Ultralife Corporation Q1 2010 Earnings Call Transcript

May. 2.10 | About: Ultralife Corporation (ULBI)

Ultralife Corporation (NASDAQ:ULBI)

Q1 2010 Earnings Conference Call

April 29, 2010 10:00 AM ET

Executives

Jody Burfening – Lippert/Heilshorn & Associates

John Kavazanjian – President and CEO

Phil Fain – CFO

Analysts

Trey Cobb – Stephens Inc.

Jim McIlree – Merriman

Ted Kundtz – Needham

Operator

Good day and welcome to this Ultralife Corporation first quarter earnings conference call. At this time, for opening remarks and introductions, I would like to turn the call over to Ms. Jody Burfening. Please go ahead.

Jody Burfening

Thank you, operator and good morning, everyone. This is Jody Burfening of Lippert/Heilshorn & Associates. Thank you for joining us this morning for the Ultralife Corporation’s earnings conference call for the first quarter of fiscal 2010.

With us on today’s call are John Kavazanjian, Ultralife’s President and Chief Executive Officer; and Phil Fain, Ultralife’s Chief Financial Officer. The earnings press release was issued earlier this morning and if anyone has not yet received a copy, I invite you to visit the Ultralife website at www.ultralifecorp.com, where you will find the release under Investor News in the Investor Relations section.

Before turning the call over to management, 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 possibility of intangible asset impairment charges that may be taken.

The company cautions investors not to place undue reliance on forward-looking statements, which reflect the company’s analysis only as of today’s date. The company undertakes no obligation to publicly update forward-looking statements to reflect subsequent events or circumstances.

A more detailed description of such uncertainties is contained in the company’s filings with the Securities and Exchange Commission, such as the company’s Annual Report on Form 10-K for the period ending December 31, 2009.

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 first quarter of 2010. Joining me today is Phil Fain, our Chief Financial Officer. Today, we reported revenue of $38.5 million for the first quarter of 2010 with an operating profit of $900,000 and an adjusted EBITDA of $2.7 million.

Quarter-over-quarter revenue was down from the fourth quarter revenue of $50.4 million. Despite the lower revenue, we showed an operating profit due to strong gross margin and disciplined expense control.

Even with a very weak gross margin in energy services, strong operational performance in battery and energy products and in communication systems led to this result.

As we continue to grow our sales of more highly engineered products and as energy services gains momentum as the economy recovers, we expect further margin growth moving forward.

In our battery business, there has been a hiatus in the ordering of some battery products by the Defense Logistics Agency while they resolicit some of the contracts that expired at the end of last year. This includes the BA 5372, the BA 5347 and the BA 5390.

While we are the only currently qualified source for several of these products, there will be competition and we're engaged in the proposal process. We anticipate contract awards to be made this quarter with shipments to resume in the second half of the year and we assume that any awardees will be the beneficiaries of catch up in demand orders.

We also saw weakness in the energy services area. A large part of our backlog was pushed out as we saw further delays in capital projects. However, we are seeing a significant pickup in orders and proposals and expect revenue to pick up this quarter and expect to be back on track in the second half of the year.

Battery and energy products, we continue to make operational progress and our China operation, we will start production of our new 9 volt product of major shipment starting in the third quarter.

At operation, we'll also commence shipments of a new version of our thionyl chloride batteries targeted at the automated meter reading market with world leading performance.

Ultralife China is growing and will be a major contributor to profitability moving forward. We also expect process improvements in our growing rechargeable business and our existing nonrechargeable business to help to grow margins.

A few weeks ago we announced a $2.4 million grants from the state of New York, the development of a large scale energy storage system for alternative energy. We will be using that grant to further develop large scale smart lithium battery systems to be integrated with wind and solar installations.

We know that efficient energy storage can cut the payback time of these systems in half if properly designed and managed. Together with the lithium battery systems that we're developing for backup power, this area would be a major part of our growth strategy in this segment.

In communication systems, a gross margin of 38% was a major contributor to profitability. The addition of the AMTI Amplifier business acquired last year and operational process improvements were the major reasons for this performance.

Moving forward the ability to utilize these advanced, compact amplifier products in our systems offering will further enhance the profitability of this segment.

As I mentioned earlier, energy services performed below our expectations. We expect this to improve with a pickup in capital spending that we're starting to see. Our focus on services over product is what will fuel improvements in the margin line of this segment as we move forward.

This group is also integral to our strategy to move lithium batteries into targeted areas in standby power.

