Ultralife Corporation
Q3 2008 Earnings Call Transcript

Published: 12 Nov 2008

[Operator:]

Good day and welcome to this Ultralife Corporation third quarter earnings release conference call. Today's call is being recorded. At this time for opening remarks and introductions, I’d like to turn the call over to Ms. Jody Burfening. Please go ahead.

[Jody Burfening:]

Thank you, operator. Good morning, everyone. This is Jody Burfening of Lippert/Heilshorn & Associates. Thank you for joining us for the Ultralife Corporation earnings conference call for the third quarter of fiscal 2008. The earnings press release was issued earlier this morning and if anyone has not yet received a copy, I invite you to visit the Ultralife website at www.ultralifebatteries.com, where you will find the release under Investor News in the Investor Relations section. In a minute, I’ll 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. These include worsening global economic conditions, increased competitive environment and pricing pressures, and disruptions related to restructuring actions and delays. The company cautions investors not to place undue reliance on forward-looking statements, which reflect the company’s analysis only as of today’s date. The company undertakes no obligation to publicly update forward-looking statements to reflect subsequent events or circumstances. A more detailed description of the risks and uncertainties is contained in the company's filings with the Securities and Exchange Commission such as the company's Annual Report on Form 10-K for the period ended December 31, 2007. In addition, on today's call, management will refer to certain non-GAAP financial measures that management considers to be useful metrics 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.

[John Kavazanjian:]

Thank you, Jody. Good morning and welcome to the Ultralife Corporation conference call for the third quarter of 2008. Joining me today are Bob Fishback, our Chief Financial Officer; Julius Cirin, our Vice President of Corporate Marketing and Technology; and Bill Schmitz, our Chief Operating Officer. Today we reported revenue of $68 million for the third quarter of 2008. These results put us on track to achieve our guidance of $130 million in revenue for the second half of 2008. Operating profit was $5.3 million with an adjusted EBITDA of $7.1 million. Adjusted EBITDA is a non-GAAP financial measure, for which the reconciliation with GAAP financials is on our website and in our 10-K report. The third quarter revenue includes $41 million in sales in our communication systems business. This represents the substantial completion of more than $120 million in orders that we received in the second half of 2007 for advanced communication systems, along with sales in other parts of the communications business. Gross margin in the segment was 28%, an increase over the second quarter margin of 27%. We expect similar margins in this segment for the remainder of the year and improvements next year as we enhance our sourcing agreements and start to reflect in our pricing the materials and logistics cost increases that have occurred since the beginning of the year. Rechargeable product revenue was $8 million and gross margin grew slightly from the second quarter to 22%. The worldwide shortage in rechargeable cells has caused significant price increases from suppliers, an exerted pressure on margins before we were able to take pricing actions. We expect this segment to grow in revenue for the fourth quarter and next year and margins to grow toward a target range of 25% to 30% over that timeframe. Non-rechargeable products revenue was down from the second quarter to $16 million and gross margin was down due to cost connected with the refocusing of activities in our UK operation and a product line transition in our China operation. In the UK, we are in the process of our changeover to an assembly distribution and service operation. Expect to see financial improvement from this in the first half of 2009. In China, we’re enhancing our product line and our production operations. While we will incur additional cost for this in the fourth quarter, this is factored into our guidance for the year. We will be introducing new versions of our ABLE thionyl chloride products – lithium-thionyl chloride products in the first half of 2009 with improved performance. Capital improvements in key areas of our process will also result in products that will be more robust with higher performance. These changes will enable significant increases in volume and profit in 2009. Design and installation services accounted for $3.6 million in revenue. Gross margins ran at 19% as we made further investments to grow this business. Our defense and government business remained strong both domestically and internationally. During the quarter, we sold over $3 million in chargers, solar panels, and rechargeable batteries to the government of Mexico and over $1 million in smart rechargeable batteries to the UK MoD. Both of these are for second half of 2008 delivery. We sold over $2 million in communications power accessories to a major US prime defense contractor for delivery next year. And with CERDEC, the R&D arm of the Army Communications Command, we entered a $2.1 million contract to further develop in conjunction with Mississippi State University, an advanced soldier hybrid portable power system. In our standby power services business, we entered into a master service agreement with a major commercial account for