(Operator Instructions) We’ll take our first question with Jim McIlree with Collins Stewart. Please go ahead.

Jim McIlree - Collins Stewart

John, that’s a pretty wide range for Q1 so what would be the primary delta between doing $50 million or $60 million in the quarter?

John D. Kavazanjian

We have still have an increase, if I look on a weekly basis in terms of supplier shipments for the month of March, we still are counting on increasing supply. We believe we have the supply chain to do it. We have all the work plans behind that, we’re in with our supplier and their manufacturers, we think everything is lined up to do that, but we’re just making sure because they’ve demonstrated the capability to produce a certain volume and they have to increase that. So it’s really dependent on them increasing their volume of output on a weekly basis during the month of March.

Jim McIlree - Collins Stewart

And this is one supplier or a couple of suppliers?

John D. Kavazanjian

We had one supplier who had a problem getting parts and it was one particular part that prevented manufacture of a board, it’s really that simple. We’re in there helping them and making sure that that’s going. It goes into multiple products that we have plain and simple, but we’re not assuming that everything else is perfect so we’ve really gone in and made sure that with everything we have that we have the right backups and the right confidence in the ability of our different suppliers to perform. So we believe we’ve done everything we can to ensure our supply chain but it still counts on some increases.

Jim McIlree - Collins Stewart

And, Bob, on the debt, I just want to make sure I have it right, $10 million of the McDowell convert is now gone so on a pro forma basis your long term debt would be about $5 million, correct?

Robert W. Fishback

Following the retirement of the $10.5 million convertible debt in the fourth quarter we added $4 million related to the acquisition for Stationary Power, we have about $3 million remaining outstanding under our current term loan as of he end of the year and then we’ve got the revolver outstanding which at the end of the year was around $11 million.

Jim McIlree - Collins Stewart

I thought you said that post-Q4 close more of the McDowell notes were converted. Is that not correct?

Robert W. Fishback

That is correct. As of year end we had $10.5 million outstanding on that McDowell convertible note and then post year end that is gone now.

Jim McIlree - Collins Stewart

So on a pro forma basis your long term debt would be about $4.5 million?

Robert W. Fishback

Well, there’s – Well, okay. Yes.

Jim McIlree - Collins Stewart

I’m just trying to figure out going forward.

Robert W. Fishback

Yes, agree.

Jim McIlree - Collins Stewart

So that’s about 700,000 in additional stock you said. I think that’s correct?

Robert W. Fishback

Yes, 700,000 shares.

Operator

We’ll take our next question with Steve Sanders with Stephens, Inc. Please go ahead.

Steve Sanders – Stephens, Inc.

I just wanted to come back to the guidance range again, is it fair to say that the current run rate for the supplier that caused the problems put you at $50 million and if they expand you get to $60 million?

John D. Kavazanjian

I think that’s exactly right.

Steve Sanders – Stephens, Inc.

And where do you stand on a second source and what’s your thinking on that?

John D. Kavazanjian

We will not have a second source for that during the term of the $24 million contract.

Steve Sanders – Stephens, Inc.

What about the $102 million? Does it use the same part?

John D. Kavazanjian

In some places it does. During the term of that contract we may have a second source. It’s something we’re actively working on.

Steve Sanders – Stephens, Inc.

And then how would you characterize the customer relationship coming out of the problems in Q4?

Robert W. Fishback

I don’t know. Ask Bill since he’s intimately involved with it.

William A. Schmitz

It’s cooperative. I mean it’s such a great product that it’s in such high demand so everybody’s working really effectively together to get this behind us and meet the customer expectation.

Steve Sanders – Stephens, Inc.

And then how did the delays impact the expected margin on the SATCOM project in the near term? You have additional freight costs, I don’t know if you have overtime, could you just talk about that a little bit.

