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Arotech Corporation (NASDAQ:ARTX)

Q2 2008 Earnings Call Transcript

August 13, 2008 9:00 am ET

Executives

Victor Allgeier – IR, TTC Group

Robert Ehrlich – Chairman, President and CEO

Tom Paup – VP, Finance and CFO

Analysts

Arthur Winston – Pilot Advisors

Bernie Kalish [ph] – JM Investments [ph]

Operator

Good day, everyone, and welcome to the Arotech second quarter earnings conference call. As a reminder, today's conference is being recorded. At this time, I’d like to turn the call over to Victor Allgeier for opening remarks and introductions. Please go ahead, sir.

Victor Allgeier

Thank you and good morning everyone. My name is Vic Allgeier of the TTC Group, Arotech’s Investor Relations firm. Yesterday Arotech released its fiscal 2008 second quarter and six-month results. By now you should have received a copy of the press release. If you have not received the release, please call our office at 646-290-6400. The release is also available on Arotech's website at www.arotech.com.

Representing the company today are Robert S. Ehrlich, Chairman and Chief Executive Officer, and Tom Paup, Vice President, Finance and Chief Financial Officer. Bob and Tom will deliver prepared remarks first and then we will be opening the call up to your questions.

I would like to remind you that in order to help you understand the company and its results, management may make some forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 during the course of his call. Forward-looking statements that can be identified by words such as expect, predict, anticipate, and others reflect management's current knowledge, assumptions, judgment, and expectation regarding future performance or events.

Although management believes that the expectations reflected in such statements are reasonable, readers are cautioned not to place undue reliance on these forward-looking statements as they are subject to various risks and uncertainties that may cause actual results to vary materially. These risks and uncertainties are detailed in Arotech's filings with the Securities and Exchange Commission. Arotech assumes no obligation to update the information in this call. Reference to Arotech's website does not constitute incorporation of any of the information thereon into this conference call.

I’d now like to turn the call over to Arotech's Chairman and CEO, Mr. Robert Ehrlich. Bob?

Robert Ehrlich

Thank you, Vic. Good morning, everybody. I’d like to begin by saying that overall while we were disappointed with our second quarter results, we are not at all discouraged, where as you see the first half, we are still ahead of last year and it was the best first half we’ve ever had. We mentioned on previous calls and in our earnings release yesterday that the second half of 2008 continues to look quite positive based on our backlog and the fact that many of the major issues we experienced in the first half have been cleared up. We still look forward to full year 2008 revenue exceeding those of 2007. Although we like most other companies are facing a number of economic challenges, we are nevertheless able to achieve revenues of $12.6 million for the quarter, almost at the same level of last year’s $13 million.

Our Simulation Division continued to perform extremely well with revenues increasing nearly 40% in the quarter to more than $7.2 million. As a result, we were able to achieve both operational and net profitability in that division. We believe that the Simulation Division will continue to perform well throughout the second half and into 2009. As a positive note, Senator Carl Levin, the Chairman of the Senate Armed Services Committee, visited our Simulation Division yesterday and was very supportive of our activities on behalf of the US military.

Among our other divisions, Armor was the hardest hit with the resumption of our David shipments only beginning near the end of June. As we’ve discussed earlier, most of the first half was played by raw materials promise from certain of our armor suppliers, which have now been corrected. We are now getting steady shipment of materials in our producing cars. As of July, the production of the David, our principal vehicle, has returned to the planned output level per month that we had anticipated for 2008 and will continue throughout the balance of 2008. While we make no forecast, we have reason to be optimistic about obtaining additional orders for the David for 2009.

The Batter Division while it has the largest backlog ever experienced a significant decline due to certain material delays from suppliers and a significant currency adjustment. Most of our battery orders are paid in dollars while the majority of our expenses are paid in Israeli shekels. The steep dollar devaluation versus the shekel had a major impact on margins for the division. There was also a delay of several months in receiving US government R&D funding resulting in expenses being incurred by the division, which would have normally been covered by these R&D funds have they materialized in the normal time frame.