backup power systems and services with a potential for a multi-year project for consolidation of their data centers. This contract has the potential to generate as much business over the next 15 months as our Stationary Power Services unit did last year, highlighting the power of our strategy involving our capability of serving national accounts. We continue to invest in R&D. At the AUSA conference in the first week of October, we have the worldwide launch of our Tactical Repeater System. With the addition of our Link Repeater System, this is the first man portable system that enables users to build field network supportable radios. The portability and the link capability allow radio networks to be built on site, on demand, and as needed as the situation dictates. We’ve already made first shipments of the link product and there was interest from virtually every defense organization to which it has been shown. We also formally launched RPS Power Systems in October, our brand of backup power hardware solutions from mission critical power needs in the telecommunications, utility, financial and information services industries. RPS provides comprehensive hardware solutions, incorporating energy storage in electronics for critical power applications and renewable energy needs. RPS will offer our customers an extensive range of market competitive products, including lead acid batteries, racks, cabinet systems, and accessories, as well as uninterruptible power supply systems, telecom invertors and power distribution units. This launch is directly in support of our position as a key player in the standby power marketplace. Earlier this month, we also participated in the much heralded Wearable Power Competition held by the DoD. This competition involved both batteries and fuel cells and started with almost 170 entrants. While the criteria included real operational metrics, it was also biased toward lower weight and did not include environmental stress testing, all of which gave great advantage to fuel cells. Even with all of this, we were one of three systems to make it through the entire competition, and only two fuel cells outperformed our system and only because of 100 grams of weight difference. Not only were we the top battery entrant by a large margin, we are also the only one that made it through all of the testing. And our system was still operating when the fuel cells stopped working, and it was the only product that finished that could be practically packaged in its current form for use today in the field. The technology that we use keeps us at the top of the pack in deployable performance, and we are already getting interests from advanced projects looking for state-of-the-art power sources. We are reiterating our revenue forecast of $130 million and our operating income forecast of $10 million for the second half of 2008. And we are reiterating the preliminary revenue base for 2009 that we affirmed last quarter of at least $250 million. The current economic situation has the entire world concern. Even though today we have a profitable, growing, and vibrant business, it would be remiss if we didn’t position ourselves to weather a slowdown. We’ve taken pains to keep our sixth overhead low and run lean operations, which means we are flexible and we can react to downturns and volumes. In the US, we’ve handled this year’s spike in communication systems volumes with the help of a flexible contract workforce. Our UK operation has trimmed down, and our China operation has significant flexibility as well in its workforce. We have portions of our R&D work, production work, and services that are outsourced and could be brought in-house if necessary. While we are prepared, we are also optimistic. Our business is founded on bringing value to important functions and mission critical applications. Our products increased the capability of these applications and drive economies. And we believe that in difficult economic times, we are a place that our customers turn when they want efficiency and value. The steps we’ve taken in the past couple of years to diversity our customer base, broaden our product offering, expand our geographic coverage, and leverage our engineering expertise to enter new, high-growth markets, place us in a strong position to not only handle a downturn, but to mitigate against one. Our standby power business is strong. And even if there are market delays in implementation, we can grow it through gains and market share. Our telematics business is expanding across car models, and we are implementing new designs at significantly reduced costs. And that should provide growth even in a market where overall car purchases are expected to decrease. Our defense business is growing very fast internationally. And our solutions bring expanded capability in power and communications in the world where the threats to security continue. We have a solid balance sheet and are generating significant flow of cash. And as a result, the Board has authorized a share repurchase program of up to $10 million of our stock. With our stock trading at a very low multiple of our cash flow, the imputed cost of that equity capital is far above our cost of debt, even in our most pessimistic scenarios of the cost of borrowing. It is our firm belief that at our current stock price, it is in the best interest of our shareholders to repurchase stock from those we would like to sell at these prices. Now I’d like to turn over to Bob, after which we will open it up for questions.