John D. Kavazanjian

Well at the end of the year we had significant overtime. We typically take the Christmas to New Year’s week as a holiday week so we were paying people to come in waiting for parts to come which didn’t happen for us. There’s overhead absorption, we moved a significant number of people over from our battery operations over to manufacture these systems so it hit us about $600,000 in overhead absorption, probably a couple hundred thousand dollars in freight and expediting and other stuff. So we factored that in for this quarter because to make sure we don’t have that again and we factored some of that not in the overhead absorption obviously because we have to count on a certain volume. But we factored that into some of our expense categories for sure.

Steve Sanders – Stephens, Inc.

And then John you talked recently about recently a near term to intermediate term target on the gross margin line of around 30%, can you just revisit that in light of what’s happened over the past few months?

John D. Kavazanjian

In the systems business we believe we should be there this quarter. It’s heavily weighted by the systems we get, we think we have a very good grasp on the costs and certainly on the pricing of these things so we feel pretty good about that. In the non-rechargeable segment that was really hit by the fact that we moved people over. That’s a heavy capital intensive business that a very high percentage of the product cost is overhead, 25% I believe of our product cost in that area is typically overhead and so we overtly started scheduling things out not making customers dissatisfied but where we could move things out we did to be able to move people over. I think we’re back in pretty good shape this quarter in that business, in the non-rechargeable segment. In rechargeable it purely was kind of a cyclical lull. Last year we had a lot of sales in that area, we spent a lot of money in the fourth quarter in rechargeable, you saw we spent some money in the R&D area for some projects with people that we’re getting reimbursed for but we don’t get the reimbursement and can’t book that until we’ve hit certain milestones which is the in the first and second quarter. Additionally, there’s another good sized project that we started shipping on in that quarter and we had a fairly, let’s put it this way, it was in the $100,000 range, six figure range in terms of scrap as we started, not anticipated, but certain legal plan for scrapment as we started that up. We’re through that now and we’re going to have pretty good shipments in this quarter. I think we started pretty much last week with some pretty significant shipments there that’ll continue and increase into the second quarter. The first project was the one we did for the UK MOD for a prime contractor. That is starting to ship this quarter. The product that the development work will result in will start to ship in the second quarter and we’ll see how that falls. We’ve also made sure that we’re conservative in how we assume that that would be accounted for. What happens in some of these projects is that even though we’re getting reimbursed you have to really look at the contractual terms that gait the reimbursement in deciding how you can book that either as an offset to expenses or as a technology contract revenue and I think we’ve taken that into account pretty well. So we expect rechargeable to come back this quarter in terms of volume, get back gross margin because again on a low volume like that given the sixth cost and test equipment and factory we have there it’s pretty easy to end up with a low margin if you don’t get the volume. So we’ll that back this quarter and even better shape in the second quarter. Again, we’re being if you look at kind of what our guidance implies we’re being careful to make sure that we accommodate any unanticipated issues in both of those areas.

Steve Sanders – Stephens, Inc.

And then a couple questions for Bob, can you just talk about run rate expense levels in 2008 with the acquisitions maybe compare them to 4Q and then carve out the amortization expense and talk a little bit about the cap ex and free cash flow outlook for 08?

Robert W. Fishback

The acquisition expenses that carried over or we’ve added in the sense in Q4 were $400,000 or $500,000 from the acquired entities in the SG&A area and because Stationary Power we added in Q4 was a half of a quarter, that may go up a little bit as we go into a full quarter in Q1. Total amortization expense for intangibles was around $700,000 in the quarter. As we go into next year I expect that to be in about the same range per quarter. Capital expenditures will be or were in Q4 about $700,000 as we go into 2008 we put together a capital plan that’s a little bit higher than that on a quarterly basis but we typically every year put a plan together that’s fairly aggressive and we typically spend in the $750,000 to $1 million per quarter as I would be looking ahead into 2008. And then free cash flow, our adjusted EBITDA in Q4 I mentioned was relatively neutral the $700,000 of capital expenditures in Q4 that would place free cash flow at about -$700,000 to -$1 million in the fourth quarter but as we go into this year I would expect for the full year we should be generating some very positive EBITDA and free cash flow should be offset or adjusted EBITDA should be offset by cap ex of $3 or $4 million for the year. We anticipate some very positive EBITDA for the year.