On the expense side, we've been steadily consolidating operations and bringing down overhead expenses or preserving our investments in development. We saw the further result of this in quarter one with overhead expenses down to $9 million. While our R&D costs were down significantly, much of that was due to the conclusion of development work that we did last year on both new customer designs and on redesigns for product cost savings. While that work continues as needed, it is not at the level that it was at for 2009.

In addition, we expect activity to pick up in 2010 as a result of the work that we'll be doing under the New York State grants, the energy stores development. Bill will talk about this more.

By generating positive EBITDA and bringing down our inventory, we'll further improve our balance sheet. Bill has put a significant focus on financial asset management and it shows.

We're now exactly where we wanted to be with excellent revenue prospects for the remainder of the year, a low operating cost base and a strong ingrowing product portfolio to drive further profitability and combine that with a focus on cash management and operational excellence to strengthen the balance sheet and grow margins.

Now I'll ask Phil to cover the financial summary after which we'll open it up for questions.

Phil Fain

Thank you, John and good morning everyone. Earlier this morning we released our first quarter results for 2010. Consolidated revenues for the first quarter totaled $38.5 million versus $39.8 million in the same period last year and $50.4 million for the fourth quarter of 2009.

The year-over-year variance reflects revenue increases for battery and energy products and communication systems of $0.4 million and $1.8 million respectively. This increase was offset by a $3.5 million decline in energy service revenue. The decrease in revenues of $11.9 million from the fourth quarter was primarily a result of the higher level of SATCOM-On-The-Move systems shipped during the fourth quarter in our communications system segment under the $20 million order we received last October.

Despite lower consolidated revenues, gross margin was significantly higher in the first quarter of 2010, $9.8 million compared to $7.8 million for the first quarter of 2009.

As a percentage of total revenues, consolidated gross margin was 25.3% in 2010 versus 19.5% for last year’s first quarter. Gross margin for our battery and energy product segment rose 4.6 percentage points from 16.5% to 21.1% primarily reflecting manufacturing efficiencies and higher selling prices realized for some of our products.

Gross margin also increased in our communications system segment by 5.4 percentage points going from 32.1% to 37.5% benefiting from the addition of the AMTI Amplifier business, which was acquired on March 20, 2009.

Project delays and in ongoing pricing pressures in our energy services segment pushed the gross margin into the red for the first quarter of 2010. Compared to the fourth quarter of 2009, the consolidated first quarter gross margin grew by 1.6 percentage points reflecting higher gross margins for our battery and energy products and communications systems segments.

Operating expenses totaled $8.9 million compared to $10 million in the same quarter of last year and $10.3 million in the fourth quarter. The across the board cost reduction and consolidation actions we commenced in the latter half of 2009 have now been realized.

These actions more than offset the increased expenses resulting from our acquisitions of U.S. Energy in November 2008 and AMTI in March 2009.

First quarter noncash operating expenses including depreciation, intangible asset amortization and stock compensation expenses amounted to $1.8 million, the same amount as a year ago.

Operating earnings were $0.9 million versus an operating loss of $2.3 million reported for the first quarter of 2009. This $3.2 million year-over-year improvement reflects the higher gross margins for battery and energy products and communications systems coupled with our lower cost base and improved operational efficiencies.

Net interest expense for the quarter was $494,000 compared to $179,000 last year. Included in the 2010 first quarter net interest expense was a total of $278,000 and expenses related to the termination of our credit facility with JP Morgan earlier this year.

Our first quarter tax provision amounted to $105,000 reflecting the alternative minimum tax on U.S. taxable income and book tax differences related to the amortization of intangible assets.

Net income was $287,000 or $0.02 per share compared to a net loss of $2.5 million or $0.15 per share for the same period last year and adjusted EBITDA defined as EBITDA including non-cash stock-based compensation expense amounted to $2.7 million in the first quarter versus a loss of $400,000 for the first quarter of 2009.

With strong cash flow generated from our operations and continued favorable improvements made to our balance sheet including the reduction of our inventory to $34 million, the outstanding balance under our new credit facility was $8 million and our net borrowings were $3.9 million at the end of the first quarter.

By comparison at the end of the fourth quarter our outstanding revolver balance was $15.5 million and net borrowings were $9.4 million.

Based on our first quarter performance and with orders continuing to pick up, we are optimistic about our ability to at least achieve our base plan for 2010, which calls for revenue of $177 million operating profit of $4.6 million, and adjusted EBITDA of $11 million.

I will now turn it back to John.

John Kavazanjian

Thank you Phil. Now I'd like to ask the operator to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go ahead and take our first question from Steve Sanders with Stephens Inc.