[Bob Fishback:]

Thank you, John, and good morning. Earlier this morning, we released our third quarter results for our fiscal quarter ended September 27, 2008. Consolidated revenues totaled $68 million, a $34.7 million increase or more than double last year’s third quarter revenue. This growth was driven by sales of advanced communications systems in addition to higher sales of rechargeable batteries and chargers, and add revenues related to the 2000 acquisitions of Stationary Power and RedBlack Communications. Sales of non-rechargeable products were lower in comparison to last year when we shipped a portion of a large order to an international customer. Gross profit amounted to $15.7 million, an increase of $8.8 million from the prior year. As a percentage of total revenues, consolidated gross margins were 23% in 2008 compared with 21% in last year’s third quarter. The overall gross margin improvement was led by our communications systems segment, which reached 28% compared with 24% last year on significantly higher sales volumes. In our rechargeable products segment, we reported 22% gross margins in the quarter, consistent with the same quarter a year ago. Margins in our design and installation services segment were 19% in the third quarter of 2008. As a reminder, this segment is relatively new as a result of the acquisitions of RedBlack and Stationary Power only a year ago. The margins in our non-rechargeable segment declined from 19% to 12%, mainly as a result of an unfavorable sales mix and the transition at our UK operations from a manufacturing center to a distribution and service center. Operating expenses totaled $10.4 million versus $6.7 million in 2007, an increase of $3.7 million. Approximately $1.4 million of this increase related to incremental costs acquired with RedBlack and Stationary Power, and $700,000 related to a greater investment in R&D. The remaining $1.6 million of the overall increase was attributable to higher sales commissions tied to the increased revenue and generally higher marketing and administrative costs associated with running a more diverse organization. Included in our total operating expenses in 2008 are approximately $1 million of non-cash expenses related to intangible asset amortization and stock compensation expenses compared to $1.1 million a year ago. As a result of higher margins and the benefit of leveraging operating costs over a broader revenue base, we reported $5.3 million in operating income for the third quarter of ’08 compared with $200,000 last year. Operating margins were 8% for the quarter versus 1% in ’07. Below operating earnings, net interest expense for the quarter was a $200,000 decrease from $500,000 last year on lower outstanding balances of debt and lower interest rates. Our third quarter income tax provision amounted to $200,000, reflecting mainly the alternative minimum tax on US taxable income after applying our applicable net operating loss carry-forwards. We continued to carry a full valuation allowance against our deferred asset, so our income tax provision for the quarter was nominal. Every quarter in accordance with GAAP, we review the valuation allowance against our deferred tax asset. And in this quarter, we once again determined that an adjustment was not necessary. The important message from conclude from this is that our cash taxes this year will be very nominal as we utilize our NOLs. In future years, we will be limited annually as to the amount of NOLs that can be utilized in accordance with the Internal Revenue Code Section 382 limitation that we have spoken of in the past. This limitation will not impact this in 2008, but the use of our NOLs after this year is estimated to be a minimum of approximately $12 million per year plus any unused NOL limitation from prior years. Taxable income above this limit will be taxed at a more normal rate in the range of 35%. We reported net income of $4.7 million or $0.27 per common share compared with a net loss of $200,000 or $0.01 per share last year. Average diluted shares outstanding were 17.7 million, up from 15.2 million a year ago. This 2.5 million share increase is mainly the result of 1 million shares issued in our limited public offering completed in November of ’07 and 700,000 shares issued from the conversion of our $10.5 million convertible note in January 2008 that pertained to the financing of the McDowell acquisition. In addition, stock option and warrant exercises during the period as well as the potentially dilutive impact of unexercised options, warrants, and convertible notes had an impact on the overall increase in average shares. Now moving over to cash flows. Adjusted EBITDA, defined as EBITDA excluding non-cash stock-based compensation expense, amounted to $7.1 million. We generated approximately $5.5 million in cash from changes in working capital, as inventory levels and receivable balances declined, offset in part by lower accounts payable balances. We continued to show improved working capital metrics, as inventory turnover amounted to 5 turns per year on a year-to-date basis versus 3 turns for all of 2007. And our DSOs were 52 days cumulatively for the year compared with 55 days for the full year of ’07. With respect to our investing activities during the third quarter, we used approximately $700,000 of cash for capital expenditures and $300,000 on contingent earn-outs related to prior acquisitions. Our financing activities included a $6.5 million paydown on our revolving credit facility and $500,000 of payments to reduce our bank term loan. As we had forecasted, we ended the quarter with a zero balance outstanding on our revolving credit facility and we had $5.5 million in cash. This compares to revolver balance, net of cash, at the end of Q2 of $5.7 million, reflecting an overall change in our net cash revolver position of more than $11 million over the three-month period. Looking toward the rest of 2008, we are reiterating our previous guidance of generating roughly $10 million in operating earnings on about $130 million in revenue for the second half of the year. This implies that our fourth quarter outlook is approximately $4.7 million in operating income on revenue in the range of $62 million based on our current backlog and anticipated order activity. We expect to see revenue in our communications systems segment come down somewhat from Q2 as we complete deliveries on the sizable advanced communications orders we received in the second half of ’07. However, we expect to see increases in non-rechargeable and rechargeable product sales in addition to growth in our design and installation services. For the full year of ’08 then, our total revenues are projected to reach nearly $270 million, practically double the $138 million sales that we achieved in 2007. And our operating income for the full year is projected to be roughly $22 million compared with the $200,000 operating loss in 2007. Our total adjusted EBITDA for 2008 will be in the range of $30 million. For 2009, we are reiterating our guidance of generating a base level of revenue in the range of at least $250 million. Our balance sheet is strong. As I noted earlier, we have minimal debt on the books. Our debt-to-total capitalization ratio was only 7% as of the end of our third quarter. And while we monitor the global financial crisis and how it may impact us, we believe we have put our sales in a position to maintain sufficient liquidity as we continue to grow the business. We’ve maintained a very strong relationship with our banks, JPMorgan Chase and M&T Bank. We're presently in the midst of working on a new credit facility as our current revolving facility is scheduled to expire at the end of January. As we go through this process, we realistically are expecting a slight increase in our cost of borrowing, but with our recent performance and our favorable outlook, we have put ourselves in good standing. We anticipate no issues with the banks in finalizing a new agreement, which we are targeting and have completed before we enter the new year. As we disclosed in the earnings release, our Board has approved the plan to repurchase up to $10 million of our own stock, as we have seen the value of our shares decline over the past few months, similar to virtually all other public companies. We believe that our stock is at very good value at the moment, and we intend to take a structured approach to the buyback, abiding by all the relevant restrictions in connection with the SEC Safe Harbor provisions. We are in the final phase of an exceptional year for Ultralife. We continue to focus on growing our top line, improving our gross margins, and leveraging our operating cost structure to enhance our profitability. In addition, we will continue to diversify our products, services, customer base, and geographic presence to smooth out the variability in our revenue going forward. That concludes my remarks. And now I’ll turn it back to John.

