Ultralife Corp (ULBI) 2011 Q2 法說會逐字稿

Welcome to the Ultralife Corporation Second Quarter 2011 Earnings Release Conference Call. At this time for opening remarks and introductions, I would like to turn the call over to Ms. Jody Burfening. Please, go ahead.

Thank you, Brandy. Good morning, everyone. This is Jody Burfening of Lippert-Heilshorn & Associates. Thank you for joining us this morning for Ultralife Corporation's earnings conference call for the second quarter of fiscal 2011. With us on today's call are Mike Popielec, Ultralife's President and Chief Executive Officer, and Phil Fain, Ultralife's Chief Financial Officer. The earnings press release was issued earlier this morning. If anyone has not yet received a copy, I invite you to visit the Company's website, www.UltralifeCorp.com, where you will find the release under Investor News in the Investor Relations section.

Before turning the call over to management, I would like to remind everyone that some statements made during this conference call contain forward-looking statements based on current expectations. Actual results could differ materially from those projected as a result of various risks and uncertainties. These include uncertain global economic conditions, increased competitive environment, pricing pressures, disruptions related to restructuring actions and delays.

The Company cautions investors not to place undue reliance on forward-looking statements, which reflect the Company's analysis only as of today's date. The Company undertakes no obligation to publicly update forward-looking statements to reflect subsequent events or circumstances. A more detailed description of such uncertainties is contained in the Company's filings with the Securities and Exchange Commission such as the Company's report on Form 10K for the period ending December 31, 2010.

In addition, on today's call, management will refer to certain non-GAAP financial measures that management considers to be useful metrics that differ from GAAP. These non-GAAP measures should be considered as supplemental to corresponding GAAP figures.

With that, I would now like to turn the call over to Mike. Good morning, Mike.

Good morning, Jody. Thank you, everyone for joining the call.

At the halfway mark for the year, I'm encouraged with the progress the team has made towards positioning the Company for continuous improvement and profitability in top line growth. On today's call, I'm going to start by making some high level observations about our second quarter operating performance and then I'll turn the call over to Phil who will take you through the detailed financial results for the second quarter. After that I'll come back and give you a brief progress report on three of the operational priorities I laid out during my initial conference call in February and share with you our thoughts about the second half and full year outlook for 2011. After that, we'll open it up for questions.

As for the second quarter reported financial results, they are relatively straight forward this quarter since not encumbered by special charges or large onetime write downs. Because the exit of the energy services business was completed by the end of the second quarter, we are now also able to reclassify energy services as a discontinued operation for reporting of the second quarter financial results. Not only does this provide better clarity of the remaining businesses for financial comparison purposes, but it allows us going forward to focus all of our attention on developing and capturing profitable growth opportunities.

Revenue in the second quarter was up 29% year over year and up 53% sequentially from this year's first quarter. Sales increased in the battery and energy products business by 23% year over year and for the communication systems business by 49%, driven by the resumption of demand from our core US government defense customers and included expected DOA and SATCOM shipments. Our China operations also continued on a growth trajectory in the second quarter by reporting a 41% increase in year over year revenues primarily as a result of sales for utility metering products.

Our Company-wide lean implementation is helping us become more productive and providing the opportunity to leverage our top line growth for our improved operating margin. Reported second quarter operating margin was 6.6% as compared to 2.9% in the second quarter 2010. We will continue to drive top line growth via new product development and sales force productivity while reducing non-valuated operating expenses to achieve our interim 10% operating margin goal. I will comment further on these efforts in a few minutes but I'd like to first ask Ultralife's CFO, Phil Fain, to take you through additional details of our second quarter financial results. Phil?

Thank you, Mike, and good morning, everyone. Earlier this morning we released our second quarter results for the period ended July 3, 2011. Our second quarter was very straight forward with the Company focused on executing the plans, an objective that Mike laid out during the February call. Simply put, we completed the exit of the energy services segment one quarter earlier than planned, posted sales growth both sequentially and versus the prior year, generated solid earnings in EBITDA, and continued to strengthen our balance sheet.

With our exit from the energy services segment complete, we have now classified all exit costs and previous operating results of the business as discontinued operations in the statement of earnings in accordance with Generally Accepted Accounting Principles. Our exit costs totaled $2.9 million and included the completion of all open work orders, the elimination of approximately 40 jobs, the closing of five facilities, and the sale or disposal of the business assets.

The cash component of the aggregate exit costs was slightly less than $2 million. Our overall costs compared favorably to the cost estimate of $3.2 million that we provided in the March 10 release announcing our decision to exit this business. The financial presentation now in place provides a clearer picture of the results of our battery and communication systems businesses. Consolidated revenue from continue operations for the second quarter totaled $43.6 million, representing a 29% increase over the $33.6 million reported in the second quarter of 2010 and a 53% sequential increase over the first quarter.

Revenues from our battery and energy product segment were $31.2 million up by 23% over last year and reflecting higher sales of rechargeable batteries and chargers to the defense industry, the resumption of shipments of our primary battery to the defense logistics agency under the indefinite quantity contract that was awarded to Ultralife in September of 2010, and the further penetration of our batteries into the utility metering business in China. Communication system sales of $12.3 million rose 49% over the $8.3 million reported for the year earlier quarter resulting from increased overall activity in the defense sector for our products.