The US government R&D program of $2 million will start to be received in the third quarter, improving the Battery company’s results. The first half of 2008 results are having disproportionate operating expenses in the raw material delays, which resulted in our gross margins falling to 21% from 31% the prior year. As a result, our net loss increased approximately by $500,000 for the second quarter versus last year.

Given the unexpected challenge we face, we are satisfied that we performed our best efforts in limiting the losses for this amount. For the six-month period, however, revenues increased nearly 6% to a record $25.9 million, while our net loss was reduced to $2.9 million or $0.23 a share.

Backlog remained steady at approximately $52 million, giving us the reason to be optimistic about a strong second half. While the world economy continues to face significant challenges, which affect all businesses, we see a favorable second half of 2008 based on our backlog and a number of opportunities we are working on, which have not yet been fully documented. As I mentioned, for the full year we still anticipate a revenue increase over 2007.

I would also like to comment on a few pending issues and some business prospects before turning the call over to Tom to give a financial breakdown and then go to Q&A. As we mentioned recently, the relief in the relief [ph] oral arguments on our motion to dismiss the class action lawsuit against us were heard in July. The judge in the case has now taken our motion under advisement and we are waiting to hear his decision. We can’t offer any predictions on what his decision will be or when it will be rendered, but as we discussed earlier, we have taken a write-down of our deductible already and have D&O insurance that we believe to be adequate to cover any contingencies.

Our Indian joint venture prototype vehicle was demonstrated a major trade show in India. And we are now among a select group of bidders in a bid to the Indian Ministry of Defense for 830 armored jeeps. We also have some other projects in India directly with OEMs that we hope will mature in 2009.

In summary, I’d like to reiterate that overall opportunity in front of us continues to be very substantial, particularly in Simulation and Battery. We believe we have leading edge technology and experienced management teams capable of capturing larger opportunities. Our market opportunity remains significant and we continue to grow as we identify new applications and new ways to utilize our technologies.

One final note, I would like to point out that based on the first half results and the low price of our stock, I plan following this call to go out and purchase shares because I believe they are extremely undervalued. I’d like to call on Tom Paup to go through a financial review of the second quarter and the first half.

Tom Paup

Thanks, Bob. Revenue for the second quarter reached $12.6 million compared to $13 million for the corresponding period in 2007, a decrease of 3.2% over the same period last year. Gross profit for the quarter was $2.8 million or 22.5% of revenues compared to $3.7 million or 28.8% of revenues for the corresponding period in 2007. The net loss for the second quarter was $1.9 million or $0.15 per share versus $1.5 million or $0.13 per share for the corresponding period last year.

For the first six months, revenues reached $25.9 million compared to $24.6 million for the same period in 2007, an increase of 5.3% over the same period last year. Gross profit for the six months was $6.1 million or 23.5% of revenues compared to $7.9 million or 32.1% of revenues for the corresponding period in 2007. The net loss for the first six months was $2.9 million or $0.23 per share versus $3.2 million or $0.28 per share for the corresponding period last year.

Our backlog, as Bob mentioned, totaled approximately $51.6 million as of June 30 this year compared to $54.2 million for the same period last year. As of June 30, 2008, the company had $1.7 million in cash, $179,000 in restricted collateral securities and restricted held-to-maturity securities due within one year, and $55,000 in available-for-sale marketable securities, as compared to December 31, 2007 when the company had $3.4 million in cash, $320,000 in restricted collateral deposits, $1.5 million in an escrow receivable, and $47,000 in available-for-sale marketable securities. Cash during the first half was invested in our Armor Division and a paydown of our working capital bank line of credit.

