Arotech Management Discusses Q1 2013 Results - Earnings Call Transcript

| About: Arotech Corporation (ARTX)
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Arotech (NASDAQ:ARTX) Q1 2013 Earnings Call May 13, 2013 5:00 PM ET


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 Vice President of Finance


Ladies and gentlemen, thank you for standing by. Welcome to the Arotech Corporation First Quarter 2013 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded May 13, 2013. I would now like to hand over the call to Mr. Kenny Green of CCG Investor Relations. Mr. Green, would you like to begin?

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. Earlier today, Arotech released first quarter 2013 results. By now, you should have all received a copy of the press release, which is available on Arotech's website at

With us on the call today are Mr. Robert S. Ehrlich, Chairman and CEO; Mr. Tom Paup, Vice President of Finance and Chief Financial Officer; and Mr. Norm Johnson, Controller. Bob will summarize the key highlights of the quarter followed by Tom who will review the company's financial performance. We'll 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 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 a useful to 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 is included in today's earnings release.

And with that, I'd like to hand the call over to Arotech's Chairman and CEO, Mr. Robert Ehrlich. Bob, go ahead, please.

Robert S. Ehrlich

Thank you, Kenny. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report strong results for the first quarter of 2013, continuing on from the solid performance of the second half of 2012. 2013 has started off well and our scope of business is significantly larger than it was a year ago.

To point out a few highlights, revenues were at $22.1 million, a year-over-year growth of 37%. We reported a net income of $404,000, given us trailing 9 months profit of $1.2 million. Compared with the second half of last year, our gross and operating margins have been improving, reaching the 25% range. In addition, we have increased our focus on keeping tight control over operating expenses, and this effort is allowing us to increase our operating profitability.

Most important is our future potential is becoming ever clear. As you can see from our press releases to date, we are seeing a continual stream of new contracts from our simulation products as well as important orders for our battery systems. Our backlog has, therefore, remained strong, standing at $76 million at the end of March at a similar level to that of March last year. This, combined with our solid performance in the first quarter, gives me increased confidence that Arotech is on the right track, and I believe that we will comfortably meet our targets for the year.

Just to remind you, at the beginning of the year, our expectations for 2013 were revenues between $85 million and $87 million and EBITDA of between $2.9 million and $3.4 million. While we are more than on track to achieve those goals, I would like to point out that we are being somewhat cautious. With regards to the U.S. budget sequester, there has been very little negative effects on us to date, and we do not know what, if any, longer-terms effects will be, so we're continuing somewhat cautiously as we go forward.

We continue -- we could potentially see some impact on the funding of some of the programs we are targeting later this year, but right now, we just don't know and don't see any problem. I should note that while most people would view the U.S. budget sequester as a negative, for business in the defense space, we believe it will ultimately put more of an emphasis on simulation-based training solutions as a way to maintain troop readiness. Thus, sequester could end up being a positive for the company, similar to companies similar to us in the high-tech solutions that provide clear and quick return on investment and savings.

Again, while it is too early to pinpoint what will happen, we are being cautious and, so therefore, there be any further developments, positive or negative, we will be open and transparent, and we'll share this to you.

I'd like to talk a bit more about the future and about our investments in R&D. Last quarter, both myself and Steven Esses, our President, met with a number of institutional investors on the road in New York and in the Midwest. We believe the reception was positive and we intend to continue with these efforts in the coming quarters. One of questions we were constantly asked was why our R&D spending was relatively low compared to other high-tech defense companies. Our income statement R&D hovers around the 3% level of revenue.

Part of the reason our R&D appears so low is that because some of our developments, especially in the battery area, in many cases, are jointly funded with the customer. When adding back the R&D that is being customer-funded, our total R&D expenditure averages about 6.5% of revenues, which is consistent with peer companies. We are well-known leaders in the battery field and many customers and potential customers come to us with portable power need. If we do not have the products to fulfill these demands, quite often, they will offer to fund part of the development. In return, we will develop our product and sell it to them at a somewhat discounted price to recover their NRE.

I hope this will maintain -- I hope we will still maintain -- I know that we still maintain full ownership of intellectual property rights that we developed through this R&D, and as these new products are developed, we are able to sell them into other markets.

We do have a number of very exciting opportunities, particularly in the batteries area, that we are exploring and developing, which we believe can significantly grow our long-term revenue and profitability.

In addition to our ongoing development of our trademark SWIPES product line, we are continuing to develop applications such as large-format batteries for submersibles and high-powered lithium batteries for rockets, satellites, UAVs and tank starters.

We were also continuing development on a prototype of a new large-format lithium battery and battery management system to power hybrid electric vehicles. We anticipate that all these development projects, as well as other ongoing programs, will start benefiting us later this year and into next year and the years beyond.

As you can see, we are placing significant focus on our R&D efforts, and we believe that over the coming 2 years, we will begin to reap substantial fruits of these investments. We believe that there are significant opportunities for large-format lithium ion batteries at better margins. We believe we can leverage our extensive know-how in the electronics management of lithium batteries, bringing significant value and generating strong returns in the coming years. We see this as an ideal time to enter these emerging markets.

As you can see, in batteries, we have a lot of -- a lot to look forward to. Even though battery revenues were $6.4 million or only around 29% of our overall revenues in the quarter, I am more excited at this time than I have been with regard to our future potential in the battery area than ever before.

The simulation part of our business continues to perform very strongly. The second half of 2012 was extremely strong and 2013 has started off just as well, and we continue to see a high-level of revenue and strong cash generation to support our investments in R&D and the new future growth opportunities.

We generated $15.7 million in revenue from our training and simulation activities around 69% of our overall revenue. In addition, we are seeing improvements in the margins within simulation. As I explained in the last quarter, we do not expect our gross margins -- we do expect our gross margins to gradually increase as we maintain our ongoing focus on cost control and increasing efficiencies.

