Ultralife Corp (ULBI) 2005 Q3 法說會逐字稿

Good day and welcome to this Ultralife Batteries' third quarter earnings release conference call. Today's call is being recorded. At this time for opening remarks and introductions I'd like to turn the call over to Ms. Jody Burfening. Please go ahead.

Thank you, Operator. And good morning, everybody. This is Jody Burfening of Lippert/Heilshorn & Associates. Thank you for joining us this morning for the Ultralife Batteries' earnings conference call for the third quarter of fiscal 2005. The earnings press release was issued earlier this morning and if anyone has not yet received a copy I invite you to visit Ultralife's website at www.ultralifebatteries.com. You can find the release under the Investor News, in the Investor Relations section. In a minute I'll turn the call over to John Kavazanjian, Ultralife's President and Chief Executive Officer who along with Bob Fishback, Ultralife's Chief Financial Officer will provide their formal remarks. Management will then take questions until 11 o'clock ET.

Before turning the call over to John I would like to remind everyone that some statements made during this conference call contain forward-looking statements including references to Ultralife Batteries' future plans and objectives. These statements represent the current views of management with respect to future events and are subject to certain risks and uncertainties which could cause the actual results to differ materially from those contemplated in the forward-looking statements. A more detailed description of these risks is contained in the Company's filings with the Securities and Exchange Commission. With that I would now like to turn the call over to John. Good morning, John.

Good morning, Jody. Thank you. And welcome everybody to the Ultralife Batteries' conference call for the third quarter of 2005. I have joining me today Bob Fishback, our Chief Financial Officer; Bill Schmitz, our Chief Operating Officer; and Julius Cirin, our Vice President of Corporate Marketing. Today we reported revenues of $15.7 million for the third quarter of 2005 and we showed an operating loss of $1.5 million, these results were in-line with our latest guidance. Revenue was driven by continued strong growth in our commercial business and contained only a minimal number of shipments for the BA-5390. Our commercial business showed strength across-the-board. Our military business, aside from the BA-5390 volume, continues to also expand. In September, we completed all of our testing and we're now in the final approval stage of the state-of-charge indicator version of the 5390. CECOM has an appropriate amount of time in which to review our data and issue a qualification. And we know of nothing at this time that would prevent that from happening this quarter. We'll announce the availability of that product as soon as we have First Article Test formal approval.

We have also been regularly engaged with the Department of Defense agencies, in reviews, in task forces, and planned meetings as they work on their battery, technology and supply plans. The value of MnO2 is starting to gain wide acceptance as the advantages are being experienced in the field. The transition strategy from sulfur dioxide to our manganese dioxide, and the introduction of the state-of-charge indicator or the SOCI version of this product are the major plan elements that still have to be decided. Field usage for the BA-5390 continues to be strong and growing. And we have been engaged in targeted activities aimed at increasing that market share. In addition, new guidelines have been issued by the Department of Defense Logistics that will require a state-of-charge indicator or SOCI in all new contracts for multi-cell batteries going forward. Our implementation is on the forefront of this effort and the technology that we have developed will be leveraged onto future projects.

The addition of this function also further increases the economic value of MnO2 or manganese dioxide. With the manganese dioxide products can be used to their full capacity without the danger of a catastrophic event. That full capacity is at least 50% more than the full capacity of SO2 or sulfur dioxide. And the amortization of the state-of-charge indicator over the longer life makes the economics of MnO2, manganese dioxide, even more compelling. We believe that the market share of the BA-5390 can only go up. Since MnO2 represents only 20% of overall usage even at peacetime levels, market share gains and the eventual full phase in of MnO2 represent an increasing volume opportunity. Our outlook remains unchanged while there may be a procurement that could lead to revenue in the fourth quarter, more predictable shipments under the next [MnO2] contract will start early next year.

In other parts of the military business, this quarter we'll start shipments for the first fielding of the Land Warrior program. Both batteries and charges are being produced for General Dynamics so that live field trials can be held early in the spring. A successful trial may result in a wider deployment of this technology later in the year. In international military markets we made first shipments of a thermal imager battery to two important new customers. Recently, we announced the award of a $3.1 million contract aimed at increasing our capability to respond to the U.S. Military, if there's a surge in demand. This will further increase our process capability both in the U.S. and in the U.K., and the disciplines that are put in place will help us across all of our product lines.

In the fourth quarter, we have also started production and will be shipping Telematics back-up batteries under our contract with General Motors. This program is progressing as expected and we continue to work with additional product platforms to bring the back-up battery to additional models as required. We also have activity on a new design for an unidentified customer with a very important Tier 1 Telematics supplier. We have seen increased interest in this marketplace, particularly, from European manufacturers as the E.U. considers legislation requiring crash notification on all vehicles before the end of this decade. This past quarter, we also started shipments to two new search and rescue customers. We continue to grow design and qualification activity in this important market.