Short term bank borrowings were $2.3 million at the end of the second quarter compared to $4.6 million at the end of the year 2007. The company had trade receivables of $7.9 million as of the end of the quarter ending June 30 2008, compared to $14.6 million as of December 31, 2007. The company had a current ratio, which is defined as current assets divided by current liabilities, which runs to 2.0 at the end of June 30, 2008, up from December 31, 2007 when we had a current ratio of 1.9. Bob?

Robert Ehrlich

Thank you, Tom. Again I’d like to thank our shareholders for their continuing support in these difficult markets. As I said, we are quite optimistic about the outlook for the second half and of ’09, and we hope that we can eventually get the stock to recognize some of the future benefits of the company.

We’d now be willing to open the floor up for any questions.

Question-and-Answer Session

Operator

Thank you, Mr. Ehrlich. (Operator instructions) We’ll take our first question from Arthur Winston with Pilot Advisors.

Arthur Winston – Pilot Advisors

Yes, good morning.

Robert Ehrlich

Hi, Art.

Arthur Winston – Pilot Advisors

Hi, Bob. We’ve been hearing about different stories on what’s going on with this Armor Division. First it was you couldn’t get the cars, then it was a change in the type of car, and now it’s absence of raw materials. I wonder if you could just explain straight as an arrow in English what happened here, what’s happening and what may happen? I’m just curious how much we’ve lost so far in this division this year and what the sales were?

Robert Ehrlich

The sales have dropped substantially. We had anticipated selling eight cars a month for the first six months. We sold far fewer than that. We only shipped I think six in June. Altogether we shipped less than ten. We suffered very much from the things that you talk about. First of all, the absence – the lateness of the car arriving, then the car design being changed by the army, and most importantly then the materials from our supplier failed the tests. That wasn’t our problem. We order the materials well in advance. The army tested them and they failed, and they gave them back and said they had to remake them. And that obviously did not allow us for armor cars because we don’t have the armor material and we can’t function. All of those problems have been corrected. As I said, we shipped nine cars in July. We should be able to ship a steady eight cars a month for the balance of the year. We are working on a significant follow-on order. The army is happy with the cars. The chief staff of the IDF was at a meeting. Recently they gave us an award because of one of our cars stopped the Paris attach in Gaza and he was particularly impressed with the performance of the car. I think that we see opportunities in India, particularly we are now – we delivered a model to a show in India that was very well received and we are now bidding for a number of projects, none of which will materialize in ’08, but should begin to materialize in ’09 and 2010. It’s a tough business though. There is no question that we are looking to find ways to enter other markets with our armor materials and our armor cars to expand their opportunities to not have these – not to be subject to these kinds of problems in a limited fashion.

Arthur Winston – Pilot Advisors

If we shipped eight cars in July, like you said, could you give me some idea what the profit was in July or profit – I assume it’s profitable.

Robert Ehrlich

Right, that’s – we make about 10% net. The cars – I don’t think we report the number, but it’s – for nine cars, it’s over $1 million of shipment. We make a profit on it and we anticipate that that will catch up. We will have a strong second half in Armor. I don’t know if it will make up for all the losses in the first half, but we hope it will –

Arthur Winston – Pilot Advisors

I mean, basically it’s possible to make $100,000 operating profit per month?

Robert Ehrlich

Correct.

Arthur Winston – Pilot Advisors

Or a $1.2 million for a year?

Robert Ehrlich

When you are getting the materials properly and the cars aren’t being constantly redesigned, yes. When things are working right, it’s a business that makes 9%, 10%.

Arthur Winston – Pilot Advisors

Okay.

Robert Ehrlich

Okay?

Arthur Winston – Pilot Advisors

Yes. I’ll let someone ask – I’ll go back -- later for another question and let someone ask.

Operator

(Operator instructions) At this time, we’ll go back to Arthur Winston with Pilot Advisors.

Arthur Winston – Pilot Advisors

I guess there is nobody else asking questions. Should I ask all my questions at once, Bob, or--?

Robert Ehrlich

Go ahead, go ahead.

