Good day and welcome to this Ultralife Corporation second quarter 2013 earnings release conference call. At this time for opening remarks and introductions I would like to turn the call over to Jody Burfening. Please go ahead.
Thank you Jessica and good morning everyone. Thank you for joining us this morning for Ultralife Corporation conference call for the second quarter of fiscal 2013. With us on today’s call are Mike Popielec, Ultralife’s President and CEO; and Phil Fain, Ultralife’s Chief Financial Officer. The earnings press release was issued earlier this morning. If anyone has not yet received a copy, I invite you to visit the company’s website at www.ultralifecorp.com, where you will find the release under Investor News in the Investor Relations section.
Before turning the call over to management, I would like to remind everyone that some statements made during this conference call will 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 potential reductions in US military spending, uncertain global economic conditions and acceptance of the company’s new products on a global basis.
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. Further information on these factors and other factors that could affect Ultralife’s financial results is included in Ultralife’s filings with the Securities and Exchange Commission including the latest annual report on Form 10-K.
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 Mike.
Thank you, Jody and thank you everyone for joining the call this morning. Today, I will start by making some high level observations about our second quarter, 2013 operating performance. Then I'll turn the call over to Phil who will take you through the detailed financial results. After Phil is finished, I'll take the call back to provide an update on our top 2013 priorities and share with you our thoughts on the full-year financial outlook for 2013 before opening up for questions.
In the second quarter of 2013, the delay of some expected Communication Systems Contract and shipments drove their revenue down 18% year-over-year, resulting in our total cost being upside down to revenue and an overall company operating loss of $1.9 million, whereas the sales teams had done their jobs in terms of winning the competitions, the subsequent DoD contract awarding process has been quite slow, especially given the refinancement of DoD work and several anticipated shipments were delayed into the second half of the year.
As a real time update, incoming July orders in backlog for Com Systems’ Q3 shipments already exceed their reported Q2 revenue. As we discussed before, our communications systems business is a project and program driven and therefore lumpier in terms of revenue make up than our battery business. This has impacted us favorably over the last three consecutive quarters where we reported strong Com Systems’ year-over-year revenue increases of 50% in Q3 of 2012, 85% in Q4 of 2012 and 7% in Q1 of 2013. However in the second quarter of 2013, the impact was clearly unfavorable.
We continue to achieve strong variable and base cost productivity gains in both of our business unit and have already implemented some additional spending rate adjustments for the remainder of the year, such that we still expect to deliver full year operating profitability.
Total company revenue in the second quarter of 2013 was down 8% and somewhat smaller year-over-year decline in our recent quarters due to signs of initial revenue stabilization in our battery and energy products business.
B&E revenue was down roughly 6% which was the smallest decline it’s been in quite some time and our sequential basis battery and energy revenue was actually up 12% from the first quarter this year with equal contributions for both our commercial and government advanced customers.
The US government defense business still represents about 40% of our total B&E revenues, when we look at what's driving encouraging B&E revenue trends, we see that our revenue from new products less than three years old was up 23% from Q1 to Q2 representing 44% of the mix in Q2 versus 39% in Q1.
Looking at gross margins for the second quarter 2013, productivity gains and strong mix led to a gross margin increase of 230 basis points year-over-year to a 26.2%. Gross margin for B&E was about 40 basis points lower than the prior year at 23.8% and essentially flat to the first quarter 2013, while B&E reduced inventory by almost $3 million from Q1 reflecting prudent operating discipline by the team. At Communication Systems, gross margins improved by 1,720 basis points year-over-year to 39.3% with about two-thirds of the improvement associated with stronger mix and our lean initiatives and one-third related to non-recurring rework charges in Q2 of 2012.
We are well positioned in both our business units for a significant operating leverage gains and already respectable gross margins on market conditions, expected sales force productivity and potential future acquisitions contribute towards higher manufacturing volumes.
With regard to operating expenses, operating expense control resulted in a 14% reduction in year-over-year operating expenses which more than offset the impact of the 8% total revenue decline and contributed with gross margin gains to deliver a 36% reduction in operating loss year-over-year.
