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Arotech (NASDAQ:ARTX)

Q1 2014 Earnings Call

May 14, 2014 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 Senior Vice President of Finance

Steven Esses - President, Director and Member of Executive & Finance Committee

Analysts

Michael Crawford - B. Riley Caris, Research Division

Alexander Cushner

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Arotech's First Quarter 2014 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. You should have all received by now the company's press release. If you have not received it, please contact Arotech's Investor Relations team at GK Investor & Public Relations. I would now like to hand over the call to Mr. Kenny Green of GK Investor & Public Relations. Mr. Green, would you like to begin, please?

Kenny Green

Thank you, operator. I would like to welcome all of you to this conference call, and I'd like to thank Arotech's management for hosting this call.

Yesterday, Arotech released its first quarter 2014 results. By now, you should have all received a copy of the press release, which is also available on Arotech's website.

With us on the call today are Mr. Robert S. Ehrlich, Chairman and Chief Executive Officer; Mr. Tom Paup, Senior Vice President of Finance and Chief Financial Officer. Bob will summarize the key highlights of the year, followed by Tom who will review the company's financial performance. We will 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 therefore, 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 demands and the competitive nature of Arotech's industry, as well as other risks identified in the documents filed by the company with the Securities and Exchange Commission.

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, forecast 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. Good morning, everyone, and thank you for joining us today. Yesterday, after the close of the market, we announced our first quarter 2014 results for a strong start for this year. Please note that these results do not yet include the first quarter results of UEC, as that acquisition was only completed on the first day of the second quarter. Beginning next quarter, we will report UEC as part of our Battery and Power Systems Division.

Revenues for Arotech were slightly ahead of those of the first quarter of last year, coming in at $22.4 million. We reported a net income of $1 million almost 4x the level we reported in the first quarter of last year. Our adjusted EBITDA was $2.4 million, a 52% year-over-year growth, and our quarterly net income more than doubled from $404,000 to $1 million. We also continued on margin improvement with gross margin increasing to 34%.

As you all know, we announced the acquisition of UEC Electronics about 6 weeks ago. Over the past few weeks, management has spent time in Charleston, South Carolina, working closely with our new team at UEC to integrate them into our Battery and Power division. We have already identified several areas of opportunity where UEC and our Battery division can work together to develop new product opportunities.

In addition, we see upsell opportunities for our products into their customer base, including the U.S. Army, General Dynamics, Raytheon and Boeing. We also believe that some of our products and engineering capabilities will appeal to their customer base as well.

Overall, it is clear that this acquisition has expanded our market opportunities in battery, electronics and power systems. While it will take some time, we believe, we will capitalize on those opportunities over the coming quarters and the next several years.

The Battery and Power Systems Division performed well in the first quarter and we expect another solid year in 2014. We continue to anticipate new orders for our next-generation SWIPES 2D model, which will likely materialize in the second half of this year.

In the quarter, the Battery business contributed $6.7 million or 30% of our overall revenue, about a 5% increase on the first quarter of last year. We are seeing increased military interest in our rechargeable lithium ion technology, as a replacement for the more traditional primary chemistry. We are working on leveraging our expertise in battery design, electrochemistry and the management systems for applications of large-format lithium batteries for things like unmanned submersibles, rockets, UAVs, tank batteries and starters for tanks.

Our engineering team is focused on the design of these demanding batteries. Their aim is to achieve the maximum performance in terms of energy and power density while carefully designing a battery management system that ensures battery performance and safety that meet the exceptionally demanding application requirements and environments of our customers. We hope to see initial revenues from these developments later this year and in the start of next year.

While as always, it is difficult to estimate quarterly timing of new orders, we see significant opportunities in the pipeline of business which we hope will materialize later this year or certainly into 2015.

Our iron flow battery technology continues to progress towards a lab-level demonstration anticipated to be done by year end. The focus of our research is on the development of the cell components and the synergy between them in order to meet our specification targets.