Trey Cobb – Stephens Inc.

Good morning. This is Trey Cobb for Steve.

John Kavazanjian

Good morning Trey.

Trey Cobb – Stephens Inc.

John, could we maybe talk about the change in segment reporting, if you could just walk me through the changes because I'm having trouble typing the previous results with the new segment reporting. I think on the last call you said primary and rechargeables were going to make up the battery and energy segments, but it looks like some of that maybe has moved to comms. So I'm not sure what the shifting parts were there.

John Kavazanjian

No, not really, rechargeable and nonrechargeable are pretty much the battery segment; communications is communication segment. The only other change is that we have a communication services group, RedBlack Communications that does a million or two a quarter that moved from the services into the comms. Phil, is there anything else there that was in addition?

Phil Fain

Yes Trey, the only other item is the reclassification of tech contracts, which now goes to the various – to the new reporting solution.

John Kavazanjian

Which ever segment that they're accrued to.

Trey Cobb – Stephens Inc.

Okay, because just going back to prior releases, it looks like primary and rechargeables were $28 million, $29 million in 1Q ‘09 and then this is showing $23 million. So there's that $6 million delta and I just – I'm not exactly sure where that flowed through. So other than what you just gave there's really nothing material that shifted around there.

John Kavazanjian

No, no that's right, you're pretty much match primary rechargeable up against the battery and energy product segment.

Trey Cobb – Stephens Inc.

Okay. And then kind of the topline this quarter was a little lighter than it was expected but was there anything there in terms of timing issues, etcetera, that would lead to a stronger 2Q or is your general thoughts that this is going to be spread out fairly even throughout the remainder of the year.

John Kavazanjian

No, no we had some definite timing thing and I think I talked about two of them. One of them was that some of the major DLA contracts expired last year in the second half of the year and they've been, let me use the word, deliberate in resoliciting them.

We know there's demand out there because we've gotten some direct orders from bases or units for product; they're not in dire straits, they have reserves that they can go into but they've resolicited for those products. So that's one thing that was in our run rate last year that – business we know is there that until they get new contracts into place, they won't be reordering. And we think it's going to take maybe a little bit this quarter but by the time they get these solicitations and awards done, it's second half of the year.

And that business has run anywhere from kind of $2 million to $5 million a quarter for us, pretty steadily and for a bunch of different battery types.

Then the second area is in standby power. This is a business that's really a three to six month lead time business. People plan these things pretty well in advance and we thought – we saw a real low – we had a very strong third quarter last year, fourth quarter, but we saw a low coming in the fourth quarter and the first quarter, and this quarter was a real low with anywhere from $1 million to $2 million in orders specifically that moved from March into April.

As soon as we saw that what's happened is we seen a real pickup in activity in that area. And in fact almost everybody that we talk to involved in there, some of our suppliers and all are starting to see the pickup also that there was a lot of reticence right through good part of the first quarter to start coming into project. But during the first quarter we've seen pretty good project commitments that give us the belief that we're going to get a pretty good recovery in the second quarter and by the third, fourth quarter be back on what we would consider to be right sizing for that business.

Trey Cobb – Stephens Inc.

Okay, I'll come back to that standby, but I'm thinking with the DLA issue, that though is not going to be really a 2Q definite, that's probably looking at more back half.

John Kavazanjian

You'll see some stuff in back half but we do have some – like I said we've gotten some – when DLA stocks batteries, people can buy them right out of inventory. If they don't stock them and if people need them and can't get them from their local inventory, they will order directly from us sometimes and we've seen little pickup in that activity, which is how we can gauge what is going on.

Trey Cobb – Stephens Inc.

Okay, that was helpful. Has there been anything else that you've seen announcements as far as the 1300 plus MRAP that were ordered a few months back.

John Kavazanjian

Well, we can only react when we get an order placed on us and when we do, we'll let you know. I mean they're buying more MRAPs to the 1300 or 1350 of them. We've been involved in working with the people we supply and given them lead time information stuff but we haven't ordered, we'll let you know.

Trey Cobb – Stephens Inc.

Okay. And then going back to the standby, obviously it sounds like activity is picking up there. But have you seen any improvement in terms of pricing pressures? How should we think about kind of margins expanding in that business?

John Kavazanjian

We don't see any improvement in pricing pressure, it is still there on the equipment side of the business. The ways we've reacted to that is really redouble our efforts in selling service. I mean in that business fundamentally we're – services where it's at, that's the model actually we're trying to change with lithium batteries in that marketplace. So we kind of last year in second and third quarter recast our efforts to emphasize service a lot more and I think that's where you get the pickup.