Arthur Winston – Pilot Advisors

Okay. In terms of – the fastest growing – you gave us your income statement, but not your balance sheet. And the fastest growing item on the income statement unfortunately for the shareholders is the growth of SG&A. And I’m wondering with the losses the company is undertaking, if you and the Board would be willing to cut back on the SG&A?

Robert Ehrlich

The fact is we are very much – the SG&A is not at all out of line with we forecasted.

Arthur Winston – Pilot Advisors

To get what you forecasted, it’s too high in relation to the size of the company.

Robert Ehrlich

Right. So we’ve got a bulk of the company if we can, but –

Arthur Winston – Pilot Advisors

How about cutting the SG&A before you broke up the company? It’s not crazy.

Robert Ehrlich

No, Art, but the problem is as a Sarbanes-Oxley company, there are certain costs. We have director fees, we have tremendous –

Arthur Winston – Pilot Advisors

Maybe we have too many directors.

Robert Ehrlich

Pardon me?

Arthur Winston – Pilot Advisors

Maybe we have too many directors.

Robert Ehrlich

We are shrinking the Board at this annual meeting this year because we find the cost of each directors, a number that we can reduce. We are looking always at areas where we can cut costs, but for a company doing $60 some odd million in revenue, you have to have a certain corporate infrastructure. If we –

Arthur Winston – Pilot Advisors

But, Bob, I think at some point instead of every quarter saying we think, we think, the shareholders with their [ph] patience, actions speak rather than words. So let’s leave it at that.

Robert Ehrlich

Okay.

Arthur Winston – Pilot Advisors

I’m going to ask you another question unless anybody else has a question because I don’t want to use up the conference call.

Robert Ehrlich

Go ahead.

Arthur Winston – Pilot Advisors

Okay. Could you just speak to the two areas of the Battery business and how they are doing ex the – in terms of the demand, the price issue, except that the bids out, and what to look for going forward in each area of the Battery Division?

Robert Ehrlich

Yes. The Battery business, their backlog has grown from $6 million to $13 million. They are generating tremendous amount of business. As you and I have talked, Art, the one area that we continue to suffer in is the zinc-air. We don’t get enough orders from the US army to justify continuing that business. We look at it always, but we haven’t yet gotten enough activity in our Alabama plant in lithium that would allow us to drop that program. We look at it continuously and we are getting very close to a decision that if the army won’t increase the orders for the zinc-air batteries, we will have enough lithium business to be able to do away with that, to tell the army we will no longer support them with zinc-air. We are not quite there. We hope by year-end to be able to make that decision.

Arthur Winston – Pilot Advisors

And the lithium batteries are growing, but the problem is just a price (inaudible) because of raw materials and then currency.

Robert Ehrlich

(inaudible) they factor their – they did all of their planning on a shekel at 4.20 and it got down to 3.2. But they pay their salaries and everything in shekels, but they get paid in dollars. So they took a huge beating on the currency change, but they are now – it’s gone up some, it’s now 3.6 and they are writing their new contracts, a lot of them in shekels.

Arthur Winston – Pilot Advisors

And the physical shipments are up?

Robert Ehrlich

Shipments are up and second half will be very strong.

Arthur Winston – Pilot Advisors

And we don’t know if it would be profitable or not because of the--?

Robert Ehrlich

It will be very profitable in the second half. The lithium part of the business and the rest of the battery business, ex zinc-air, will be very profitable in the second half.

Arthur Winston – Pilot Advisors

Okay, good. The cash rain in the first half, now you think it was a balance sheet, but the CFO read the balance sheet I think.

Robert Ehrlich

Right.

Arthur Winston – Pilot Advisors

It was pretty large, can we stem the tide at some point?