Utility markets are representing areas of new opportunity as well. With an important design in the remote metering market and new developments in the pipeline inspection market. Manganese dioxide batteries have a very small market share in this application for pipeline inspection with lithium/thionyl chloride batteries dominating. New safety regulations will make it unlikely that thionyl chloride will now qualify for use and this presents the potential for some major market share gains. There's still strong activity in medical applications, this is both in wearable devices where our Thin Cell has great interest, and applications for transportable products for rechargeable batteries. The trend is toward devices that are more transportable and wearable, and we have seen many opportunities to replace heavier, bulkier, old technology batteries with lithium ion and lithium polymer rechargeable cells.

While our rechargeable business was down slightly in quarter-to-quarter revenue due to the ending of our digital camera battery supply agreement, the revenue exclusive of this contract grew 50% in going to $2.2 million. With this transition to higher end products our gross margin moved up to 20%. We continue to be very optimistic about the long-term outlook for growth of this business as we win new designs in new applications. Prospects for the market for larger batteries in rechargeable markets also continue to expand. The UBI-2590 is winning designs in military and commercial markets because of its performance and capacity, but also because of it's leadership implementation of the SMBus Smart Battery specification. This allows extensive communication between the battery and the charger or the battery and the device, and allows for optimum performance. In charging, it allows the maximum capacity to be achieved and the best cycle life performance over time. In operation, it allows the best usage of the battery. We have seen the use of this feature extensively by applications that require the construction of multiple battery systems. The balancing of the batteries in both charge and in discharge is enabled by utilizing this feature to monitor operation.

During the fourth quarter we plan to launch our new suite products based on our Land Warrior designs. This will add another range of options to our portfolio of large rechargeable batteries. Looking forward to the fourth quarter we expect revenue in the range of $19 million and a slight loss on an operating basis. We have recently taken steps to lower our revenue breakeven level so that the BA-5390 volume will not be the key factor in ensuring profitability. Our business model now features a lower level of overhead costs along with increased flexibility to meet demand. And it is designed to grow margins through the sale of more complex products and through operational efficiencies. Having made this adjustment, we can now better manage the business in the face of ongoing order flow uncertainty for the BA-5390. When orders and then shipments commence and we still do expect the 5390s will contribute to revenue growth, we can treat this as an opportunity to revise guidance upward.

For 2006, we're very optimistic. We will continue to grow in existing markets and penetrate new markets, and we believe that we'll start to get back on track with steady and more predictable shipments of the 5390. Based on ongoing discussions and task forces that we have been part of we have been lead to believe that the procurement strategy for the 5590/5390 family of products will come together in the next several months. We need to truly understand this in order to provide you with a reasonably accurate projection of next year's anticipated order flow. We will keep you informed and provide guidance for 2006 at the latest on the Q4 conference call. In the meantime, what we can say is that we're confident in our ability to deliver steady revenue growth from our Q4 run rate through 2006. Our commercial success assures us of that growth. The total amount of that growth will be dependent on our assumptions for the 5390 product. Now, I would like to turn it over to Bob Fishback, who will cover some of the financial highlights, after which we'll open it up for the Q&A. Bob?

Thank you, John. And good morning, everybody. This morning we released the results for our third fiscal quarter that ended on October 1, 2005. Consolidated revenues for the quarter amounted to $15.7 million. As expected, revenues were lower than last year due to a decline in shipments of BA-5390 batteries to the U.S. Military. Offsetting this decline in part were higher sales of smaller cylindrical battery products. Gross margin for the third quarter of '05 was $2.4 million or 15% of sales, this compares with last year's third quarter margin of $4.9 million or 20% of sales. Our non-rechargeable operations reported a 14% margin this quarter versus 22% last year as production volumes were reduced mainly in our large cylindrical product line. In our rechargeable operations margins were $500,000 or 20% compared to a breakeven margin last year due mainly to a more favorable product mix.

Operating expenses in the third quarter of '05 totaled $3.9 million, an increase of 500,000 over the same quarter last year. This increase resulted from higher product development and administrative costs. As a result, we reported an operating loss for the third quarter of '05 of $1.5 million, compared with an operating income last year of 1.5 million. Income taxes for the quarter amounted to a tax benefit of $400,000 related to the taxable loss from the Company's U.S. operation. However, due to our net operating loss carryforwards the cash impact of taxes is negligible. The net loss for the third quarter amounted to $1.3 million or $0.09 per common share, compared with net income of 1.4 million or $0.09 per diluted share a year ago. Average shares outstanding for the third quarter of '05 were 14.6 million shares, up 400,000 due to stock options that were exercised during the past year.

