Arotech Management Discusses Q4 2012 Results - Earnings Call Transcript

Mar.19.13 | About: Arotech Corporation (ARTX)

Arotech (NASDAQ:ARTX)

Q4 2012 Earnings Call

March 19, 2013 9:00 am ET

Executives

Kenny Green - Senior Partner of Israel

Robert S. Ehrlich - Chairman of the Board, Chief Executive officer and Chairman of Executive & Finance Committee

Thomas J. Paup - Chief Financial Officer and Vice President of Finance

Analysts

Mark C. Jordan - Noble Financial Group, Inc., Research Division

Alexander Cushner

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Arotech Corporation Fourth Quarter 2012 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded March 19, 2013. I would like to remind everyone that forward-looking statements for the respective company's business, financial condition and results of its operations are subject to risks and uncertainties, which could cause actual results to differ materially from those contemplated. Such forward-looking statements include, but are not limited to: product demand; pricing; market acceptance; changing economic conditions; risks in product and technology development; and effective the company's accounting policies; as well as certain other risk factors, which are detailed from time-to-time in the company's filings with the various securities authorities.

I would now like to hand over the call to Mr. Kenny Green of CCG Investor Relations. Mr. Green, please go ahead.

Kenny Green

I would like to welcome all of you to this conference call and thank Arotech's management for hosting this call. Yesterday, Arotech released fourth quarter and full year 2012 results. By now, you should have all received a copy of the press release, which is also available on Arotech's website at www.arotech.com.

With us on the call today are Robert S. Ehrlich, Chairman and Chief Executive Officer; Mr. Tom Paup, Vice President of Finance and Chief Financial Officer; and Mr. Norm Johnson, Controller. Bob will summarize the key highlights of the quarter and the year, followed by Tom who will review the company's financial performance. We'll then open the call for the question-and-answer session.

Before we start, I'd like to point out that this conference call may contain projections or other forward-looking statements regarding future events or the future performance of the company. These statements are only predictions and there can be no assurance that they will, in fact, occur. Arotech does not assume any obligation to update that information. Actual events or results may differ materially from those projected, including as a result of changing market trends, reduced demand and the competitive nature of Arotech's industry, as well as other risk items filed in the documents filed by the company with the SEC. In addition, certain non-GAAP financial measures will be discussed during this call. These non-GAAP measures are used by management to make strategic decisions, forecasts, future results and evaluate the company's current performance.

Management believes that the presentation of these non-GAAP financial measures is useful to investors' understanding and assessment of the company's ongoing core operations and prospects for the future. Unless it is otherwise stated, it should be assumed that any financials discussed in this conference call will be on a non-GAAP basis. A full reconciliation of non-GAAP to GAAP financial measures is included in today's earnings release. And with that, I'd like to introduce Arotech's Chairman and CEO, Mr. Robert Ehrlich. Bob, please go ahead.

Robert S. Ehrlich

Thank you, Kenny, and good morning, everyone. I'd like to thank you all for joining us today. Yesterday, after the close, we announced our fourth quarter and full year 2012 results and they represented another strong year for Arotech.

Pointing out a few highlights. We grew revenues to $80 million in 2012, a year-over-year growth of 29% and the highest level of revenue in our history, even including years when our now discontinued Armor Division revenues were included in our results. Our EBITDA grew as well, by over 5x to $1.9 million. In the second half of the year, our business became profitable on a GAAP basis, and our strong focus on keeping tight control over operating expenses and working off our record backlog began to pay off.

Most important is that our future potential is improving by virtue of significant simulation wins and the introduction of higher-margin Battery Systems. We issued guidance several weeks ago, calling for full year 2013 revenues of between $85 million and $87 million and EBITDA in the range of $2.9 million to $3.4 million.

In our current backlog in that $85 million, we feel comfortable with these predictions and are continuing to hope for them with a positive outlook on the future. Bear in mind that this guidance is based on what we see today and then we'll take account of any future developments. I should add that while it is too early to see any of the effects yet that the U.S. budget sequester will have on programs, we are -- that we are targeting, should there be any developments, we would aim to be open and transparent in sharing them with you. We don't see any at the moment, but obviously, if anything materializes, we'll report it to you.