Operator

We’ll take our next question with Ted Kundtz with Needham & Company. Please go ahead, sir.

Ted Kundtz - Needham & Company

Couple questions for you, I just want to go back through some of these contracts that we’ve got here. The SATCOM-On-The-Move contract, that’s the one that caused the delay, where are we in that whole contract? There’s a $24 million contract, how much have we shipped so far and what’s the balance?

John D. Kavazanjian

We shipped about a third of it during the fourth quarter and most of the rest of it will go – does it all go this quarter, Bill?

William A. Schmitz

No it stretches out.

John D. Kavazanjian

It all goes out by the end of the second quarter, so in the first half of the year. There’ll be some pretty healthy shipments this quarter. And on the other communications systems order, the $62 million and the $40 million we’ll start shipping on those – I think we started shipping on those.

William A. Schmitz

We started to ship them already.

John D. Kavazanjian

We did start shipping on those already.

Ted Kundtz - Needham & Company

And how does that shipment rate look to you guys? Is it fairly equal or is it weighted in any particular quarter?

John D. Kavazanjian

They’re asking us to get up to a certain run rate in the second quarter and then they’re going to make a determination whether they increase it or not. I’m not trying to be evasive here but there’s some chance they’ll accelerate it, there’s some chance they’ll spread it out so we’ve kind of assumed that that’s going to go throughout the year.

Ted Kundtz - Needham & Company

Can you say what that run rate target is?

John D. Kavazanjian

I don’t have the ability to say that right now, Ted, to be honest with you.

Ted Kundtz - Needham & Company

The question was asked, I just wanted to get a little more clarification on it again, was the component issues there, it’s the same supplier. [Inaudible] the parts you said but it’s already starting so –

John D. Kavazanjian

The part that was in short supply at the end of the year is designed into several of our systems and we are getting the flow we need right now. Let’s put it that way. We’re getting the flow we expected right now. It’s got to increase kind of by the second half of the year we expect to have maybe it’s earlier but by the second half of the year we expect to have alternatives. Given that we’re happy that we get the supply going on this thing we don’t really need an alternative but we’re certainly going to try to back ourselves up.

Ted Kundtz - Needham & Company

So there’s no issue with the performance of the part, it was just the supply of it.

John D. Kavazanjian

It was just the supply. There was just one part missing, I think it was – I don’t want to get too fancy on this, but it was one part missing that they couldn’t get and they had commitments for and which we wish we would have known about sooner to be frank with you.

Ted Kundtz - Needham & Company

I was just sort of a little puzzled why you don’t have a better clarity on the first quarter here given it’s so late in the quarter already. You’d think they have the parts or they don’t have the parts to ship to you.

John D. Kavazanjian

We are expecting increases in shipments every week of the month of March and if those happen we’ll be at the higher end.

Ted Kundtz - Needham & Company

This $102 million of this advanced communications systems product, you haven’t identified who that’s with or where that’s going. Is that correct?

John D. Kavazanjian

That’s right. I think what we’ve said is that some of it is, it’s packaged in different ways, it’s multiple configurations packaged in different ways, some of it goes into vehicles and some of it is human carried.

Ted Kundtz - Needham & Company

How long does that business go for, what’s the timing on that entire contract? Is that sometime this year or is that going to go into 09?

John D. Kavazanjian

No, we’ve said that’s all for deliveries in 08.

Ted Kundtz - Needham & Company

Is there potential follow on business there?