Robert Ehrlich

Yes, two things happened. One, we bought out the minority interest in the Armor business. We also invested money to keep them going because they were not making enough money to carry themselves on a cash flow basis. And we have these currency losses. So the combination of that’s now improved in July already, it’s improved and we anticipate that not being a kind of a problem going forward. We should see cash. I mean, we expect a substantial amount of cash by the end of this month, but we will be back in a much stronger cash position as of the end of the month.

Arthur Winston – Pilot Advisors

Arotech has very little debt.

Robert Ehrlich

Yes, virtually very little.

Arthur Winston – Pilot Advisors

Yes. And has got a little bit of cash. And the Simulation business is worth multiples of the share price.

Robert Ehrlich

Yes, correct.

Arthur Winston – Pilot Advisors

And this probably depend –

Robert Ehrlich

The Simulation business is probably worth twice the current stock price.

Arthur Winston – Pilot Advisors

Yes, at least. And there has to be more than one buyer interested. Is there any way we can do something to the shareholders to realize some value someway somehow, given that situation?

Robert Ehrlich

We view that as our crown jewel. We’d rather look at doing something with Armor if it’s possible to get – realize some significant value for that and invest those proceeds into further simulation business because eventually the market will appreciate that our Simulation business is really a solid business. It’s worth at least twice what our current trading value is.

Arthur Winston – Pilot Advisors

If the Simulation business is worth as much as you and I think, and we can always (inaudible). What about the possibility of borrowing, I don’t know, $4 million or $5 million if you could find a lender and buying back stock? Stock will be down again today. It’s not a – it’s skill [ph] of book value. Is it crazy to do that?

Robert Ehrlich

We have talked to some lenders there. They are tremendously skittish. We’ve asked some help from KeyBanc. We have a credit line with them, we asked them to expand it. They were very reluctant. Then we find that all the credit lenders right now are sort of semi-paralyzed.

Arthur Winston – Pilot Advisors

Okay, it’s fair. Okay. I just hope you can do better, Bob, it’s a bad time.

Robert Ehrlich

Okay, I agree with you. We hope that we can demonstrate that in the second half, Art.

Arthur Winston – Pilot Advisors

Okay, thank you very much.

Robert Ehrlich

Okay.

Operator

(Operator instructions) We’ll go next to Bernie Kalish [ph] with JM Investments [ph].

Bernie Kalish – JM Investments

Hi, good morning, gentlemen.

Robert Ehrlich

Good morning, Bernie.

Bernie Kalish – JM Investments

Some of these wins we’ve had with the simulators, any follow-up like from the MTA wins and the LA wins, are there any follow-up from other municipalities?

Robert Ehrlich

Yes, we have some bids out for subway simulators. We have not won them yet, but we have some serious bids out. We also have a number of bids out for other military simulation that we hope to hear from in the next several weeks, but again – we don’t make any announcements or predictions until we have signed contracts with whoever the customer is. But we do –

Bernie Kalish – JM Investments

Again, I noticed this battery, the bus battery has been put to sleep for a long time, but being where the gas prices are, is there any interest of somebody maybe buying the whole kit and caboodle?

Robert Ehrlich

If someone would call me, I would sell it to them. We have not gotten interest in it. We have some interest in other variations of electric vehicle batteries and we were talking to some people about doing some things there, but nothing that we can really talk about at this stage.

Bernie Kalish – JM Investments

All right. Hopefully the second half will be as strong as you think and you will be able to satisfy Art and all the other shareholders.

Robert Ehrlich

We are trying.

Bernie Kalish – JM Investments

Thank you.

Operator

We have no further questions at this time. Mr. Ehrlich, I’d like to turn the conference back over for any additional or closing remarks.

Robert Ehrlich

Okay. Again I thank the shareholders for their patience and hope that we can demonstrate the second half, justify their confidence in continuing with us, and hopefully get some movement upward than the stock price. Thank you all.

Operator

That does conclude today’s presentation. Thank you for joining us and have a great day.

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Source: Arotech Corporation Q2 2008 Earnings Call Transcript

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