Beyond that, looking further into the future, we have a number of exciting opportunities, particularly with the Battery area, that we are exploring and developing, which we believe can significantly grow our long-term revenue and profitability. While I cannot discuss any specifics on this now, I can report that I'm more excited at this time than I've ever been about the future of Arotech with respect to its 2 lines of business.

Our investment in R&D in the past few quarters has already begun to provide a good return on investment. In the area of SWIPES, you may recall that in late 2011, we lost our innovative trademark SWIPES program, which is the Soldier Worn Integrated Power Equipment System. Our power hub enabled extended mission times due to the high energy density of the batteries, as well as reducing battery weight by something approaching 30%. The SWIPES hub continuously charges the secondary batteries inside the various devices that today's soldiers are carrying, such as communications equipment, GPS units and shock detection systems. The SWIPES power hub is also unique in the way it is built. It is modular and adjustable. It is designed to accept new applications as they are developed, and become available to us, and as OEMs ask us to make those adjustments and allows for individual modification for each soldier's requirements as well.

This slide -- this system has become so successful. Only a few weeks ago, we were able to report an additional $2.4 million order from the United States Army for over 1,500 additional units. In fact, since its launch, SWIPES has provided us with over $4 million in revenue and is continuing to grow. As you know, the U.S. Army is the world's leading military force, especially when it comes to the use of technology on the battlefield. The fact that they repeatedly choose our SWIPES system, as well as rewarding it a top 10 best army innovations award upon its launch, is a testament to the effectiveness and value of the products we offer.

Throughout 2012, the majority of SWIPES orders were from special operations units, Rangers, other special forces. This stream of orders reflects particularly favorably on the product's increasing acceptance among ground forces in the U.S. military. We see significant growth potential for this product, first within the U.S. military and eventually to other militaries in the world.

In addition to SWIPES, in the Battery Division, we are continuing to develop applications such as large-format batteries for submersibles and high-power lithium batteries for things like rockets, satellites, UAVs and tank starts. As previously discussed, we hope to see these products begin to generate revenue in the coming quarters. Toward the end of the last year, we announced a program to develop a prototype for a large-format lithium battery on a battery management system to couple with hybrid electric vehicles. We will complete the prototype during this year, and we will be in a position to offer it to the market at the end of the year.

The hybrid vehicle electric market has matured significantly in the past several years and hybrid electric vehicles are now much more accepted by the consumer than they were in the early '90s when we first explored the electric vehicle market. In recent years, hybrid electric vehicles have become much more common on the road. Consumers are more familiar with the technology and their fuel efficiency benefits particularly, given the high gas prices over the last few years. Additionally, manufacturers are increasingly forced to adhere to CO2 emission standards and have to include hybrid vehicles in their product range to meet these target requirements.

Lastly, we now see a market whose time has finally come, driven both from the demand side and the supply side. However, we are still taking a careful approach in this young developing market, undertaking only funded projects, having learned a lessons from our previous foreign entry in the electric vehicle business in the 1970s with zinc-air batteries -- in 1990s, I'm sorry, with zinc-air batteries. We believe we have significant opportunities for large-format lithium-ion batteries that have better margins, and we are working on them extensively.

Toward the end of last year, we announced this story for large-format batteries, the high [indiscernible]. We believe that our extensive knowledge in electronics and battery management give us a particular advantage in managing these large systems and large battery products. As you can see, we have a lot of things developing in the battery area and are looking forward to the significant growth in that aspect of our business.

In Simulation, 2012 was a year of substantial success in that unit, and we -- and our involvement in R&D and new future growth opportunities generated $16 million in revenues from Training and Simulation, around 3 quarters of our overall revenue, and generated $6 million in positive cash flow.