[John Kavazanjian:]

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

[Operator:]

Thank you. (Operator instructions) And we’ll take our first question from Ted Kundtz with Needham. Please go ahead.

[Ted Kundtz:]

Yes. Hello, everyone. Couple of questions for you. John, you are – I know last time we spoke, the last conference call was – you were looking at the communications systems business really a – sort of in the range of $160 million in total this year and then dropping down to the $110 million reflecting the completion of that large contract. A, do you still feel that’s the right number? I guess that’s part of your $250 million goal. And secondly, what kind of visibility do you have on that so far? And what do you expect the mix would be between the US and international side of that business?

[John Kavazanjian:]

Okay. So – good question. First, we haven’t changed our outlook on that. I think if anything because of the repeater product, we are a little more optimistic about that segment. In terms of SATCOM, there is still a multi-year SATCOM project going on. We know that it’s funded in the supplemental, which is passed and passed out to all the services. We’re expecting – most of the contracting action is kind of quiet in October as the Pentagon dispenses the budget money to people before it gets down to the different commands. So we’re expecting – I hate to always predict when the government is going to let contracts, but we’re expecting them to start letting contracts of that in the next few months. And so we think that business for next year is in pretty good shape. Internationally, there are some prospects for the SATCOM systems. Whether they happen – but we’re not counting on them in 2009. Whether they happen in ’09 or 2010, I think some of the other people in the world who have man-pack radios and vehicle-based systems. Allies that we have are looking at SATCOM on the move and they are coming to us to look at our systems. So I think that’s a potential for doing better in that segment next year than we projected. On the Tactical Repeater side, we have some – some of that’s in our forecast for next year, but it’s a huge opportunity outside of the US military, which does use handheld radios – but outside of the US military, a lot of the services in the world, it really is a predominant method of communication. And there is – like I said, there’s virtually nobody we’ve talked to who isn’t interested immediately in a portable repeater. I mean, repeaters predominantly used to be big ground station installations, and then the portable ones really weren’t transportable except on the back of a vehicle. And this is basically a suitcase. And so we are pretty optimistic about this. I think there is real opportunity there. And I think the work we did to do the link repeater, which lets us build networks of these, and both the SATCOM systems and stuff, right from a ground radio just – and makes it a pretty good value proposition to people. So I think next year, I think we’re pretty confident in our plan. And if parts of it don’t happen the way we expect it, there are other parts we can make up with, because we have a pretty solid business there.

[Ted Kundtz:]

Okay. So more visibility or more confidence on the US side of the business and the international side, but hopeful on the international. Is that – but with less visibility? Is that the –?

[John Kavazanjian:]

SATCOM systems, I’d say, we are more confident on the US, but the Tactical Repeater, as I was saying, that will be – that’s going to be more – we're more optimistic internationally on that.

[Ted Kundtz:]

Okay. Another question, just how much of your business is auto related? Now, what percent of revenue is that?

[John Kavazanjian:]

About 5% of our business is auto related.

[Ted Kundtz:]

Okay. And where do you see that going next year? Is that with the design you are getting? Is that a possible increase even despite this kind of anemic environment?

[John Kavazanjian:]

Yes. We expect two things to happen. Number one, we’re going to expand over more platforms. We see a big platform growth in terms of the number of vehicles that we’re planned to go into. So the backup battery for our customers, which is a small percentage of vehicles, we expect that percentage to go up significantly as much percentage than anybody’s most pessimistic predictions about where auto sales will fall. So we’re not – we are having a huge number in it for next year, and I think we’re feeling like it’s okay. We are in pretty good shape there. And the other thing we are doing is, with some of our customers we’re doing some redesign. We’ve learned a lot about this business and most of the customers came to us after they designed their systems. And so we had to come in after the fact. We’ve been working with almost all of them and say, gee, as you get to your next generation, here is how we can reduce your cost and the cost of the backup, and also help ourselves as well, but really bring them a little better value and help our margins as well. So we think that there is at least one customer where we’ll be able to do that next year. Yes, we’re feeling pretty good about that. (inaudible).

[Ted Kundtz:]

Okay. It should be a growth business. Okay.

[John Kavazanjian:]

I think we have real very prudent number in there.

[Ted Kundtz:]

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

[Bob Fishback:]

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

[Ted Kundtz:]

You will? Okay. Okay. That's how you get there. Okay.

[Bob Fishback:]

Yes.

[Ted Kundtz:]

So gross margin is up as little bit and cost coming down. Okay.

[Bob Fishback:]

Right. Yes, some of the work we’ve done in taking overhead out into some operations, UK as an example, it takes some time before you start seeing that. And so that will happen. And then the other effect is that we’ve moved our sales force to a little more of a variable comp plan over time here. So, as volumes come down, commissions come down also.