John D. Kavazanjian

We think so. Look the fact is that wherever you see – let’s talk about that particular communications systems business. Wherever you see a radio there is a need for that radio to talk longer, further and over more different frequencies. And so when the vehicle mounted or backpack radios, they want the power and capability to go to SATCOM for example which is different frequencies and higher energy, more power. And so we put together systems that are comprised of converters, amplifiers antennas in different configurations to serve that market. We think that’s a big market. We think people keep talking about this is tied to [EMRAPH]. We think it’s tied to vehicles, we think that every time a vehicle is procured and a radio is put in a vehicle our goal is to have one of our systems in there to make that radio perform better, talk longer and over a wider distance. With the handheld radios we think that’s the next frontier. There’s hundreds of thousands of handheld radios deployed in the world. Most of them are deployed outside of the United States military actually in places like Kenya and Indonesia and Japan and UK and Australia and other places and so we think those radios typically have a radio to radio range of about 2 miles and that’s why we designed our portable tactical repeater product because it’s a hub that enables you to through that hub communicate over much longer distances with those radios and we think that people are going to want to do that. The systems business and there are other products we have that we’re working on the systems business that play on those and other trends that we see. We think that’s not just US military, it’s a worldwide trend in defense and in government.

Ted Kundtz - Needham & Company

The margins on this business would be what, in what range?

John D. Kavazanjian

Because these are highly engineered products, they’re typically 30% range margins. We think with more complex systems they could be higher but I think 30% in our experience is a good number for it.

Ted Kundtz - Needham & Company

Is all the work at McDowell, the integration, completed? Should there be any more charges or is everything finalized by now?

John D. Kavazanjian

Let me address the charges. When we made the settlement on McDowell we looked at the inventory and we said that we were not comfortable with the valuation of it. Part of the negotiation was the valuation. Our obligation is to value the inventory based on what we know as best we can but we did not have the experience to look at parts necessarily and say this is obsolete, this is going to sell. We look at some parts and we say when is that going to sell, the next thing you know you get a big order for it. There’s cyclicality to the business, there’s very, very large product offering. Literally thousands of different options. The thing that they did really well is really cater to the needs of customers and that spawned a lot of different products and our goal over time is to make those more platform oriented so that we can do variations on them but right now there’s lots of different products. So every time we get new information we reassess, every time we make new buys on products, we reassess. Do we have the right standard set for the parts that we have in stock already? And so we think we have done the best job we can. We did a full audit, we got everything into our facility here, we sorted everything out, we looked at rev levels, we went through it, we went through it with our external auditors and one of the things that took a long time in the month of January was to do the audit ourselves, do the inventory, audit it ourselves and go through it with our auditors and look at valuations and make that adjustment. We think we’re there. We really do. We get new information every day but we’ve substantially gone through that stuff.

Ted Kundtz - Needham & Company

It should be fairly complete? You don’t expect any more charges?

John D. Kavazanjian

We wouldn’t be doing our job in terms of posting financial statements if we thought there was more work.

Ted Kundtz - Needham & Company

It’s just taking a long time to get this totally finalized.

John D. Kavazanjian

Yes, it has.

Ted Kundtz - Needham & Company

Do you guys give any backlog numbers, where you were at the end of the year?

John D. Kavazanjian

We typically don’t give backlog numbers because ordering patterns are not any indication of the health of the business typically. In one part of our business if you look at the 9 volt business we don’t want people to have backlog because it’s an order to stock business. We want it to stay lean. In the business we sell directly to militaries that has to do with budget approvals and then the ordering patterns change, sometimes they place orders out for long periods of time, sometimes they order a month at a time, DLA or the UK MOD, it’s really it’s not a good predictor and then of course in the systems business it is fairly project oriented. The big orders that everybody likes to focus on, big orders is very project oriented. And so it depends on when those happen.

Ted Kundtz - Needham & Company

Are you seeing any stretchouts in the military ordering? Any deferral of budgets just pushing out of any quarter patterns?