In 2012, margins for our Simulation products were around 23%, reflecting the tight competition in these markets. While we do not expect these markets to -- while we do expect these markets to gradually increase as we are focused on cost control and creating efficiencies, there are likely to be some quarterly fluctuations.

In 2012, our primary focus was on successfully fueling the VCTS product -- suite of products from the U.S. Army. To date, we have delivered half of the units on order, 14 of the 28 suites that have been ordered in the $60-plus million program, and are on schedule to deliver the balance of the contract over the following year.

We also recently awarded a number of additional contracts, rounding out the strongest year in our history in the Simulation Division. As a further development, in October of this year, as you may remember, we announced that we were selected to supply live firearms training simulators to a Hong Kong police force, a deal valued at $3.8 million.

With respect to the program we have with the Hong Kong police, we see many more opportunities developing in other European countries, because the Hong Kong police force spent the most time evaluating the product. And finally, when we were approved for that, they then gave us a stamp of approval that we can market to other countries in that area.

During the year, we were also awarded some large contracts, both with the Air and Army National Guard. In early summer, we hope to hear about our bid that we filed for the Common Driver Training program that was submitted a few weeks ago.

With that said, I would like to turn over the discussion to Tom to give you more detail on the financials.

Thomas J. Paup

Thank you, Bob. For the full year, revenues from continuing operations were $80.1 million compared to $62.1 million for 2011, an increase of 29%. Gross profit from continuing operations for 2012 was $17.9 million or 22% of revenues compared to $16.2 million or 26% of revenues for 2011, a 4-point decrease in the gross margin percentage. The reason for this decrease was due to some high revenue projects with large component of lower margin hardware included, which were delivered in 2012.

Adjusted EBITDA from continuing operations for the year was $2.6 million compared to $1.7 million for the corresponding period last year, an improvement of 53%. We believe that using adjusted EBITDA over -- enhances the overall understanding of our financial performance.

The company reported an operating loss from continuing operations for 2012 of $861,000 compared to an operating loss from continuing operations of $3.1 million in 2011. The company's net loss from continuing operations for 2012 was $2.0 million or $0.14 loss per share compared to a net loss from continuing operations of $5 million or $0.35 per share in 2011.

The company's net loss from all operations, including discontinued operations for 2012, was $3.2 million or $0.22 per share, compared to a net loss from operations, including continued -- discontinued operations of $12.3 million or $0.82 per share for 2011.

For the fourth quarter, revenues from continuing operations reached $22.1 million compared to $18 million for the corresponding period in 2011, an increase of 23%. Gross profit from continuing operations for the fourth quarter was $5.3 million or 24% of revenue compared to $5.1 million or 28% of revenue for the corresponding period in 2011.

Adjusted EBITDA from continuing operations for the quarter was $872,000 compared to $2 million for the corresponding period of 2011, a decline of 45%. The company reported operating income from continuing operations for the fourth quarter of $17,000 compared to an operating loss from the continuing operations of $60,000 for the corresponding period in 2011.

The company's net loss from continuing operations for the fourth quarter was $72,000, or basically breakeven per share, compared to a net loss from continuing operations of $1.6 million or $0.11 per share for the corresponding period in 2011.

The company's net income from all operations, including discontinued operations for the fourth quarter of 2012, was $256,000 or $0.02 per share compared to a net loss from all operations, including discontinued operations of $5.3 million or $0.37 per share for the corresponding period in 2011.

The backlog of orders from continuing operations totaled approximately $87.7 million comprised of Simulation at $72.4 million, and Battery at $15.3 million as of December 31, 2012, compared to $81.9 million as of December 31, 2011, which was comprised of Simulation at $71.7 million and Battery at $10.2 million.

As of December 31, 2012, the company had $1.6 million in cash and $186,000 in restricted collateral deposits, as compared to December 31, 2011, when the company had $2.3 million in cash and $1.7 million in restricted collateral deposits. The company had trade receivables of $9.6 million as of December 31, 2012, compared to $11.9 million as of the same period last year. The company had a current ratio of 1.37, current assets divided by current liabilities, which is pretty much the same as 2011, which was 1.36.