Turning to cash flows for the third quarter, EBITDA was a negative 750,000 including depreciation and amortization of 800,000. During the quarter, working capital changes resulted in a net decrease in cash of approximately $4 million mainly related to the temporary build up in large cylindrical inventory levels. Receivables also increased slightly due to the timing of shipments. We spent approximately $1.2 million in the third quarter for capital asset additions. Financing activities during the quarter included cash inflows of $1.2 million from the exercise of stock options and cash outflows of approximately 300,000 for debt principal payments. Overall, the cash flow activities resulted in a net usage of cash during the quarter of $5.2 million and we ended the quarter with total cash and investments of $3 million. Due to the recent financial performance our lending banks have amended our credit facility to incorporate adjustments to certain debt covenants as of the end of the third quarter. This amendment also provides us with additional borrowing capacity under our revolver of approximately $8 million. Throughout the past few months we have been working closely with the banks to make sure they fully understand our current financial situation and we are pleased by that support. Overall total outstanding bank debt at the end of the third quarter was $8.1 million related to the $10 million we borrowed under the five-year term loan in June of '04. Total debt as a percentage of total capitalization remains at only 12%.

As we look forward, we're projecting that revenues for the fourth quarter will be in the range of $19 million, in-line with our most recent guidance for the second half of the year of 35 million. At this time, we're taking a conservative stance by assuming that we will receive no orders for BA-5390s from the U.S. Military during the quarter. In our revised guidance announcement we mentioned that we were taking actions to reduce overhead costs by up to $1 million per quarter. These actions have included personnel reductions and tighter spending controls which will lower our go-forward breakeven operating income to a quarterly revenue level of approximately $18 million. This assumes a steady rate of production commensurate with this level of revenue. During the fourth quarter, however, we plan to reduce inventory levels by maintaining a temporarily lower production levels consistent with the third quarter run rates, which will result in under absorbed overhead costs. As such, we are projecting an operating loss in the range of $500,000 for the fourth quarter.

Based on our revenue outlook for the fourth quarter we expect to generate positive EBITDA. At this time we expect the changes in working capital will result in a modest increase in cash in the fourth quarter as inventory levels are reduced. We expect the cash we generate from operating activities will cover our anticipated capital expenditures and debt service costs. Overall, we expect that funds generated from internal sources will be sufficient to support the Company's ongoing operations, and our investment and growth for the remainder of '05 and on into '06. We continue to be optimistic about our future. We have successfully grown the commercial side of the business over the past year by focusing on our target markets. We believe that the military business will stabilize over time, and that our advantage technology will result in increased market share. We have developed a business where our customers are very impressed with our capabilities and we're confident that our persistence and focus will result in significant success over the next few years. That concludes my remarks and I'll turn it back to John. Thank you, Bob. Operator now I think we would like to open it up for the question and answer session.

Thank you, sir. [OPERATOR INSTRUCTIONS]. We'll take our first question from Steve Sanders with Stephens.

Good morning. John can you just talk a little bit more about the final stage of approval? Just give us some additional detail on what that means.

Yes, whenever you have a new function, such as, the SOCI is, a specification is written. And that specification a lot of times it's written with tests where you don't always know the outcome. We have destructive tests that we do on it. Whether it's a nail penetration test or a bullet test or whatever where, it's not as much did you pass the test. It's what happened when you did it?

And so there were -- once we finished all the testing and we looked down and interpreted the data and went through it with CECOM, they asked us -- and that was done in September. There was one new test that they asked us to do some additional work on and get the more data on. And we have done that and we have -- actually we have a little more data to get together because we have to write the final report. And that will be submitted -- I believe it's going to be next week, Bill?

Within the next couple of weeks.

Within the next week or two we have to -- there's a lot of report writing that goes on. Whenever a question is asked you have to provide pretty detailed answers. So that's what we mean. And that's why, I think, we were pretty circumspect when we said we would have all the work done in the third quarter. But it's sometimes a week to week thing about when somebody can actually review it and it goes through all the reviews before you get a final approval on something.

Okay. And then just an update on the issues around the lack of 5390 orders. It doesn't sound at this point like it's a demand issue. It doesn't sound like a competitive issue. It does sound like they are working down inventories. You are dealing with some red tape. You have got some education to do. But can you just provide some more color on what you think the issues are and where we are in resolving them?