John D. Kavazanjian

We see projects move around, okay, so we thought – We’ve been asked before about for example about the [decrew] program, the dismounted ID jammer program and we’ve been thinking for a year that they were going to buy more into that program but the military sets priorities and one of their priorities is to order more vehicles, more EMRAPHs and now you see EMRAPH coming down but they’re also in place of that, it’s not that they don’t need vehicles, it’s that they’ve decided that they’re looking to see if they’ll buy different vehicles, lighter weight, faster versus more heavily armored. So the priorities change is what we see and it all depends kind of on the situation on the ground and assessment of what they need in the coming months is how they decide their priorities.

Ted Kundtz - Needham & Company

So no particular tend there?

John D. Kavazanjian

No. It’s just that the more areas that we can participate in the more we can insulate ourselves from funds that move around.

Operator

We’ll take our next question with Walter Nasdeo with Ardour Capital. Please go ahead.

Walter W. Nasdeo – Ardour Capital Investments

Most of my questions have actually been touched upon already but I was wondering what the DSOs were for the quarter?

Robert W. Fishback

The DSOs were consistent with where we reported last quarter which was around 55 days.

Walter W. Nasdeo – Ardour Capital Investments

And have you broken out again this quarter, it’s a question I ask you every quarter, of military versus the commercial sales or the industrial sales, what the percentage was?

John D. Kavazanjian

We didn’t break it out. I think we were a little more, because of these communications systems sales we ended up being more heavily weighted to defense and government so we might have been in the past where we were kind of 62 to 1, we might have been closer to 3 to 1 this quarter. Does that sound right to you, Bob?

Robert W. Fishback

Yeah, that’s about right.

John D. Kavazanjian

Probably closer to 3 to 1. We still consistently run about 50/50 on the battery side, military or defense and commercial, but on the growth and the systems businesses has changed that a little bit.

Walter W. Nasdeo – Ardour Capital Investments

As far as the capacity that you guys have there is that still going to be sufficient or do you expect any capital expenditures going forward as you grow this system oriented business more?

John D. Kavazanjian

I think we’re in pretty good shape in capacity. This business really does require, because it is engineered content and we’re not bending our own sheet metal, we are making our own cables in some cases but we’re not putting a lot of capital intensive labor into these products. Our labor is more assembly and test and so really the capacity there is floor space and people. We did announce that we’re starting a small operation in West Point, Mississippi because we have some development projects going to [inaudible] Mississippi and Mississippi State University so that’s in recognition that we might need more floor space and frankly it helps us a little bit to spread out our, not too much, but have another labor base because there are times when economies are cyclical in different parts of the country and we will be people intensive in some of these businesses as we go forward, not capital intensive. And when I say intensive meaning that’ll be the biggest gait is hiring and training people and we want to have two different pools of labor to be able to pull from because we do go through periods where unemployment gets very low in particular areas and it’s happened to us before up here. So we think we’re in pretty good shape in terms of the resources that we require.

Walter W. Nasdeo – Ardour Capital Investments

Is that Mississippi facility going to be more of assembly or manufacturing?

John D. Kavazanjian

It’s going, well we call assembly manufacturing, but it’s going to be more assembly on the front end, it won’t be heavily – assembly and test. I mean the capital equipment required will be test equipment, it’s nothing like the non-rechargeable battery business where we have large coding, mixing, dry rooms, compressors, etcetera.

Walter W. Nasdeo – Ardour Capital Investments

And then just lastly what’s the total number of employees at year end?

Robert W. Fishback

We had around, I think it was 1,150.

John D. Kavazanjian

That was what I thought. 1,100 or 1,200 employees.

Operator

We’ll take our next question with Ryan Jones with RBC Capital Markets.

Ryan Jones – RBC Capital Markets

This Amit Daryanani actually.

Amit Daryanani – RBC Capital Markets

I had a really quick couple of questions. First, the $500,000 of professional fees you had this quarter, is there any residual flow through in the next quarter?

John D. Kavazanjian

We don’t think so, we might have a little bit higher fees because with a more complex organization certainly our audit fees will go up but we had certain legal fees, we had to do an audit on the front end of our acquisitions, those fees hit us during the quarter, we had some consulting fees connected with work that was done in conjunction with expanding our bank line so I would say that most of those, but not all, will not be recurring.