In terms of our major programs, our strategic win of the Virtual Clearance Training Suite, or VCTS program in 2011, continues on track in the production phase. Just to remind you, this is a $78 million program for 28 suites, each with 16 simulation devices and 4 trailers.

As of the end of the first quarter, we delivered 14 VCTS suites and are on schedule for the balance of that contract. It is important to note that there is further potential upside for this project beyond the original win and recent modifications. There is potential for additional suites and also the customer has over 25 million in options that could be added. We also have other ongoing projects in which we are executing.

Last year, we received an initial contract and a follow-on option from the Air National Guard for a Boom Operator Simulator Systems, or BOSS, as it's called. The BOSS is intended for squadron-level training for in-air refueling. This is a critical Air Force task requiring a very significant level of expertise and training. The BOSS is a classic example of a military training program where a simulator's ROI and savings are huge. Live in-flight training is not only exceptionally expensive, mid-air high-speed refueling mistakes or collisions are absolutely disastrous.

The total contract was an excess of $25 million over 5 years, of which $23 million is currently funded. We have completed the initial design and are executing the first unit production phase with full production of the 17 units ordered scheduled to commence in this quarter.

With regard to our other developments, earlier this year, we submitted our bid for the common driver training program, CDT, and are now awaiting to hear news regarding the selection, which is expected to be awarded later this year.

All in all, our simulation unit is a strong, stable profitable and cash generating business that benefits Arotech as a whole. Simultaneously, our battery activities are also performing well and have the potential to join simulation as a future engine of growth.

In the past few months, we have increased our focus on expense reduction. In this regard, we had, among other cost savings, reduced CEO compensation, both salary and benefits. We see this as a strong demonstration by management on the importance of keeping costs under tight control.

We will continue to focus on keeping expenses low to improve operating margins and profitability. And with that, I'd like to turn the call over to Tom for a review of our financials and the discussion of our cash position. Tom?

Thomas J. Paup

Thanks, Bob. Revenues, as you mentioned, for the first quarter of 2013 were $22.1 million compared to $16.1 million for the corresponding period in 2012, an increase of 37%. Gross profit for the first quarter of 2013 was $5.3 million or 24% of revenues compared to $4.3 million or 27% of revenues for the corresponding period in 2012.

Adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, for the quarter was $1.5 million compared to $481,000 for the corresponding period of 2012, an improvement of 314%. We believe that this information concerning adjusted EBITDA helps enhance the overall understanding of our performance.

The company reported an operating profit for the first quarter of 2013 of $841,000 compared to an operating loss of $889,000 for the corresponding period in 2012. The company's net income for the first quarter of 2013 was $404,000 or $0.03 per share compared to a net loss of $1.1 million or $0.08 per share for the corresponding period in 2012.

Our backlog of orders, approximately, was $76.3 million as of March 31, 2013, compared to a $77.3 million as of March 31, 2012. The breakdown is as follows: Simulation was $59.8 million of the backlog compared to $67.9 million as of the March in last year; Battery was $16.5 million as of the end of March compared to $9.4 million as of 3/31/2012.

On the balance sheet, as of March 31, 2013, the company had $378,000 in cash and $489,000 in restricted collateral deposits as compared to December 31, 2012, when the company had $1.6 million in cash and $186,000 in restricted collateral deposits. The company also has $1.1 million in available unused bank lines of credit with our main bank as of March 31, 2013, under a $15 million credit facility granted to our FAAC subsidiary, which is secured by the company's assets and the assets of the company's other subsidiaries and guaranteed by Arotech.

The company's cash and availability position improved in the 30 days following the end of the quarter. As of April 30, 2013, Arotech had, corporate-wide, approximately $875,000 in cash and $3.6 million in unused credit availability. This is a substantial improvement, as I suggested, from the end of March when our cash position was 378 and we had $1.1 million in availability.

The improvement was primarily due to the collection of $3.5 million in milestones immediately after the quarter closed. As we mentioned in the past, with our larger projects and the result of larger payment milestones, we have greater swings in cash and availability than we've had in the past. This is the primary driver why we increased our credit facility with our primary bank in 2013 to $15 million from $10 million in 2012.

The company had trade receivables of $14.3 million as of March 31 compared to $9.6 million as of December 31, 2012. We had a current ratio, which is current assets divided by current liabilities, of 1.36 as of March 31, 2013, compared to 1.37 as of the end of the year December 31, 2012.

Back to you, Bob.

Robert S. Ehrlich

Okay. We'd now like to open it up to questions, and we'll take them in the order that we -- that they've been filed.

Question-and-Answer Session


[Operator Instructions] It seems there are no questions at this time. Before I ask Mr. Ehrlich to go ahead with his closing statement, I would like to remind the participants that a replay of this call scheduled to begin 2 hours. In the U.S., please call 1 (888) 295-2634. In Israel, please call 03925-5921. Internationally, please call 972-3925-5921. A replay of this call will also be available in 3 hours on Arotech's website, Mr. Ehrlich, would you like to make your concluding statement?

Robert S. Ehrlich

Sure. First of all, I'd like to thank the shareholders for their continuing support. We're obviously delighted by the first quarter results and are looking forward to a strong second quarter. We're pleased with our business. We're being cautious only because, in light of the environment, one wants to be sure that the outlook continues to improve before we make any further adjustment. Nevertheless, we are very optimistic this has been a stronger quarter as we've had, and we believe that we will continue to perform well during the balance of the year. So we hope that the shareholders will appreciate the efforts we put into cost-cutting and revenue growth, and we'll hopefully see recognition in the stock price. Thank you all very much.


Thank you. This concludes the Arotech Corporation First Quarter 2013 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.

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