Most of that business has been selling equipment and then picking up service where you could, we've changed that. And that's the thing that really has to change for us to improve margins in the short run.

Now in the long run, there's going to be some shake out and pricing pressure will abate but it’s artificially low right now. But we're assuming that's not going to change, let me put it that way and dealing with it in that way.

Trey Cobb – Stephens Inc.

And you guys have obviously made margin strides this quarter. Kind of what levers do you have left to pull to help drive additional upside? Is it more a function of volume at this point or is there still some fat that you have left that you can trim.

John Kavazanjian

Well, the margin improvement was more than just fat trimming, it was process and product. We acquired the McDowell business, three and half years ago, that was a $20 million a year business; this is now a $50 million or $60 million a year business for us. It grew very fast, we did very well with it but we knew that there was engineering work. While we put our resources on the engineering of the system side, we knew on the components side there was engineering work to be done. There was a lot of work that we've done in the last year that was R&D expense, quite frankly to re-engineer products to reduce cost. I mean you actually had to, you have to re-engineer to take cost out of some of these things. That's what we did, we put a big effort on it and we're starting to get the pay back for it.

We still have more to go. I mean there's still opportunity in those product lines to take existing products and reduce cost for new designs, working with vendors on sourcing and things like that.

Trey Cobb – Stephens Inc.

And you're still expecting R&D, I guess to tick up a little bit and maybe kind of hit that operating expense, $10 million run rate.

John Kavazanjian

The part of R&D that – it’s not people that we reduced, it was materials, prototypes – we go through a lot of materials when we do a new part to qualify it, actually burn through whether it's destructive testing or prototypes or whatever. And then we use outside services for some things. We do some of our own engineering but we don't do board layout and some of the work – that kind of work that – we did a lot of that last year both in redesigner products but also in new products as well. The work that we've done for General Dynamics and UK MOD and several medical accounts, we wanted to own the design. So we did the engineering work, we can't amortize that stuff. So there was a lot more of that last year just because of where it was.

This year we have a little bit of benefit in that, the areas in which we want to do more engineering we doing that cooperatively with some of the work we're doing in the State of New York and the large lithium batteries. That’s where we have targeted to do a lot of our engineering this year and the good news is that we're getting help with that.

So I believe you'll see the engineering line go up a little bit but we still expect to keep our numbers down pretty well here on the overhead side.

Operator

And we'll take our next question from Jim McIlree with Merriman.

Jim McIlree – Merriman

John, you talked about DLA and the resolicitation and then you said there will be competition. Were you referring to competition within the solicitation or were you suggesting that there's going to be dual source for these particular battery types?

John Kavazanjian

I can't speak, Jim, whether DLA is going to single the dual source, they’ve pretty done single sourcing in the way they've awarded contracts in the past. They could certainly change that but I believe it has been solicited as single. But there'll be other people bidding it. I mean there are other people who can build these products. On some of them like the 5372, which is a small backup battery, there are other qualified sources. But on something like the BA 5347, and if you remember five years ago we got awarded the 5347, which is a thermal sight battery. We got 60%, somebody else got 40%; that other person never was able to qualify.

So, a couple of things could happen. Number one, we could just get reawarded things like the 5347 and 5390 where we're the only one but we are bidding against other people. They could come back and do two – just to get somebody else against you, if they qualify. They did not say they were going to do that in the solicitation but it's possible that they could do that. They make it competitive, that's their job.

Jim McIlree – Merriman

Okay. And back in October of last year you got a $20 million order for Satellite-On-The-Move products. Have you completed the shipment of that order?

John Kavazanjian

Yes, we have. It was completed during the first quarter. Most of it we shipped in the fourth quarter and we completed it in this quarter.

Jim McIlree – Merriman

So, it kind of sounds like Q2 communication systems unless there's something that – a lot of little stuff they haven't announced, it sounds like that that would be down relative to Q1. And it kind of sounds like Q2 dips again and then you have a very strong second half in order to make your projections, I guess that's what I'm really asking. Is that how you're mapping out the year? Is that Q2 is a little bit weaker and then you get a big hockey stick for the second half?

John Kavazanjian

To be honest with you, Jim, we have enough ups and downs in our business right now that we're looking at it pretty smoothly for the rest of the year to be honest with you. I won't tell you we anticipated Q1 being down but we knew that there were a lot of things up in the air coming into quarter one. I'd love to tell you I can predict right now what's going to happen in Q2 but I can't, but I can tell you that we're seeing a very good strong maybe even better than normal order flow in the second quarter. Business is very, very healthy in all the segments. So I would not assume that there'll be a down and I think we're looking at fairly even flow across the rest of the year.