As compared to our previously stated operating expense ratio targets, the government contracting process related Communication Systems Q2 revenue really skewed our stated operating expense ratios in the quarter. That said, relative to our stated 30, 5,5,10 equals 10% operating margin business model. We are continuing to deliberately spend several points higher than target on our new product development and sales force productivity initiatives to fundamental components of each of our businesses organic growth strategies.
Well this action can result in a short-term fluctuations and operating profit due to the misalignment with revenue realization. We are still bullish on our margin enhancements and growth opportunities these investments will bring. In summary, we are cautiously pleased by the initial indicators of battery and energy products revenue stabilization.
For the present period of ongoing year-over-year revenue decline in battery any products has been challenging and the revenue swings in our communication systems business can be at times both exciting and frustrating throughout our ability to business model and discipline operating mechanism have led to variable cost productivity gains, lower operating expenses and the quarter end cash balance of $11.6 million, the highest it's been in over five years.
We work on these fundamental business equations every day and when combined with the new product and opportunities pipelines we've been able to fund as a result of this cadence. We are well positioned for continued operating leverage gains as both businesses return to sustainable top line revenue growth.
In a few minutes, I'll talk more about the rest of 2013, but first I'd like to ask Ultralife’s CFO, Phil Fain to take you through additional details of the second quarter 2013 financial results. Phil?
Phil Fain - Chief Financial Officer
Thank you, Mike and good morning everyone. Earlier this morning, we released our second quarter results for the period ended June 30, 2013. For purposes of reviewing our second quarter financial results, I will discuss operating results from continuing operations for 2013 compared to 2012.
Consolidated revenues for the second quarter totaled $17.3 million, representing a $1.4 million or 8% decline from the $18.7 million for the second quarter of 2012. Revenues from our battery and energy products segment were $14.7 million, a sequential increase of 12% over the first quarter, but a decline of $0.9 million or 6% from last year. This decrease is primarily attributable to lower shipments of rechargeable batteries in certain commercial and international defense orders have been shifted into the second half of 2013. This would partially offset by a 12% increase in 9-volt battery shipments over the prior year.
The sales mix of our battery sales were split 60-40 between domestic and international in 2013 versus a 53-47 split for the year earlier period and 50% of our second quarter sales were to commercial customers.
Communication System sales of $2.6 million decreased by $0.6 million or 18% from the prior year, and was $5.4 million lower than Q1. This decrease was attributable to delays in the final sign-off in purchase order issuance of several large high margin funded projects which we expect to ship in the second half of 2013. In fact, since the second quarter closed we have received the signed purchase orders for almost $3 million of these funded projects with the remainder expected in the second half of the year.
Our consolidated gross profit was $4.5 million consistent with the second quarter of 2012 despite the $1.4 million sales decline. As a percentage of total revenues, consolidated gross margin was $26.2 million versus 23.9% for last year’s second quarter, an increase of 230 basis points. The year-over-year improvement reflects favorable product mix of Communication Systems sales, continued lean improvements and the absence of the rework reserve recorded in the second quarter of 2012.
Gross margin for our battery and energy product segment was 23.8%, a 40 basis points decline from 24.2% reported last year. The decline was due to lower overhead absorption in our Newark facility with the volume declines in our deliberate decisions to better balance production and inventory levels with demand which resulted in inventory reductions of almost $3 million from Q1. The business continued to benefit from improvements in overall productivity which resulted in the elimination of virtually all labor and material manufacturing variances from the year earlier period.
For Communication System segment, gross margin was 39.3% compared to 22.1% last year, an improvement of 1,720 basis points. The improvement resulted from a stronger product mix, continued productivity improvements and the recording of a reserve in the 2012 period related to the request by a strategically important customer to rework and upgrade certain McDowell products. This reserve unfavorably impacted the second quarter of 2012 gross margin by approximately 600 basis points.
Operating expenses totaled $6.4 million, a reduction of $1 million or 14% from the $7.4 million reported for the second quarter of 2012. The reduction highlights the actions taken in 2012 and in 2013, to minimize discretionary spending not directly related to revenue generation. This includes more focused R&D spending on new products and continued reductions in G&A expense as a means to fund the increases in future new product development and the sales force.