Amit Daryanani – RBC Capital Markets

Not to beat a dead horse here but the component provider, was this component provider put on the AVL by you guys or by the OEM itself?

John D. Kavazanjian

By us. This is a part that we’ve been using, McDowell Research started the SATCOM system in early 06, Bill?

William A. Schmitz

2005.

John D. Kavazanjian

2005 I think. They had one good sized contract that happened that they shipped in the quarters before we bought the company. Then last fall we got another order which contained this component also, same type system. We did some changes to the system to make it more repeatable that was shipped in the spring of this year and then with this system, still had the same parts. So we have a long history, it was really a matter of getting an order for three times the quantity that they’d ever gotten before.

Amit Daryanani – RBC Capital Markets

So far it sounds like the ramps are going in line with expectations for this component, right?

John D. Kavazanjian

We are where we expected to be.

Amit Daryanani – RBC Capital Markets

And then just my final question, just kind of looking at the history for the last few years with you guys, there have been a number of negative pre-announcements every quarter and partially it’s because we are in a lumpy business and revenues can flow around, but I’m just – given that lumpy nature, given the history of the pre-announcements, have you guys looked at potentially backing away from given quarterly guidance because surely the lumpiness does impede the predictor power you guys have.

John D. Kavazanjian

Amit, that’s a really good question, that’s something that we’re kind of looking at each other here because it’s a very serious discussion we’ve had and we had with our Board, we had with our finance committee and it’s something we’re going to look at and we’re going to look at with our Board very seriously next week and going forward to say what do really have a capability to give. The only defense I can give you is we studiously look at this and say we want to tell people what we really think is going to happen. We haven’t been very good at that, but it’s something that we’re actively talking about.

Amit Daryanani – RBC Capital Markets

Our take is just the programs you have are so lumpy that I think it’s beyond your control to [inaudible] how they flow out. And then just finally, could you just talk about what sort of appetite do we have to do acquisitions at this point or is the focus more to totally drive revenue growth at least through 2008?

John D. Kavazanjian

There are some areas in which I’ll say the acquisition of ISC which is now RedBlack Communications was relatively seamless because they really are engaged in markets we’re engaged in, they have services that we’ve used in the past, we actually subcontracted work to them in the past, we knew them well and it very easily slipped right in with what we’re doing. Our salespeople get calls to sell their products, their services all the time. So things like that I don’t think we’re going to shy away from if they come up. Right now our goal is to really look at long term revenue growth opportunities and we think Stationary Power gives us the platform to be able to do that. We can do that with what we have and with products that we’re developing moving forward. So we don’t have any plans for any big acquisitions coming forward but on the side of some smaller things that integrate well with what we’re doing, maybe help us vertically integrate in some ways, we’ll continue to look at those, but frankly we’d like to do with Stationary Power what we did with McDowell business. The McDowell business was a little over $20 million a year business when we bought the company and that business going to be $150 to $160 million this year maybe if we keep cranking this.

Operator

We’ll take our next question with Colin Rusch with Broadpoint Capital. Please go ahead.

Colin Rusch - Broadpoint Capital

I’m just wondering if you can give us an update on the development of the channel strategy? How large is the service infrastructure at this point and how do you see it growing in 2008?