[Ted Kundtz:]

Okay, got it. And then just on your gross margin target for next year, I know your longer term goals. What do you think kind of improvement you could see if you could comment on that or not – specifically.

[John Kavazanjian:]

Yes. We’re not – yes, Ted, we’re not shy about it. I mean, our goal we think is very achievable to get gross margins up to 27%, 28% level.

[Ted Kundtz:]

In next year?

[John Kavazanjian:]

I would say by the end of next year. We’re putting a lot of investment now into, for example, growing our infrastructure with standby power, which is why the margins there are where they are. We think there is a lot of headroom there. A lot of the adjustments we’re making in – I mean, when we were primarily a non-rechargeable battery company, we’ve had 27%, 28% gross margin there. And the things we are doing to restructure ourselves to get ourselves back to there in both the UK operation and in our China operation. We’re making investments now that we’ll pay back.

[Ted Kundtz:]

Okay. Terrific. Thank you.

[John Kavazanjian:]

Okay.

[Operator:]

Thank you. And our next question comes from Jim McIlree with Collins Stewart. Please go ahead.

[Jim McIlree:]

Thanks. Good morning.

[John Kavazanjian:]

Good morning, Jim.

[Jim McIlree:]

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

[John Kavazanjian:]

The latest calculation (inaudible) first of all, that our Section 382 limitation is around 12. It might be a little higher than that. As you get into the detail calculation, it could be as high as 13 maybe – somewhere in the 14. And so, above that, you pay taxes. If you don’t use it in a particular year, you get a carryover. So, for example, last year we didn’t use it all. We had a carryover to this year.

[Bob Fishback:]

Yes, we didn’t use it at all. We had a loss.

[John Kavazanjian:]

So it’s $24 million than this year.

[Bob Fishback:]

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

[John Kavazanjian:]

And this is US taxes.

[Bob Fishback:]

Correct.

[John Kavazanjian:]

So we have a tax loss –

[Jim McIlree:]

And that applies to the pretax income?

[John Kavazanjian:]

Correct. Correct.

[Jim McIlree:]

Okay, great.

[Bob Fishback:]

We have some substantial carryover. We are making money in the UK, and we have a tax loss carry-forward in the UK, which we will utilize against those profits that accrue to that operation, and a similar situation for China. As we – when we start making money in China, we will have some carry-forwards there as well.

[Jim McIlree:]

Right. That’s very helpful. And can you give either in detailed or general parameters what percent of your business in Q3 as well as all of ’08 as well as all of what you expect – or what you expect in all of ’09 to come from military? And when I think of military, I’m thinking direct to DoD, direct UK MoD, and all your international customers, as well as two prime contractors who then sell to US and international armed forces?

[John Kavazanjian:]

I think – I mean, I can just tell you in kind of round numbers we’ve been at probably 70%, would you say this here, Bob?

[Bob Fishback:]

Yes. It’s been heavy because the communications systems –

[John Kavazanjian:]

Yes, military sales have been about 70% this year. Next year, it would probably be – our plans probably we’d put it in about the 60% range.

[Bob Fishback:]

Yes, probably two-thirds.

[John Kavazanjian:]

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

[Jim McIlree:]

Right. And so that remaining piece would be the telematics, the 9-volts –

[John Kavazanjian:]

Design and installation services –

[Jim McIlree:]

Right. And then whatever portion of rechargers go to the commercial segment.

[John Kavazanjian:]

Right.

[Jim McIlree:]

Okay. And then lastly, on the buyback, are you intending to borrow money in order to buy back stock, or is the intention to take excess cash and use that to buy back stock?

[John Kavazanjian:]

Well, if necessary, we would borrow money. Right now we have $5.5 million in cash at the end of the quarter. We would anticipate being close to $9 million to $10 million at the end of the fourth quarter unless we made some big capital expenditures or spent money for an acquisition or something, which I wouldn’t comment on right now, we wouldn’t – we probably wouldn’t be able to buy that much stock before the end of the year. So unless we did something different in terms of other big expenditures, we likely wouldn’t be able to – we wouldn’t likely go into our borrowing line. I don’t know. It just – it kind of depends on the prices of stock we buy it at. And as you know – or Mike should know there is a limitation on how much we can buy 25% of the average trading volume over a period of time and stuff. So, per day – we can’t buy – we don’t – during self-imposed blackout periods we don't intend to buy, and we wouldn’t buy stuff like that. So, in a practical sense, we wouldn’t end up borrowing. Is it possible we would? Yes, possible. But in a practical sense, we likely would not end up borrowing to do it. And like I said, unless we had some other major expenditure that came up.

[Jim McIlree:]

Right. Okay.

[John Kavazanjian:]

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

[Jim McIlree:]

But it’s not necessarily the plan right now?

[John Kavazanjian:]

Exactly.

[Jim McIlree:]

Okay, that’s helpful. Thank you very much.

[John Kavazanjian:]

Okay.

[Operator:]

And our next question comes from Richard Baxter with Ardour Capital. Please go ahead.

