Arotech's (ARTX) CEO Robert Ehrlich on Q2 2014 Results - Earnings Call Transcript

| About: Arotech Corporation (ARTX)

Arotech Corporation (NASDAQ:ARTX)

Q2 2014 Results Earnings Conference Call

August 12, 2014 9:00 a.m. ET

Executives

Robert Ehrlich - Chairman and Chief Executive Officer

Thomas Paup - Chief Financial Officer and Senior Vice President of Finance

Kenny Green - GK Investor & Public Relations

Analysts

Michael Crawford - B. Riley

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Arotech's Second 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 Relations or view it in the news section of the company's Web site www.arotech.com. I would now like to hand over the call to Mr. Kenny Green of GK Investor Relations. Mr. Green, would you like to go ahead, 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 second quarter 2014 results. By now, you should have all received a copy of the press release, which is also available on Arotech's Web site at www.arotech.com.

With us on the call today are Mr. Robert S. Ehrlich, Chairman and CEO; and Mr. Tom Paup, Senior Vice President of Finance and Chief Financial Officer. Bob will summarize the key highlights of the quarter 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 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 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 financial 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 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 are included in today's earnings press release.

And with that, I'd like to now introduce Arotech's Chairman and CEO, Mr. Robert Ehrlich. Bob, please go ahead.

Robert Ehrlich

Thank you, Kenny. Good morning, everyone, and thank you for joining us today. Yesterday after the close we announced our second quarter 2014 results. We saw an impressive results which were the highest in our company's history.

Revenues for Arotech were up 24% year-over-year as well as sequentially, coming in at $27.8 million. In addition, just over half of our revenues came from the battery division which now includes the operations of UEC, which he purchased at the very beginning of the second quarter. Our margins also came in at record levels with gross margins of 37%, well ahead of our historical range. Operating income, our record of $2.3 million, which is a strong 8% margin.

Net income in the quarter was $1.8 million combined with the net income of the first quarter and the first six months of 2014, we already are ahead of the net income for the entire year of 2013 which was $2.3 million. And adjusted EBITDA for the second quarter was $4 million, which means so far this year we have recorded $6.3 million in adjusted EBITDA. While this quarter was particularly strong and we believe that 2014 will prove to be an excellent year for Arotech overall, we don't yet have enough information with regard to the second half of the year to warrant updating our current outlook.

This is due largely to the inherent unevenness in the revenue timing amongst quarters with the billions involved in many projects spanning multiple quarters. That said, given our performance year-to-date, we are confident that we will exceed the upper bound of our EBITDA guidance range and we look forward to providing more definitive information in our next quarterly call.

Turning now to the battery division. The Battery and Power Systems division continues to perform well and now consolidating the UEC acquisition, accounts for over half of our quarterly revenues for the first time. Revenues in this division were $14.6 million or 53% of our total. We also saw an increase in the gross margin in the battery business which was part of the reason for the very strong gross margin in the quarter. Over the past year we have seen generally increased interest in battery and power technology from both military as well as commercial markets.

Advanced militaries are using increasingly sophisticated weaponry based on mobile computer systems and electronics which require efficient battery power. In addition, there is recognition in the military and commercial markets that they need to transition from old technological methods to newer and more efficient methods to power their systems. As such, our Battery and Power Systems division has been busy. We announced a number of new orders for various military and security related customers throughout the quarter. I note that while as always it is difficult to estimate the exact timing of new orders, we continue to see many promising opportunities in the pipeline.

In terms of our new product development and sales efforts in the Battery and Power Systems division, our next generation SWIPES 2D is on track and we hope to see the first orders in the next several months. We are also seeing increased military interest in our rechargeable lithium ion technology as a replacement for the more traditional lead acid chemistry. In terms of our work on large format lithium batteries, we are continuing our R&D development leveraging our expertise in battery design, electrochemistry and management systems for applications such as unmanned submersibles, rockets, UAVs and tank batteries and starters. We believe that we will see the initial return from these developments in the next several years.