Moving to our Simulation division. We reported $15.7 million revenue from Training and Simulation, about 70% of our overall quarterly revenue, with a solid increase in gross margins and net income. As we discussed last quarter, some continued uncertainty regarding timing of U.S. Military spending continues. Some orders we had anticipated to have already received in the first half have been pushed out somewhat and are now expected in the second half. We, nevertheless, predict a very profitable Simulation division in the full year results.

In terms of our major programs, VCTS continues on track. As of the end of the first quarter, we have produced all 28 suites and have only 3 left to deliver. We believe that there will be follow-on orders in the future, but we can't stress the timing because it's uncertain for us. Our BOSS program has cleared an important milestone with the installation, acceptance and commissioning of the first production simulator at the 186th Air Refueling Wing of the U.S. National Guard in Maryland and Mississippi.

We look forward to installing this important training device for the Air National Guard at 16 more sites over the coming next 1.5 years. We have started to see a resurgence in the sales of our commercial driving and force option stimulators to the municipal market, which is a pleasant surprise for us.

Two examples, which we recently announced, include the receipt of an award from the Nashville Metropolitan Transportation Authority for our bus driving simulator and an additional order from the University of New South Wales in Australia for the installation of 12 network research driving simulators. These research simulators will be used by the university to study inter-vehicle connectivity and future highway designs.

In summarizing our first quarter, our business is strong, stable and profitable. UEC will begin to contribute in this quarter. Arotech is a different company now with UEC, and we anticipate significant future upside as we integrate them into our Battery and Power division. We need to appreciate that this will be an organic process and increasing contribution will be realized over time. I believe that 2014 will be a good year for Arotech and an improvement over last year. I also believe that the substantial benefits from the acquisition of UEC will be clear and increasingly materialize in the last quarters and into 2015 and beyond.

With that, I would like to turn the discussion over to Tom to review our financials and discussion of our cash position. Tom?

Thomas J. Paup

Thanks, Bob. Revenues for the first quarter reached $22.4 million compared to $22.1 million for the corresponding period in 2013, an increase of 1%. Gross profit for the first quarter was $7.3 million or 32.8% of revenues, compared to $5.3 million or 23.9% of revenues for the corresponding period in 2013, an 8.9-percentage-point increase in gross margin.

Adjusted EBITDA for the quarter was $2.4 million compared to $1.5 million for the corresponding period of 2013, an increase of 61%. We believe the information concerning adjusted EBITDA enhances our overall understanding of our performance, and we compute adjusted EBITDA, which is a non-GAAP financial measure, as portrayed in our press release which was issued last night.

The company reported an operating income for the first quarter of $1.3 million compared to $841,000 for the corresponding period in 2013. Operating expenses grew to $6 million versus $4.4 million in the corresponding period. A large portion of the increase was due to the R&D investment related to development of our iron flow technology, as that was a onetime G&A expense of $537,000, and also our acquisition expenses were in that category.

The company's net income for the first quarter of 2014 was $1 million or $0.05 per share, compared to $616,000 or $0.03 per share for the corresponding period in 2013. Our backlog for orders totaled approximately $51.9 million as of March 31, 2014, compared to $58 million as of the end of the year. The company received $15.3 million in new orders in the first quarter of 2014. The 3/31/2014 backlog was made up of $39.1 million in Simulation and $12.8 million in Battery, as compared to the $59.8 million and $16.5 million for the same period, respectively.

As of March 31, 2014, the company had $6.4 million in cash and $496,000 in restricted collateral deposits as compared to December 31, 2013, when the company had $5.8 million in cash and $498,000 in restricted collateral deposits. The company ended the first quarter with $2.5 million in short-term bank debt and $1.8 million in long-term bank debt outstanding. That's compared to the end of the year when the company had no short-term bank debt and $1.8 million in total long-term debt outstanding.

The company had also $10.5 million in available unused bank lines or credit with its main bank as of March 31, 2013, under our $15 million credit facility under our FAAC subsidiary, which was secured by the company's assets and the assets of the company's other subsidiaries and guaranteed by the company.