Let me put it this way. Given the diversity of the business right now, if there's some ups and downs that will be for some artificial reasons, not for demand reasons as far as we can tell right now. Now that's absent a SATCOM order on MRAP. We've pretty much given our guidance and talked about it absence in an order like that because we learned a hard lesson last year that you don't have anything until you have it.

Operator

And we'll take our next question from Ted Kundtz with Needham.

Ted Kundtz – Needham

Yes, good morning John. Could you comment a bit more on the gross margins you achieved in the communication systems business? They were sort of at record highs here at this 37.5% level. And I'm just wondering you mentioned what led to it, I'm just wondering is that a sustainable margin for you or was it something about the mix in the quarter that led them to be so high because that was a lot higher than I thought, certainly than I have modeled but – than I thought you could even get to. So could you give your future outlook for that?

John Kavazanjian

I think it’s absent SATCOM, I think it's sustainable. By having our own amplifier line, that's a big deal. By re-engineering some of the products that we had that were electronic intensive products, that's a big deal. We have kind of a couple of different kinds of products in our product line. There's the amplifiers, which are very complex. There are some electronics products which are power based, kind of power supply type products, those are less complex but have electrical parts and then there's mechanical parts, cables and mounts and things.

We tend to have really good margins on the mechanical parts and really good margins on the amplifiers but not so great on the electrical, which is kind of counterintuitive if you think about the engineering complexity. So we really took it on really a year and half ago to go after the electrical parts and get those re-engineered. And it really was a matter of doing them more efficiently, sometimes changing vendors, sometimes changing parts. But even changing vendors you need engineering to do that to make sure that you have the same performance. So we've done a lot of that work. We're still doing more of it. That was a big – so it was both amplifiers and getting the margins up on the electrical parts with engineering, good solid engineering work that did that.

I think it's sustainable. The one warning I'll give you is that quite frankly at margins 35% to 40% margins SATCOM systems have a lower margin than that under the government contracts. If we got a big SATCOM order, we could actually bring down our margin percentage. Now, we're going to take it, okay, and we're going to be really happy with it. But I think we've said in the past pretty clearly that we didn't have any new products coming over the last two years or any going forward that have less than a 30% gross margin, and some of them are better than that. And so, we're just seeing the effect of that stuff kicking in, that's all.

I would be remiss – I mean I know we're focused on the – talking about communications, I would be remiss if I pointed out that in the battery space without building any of the DLA products, the cylindrical parts of DLA, which really brought my utilization down there in batteries, we still had phenomenal percentage in the factor. And that was pure blocking and tackling. We've done some process improvements over the last year that are really, really, really helping us there in terms of efficiency. So good work by the guys in that group.

Ted Kundtz – Needham

Okay. And that was my next question of where the margins are going on that one as well. And so you think on the battery side as a combination now, those can keep this 21% level as kind of a base level and you can keep moving up from there.

John Kavazanjian

Oh yes, there is margin to be had with our new 9 volt in China. (Inaudible) had with our added products in China, our thionyl chloride product and then there's margin to be had by bringing back the military cylindrical stuff, which really absorbs a lot of overhead in the factory. So on an incremental basis it's really good. Most of our depreciation and factory overhead is in that area, that's where our capital is.

Ted Kundtz – Needham

Okay terrific. Could you give a little more color on the UK MOD, what are you seeing out of that area?

John Kavazanjian

We continue to do engineering work to get parts qualified. We've done – most of the work that resulted in NRE expenses was done last year. We have a little more work to do on – we have a full portfolio. There's a couple of products that they want some changes on but there's nothing real big and we're starting to produce. We're doing one battery type of the new ones. There's another one that we think will bring in – it won't be the second quarter but by the third quarter and then we have a new charger that we will have done by the end of the year. So we're moving along pretty well there.

Ted Kundtz – Needham

Okay. The UK MOD business as a total is – can you give us any numbers around that or not?

John Kavazanjian

It's a double digit percentage of our battery business, let me put it that way.

Operator

And we'll take our next question from Walter Nasdeo with Ardour Capital.

John Kavazanjian

Oh my God.

Operator

(Operator Instructions) And it does appear that we have no further questions at this time.

John Kavazanjian

Well, thank you very much. We'd like to thank everybody for joining us today and participating and we really look forward to sharing our progress with you again next quarter. Thank you.

Operator

That does conclude today's conference. Thank you for participation.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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