During the quarter, we launched a new Man portable hybrid power management system demonstrating to the U.S. Department of Defense with very positive feedback. The hybrid system is designed to optimize the efficiency of field generators. Numerous reports throughout the U.S. Department of defense concluded that the generators are used well below capacity. Our system turns on the generator only one the battery's state of charge falls below a certain limit. All excess energy produced is used to charge the battery array, making full use of generator output. We believe this could be a real game changing technology for the military. While there are many relevant applications, we also see several opportunities in the commercial market for this product as well.

With respect to the iron flow battery, in terms of the iron flow battery we continue to progress towards a lab level demonstration and hope to be ready for the demonstration sometime around the end of the year. Overall, we continue to leverage our experience and expertise with battery and power technology which we are using to bring out new products with solutions for both our existing and new markets. Our ongoing efforts we believe place us in a strong position for continuing long-term growth and success in the Battery and Power Systems division.

On to Simulation. Moving to our Simulation division. We reported $13.2 million in revenues from training and simulation, 47% of our overall revenue for the quarter. In addition, our Simulation business continued strongly to increase to provide solid gross margins. As we already discussed last quarter, our revenues depend upon the timing of awards, especially the more significant awards from the U.S. military. For example, this $36 million VCTS follow-on order which solidifies our originally anticipated expansion of the business, was anticipated earlier in 2014 but was not received until the end of the second quarter. This timing delay has pushed some of our Simulation revenue from fourth quarter of 2014 into 2015 which we had reported before.

The Simulation division has, however, significantly increased its margins and profitability and continues to make a very strong contribution to our bottom line, to growth and we are delighted with its performance. In terms of our major programs, as you know we received a significant $36 million VCTS follow-on order towards the end of the second quarter. $20.4 million of that order is funded with additional $15.6 million in options which we believe will be funded in the next two fiscal years. The order adds a [fifth trail] (ph) to each of the previously contracted 28 training suits and we configured VCTS to match the Army's current operational concept for route clearance missions and includes options for continuing contract and logistical support of the fielding systems.

Our BOSS program continued successfully. We have successfully installed three of the 17 systems thus far and are receiving great customer reviews. We have entered a steady production phase and look forward to our remaining installations over the next 18 months. Our customer has been actively upgrading this program as we have demonstrated its success and have already exercised six engineering change proposals valued at $4 million. We are seeing a resurgence in sales of our commercial simulators despite the economic challenges for public safety and transit market segments which they continue to face as municipal funding had started to become more available.

During the quarter we received orders to upgrade transit driver training simulators for a number of agencies throughout the United States. Given that long time customers continue to come back to us to upgrade the simulators we delivered to them in the past, it is clear that they see the value of simulation training and have a thriving program they want to maintain for years into the future. In May we announced the receipt of an award for the Nashville Metropolitan Transit Authority for our bus driving simulators and also received an order from the University of New South Wales in Australia for the installation of 12 network and research driving simulators. These research simulators will be used by the University to study inter-vehicle connectivity and future highway designs.

We also capitalized on our investments in new multi-screen, modular theatre capability with our MILO Range use of force product with an award from the from [Pemak] County Sherriff's office as a first. We also have fielded our firs MILO response system to Rockland County EMS. MILO Response is a judgment training system for emergency medical personal and was selected as a "hot" product from the editors of EMS magazine.

In summary, our second quarter and first half, we are very pleased obviously with the results of our performance. Our business is clearly strong, stable and increasingly profitable. 2014 is set to become a record year for Arotech in terms of both revenue and profitability and I look forward to further updating you on our progress in the next coming quarters.

And with that I will turn it over to Tom Paup, our CFO, for a review of the financials and a discussion of our cash position. Tom?