John D. Kavazanjian

First, with RedBlack Communications they have a market for services that’s pretty well defined in the government marketplace that when they had financial issues over the last couple of years, they had one big customer there who they were getting all their business with, they didn’t really have sales and marketing and when they lost that customer they turned to product sales. So there’s still some product sales there but I think there’s a lot of capacity that they have there to do more services to a pretty good extent. They were doing about $10 million a year with their services in the past. So we think there’s capacity to grow that pretty well to $10 million or above in services. On the Stationary Power side really we have a very solid infrastructure that we’ve augmented some but with the addition of an operating manager down there and some finance staff down in Tampa which is their headquarters we’ve expanded now, they had started just as we were doing the acquisition to put offices in Atlanta and the importance of the offices is not that they can’t do installations in other places but they have to fly crews there to do it. And then the implication of that is if you fly a crew there and do it, you can’t pick up the service contract because you have to have somebody, you get service within a four hour driving distance and where you are at that point in time. So we’ve added Atlanta, we’ve now added Dallas so we have a real opportunity to add more there. It’s not a huge infrastructure when we do it we just need crews and van and parts to do that. I think there’s capacity to do that, I guess. I think we have infrastructure and we’ve given them management infrastructure and financial wherewithal to be able to do that more.

Colin Rusch - Broadpoint Capital

Can you give us any sense of the scope of how that’s going to grow throughout the year?

John D. Kavazanjian

We said we did about $1.5 million in the month and half that we had them, they had been running pretty much at $1 million, in 06 they ran about $9 million, in 07 they’re at about a $12 million rate, kind of 30% growth. 30% growth I would say would be the bottom. I think we’re now in the wherewithal to grow that even faster. It’s not prone to some explosive contract growth like we had with the communications systems business but I think we can grow that thing. 30% would be a bottom for me in terms of the speed we can grow that business with. The other thing we want to do that we think is there is that every time we do an installation we have the opportunity to get contact maintenance and contract maintenance is usually a good predictable revenue stream, it allows you to get critical mass in particular areas to put resource that when they’re not doing that maintenance can do installation work and I think that really does change the model when you get a percentage of contract maintenance. They’re kind of $12 million run rate they were under 10%, they were probably under 5% of contract maintenance. They did do maintenance but it was time and materials as need type work. My goal is that we start getting contract maintenance up to be a decent 10 to 20% of that service sector and that’s good and it’s also good business because it’s business you get paid for before you do the work.

Colin Rusch - Broadpoint Capital

On the Stationary Power applications how do you think about the timeline for the sales cycle and can you give us a scope for how to think about that going forward?

John D. Kavazanjian

I can tell you what we’ve learned in the last six months since we’ve been working with the team down there and that’s that there are some things that happened right away. There was a big power failure in Florida yesterday and when systems which went on to lead acid batteries came back online all of a sudden alarms went off because some of those lead acid batteries didn’t do too well. My analogy is if you discharge your car battery all the way try to do that three, four, five times. One of those times it’s not coming back and so when they went to recharge those strings of backup batteries, some of them didn’t come back so Stationary Power is probably getting calls as are people like them today from customers that are saying quick I need – now they’re putting redundancy in, I have a redundant stream that needs to be replaced. So there’s some of that business that’s very event driven and happens very fast. There’s some of the business that goes on a cycle where companies like Verizon and Qualcomm, people that have cell phone towers like Sprint and AT&T know that on a rotating basis they have to kind of rotate through that every two or three years or whatever their cycle is based on how they use those backups, they have to change them. So those kinds of cell cycles those can be three, four, five month cell cycles, six month cell cycles if the customer doesn’t know you. Then again if the customer knows you, you may be on their list of people they bid for particular jobs and it may be a month or two. I don’t know if that helps but there’s a real range of how that business happens.

Colin Rusch - Broadpoint Capital

And the last question is just about how do you estimate customer acquisition costs? Clearly if you’ve got a couple different ways that you’re gaining customers, how do you put numbers on that?

John D. Kavazanjian

Customer acquisition in any particular market?

Colin Rusch - Broadpoint Capital

Why don’t we just stick with the Stationary Power and the RedBlack.