Yes, we actually had a review last week with our partners in the Defense Department. Our market -- we have been gaining market share. Demand has been going up for our product for the 5390. They do need to reorder. It's really a question strategically about how much they -- we believe that they'll do a procurement this quarter. It's really a question of how much they want to buy this quarter. How much they want to wait to buy under the contract. Buy the new part number, which will be after the beginning of the year. Some of that also it may not -- it has to do with transition from SO2 to MnO2. It has to do with transition of the SOCI, those are two of the things that they have to take into account. But it also has to do with the fact that how budgets get given out in the military.

The fiscal year starts October 1st, until budgets are given out they can spend, I think something like 90% or 85% of the previous year's budget. They don't get all the final budgets until late in the quarter. So in general when they place their order backlogs for six months, nine months, a year's worth of demand depending on the product, that doesn't happen until after the first of the year. And that's the indication we get from them. So we're still being told they are going to do a small procurement this quarter because they need it because inventory levels are down. But they are really trying to place -- wait to place a bigger order until they have the new product done and they have new budgets, which will be -- our indications is right after the first of the year.

Okay. Where does the inventory stand on the old version of the 5390 and do you see this as an issue going forward?

Our inventory, Steve?

Yes.

We've got probably -- we sell it to people other than directly to CECOM from time to time. We have sold some to Canada. We have sold some to Australia. We actually, I think, sold some from time to time -- we sell to the National Guard. There's other security agencies in the government that use it. So we have a demand -- I don't want to give you -- I hate to give you exact numbers, but for competitive reasons. But we have probably enough to satisfy what we believe will be a procurement for it this quarter, and maybe about five quarters worth of our ongoing demand; four or five quarters. We actually are concerned because we think we have to keep some raw materials on stock because we think even when it goes to SOCI some of these other agencies will want to -- won't want to spend as much money. The SOCI version is a few dollars more. They might want to buy the old version still.

Okay.

We're confident we're in very good shape on the inventory and, in fact, thinking that some day we may have to end up building more of them.

Okay. And then Bob, when will we see the full benefit of the cost cuts and are those relative to a $4 million kind of operating expense run rate?

We'll see the benefit or a good portion of the benefit as we roll through the fourth quarter here. On a lot of the personnel actions that we took were affected in -- at the end of Q3. So as we're tightening costs, controls and taking measures along throughout the fourth quarter, we should get the full benefit in Q1.

Okay. Thank you.

And we'll go next to David Lee, Ardour Capital.

Hi, can you just elaborate a little bit on the cuts other than these personnel cuts, how you're going to reduce your operating expenses?

Yes, David there's a few things you do. First of all, in personnel we moved -- we did two things, one, is we had a fair number of temporary employees in-house. And we moved some people who were classified as overhead, maybe in quality functions and such, over into some of the direct labor jobs, and reduced our number of temporary employees. That's one of the things we did. A lot of it -- the second thing is we reduced a number of temporaries because we brought in a fair amount of automation. I think we're pretty clear last year that this was going to be the year we were going to automate a number of our processes. And we've qualified, I think, two new processes that were automated this quarter that really -- in the third quarter that really help us there in our -- specifically in our cathode preparation area and a few others. So that's one area we do.

And second area we did it in is, in the area of overhead expenses. We did a few organizational changes that really helped us deal with it in terms of applying -- specifically applying IT in some cases to having to do with less indirect labor employees, combining some functions -- just doing normal trimming, and also cutting down on discretionary expenses. Things like travel, association fees, conferences we might go to. I think we took a real hard look at how we did conferences and we got a lot more targeted in how we do marketing at trade shows and all. So all those things together -- I hate to -- I think there's somebody in government once said, a million here, a million there, and sometimes you have real money. $10,000 here, $10,000 there and when you are running overhead expenses like we were you can take them down. That's what we have done.

The last area is, we had significant opportunity, I think last year was the year of automation -- or this year is the year of automation. As we move into next year, next year it is really focusing on our other areas of product cost. We have been really focusing -- we were focusing on ramping up production and then on automation. I think our next focus is in really honing our processes and taking our scrap numbers down. They are not out of where we should be, but I think if we're going to be a really excellent manufacturing company they could be lower. And I think Bill is working pretty hard on that. But the other thing is there's product design things we can do with alternate materials and all of that really will reduce our cost to produce. We have a lot of experience now. I think we have made -- from making 100,000 D cells in all of our lives three years ago, we have probably made 20 million D cells in the last 3 years. And we pretty much understand now how we can make some improvements in that product.

And then our small cylindrical cells, how we can make improvements in our product. And when you are making 5, 10 million a year of something, taking a dime out saves you a lot of money, and we have nickels and dimes to save in our 9-volt and our D cell, and now that our 5/4 C cell is going into volume with GM and some of the search and rescue products, there's money to be saved there. And I think you'll see that next year.