Despite the lower revenue, operating expenses as a percentage of revenue decreased from 39.6% for the year earlier period to 37.0%. The lower sales in the resulting impact on gross profit led to an operating loss of $1.9 million compared to an operating loss of $2.9 million for the 2012 period. Second quarter non-cash operating expenses including depreciation, intangible asset amortization and stock compensation expenses amounted to $1.1 million versus $1.3 million for the year earlier period.
This brings us to adjusted EBITDA to find that EBITDA including non-cash stock-based compensation expense of negative $0.8 million versus negative $1.7 million for the second quarter of 2012. Other expenses primarily comprised of foreign currency translation and interest expense, amounted to approximately $30,000 versus $0.1 million in 2012.
Interest expense continues to be favorable as there were no draws made upon our revolver at any point during the quarter, and the revolver balance remained at zero. And our tax provision of $0.1 million, primarily reflecting income taxes for our profitable China operations, and the timing of deferred taxes consistent with that reported for the 2012 period.
Net loss from continuing operations was $2.0 million or $0.11 per share, compared to a net loss of $3.2 million or $0.18 per share for the same period last year. Net loss from discontinued operations was $0.1 million or $0.01 per share reflecting the final post closing working capital adjustment under the terms of the RedBlack sale, which occurred in the third quarter of 2012.
The net income from discontinued operations was $49,000 in 2012. The company’s liquidity remains solid with cash on hand of $11.6 million no debt, working capital of $43 million and the current ratio of 4.0. By comparison, the net cash on hand at the end of the second quarter of 2012 was $3.8 million and the current ratio was 3.0.
Inventory increased by $2.7 million over the first quarter and $0.7 million over year end due to the timing delays and closing in the large orders for the communication systems business which we expect to shift before the end of the year. I can assure you that our focus on reducing inventory levels through the lead process and building our cash position for acquisitions continuous to be a top priority.
Well there is no doubt that we are dissatisfy with our second quarter results, the resulting actions we have taken and better planned will continue to drive down or breakeven point further while preserving our strategic investments. This will help ensure greater leverage toward business model and confident ability when the results of our efforts to grow the business both organic and through acquisitions are realized.
I will now turn it back to Mike.
Thanks, Phil. The top priorities that we are pursuing to drive efficient operational execution and to reposition the company for growth remain, number one, improvement in profitability and the number two executing our growth gain plan, while at the same time also leveraging our China operations for global growth competitiveness. We continue to set as our goal to improve profitability every quarter and to do so continue to be guided by 30, 5,5,10 equals 10% operating margin business model in our day-to-day actions.
The targeted 30% gross margins allowed a 5% cost headwind needed for each to the new product development and the selling initiatives essential to increasing competitive advantage and driving growth. When achieving these parameters and capping G&A expenses at 10%, we will achieve our interim operating margin goal of 10%.
We still hold the view that our new product development and sales force effectiveness is paramount to our long-term growth potential and with improving gross margins and strong cash position, the investments are still important to make.
That said, we also want to make sure, we are impacting profitability, because of a high spending rate that due to external factors isn't going to make any real difference in the speed in which revenue is realized.
Looking more specifically at our revenue growth game plan execution. The focus remains on three main elements, expanding our market and sales reach, new product development and pursuing acquisitions.
For the Communication Systems’ business, the team is actively engage with multiple global OEMs as well as a widening group of global special operations forces supporting SOCOM's vision of a global soft network within [NETO] and its allies. Our ties are strong in the EU and growing in other regions of the world.
Domestically, Com Systems is penetrating more US Special Forces groups than in previous years with recent traction gain in the areas of the US Army and US Air force to complement their strong existing presence in the US Navy and Joint Special Op commands.
In almost every new project or program opportunity for the Communication Systems business, a new product development or advancement is required in order to satisfy the end user's need. As such, we have been working on several new products that drive revenue growth opportunities. These include our new lightweight portable amplification system or LPAS, the A-320 handheld vehicle adaptor or HVA, our A-301-150 satellite radio combiner and for the upcoming rifleman radio, our vehicle integrated power enhanced rifleman's system.
As an update for the LPAS system which utilizes our very successful A-320 amplifier and an integrated rechargeable power supply and allows for either dismounted vehicle operations using AC/DC or battery power. To-date we have fielded over 150 units and have orders pending for roughly another 250 units. The LPAS list price is approximately $10,000 each.