Tom Paup

Thanks, Bob. Revenues for the second quarter reached $27.8 million compared to $22.4 million for the corresponding period in 2013, an increase of 24%. Gross profit for the second quarter was $10 million or 35.8% of revenues, compared to $6.3 million or 28.2% of revenues for the corresponding period in 2013, an 7.6 percentage-point increase in the gross margin between the two periods.

Adjusted EBITDA for the quarter was $4 million compared to $2.5 million for the corresponding period of 2013, an increase of 59.1%. As mentioned previously, we believe that adjusted EBITDA enhances the overall understanding of our current financial performance, a computation of the adjusted EBITDA is explained in our 8-11-2014 press release.

The company reported an operating income for the second quarter of $2.3 million compared to $1.6 million for the corresponding period in 2013. Operating expenses for the quarter grew to $7.6 million versus $4.7 million in the corresponding period last year. A large portion of this increase is due to the consolidation of the operations of UEC which was acquired at the beginning of the second quarter as well as an increase in R&D investment related to the development of the iron flow technology.

The company's net income for the second quarter for 2014 was $1.8 million or $0.09 per diluted share, compared to $1.5 million or $0.09 per diluted share for the corresponding period in 2013. Revenues for the first six months of 2014 reached $50.2 million, compared to $44.4 million for the corresponding period in 2013, an increase of 13%. Gross profit for the first six months of 2014 was $17.3 million or 34.5% of revenues, compared to $11.6 million or 26.1% of revenues the corresponding period in 2013. This is an 8.4 percentage point increase in gross margin.

Adjusted EBITDA for the first six months of 2014 was $6.3 million compared to $4 million for the corresponding period of June 13, an increase of 57.5%. The company reported operating income for the first six months of 2014 of $3.6 million compared to $2.4 million for last year. Operating expenses in the quarter grew to $13.7 million versus $9.2 million in the corresponding period in 2013, again a large portion was due to the consolidation of the UEC into our operation.

The net income for the first six months of 2014 was $2.8 million or $0.14 per diluted share compared to $2 million or $0.12 per diluted share for the corresponding period in 2013. Our backlog of orders was $74.1 million as of June 30, 2014, compared to $58 million as of December 31, 2013. The breakdown of our current backlog is $52.4 million for Simulation and $21.7 million for Battery and Power Systems which includes the UEC acquisition.

As of June 30, the company had $972,000 in cash, $249,000 in restricted collateral deposits as you compare to the end of the year 2013 when the company had $5.8 million in cash and $498,000 in restricted collateral deposits. The company ended the second quarter with $5.1 million in short term bank debt under our credit facility and $23.8 million in long-term loans outstanding, which include $4.3 million in current and $19.5 million in long-term debt. This is compared to the end of the year at December 31 when we had no short-term bank debt under our credit facility and $1.9 million in long-term loans outstanding, which included $995,000 in current debt and $1.8 million in long-term debt. The increase in bank loans obviously is due to our acquisition of UEC, the purchase of UEC.

The company had $7.6 million in available unused bank lines of credit with our main bank as of June 30, 2014, under our $15 million credit facility under our FAAC subsidiary, which is secured by the company's assets and the assets of other subsidiaries and guaranteed by Arotech. The company had trade receivables of $12.9 million as of June 30, 2014 compared to $12.4 million as of the end of the year December 31. We had a current ratio, current assets divided by current liabilities, of 1.7 compared to the end of the year when our current ratio 2.1. It should be noted as a subsequent event in July 2014, the company sold 3,289,000 shares of our common stock raising a gross amount of $11.5 million.

Back to you Bob.

Robert Ehrlich

Thank you, Tom. I think we are ready to field the questions.

Question-and-Answer Session

Operator

(Operator Instructions) First question is from Michael Crawford of B. Riley. Please go ahead.

Michael Crawford - B. Riley

Bob, I understand that you still can warrant upgrading your current outlook despite having generated $6.3 million of EBITDA for the first half. Can you remind us what the upper bound of your EBITDA [mains] (ph) was and what your current outlook is?