[Richard Baxter:]

Thank you. Good morning, guys. I guess one – I guess with regard to the economic environment, can you talk a little bit about your visibility into – your sales visibility into some of the different segments? I know there are different depending on contracts and such. And I guess a follow-up, the second one would be, your growth into the RPS Power Solution sort of the difference that strategy is with some of the other Stationary Power targets you have or other businesses you have?

[John Kavazanjian:]

Sure. In terms of visibility in the battery world, both the commercial and the military batter world give us pretty good visibility. I mean, we’ve had our ups and downs with visibility from Defense Logistics Agency. So that mostly goes around their procurement cycles and when money is appropriate, but we’re pretty much booked out to the first quarter to them. So we have pretty decent visibility in the beginning of the year. And run rates have been fairly stable over the last few years there. So I think our predictability is good. And with our other commercial business and our telematics business, it’s been very predictable for us and very smooth. It goes up, it goes down, but it’s smooth. And on kind of a running average, we’ve been able to plan and predict that pretty well. In the military, defense business for communications products, I think our normal communications sales run kind of our base business – you know, $30 million plus a year business runs very, very predictable. A lot of that’s on the GSA price list. I can’t always predict what parts we’re going sell, but it seems to be a very good steady volume. It’s a lot of replacement business. It's enhancement business. It runs pretty well. The big project stuff, notably this year SATCOM, we were blessed. We got – we booked an entire year the beginning of last year. I’m not sure that that’s going to happen that way again. But I expect to have a pretty – we have pretty good visibility of what’s in the budget. We know what’s going through contract cycles. Can something be interrupted and changed? Yes, absolutely it can if priorities change. But we're involved in some of the different parts of that business now that we would have told you a year ago that there would be another tranche of fielding of IED jammers. That threat went down. Instead SATCOM systems became the important procurement. And we play a part in both of those. So one went down and the other one went up. But I would tell you that I think we have pretty good visibility. We know what the vehicle plans are pretty solid. We know what communications products are going in them. We know that they're going to be SATCOM for them. So again, do I have a ton of backlog? No, because we’ve run through budget – defense budget cycles, but I think once with the money dispensed and once normal contracting processes go through, we’re going to be in pretty good shape with visibility for next year. On the power side, we generally book out – our fourth quarter that we’re in right now and part of our first quarter is already booked. We book out three to six months because crews have to be scheduled and people plans mostly rotate around facilities, plants and stuff. So we have very good predictability in that business. And our customers generally share their plans past that with us. So – like I said, I think we’re in a mode now where we have very diverse business with pretty good visibility there. In terms of RPS, that’s merely a recognition of the fact that in our standby power business, we use component parts. And we buy those from people outside. But like almost everybody else in that business, we also can operate as a distributor for those parts. One of the differences between us and some of the people and some of the other companies in business is, we buy direct. We are a battery company. We buy direct. A lot of the people who do installation of these kinds of systems buy through distribution, which puts another profit center and another step in the process. We generally buy direct – our products direct. So if we have products in inventory that we buy direct and we can do that and there are people there who are looking for somebody to distribute, we also can be a distribution channel to that marketplace. So, our RPS for us is a recognition that we buy batteries direct from some people and there is another tier of distribution in that marketplace that other people buy from, why shouldn’t we be that also? And that’s why we’ve done that.

[Richard Baxter:]

Great. Thank you.

[John Kavazanjian:]

Okay.

[Operator:]

Thank you. And our next question comes from Colin Rusch with Broadpoint AmTech. Please go ahead.

[Colin Rusch:]

Good morning.

[John Kavazanjian:]

Hi, Colin.

[Colin Rusch:]

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

[John Kavazanjian:]

Yes. I think you usually ask me about standby power; right?

[Colin Rusch:]

Well, standby power in particular, and then any other areas would be great?

[John Kavazanjian:]

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

[Bill Schmitz:]

Yes.

[John Kavazanjian:]