Also for the A-320 HVA which enables the operator to use a same radio in a vehicle or during dismounted operations for commercial or military vehicles and supports over 16 different radio configurations, we have shifted over 250 units thus far to 14 different customers and they have a list price of roughly $4,000 each. This product has been heavily fielded on vehicles within the U.S. special forces groups and we also have strong interest from potential Latin America and European users.
In another recent development based on the successes of the LPAS and the HVA and working with key customers personnel, we have developed an even smaller and lighter vehicle monitory system to support a variety of handheld radios. The new product is called the universal vehicle adapter or UVA and prototypes are being delivered this month to OEM and special op end user evaluators for testing and trials in support of a large fleet of vehicles. It's fielded, quantities are expected to be in the thousands across several service branches with a list price of approximately $3,500 each.
As we said during our last call, since the launch of a few of our new products less than a year ago, we have generated close to $3 million in new revenue for a business unit whose total revenue in 2012 was $30 million. Several other new products we referred to over the last several calls and the new UVA opportunity just mentioned have multi-million dollars potential awards tied to them. Given the strong influence these new products can have on achieving future organic revenue growth for communication system, we will continue to invest in their development, whereas low revenue quarters like the recent second quarter can be frustrating due to a long order conversion cycles.
When we look at the communications systems opportunity pipeline, which has grown more than two-fold over the last two years, and is now totaling roughly eight to nine times the amount of recent annual revenue levels, we remain confident that our communications systems organic growth strategies of widening the customer aperture and new product development will lead to sustainable annual revenue growth.
Regarding targeted market and sales reach expansion for the battery and energy products business, we have recently been advised that we've been recommended for ISO-13485 certification, a key prerequisite as we continue to grow our battery and charger opportunities in the medical devices space.
As you may recall, we received initial orders in Q1 for medical cards and medical device battery packs. Those units are presently undergoing final testing and shipments are expected to begin later this quarter. We view the ISO certification and initial shipments of our new battery and charger platforms designed specifically for the medical markets as important milestones in our strategy to leverage the proven military grade reliability of our batteries and chargers to grow our business in commercial markets, where they also demand the highest level performance and reliability given the mission critical demands they serve.
Another important part of the B&E sales and market expansion strategy is to drive global market penetration of the primary cells that we manufacture in our own plants in both the U.S. and China. In addition to the opportunity to broaden the top line revenue of our proven primary cell battery products, additional buyer will bring immediate operating leverage for a business model and yield further gross margin improvement.
Some of the areas our new VP of Global Primary Sales is initially focused on include using our final cord ½ AA cells from our newly automated line for smart metering applications in Europe, leveraging the performance of thin cells for the China Topaz market replacing coin cells and serving your need for the recent legislation in five U.S. states and two major municipalities that all homes or to have at least one 10 year (inaudible) per floor a strong fit for our new next generation 9-volt lithium battery.
(inaudible) our new Global Primary Cells head we expect to improve both our customer targeting and technical support and thereby continue to improve the productivity of our sales resources. For an update on the numerous new products that battery and energy products line saw over the two years, for the GenSet Eliminator we now have two customers who have purchased units with two other units undergoing site demonstrations for evaluation purposes and for the multi-kilowatt module, MKM large format battery.
We now have 14 different countries, in which we have shipped 103 units. Many of the products have been applied for use in DC energy storage banks, for generator optimization, and disaster response team purposes. It should have also been noted that the (inaudible) on the route of the medical car market batteries.
Regarding a new high capacity 5390, 2590 CFx batteries and cells, we have now shipped over 1000 total units to over 75 customers. And lastly for our new conform shape battery, we have shift over to 90 units and 22 different customers for evaluation. Again at this point the total dollar revenue obtained from many of adjustments new product is still relatively small.
As we said earlier from Q1 to Q2 2013, revenue from products that were less and equal to three years old grew 23% demonstrating the slow but steady aggregate effect that new product development can have in our growth equation going forward.