The company ended 2012 with $9.8 million in short-term bank debt and $1.9 million in long-term debt outstanding for continuing operations, that's compared to 2011 when the company had $6.6 million in short-term bank debt and $1 million in long-term debt outstanding.

As previously announced, in February of 2013, Fifth Third Bank in Eastern Michigan increased its line of credit to the company from $10 million to $15 million and extended the expiration of the credit line to May 31, 2015. We feel this will help us with our working capital needs for the immediate future.

If I could turn it back over to the operator to explain the question-and-answering format.

Robert S. Ehrlich

I'd like to add one more thing before we do that, Tom.

Thomas J. Paup

Yes.

Robert S. Ehrlich

I just want -- I overlooked pointing out the fact that by virtue of having won the VCTS contact, in 2012, we were awarded a couple of contracts in the Air and Army National Guard, the most significant being a program called the Boom Operator Simulator Systems, or BOSS, which is a contract with some $25 million that we were awarded in 2012, which we have begun work on and we'll continue to deliver into 2014. So we've expanded our cooperation with the Air National Guard. We recently got an additional $6 million order from them for state [ph] further-driving simulators.

With that said, I think we view our prospect is very good going forward, and wanted to insert that before we open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Mark Jordan of Noble Financial.

Mark C. Jordan - Noble Financial Group, Inc., Research Division

A question for you or Tom, relative to the operating expenses in the fourth quarter. If you look at G&A sequentially, it increased over $900,000, and selling expense was up about $360,000, sequentially, again versus the third quarter. What specifically was the catalyst for those increases?

Thomas J. Paup

We have some stock -- restricted stock expenses that get charged to G&A, believe it or not, that's the accounting for that. And that came -- that was in the fourth quarter of this year. And in terms of the selling and marketing expenses, we made a conscious effort to invest in that, and we've ramped up our group, particularly in the Simulation Division.

Mark C. Jordan - Noble Financial Group, Inc., Research Division

Okay. I'd like to go back, Bob. Could you go over comments again on the common driver? It seemed to -- your voice seemed to have broken up a little bit in terms of what your comments were on the status of that program?

Robert S. Ehrlich

Yes. That program -- we submitted our bid, I think it was about 3, 4 weeks ago. We anticipate some kind of a determination somewhere in, I would say, the late summer to early fall. Obviously, sequester plays a role that, when that fast-track award will be granted. While we're clearly the most qualified party, we believe, to win that award, one should note that having won VCTS and brought the 2 biggest programs that the government has granted for small business their [ph] side, we want to caution our investors that it's conceivable that PEO STRI may want to choose someone else, just because we've won all their big programs. We're hoping that we'll win this one as well, but there are no guarantees, although we clearly believe we're the most qualified. And we'll know sometime, hopefully, by late fall.

Mark C. Jordan - Noble Financial Group, Inc., Research Division

Final question, relative to the Boom training program. Is there a similar type program that would be initiated for the next generation of tanker? And this is -- would that be similar to what you're doing for the -- on the Boom program for the National Guard?

Robert S. Ehrlich

It's certainly possible, but we have not heard of such -- I don't think there's been any indication of such a program being fielded at the moment.

Operator

The next question is from Alex Cushner of Robert W. Baird.

Alexander Cushner

But following up on Mark's question about SG&A and margins in general. You talked a little bit about efficiencies. You didn't go into much detail about why 2013 is going to be a year of progress on margins. Could you please spend some time on that?

Robert S. Ehrlich

Yes. Alex, one of the things we're doing is, as we've talked about, we're trying to change the mix of the products. There's -- the BOSS program has better margins than VCTS and some of the large Battery programs that we're working on have better margins than the normal radio -- field radio margins. So we see improved progress through SWIPES and through the BOSS program, increasing the margins in those 2 units.

Alexander Cushner

So in addition to mix, is there any other thing you're doing? Obviously, mix is an important component.

Robert S. Ehrlich

Well, we're hoping we have more revenue and better margin. Well, we anticipate a growth in the revenue line in the products that we think have higher margin.