Robert Ehrlich

It was 8.3. We are obviously very optimistic we will blow through that. We don’t want to yet project the top number, what it could be. We are obviously very excited about the way the margins are coming in and the prospects of the third quarter. But we would like to wait to get a little more data and we will report at our next reporting. We will then probably look at revising the guidance because the things are turning out much better than we had originally anticipated. But, again, it's take time to absorb UEC and to look at the overall business.

Michael Crawford - B. Riley

So that’s -- good to hear that UEC is coming in better than anticipated on the margin side. You did say the margins were up on battery overall. Did you give the segment margins?

Robert Ehrlich

I will have to turn it over to Tom. I think we did give the segment margins for the batteries, but Tom may have that.

Thomas Paup

Well, we will report it tomorrow in our segment information or when the file the Q in the next couple of days relative to battery versus simulation. And the overall for the quarter is about 37% and if you want to break that down, battery at 31% and simulation at 43%.

Michael Crawford - B. Riley

31% and 43%. Thank you. You know in the future if you could also publish a preliminary balance sheet or other financial information that would be very helpful even though the Q isn't out yet. On SWIPES 2D, you said is on track, is that on track to be a final product or on track to be (indiscernible)?

Robert Ehrlich

It is the final product. We are now anticipating the first orders from the U.S. military that we hope to be able to deliver in the fourth quarter.

Michael Crawford - B. Riley

Okay. And what about on the IDF for SWIPES type product?

Robert Ehrlich

They have enthusiastically endorsed the product but the supplier of the future solider has held it up for some other things that they are trying to incorporate. So our system will be part of the future solider, the orders won't come until the (indiscernible) signs off on some of the things that they have ask the army to reconsider. But we are aloft for that business it's just a matter of, does it come sooner or gets delayed. Again. You know we keep telling you, Mike, the nature of the business is that things get pushed a little bit not out of our control but the idea of SWIPES, the new SWIPES, and they are ready to go with it.

Michael Crawford - B. Riley

Thank you. On the training side, it the past you have expressed confidence that that business will continue to grow and you did receive this very nice follow on order in extension on virtual clearance suites. And so I think there is some other large opportunities, whether it's in wheeled vehicles or other that you are chasing. Can you just comment on the status of the pipeline there?

Robert Ehrlich

I don’t have the numbers in front of me exactly but I know the pipeline is the biggest we have ever had. In terms of weighted opportunities, are in the neighborhood of over $200 million.

Thomas Paup

Just to be clear, those are not orders. Those are the opportunities that we have.

Robert Ehrlich

Right.

Thomas Paup

That we have put a probability on.

Michael Crawford - B. Riley

Right. Okay. Thank you. And then just regarding the backlog, thank you for giving the breakout between training and battery. I guess on the overall revenue side, can you just go into the dynamics a little bit of why revenues were up $6 million quarter-on-quarter while UEC is expected to be kind of a $30 million to $40 million in revenue business.

Robert Ehrlich

The UEC is doing better than we had forecast. We were obviously, since we very new to it, we wanted to be very conservative. They have done an outstanding job both in revenue and EBITDA and the simulation as you know, because we had anticipated VCTS for the second quarter and didn’t get it until the end of the quarter. That accounts for the shift between revenues -- batteries being somewhat better than expected and simulation being slightly less than we had expected but nevertheless margins being out of sight.

Operator

(Operator Instructions) 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) 782-4291. In Israel, please call (03) 925-5921. Internationally, please call 972 (3) 925-5921. 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 Ehrlich

Yes. I think we once again have demonstrated an outstanding quarter. We anticipate have an outstanding year once again. We do keep trying to note to investors that the quarters can be somewhat lumpy as things move from one quarter to the other. But if you look at us year-on-year, we will be much better than last year and fully anticipate exceeding the EBITDA forecast. By how much, we will be prepared to talk about in our next call. So we are quite optimistic. We are pleased with the results and pleased with the direction the business is going. And I thank the shareholders for their continuous support.

Operator

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

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