Regarding the financial outlook for 2013, although our pending funded project pipelines remains strong, given the so than expected contracting rate for current U.S. government defense opportunities, we are lowering our prior revenue guidance and are expecting to see up to 10% to 12% year-over-year revenue decline. However with ongoing operational productivity improvements and some additional second half spending adjustments, we still expect to show full year profitability and year-over-year operating profit improvements and expect to see an operating margin rate in the low single digit range.
For communication systems our new product driven pending business funded opportunities funnels for both domestic and international projects remain strong. However with the contracting delays versus expectations experience in Q2 and recently submitted DOD and play work furloughs, we don't see the catalyst that will suggest a recovery capable fully offsetting the Q2 revenues setback. Therefore we have taken a conservative view that in terms of comm. Systems revenue full year growth is now likely to be flat to low single digits.
For battery and energy products, we were pleased to start to see some levering off in the revenue decline and attribute that to diversifying our revenue by new product development driven international and commercial opportunities as well as maintaining our position in some of our key existing customers serving the government and defense market.
We also know that one quarter doesn't represent a trend. As such we continue to hold the view that B&E volume gains from our new products, new market segments and new customers may not be able to fully offset the U.S government defense revenue decline. Although we're anticipating sequential quarter to quarter revenue improvements through the rest of the year, when we look at those run rate improvements versus prior year revenue levels, it's still too soon to project any year over year revenue increases and we expect in total Europe B&E revenue to be down by approximately 15% to 20%.
In closing, the current economic environment remains very difficult. And our quarterly profitability can be impacted from time to time, other lumpiness in our revenue curve. However, the strong operating discipline that we have established over the last few years is continuing to drive gross margin improvements, keep operating expenses low and allowing us to maintain a debt free solid company cash position. When we combine this to validate the business model, but the traction we are gaining from our growth strategy, based on expanding serve market and new product development revenue opportunity funnels in both businesses, we remain confident that the actions we are taking will lead to the shareholder value creation, each of us is expecting.
Operator, this concludes my prepared remarks and we would be happy to open the call for questions.
(Operator Instructions) We will go first to Matthew Paul with Sidoti & Company.
Matthew Paul - Sidoti & Company
In regards to the increase in gross margin you saw for the Communication Systems business, could you comment a little further on how you've increased productivity and furthermore if you could sustain levels around that range?
Sure Matt. A couple of things, a couple of different fronts. First and foremost is our lean process. And our lean process is focused on every single step that goes into making other products along the line as it exists today in taking those steps and reconfiguring the line, so in some cases including our 20 watt amplifier line, we are able to reconfigure the line, cut out certain steps, reduce the labor required on a per unit basis, cut back on some material usage and (inaudible) we wind up with a couple of points increase in gross margin.
That exercise is going on for all of our products. It is time consuming but well worth it across all three of our operations. So that is step one. Step two is certainly focused on pricing, understanding the competitive environment and what the market we will bear, in step three Matt as you know I do want to point out that there was a rework reserve that was recorded last year that unfavorably impacted the Com Systems margin and the total margin that we want to make sure that you are aware off. So the long way of answering our question that, we're certainly focused on that 30%, the key point is dealing with the increasing volume for the absorption for the Newark facility.
Matthew Paul - Sidoti & Company
And moving on in regards to the delays in the contract orders you've seen in this quarter, you noted that you received (inaudible) for $3 million since the end of the second quarter. Can you maybe go into detail, how large is the total piece of delayed contracts?
Matthew, as everything came in, we would not have been reporting a $5.4 million decrease in revenue from the first quarter of 2013. So it's certainly in that range.
Matthew Paul - Sidoti & Company
Last question with the cash balance increase yet again, has anything changed in your outlook on potential acquisitions in the aggression Ultralife should show or will show?
No, Matthew. I mean, we're very interested in pursuing acquisitions. We continue the process as soon as if something becomes relevant then we can talk about, we will let people know about it. But our stance on acquisition does not change at all.
(Operator Instructions) There are no further questions at this time.
Thank you once again for joining us to the second quarter 2013 earnings call. We look forward to meeting with you over the next couple of weeks as we've done in the past and sharing with you our quarterly progress on each quarter's conference call in the future. Thank you very much.
This does conclude today's conference. Thank you for your participation.
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