We have versions with 2.6 Amp-hour cells, with 2.9 Amp-hour cells, with 2.4 Amp-hour cells, smart, not smart, smart and submersible, different pin-out and versions for people. So we keep expanding to match what people need in their applications. We are also – you’ll also see us take the smart technology and put it into non-rechargeable batteries, or applications out there, things like unattended ground sensors that are asking for it, and we're starting to do that now. So that’s a whole new expansion in that battery world, as well as we’re going to put our 15.5 Amp-hour diesel into products as well to push the technology capacity-wise in non-rechargeable. So in the battery world we just keep pushing the limits of technology and packaging. In the communications world, I think the Tactical Repeater and the Link Repeater are our real focus here. And people have some particular needs that Link Repeater has some really interesting ways to connect. It’s the way – instead of going radio to radio, you can go to the Link Repeater and go out – outside of that radio network to a SATCOM link or to some other kinds of dedicated local network links. And so we’re getting some really interesting queries on those. And as we start getting that product out there, I think you will see us customize that. And one of the things we did when we bought RedBlack Communications is we acquired a first-class capability for communications systems software and hardware, and they did the Link Repeater product and they are participating in doing some of these systems, which involve actually some software capability on top of the hardware. So you will see us push more into more complex systems maybe customize for some particular needs for people in that area. In standby power, besides expanding our footprint to serve the customers that we're attracting, you’re going to see us start to move lithium ion batteries next year into that field. It will be – first targets will be things like maybe central office applications in telco where there is a real need to save space and get more backup time mandated by the post-Katrina FCC ruling, which is expected to really hit in ’09. Many, many people have doubled their capability, and these people have installations where they don’t have more space. And it’s not just a more robust solution that you can monitor and that will last longer, but save a significant amount of space with it, but also a lot of some of the attended applications, not just in – we’ve talked a lot about unattended things like muxes, multiplexers that are out there for cable installations, or fiber hubs, but also monitoring for water supply, lot with petroleum pipeline water supply, where there is monitoring, and where systems – mission critical systems for those kinds of utilities have to be backed up. So you will see us move lithium batteries into there, and we have some active design work going on there as well. So I think that’s where you will see it the most. We’re also looking at lot bigger things to work at, but we are also looking at larger format energy storage. And we have access to some technology that we think is pretty interesting for those kinds of things. And wind in solar farm solutions, initially we’ve targeted kind of the micro-grid applications of those, not the real huge installations, megawatts. But they're getting our attention because people are calling us. They are really not getting good solutions. People do a sizing of a backup energy storage for wind power. Wind power can’t exist without energy storage, as you know. And they look at lead-acid batteries, and they find out that they can really only discharge them halfway. So with the capacity they have, they really have to double it. And then they look at the footprint and the cost and weight and trailer trucks for these things. So long-term I think you’re seeing it, we’ll look at that. And then the other thing that you will see us do is in portable power. We showed it at our annual shareholder meeting, our Analyst Day, we’ll show it also. We had it at AUSA. We have a fuel cell based charger. And our partner is finishing off the design of the product there and the fuel cell component of it. We will have that in the market. It's basically a charger unplugged. Same charger box that everybody is used to, but there's no plug in it, and it charges batteries. And it does it because it's got a fuel cell with a replaceable fluorohydride [ph] pack. We think that – we’ll have that in the market next year, as well as we are doing a lot of work, as I said, with the project with Mississippi State on hybrid fuel cells and we’re doing some work on solid oxide. I think we have a real interest in solid oxide as the way to get two to three times the capability – efficiency of using fossil fuels as a diesel generator as something that's going to be real important in the future, because oil price may be down, but we all know in the long-term it’s going up. It’s simple as that.

[Colin Rusch:]

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

[John Kavazanjian:]

Yes. I think we said we’ve seen some increases over the year. And we’ve probably been between freight and material prices. We’ve probably seen increases in the 1% to 2% effect on our P&L from those. And we are just getting to pass along some of those costs because of contracts that we’ve had. So we’re really not seeing decreases in prices of basic materials. If we get them – we're obviously keeping our eye on this, because it’s abated and we all know commodities prices have come down. It’s a question of will we see that in our numbers. We buy aluminum, we buy manganese dioxide, we buy lithium metal. It's a question of whether – can we get that reflected in those. We’ve had some slight increases. Can we roll them back? We haven't anticipated that yet, Colin. Where we do have some real opportunity is in some of our communications systems that use a lot of transformed products. So, some of the metal frames we have, the cost of the metal is only 15% maybe of the total cost of the product. So commodity price changes aren’t going to affect it that much. But that says that there is a lot of value-add in there. So there are opportunities to really look at different sourcing for those products, and our electronics product. In our amplifier line, we're looking at some new technologies in transistors that can help us. And certainly the more we have electronics based products, the more we take advantage of what people are really used to, which is prices coming down, costs coming down in electronics. So right now, we have planned in next year to get some price help – cost help – I’d say price help with people. We haven’t planned – we’ve planned some very small price increases in our business plan. If we can hold those back or drive those down, that will help us. And we do have some plans, as I said, in communications products. We are going to improve those margins with some different sourcing and some electronic components in some of the heavy metal transformed parts. So, that 28% – our goal is to get there over 30% and we think we can do that next year.

[Colin Rusch:]

Perfect. Thanks so much.

[John Kavazanjian:]

Okay.

[Operator:]

Thank you. And our next question comes from Jimmy Kim with RBC Capital Markets. Please go ahead.

[Jimmy Kim:]

Good morning.

[John Kavazanjian:]

Good morning.

[Jimmy Kim:]

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

[John Kavazanjian:]

Probably – I don’t know. Bill, (inaudible) 25% of overhead in our product cost?

[Bill Schmitz:]

Yes, it’s typically around the model 25% overhead, 25% labor, and 50% –

[John Kavazanjian:]

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

[Jimmy Kim:]

I’m sorry. So, overall 50/50?