The company had trade receivables of $14.9 million as of December 30 -- or March 31, 2013, compared to $12.4 million as of the end of the year 2013. The company had a current ratio, current assets divided by current liabilities of 2.23 compared with a December 31, 2013 current ratio of 2.12.

Back to you, Bob.

Robert S. Ehrlich

Thank you, Tom. I'd just like to say before we turn over to questions that we were all very pleased with the results of the first quarter and are keen on the year going forward with the absorption of UEC into our operations.

With that, I'll turn over the floor to questions from the participants.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Mike Crawford of B. Riley.

Michael Crawford - B. Riley Caris, Research Division

Could you give us some more color on the gross margin by each of your segments? And also, what accounted for the substantial increase in gross margin year-over-year on similar revenue level, please?

Robert S. Ehrlich

Tom, can you deal with that?

Thomas J. Paup

Yes, I'd be glad to do that. The Battery gross margin was in the 30% range for the quarter and the Simulation in the 35% range. This compares to last year of 19% and 27%. The battery improvement can be attributed to the fact that we had some substantial SWIPES business in our U.S. subsidiary, electric fuel battery. And in the Simulation group, the fact that our VCTS project is starting to finish up and the ending values this year compared to the first quarter of last year, relative to our gross profit on that project, is much higher. And that really is kind of a product mix as well in Simulation as the BOSS project, which is at a higher-margin in Simulation becomes more prominent in the total overall mix of the business.

Michael Crawford - B. Riley Caris, Research Division

Great, Tom. So as the Training division switches more towards BOSS this year, do you expect that you can maintain that type of gross margin for Simulation through the year?

Thomas J. Paup

Well, we would hope so. There's, obviously, no guarantee as month and month, quarter-to-quarter, our business has -- we have many components. So one can be more dominant than the other. We're also looking at potential add-on orders to existing contracts. So we would hope so, and we'll just have to wait and see.

Michael Crawford - B. Riley Caris, Research Division

And despite the fact that VCTS is coming off, the company has repeatedly expressed a belief that this business can continue to grow for a couple of years just based on amount of opportunities you're tracking in a pipeline. Have any of those opportunities moved closer to an RFP or an award process that we could watch, that you can discuss?

Robert S. Ehrlich

Steven, why don't you try and respond to that? Yes, I think the answer is yes, but let Steven tell you a little more about the opportunities that are close to materializing.

Steven Esses

So specifically on VCTS really, Mike, I can't speak towards it, but we believe that there are opportunities that we will see this year. It is directly connected to VCTS or, let's call it, other opportunities created because of the success of the program. So we believe that you will see something over the next 2 quarters related to the success of that program.

Michael Crawford - B. Riley Caris, Research Division

Okay. And then just back, if I just went through a couple real quick, please bear with me, to the Battery business. So you're expecting or hoping to see your first revenue in your large-format batteries that you've been developing in multiple fronts for a couple of years. And when that does come in, is that something that might be at above or below segment margin and then what happens if and when that would translate to full production work within the margin? How would that affect it?

Robert S. Ehrlich

The margins for those large-battery projects are in the 30-plus-percent range. We hope as we're delivering the first units for tests, they're in that margin range and we then expect when they're successfully tested that they will become regular production models that will maintain those kind of margins, Mike. That was the -- that's been the whole objective of this program.

Michael Crawford - B. Riley Caris, Research Division

Okay. Bob, and then on the SWIPES, the 2D, is that just for the U.S. or is it something else that you're developing for -- potentially for the IDF?

Robert S. Ehrlich

The 2D is for the U.S. Military, but we are -- also, we have delivered the first test units to the IDF of the SWIPES -- the Israeli SWIPES version. And apparently the tests are going very successfully and we expect to see orders yet this year for the beginning of that program in Israel.

Michael Crawford - B. Riley Caris, Research Division

Okay. And then last question relates to the iron flow technology. So did I hear you properly that some of the dollars that you pulled out to provide an EBITDA number, was the $537,000 invested in the iron flow technology development?