Okay. And so when do you expect this 1 million in quarterly -- on a quarterly basis to happen? The reduction in overhead. When is that going to begin?

This is Bob. We -- like I said, we took some actions on the personnel side at the very end of September, so we'll see the benefit from that throughout Q4. And then these other actions where we're tightening expense controls and I've been watching things much more expeditiously and carefully, we will see the benefit throughout the quarter. So we should see the full benefit of the million in Q1.

Our goal is to have these savings hitting the road on January 1st.

Okay. And just one last question, what was your DSO for the quarter?

The DSO for the quarter year-to-date now is about 43 days.

Okay. Thank you.

[OPERATOR INSTRUCTIONS]. We'll go next to Mark Grzymski, Needham & Company.

Good morning.

Good morning, Mark.

John, just looking at the 72 to 73 million in revenues this year, what percentage is going to be 5390s?

5390s will be about 11 or 12%.

11. Okay. And looking at the difference between Q3 and Q4, I see in the press release you are talking about GM orders, the General Dynamics is that kind of the bulk of that incremental gain in quarter-over-quarter?

Yes, well, it's GM -- GM and general allowances you said. It's -- some of the work was done for overseas militaries. I think the German military order we announced there's some increase in revenue there quarter-to-quarter. This thermal imaging product to a couple of overseas militaries, that's an increase quarter-to-quarter. There's some of the general commercial business we do in the U.S. and in the U.K. is up quarter-to-quarter.

Right. Okay, and what percentage of say the 19 million would you expect to be Telematics and Search and Rescue?

Well, Telematics was about -- the GM contract is about $2 million a quarter over three years. $8 million a year or so. That's -- I think search and rescue is probably, I don't know, $1.5 million, in that range, it might be a little more, a little less depending on the quarter. I don't have an exact number for this last quarter.

Okay, great. Hey, Bob, option expense, what are we going to look at here in '06 on a quarter? What is it going to look like?

We're still in the midst of evaluating everything and sorting things out from our end. Right now rough estimate would -- based on what we have outstanding, it will probably be in the range of about $0.5 million a quarter of expense. But that I will caution and say it's very preliminary. We still have to do a lot of detail work to sort that out from our end, and looking at the various models and assumptions that go into those models, so. But right now I would tell you that's a rough estimate.

Okay. And finally, John, what else are you doing or kind of can you do to help with the transition to MnO2 sooner than later? Are there any tactics you are using in the government or -- can you elaborate on that?

Well, first of all, we do everything we possibly can with CECOM, DLA. With CECOM it used to be the one-shop stop for logistics, for the technical support and for the policy. And when DLA picked up the logistics support and CECOM kept the technical side, you know there needs to be a multiservice coordination on policy. And I think that's something that we didn't realize, and I think that's something that the services didn't realize until recently. And I think we were the catalyst that kind of got everybody to say, oh, my gosh this is something that has to be done. And so we have gotten extraordinary cooperation from CECOM, DLA and the Office of Secretary of Defense on starting to bring that together. And what that -- that was really the most important thing I think we've done. That gave us the ability to raise visibility levels and get people back on the track of, this is the way -- it's very obvious if you look at it, this is the way that you want to be going.

What we have done ourselves directly is we have a very focused marketing campaign direct to the bases, to the [end] theater, logistic centers, and to the command structure, logistics and operations command structure in the Army and the Marines, directly to promote our product and to get people out there. We have gotten samples out to people at the different bases. We have gotten -- here's what you won't get when you use the product and we have gotten great feedback from that. So I think that's -- and the feedback we have gotten from the guys from CECOM and from DLA is, they get calls all the time from people saying, jeez, Ultralife is telling us there's this new battery out here, and it gets 50% more energy, and it really is safer, and is this right? And they are saying, yes, everything these guys are saying is true. So they can't promote our product, but they can say, yes, they are telling you the truth. And so I think that's been an important factor in doing that as well. But nothing will replace -- nothing replaces it when you can get the logistics and command people, which is what we're working on, to finally say, all right, here's what we want to do. We're going to go move this thing.

Okay, great, guys. Thanks.

[indiscernible]. We have no other questions standing by at this time. I would like to turn the conference back over to you for any additional or closing remarks.

Well, I would like to thank you all for joining us today. We're working really hard to get Ultralife back to growth and profitability. We're confident in how we're going to do that. We really look forward to sharing our progress with you again next quarter. So thank you very much.

And ladies and gentlemen, that does conclude today's conference call. We do thank you for your participation. You may disconnect at this time.