[John Kavazanjian:]

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

[Jimmy Kim:]

I see. I see.

[Bill Schmitz:]

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

[Jimmy Kim:]

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

[Operator:]

Thank you. (Operator instructions) And we’ll take our last question from Steve Sanders with Stephens Inc. Please go ahead.

[Steve Sanders:]

Good morning.

[John Kavazanjian:]

Hi, Steve.

[Steve Sanders:]

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

[John Kavazanjian:]

The master service agreement –

[Steve Sanders:]

Yes.

[John Kavazanjian:]

Project I talked about? It’s really – it’s pretty straightforward. We are seeing a lot of people consolidating data centers. Data centers, people who have nine data centers wanting to go to three. And what they are realizing is, they can consolidate operation, they are realizing that they can do better on energy, infrastructure, things like air-conditioning and such, and that the associated increase in cost of communications isn’t going to really – isn’t going to be that much. And so we have one customer who doesn’t care to be told who they – just doesn't want us to say who they are, who has asked us to participate in their consolidation of data centers. And we’re doing one of them in the fourth quarter. And with all of these things, the revenue – in the standby power business, revenue sometimes is tough to predict quarter-to-quarter and that we have completion criteria and we very studiously watch the revenue recognition there. So we may do a lot of work in the fourth quarter on one part of a project, and it gives us acceptance criteria, may not be able to take the revenue in the first quarter. That’s why I kind of have to say over 15-month period of time. But we’ll probably do $2 million worth of business with them in the fourth quarter. And that potential was there over the – per quarter over the next year. So, you do the math, it’s kind of $8 million to $10 million worth of business there on stuff that's planned out, that we have visibility on, that as long as we perform it’s pretty much our business. And Stationary Power services in 2007 did $9 million in business. This is just one account, and it's a model and the kind of account that we have an eye to doing more of. I mean, there are other people out there doing the similar thing. And for us, it’s being able to match up. That’s just happened to be one where they were in the territory that we already serve and there are other territories that they are in that this will prompt us actually to be able to plan to expand into some other geographies to be able to serve this particular customer. We have similar discussions with other customers about what they are trying to do and then to serve them where we would have to be. And that’s really driving our strategy of where we expand as well.

[Steve Sanders:]

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

[Bob Fishback:]

Yes. I mean, overall we’ve seen some decrease in overall sales in that business. That business, the non-rechargeable business tends to carry a lot of our overhead infrastructure. So, how we allocate those costs going forward is something we’re taking a hard look at. But we’ve had some significant projects last year that carried some high margins on it with some particularly international sales that have not recurred at least at this time this year. So we’ve had some incremental material costs with higher energy and so forth, and that’s driven our current gross margins down a bit. Looking ahead into 2009, as we make some changes with our UK operation and that transition shore up some of the product line issues at China, we expect those numbers would come back into the 20% plus range.

[John Kavazanjian:]

Yes. Bob is being kind of nice about it, better than I’d be about it. We have some contracts with some auto companies and we have contract with a government that’s been the majority of this business this year, and our 9-volt customers that those contracts primarily expire at the end of this year and then with the government in the first half of next year where we couldn’t pass along cost increases as price increases to them. I mean, that’s a big chunk of it, Steve. And then we are flowing – as we transition to UK, there are some costs still there that have to go somewhere. And because we were assembling non-rechargeable batteries, they have to go into that product line right now. And so we’re burdened by that a little bit as well as in China. We are making – we are holding back some things and making some investments because we are doing this whole new product line. It’s as simple as that. And so this is the time to do it. We have strong business in other areas, and we’ve got to take those expenses now.

[Steve Sanders:]

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

[John Kavazanjian:]

We don’t – I wish I could tell you we had visibility of that. If you ask us right now how we would plan it, we’d pretty much stay at pretty flat.

[Steve Sanders:]

Okay. And obviously the question is –

[John Kavazanjian:]

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

[Steve Sanders:]

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

[John Kavazanjian:]

Oh, yes.

[Steve Sanders:]

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

[John Kavazanjian:]

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

[Steve Sanders:]

Okay. Okay. That’s it. Thanks very much.

[John Kavazanjian:]

Okay, Steve.

[Operator:]

Thank you. And there appears to be no further questions from the phone lines at this time.

[John Kavazanjian:]

Well, thank you, everybody. Some closing comments. I mean, we feel that the prospects for this company have never been brighter. We have virtually no debt. We are generating cash, and we really see long-term growth in our products, markets, revenue and profits. While there is concern about the general state of the world economy, we think the strength that we have and really being focused on our customers’ applications and bringing them products and services that make them more efficient is what’s going to enable us to grow and prosper. I want to remind everybody, on November 13, we're holding an Analyst Day at our New York headquarters. And for those of you who won’t be attending in person or for other interested parties, it will be webcast and details will get posted on our web site. So, thank you. And we look forward to talking with you again next quarter.

[Operator:]

And ladies and gentlemen, that does conclude today’s conference. Thank you for your participation. You may now disconnect at this time.