John D. Kavazanjian

How do we estimate customer acquisition costs? I think right now our approach is we think there’s geographies where that market – that market’s growing and it’s growing because more and more installations are going in that need backups. As soon as they start doing fiber to the home there’s the hub in that home in the garage with a backup battery so there’s more and more applications and more and more things that need backups plus the FCC now is pushing from four to eight hour backup times, that requires more batteries so we think that’s a growing market so we think there are geographies that in particular are growing faster because new installations, new homes, new things are going on. You follow where the population’s growing and so we look at those markets and we see, I don’t know about customer acquisitions, but we see unfulfilled demand, we have a model for what it costs us to put in a salesperson and a couple of maintenance people, give them the van and the tools they need, get the right level three electricians or whatever we require in that space and then we have a model for what kind of revenue we think those installations can generate. We know what it can do on the installation side. We’re learning what it can do on the contract maintenance side. That’s something we’re going to learn over the next year. And then as we go forward we want to change that model because we think with remote monitoring capability of smart batteries that changes the model of what a crew can do or what one office can do in terms of maintenance because if you can do predictive maintenance instead of reactive maintenance, it changes the equations. So that’s how we look at it. We don’t look at it as a cost of acquiring customers, we look at it as how do we serve markets that are underserved right now.

Operator

We’ll take our next question with John Barr with Bookingham Research. Please go ahead.

John Barr - Bookingham Research

I wonder if you guys could just clarify the $24 million contract with Raytheon. You said the customer and the supplier were working with you on it, and did you also say that you shipped one-third of that?

John D. Kavazanjian

Yeah, one-third of that shipment went in the fourth quarter.

John Barr - Bookingham Research

And then also said that the rest would be completed by the end of the second half?

John D. Kavazanjian

By the end of the second quarter.

John Barr - Bookingham Research

And is this contract sole source for you guys?

John D. Kavazanjian

Yes, it is.

John Barr - Bookingham Research

One other detail question if you could on the inventory increase, do you have a sense yet for how much is work in process versus completed product?

John D. Kavazanjian

Bob can look right now, but if you look at the inventory increase it almost totally ties to we were staged for that $7.5 million in revenue plus what we were going to do in the first part of this quarter and if you do the math on margins and take a little off for labor content that pretty much represents what our inventory increase was. If we would have shipped that $7.5 million inventory would have been flat, even in a growing business.

Robert W. Fishback

I don’t have the number right in front of me but probably work in process inventory was probably about 25% of the overall inventory I’d say.

John Barr - Bookingham Research

And then can you tell us what the part was or characterize the part for us a little bit?

John D. Kavazanjian

We’ve been asked not to only because the competitive issues here, but we’ve said it was an electronic board, it was a circuit board and it was for lack of one component that the contract manufacturer of the board.

John Barr - Bookingham Research

And McDowell had worked with this board for a long time?

John D. Kavazanjian

Oh, yeah. It’s been contained in every SATCOM system that was made going back to 2005 or 2006.

John Barr - Bookingham Research

And how do you not have a second source for this? Wouldn’t that be part of your proposal to the government?

John D. Kavazanjian

Not particularly. There’s a cost associated with putting second sources in place for things and there’s board layouts, there’s components qualifications and a lot of things there’s fairly sensitive qualification required and you have to kind of pick and choose, this is a very complex system, if I did it for every part in this system, it would be a very large increase to our research and development costs so the question we ask ourselves right now is what else should we be second sourcing and what’s that going to cost and what’s the best business decision there.

John Barr - Bookingham Research

So the supplier just wasn’t able to ramp with you?

John D. Kavazanjian

They believed they had commitments from their suppliers and they didn’t get the parts in time. It was literally that simple. But like I said we wish we would have gotten a little heads up on it because we frankly think by getting involved in this we were able to help ensure that this doesn’t happen again.

Operator

And that completes today’s question-and-answer session. At this time I’d like to turn it back over to management for any additional or closing remarks.

John D. Kavazanjian

2008 is shaping up to be by far the strongest in the company’s history. We really believe we’re on track and are actively ensuring that we have parts supply. So the first quarter will get us off to a great start. We want to thank everyone for participating and we really look forward to sharing our progress towards that end on our next call. Thank you very much.

Operator

Once again ladies and gentlemen this will conclude today’s conference. We thank you for your participation. You may now disconnect.

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