Alexander Cushner

Understood. But nothing on cost control that's currently in the cards? It's...

Robert S. Ehrlich

Well, no. I should point out that we have gone through an overall deduction programming in management compensation. And that will be, I believe, it's in the 10-K. We'll demonstrate that we've adjusted executive compensation to a lower level, so to reflect -- keeping the cost under control.

Alexander Cushner

Could you talk a little bit about -- obviously, you are all but 1 week done with Q1. Can you give us some sense of where Q1 will end up?

Robert S. Ehrlich

I think Tom said yesterday that we're being just optimistic that things look good. Beyond that, I don't think we -- we don't have yet final February numbers, and obviously, we're into March. But we're modestly optimistic about the first quarter and we're -- we like to look at the whole year plan. We're much more comfortable about our guidance for the full year than quarter-to-quarter, because sometimes a Battery order will slip from March to April and it will affect the quarter and we don't want to be called on the fact that you'll be disappointed in the quarter, and the next quarter is a much better one and people don't recognize it.

Alexander Cushner

So on -- looking at the year, your guidance, since you guys gave the year guidance, there's been a number of awards that have hit the tape in both business units. And yet that did not promote even a modest nudge higher in your EBITDA projection or your topline projection was -- clearly, that was already in backlog -- or in your thinking, in terms of producing those numbers, I guess, but can you give any clarity around that? Because, as investors, we're hoping, obviously, that both the topline and the bottomline are going to be nudged up throughout the year?

Robert S. Ehrlich

We have been getting a bunch of new orders, and the backlog is gone. There is a sense of trying to be somewhat conservative in this environment with the sequester, so we're quite optimistic that the outlook for the year is good and considerably stronger than we've said. But we don't want to say it until we have more evidence, which will take a little while. Because we don't know what's out there that might come back to hurt us. So right now, we're -- I'm very optimistic. Tom said, "Bob, you have to be somewhat more cautious because of the nature of the business." And I defer to his judgment that we temper our enthusiasm somewhat until a little later in the year.

Alexander Cushner

Great. That's really helpful. I appreciate you framing it that way. The -- if you could talk, again, about the mix a little bit here. The Battery business, not in the office right now, the Battery business for the year represented what percent of total sales?

Thomas J. Paup

About 25%.

Robert S. Ehrlich

About 25%.

Alexander Cushner

And the current model that you've -- or guidance that you gave, what percent will batteries represent of business in 2013?

Thomas J. Paup

About the same.

Robert S. Ehrlich

I think that -- I agree with Thomas. While both will increase, I think the percentage will stay about the same.

Alexander Cushner

Right. Okay. Well, it's -- again, congrats on the progress. Obviously, we're -- I can't speak for all investors on the call, but I, in particular, am hoping that the -- there's going to be meaningful margin improvement through both cost reductions and mix. And I look forward the call and throughout next quarter.

Robert S. Ehrlich

Well, thank you, Alex.

Operator

[Operator Instructions] There are no further questions at this time. Before I ask Mr. Ehrlich to go ahead at his closing statements, I would like to remind participants that a replay of this call is scheduled to begin in 2 hours. In the U.S., please call 1 (888) 782-4291. A replay of this call will also be available in 3 hours on Arotech's website, www.arotech.com. Mr. Ehrlich, would you like to make a concluding statement?

Robert S. Ehrlich

Yes, thank you. I think that we're pleased with the progress we made in 2012. We expect 2013 to be an improvement on that. I hope to be that my optimism is what's materialized, and we certainly are working on improving margins and the products and cutting costs where we can. So we're quite enthusiastic about the outlook for all of our units and all of our products, and obviously, hope the SWIPES will really blossom into a major product category, which would then help us going forward into the future. I thank the shareholders for their support. We know we've had some tough times in the past, but we are now on the path to a much better result, both revenue and profitability. Thank you all.

Operator

Thank you. This concludes the Arotech Corporation Fourth Quarter 2012 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.

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