Steven Esses

The deal cost.

Michael Crawford - B. Riley Caris, Research Division

Deal cost for UEC?

Steven Esses

Yes.

Robert S. Ehrlich

Included in our operating expense was -- we included in the operating expense the costs that we've invested in the flow battery. The deal costs are reflected in the adjusted EBITDA.

Thomas J. Paup

Mike, I kind of went fast over that, Mike. I'm sorry I think you probably can understand why there was a misunderstanding.

Steven Esses

Basically, Mike, our net numbers include all the costs, including the deal costs attributed to the first 3 months. The adjusted EBITDA takes them out.

Michael Crawford - B. Riley Caris, Research Division

Great. And so, in that regards, so you are investing, I believe, only about, I think, $0.5 million this year to get your breadbox-sized, lab-scale prototype?

Robert S. Ehrlich

That's correct. That's correct.

Michael Crawford - B. Riley Caris, Research Division

Which, if successful, then you would -- when would you start to seek a partner? Would that be after that or are you already starting to talk to people?

Robert S. Ehrlich

Yes, we would -- no, no. We would -- it's not time to talk to people. We would start talking to them as we are going ahead with the larger version test model, because they'll need to see something more substantial than a lab model. We will begin talking to people next year about it, but we will not press hard on partners until sometime in 2015.

Operator

[Operator Instructions] The next question is from Alex Cushner of R.W. Baird.

Alexander Cushner

Can you talk a bit more about the UEC transaction? You did in your opening remarks, but just looking for a little more color in terms of what you think in terms of the revenue opportunities in EBITDA? I know it's been only a couple weeks still, but just interested in your thoughts there.

Robert S. Ehrlich

Well, we obviously, expect it to be a significant contributor. We are hoping to see combined revenues for the year -- don't forget we don't own the first quarter -- in the $40 million range, somewhere between $40 million and $42 million for the full year, with substantial EBITDA contribution. They reported to us that they had a very solid first quarter, which we didn't own, unfortunately, but they had a very good first quarter and they expect that to continue into the second quarter. We're spending time with them. Steven and Tom are spending a lot of time with them, getting a better sense for the opportunities and for trying to get them on a similar program for evaluating opportunities as we have in our other businesses. So we have very high expectations for them over the next couple of years. There are a number of programs that they're bidding on. Obviously, if they win those, we'll have a very successful integration.

Alexander Cushner

Do you know what their -- or are you disclosing what their current backlog is?

Robert S. Ehrlich

Because we don't have it audited, we'd rather not, because we will include them in the second quarter report. By then they'll be part of our business. Their numbers are not audited so we just -- they reported to us what they've done, but since they're not audited, we don't -- we're not disclosing those numbers because we don't have the same reliability and stuff that BDO has gone through.

Alexander Cushner

Understood. And then in terms of the guidance that you set after last quarter, how would you describe that? We're now 1 quarter into it, are we -- does it have upward bias? What's your thoughts?

Robert S. Ehrlich

We think, at this point, that the guidance we provided is still good. We're not ready to consider any adjustments to that until we're further into the year when we see what opportunities UEC will materialize and what programs of the Simulation business we'll likely win yet this year. So we'll have a better look at it at the end of the second quarter.

Operator

There are no further questions at this time. Before I ask Mr. Ehrlich to go ahead with his closing statement, 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) 254-7270. In Israel, please call (03) 925-5937. Internationally, please call 972 (3) 925-5937. 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 your concluding statement?

Robert S. Ehrlich

Yes, thank you very much. We, obviously, are pleased with our first quarter results. We have been focusing on margin improvement, which is now being demonstrated. We are optimistic about the rest of the year, but are not prepared to do anything to change anything until we get a little further into UEC and some of the opportunities in Simulation and Batteries. Once we have a better handle on that, we'll, obviously, talk to our shareholders about our outlook going forward for the rest of the year. But we anticipate a strong year.

Operator

Thank you. This concludes the Arotech First Quarter 2014 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.

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