Our consolidated gross profit from continuing operations was $11.8 million in the second quarter of 2011 compared to $9.0 million for the second quarter of 2010. As a percentage of total revenues, consolidated gross margin was 27.1% in 2011 versus 26.8% for last year's second quarter. Gross margins for our battery and energy product segment of 23.2% was approximately 50 basis points below the year earlier period due to severance charges incurred to make permanent reductions to our work force, resulting from our lean initiatives and other operating efficiency measures.

For our communications system segment, gross margin of 36.9% was favorable to the prior year by approximately 60 basis points primarily due to product mix. Gross margin for the second quarter of 2011 represents a 380 basis point sequential improvement over the first quarter after adjusting the first quarter to exclude energy services and the $2.7 million charge relating to the DCCA settlement. The sequential gross margin improvements are 180 basis points for the battery and energy products segment, also adjusting for the $2.7 million DCCA settlement charge and 130 basis points for the communication system segment. These improvements primarily reflect the favorable impact of the permanent gains from our lean initiatives and product mix.

Operating expenses from continuing operations totaled $8.9 million for the second quarter of 2011 compared to $8.0 million for the year earlier period. The overall increase over 2010 was primarily a result of higher research and development expenses reflecting increased new product development activity, higher selling expenses resulting from our investment to further expand the sales force, costs associated with the relocation of our AMTI facility to a larger footprint to allow both growth and consolidation within our communications system segment and severance costs associated with the elimination of certain staff positions. As a percentage of revenue, operating expenses were 20.5% for the second quarter of 2011 compared to 23.8% a year ago.

Second quarter non-cash operating expenses from continuing operations including depreciation, intangible asset amortization, and stock compensation expenses amounted to $1.3 million equal to the amount reported for the year earlier period. Operating income from continuing operations grew to $2.9 million, representing an operating margin of 6.6% compared to $1.0 million for an operating margin of 2.9% for the same quarter last year.

Other expenses primarily comprised of interest expense and foreign currency amounted to $170,000 for the second quarter of 2011 compared to $340,000 for the year earlier period, resulting from a reduction in our borrowing rate and the strengthening of the British pound to the US dollar. Our second quarter tax provision was $130,000 compared to $67,000, reflecting book tax timing differences, primarily related to the amortization of intangible assets.

Net income from continuing operations for the second quarter of 2011 was $2.6 million or $0.15 per share compared to $0.6 million or $0.03 per share for the same period last year and adjusted EBITDA, defined as EBITDA including non-cash, stock based compensation expense amounted to $4.2 million in the second quarter versus $2.2 million for the second quarter of 2010. The net loss from discontinued operations was $2.1 million or $0.12 per share, reflecting the costs incurred in the second quarter for completing our exit of the energy services business. This compares to a loss of $0.6 million or $0.03 per share in the second quarter of 2010 which represents the operating loss of the energy services business for that period.

The Company's liquidity remains solid. With the improved operating results for the quarter, the cash generated from our lean initiatives, and a continued focus on our balance sheet we reduced our outstanding revolver to $3.7 million at the end of the second quarter. This represents reductions of $6.5 million and $4.9 million from the outstanding balances at the end of the first quarter and at year end respectively.

At the end of the second quarter, the Company was net cash positive with the cash balance exceeding the outstanding revolver. This compares to a net borrowing position of $3.4 million at the end of 2010. We have also reduced our inventory by $10 million from the first quarter of 2011 and our 90 day past-due receivables to 1% of our total accounts receivable. Although our operating expense base has been significantly reduced over the last 18 months, we have and will continue to reduce non-revenue producing operating expenses and further consolidate our operations and drive operating efficiencies.

We remain mindful of the importance of striking the critical balance between making ongoing cost reductions and exercising strict expense control on the one hand and providing the necessary funds for product development and revenue generation on the other. We are focusing our attention on executing the top priorities which Mike has outlined for you. Over time, these will allow us to leverage the business model improvements we have implemented thus far and those in process to generate strong incremental returns on revenue growth and to achieve our interim goal of a 10% operating margin.

I will now turn it back to Mike.

Thanks, Phil. As we have said before, Ultralife possesses the elements to achieve sustainable top and bottom line growth by applying a disciplined, focused execution and a more deliberate approach to new product development and sales. We have established several priorities to achieve this objective and I'd now like to update you on their status.

Our first priority has been optimizing the Company's profitability. With the exit of the energy services business, which was dilutive to our quality of earnings, our business model is now capable of achieving the 10% operating margin target set as an interim goal for earnings quality. As a reminder, to accomplish this objective we're working towards achieving a gross profit as a percent of sales approaching 30% and building an operating expense structure weighted towards new product development and sales force productivity yet when combined with a leaner overhead G&A cost base results in a total operating expense ratio to sales of approximately 20%. Gross margin improvements will continue to be realized as we widen the reach of our lean initiatives and expand the value proposition of our new products.

Year to date, our COG savings from lean projects is contributing approximately 165 basis points towards our 300 basis points near-term lean related gross margin rate improvement goal. We are also starting to look more closely at our global manufacturing footprint to develop the most cost effective and lead time efficient supply chain. Lastly, we will constantly search out new ways to reduce our overhead G&A which efforts to date in 2011 have led to a reduction of our annualized run rate G&A costs by approximately $2.9 million or 180 basis points on a percent to sales basis.

Our next priority has been to develop and execute a growth game plan. To achieve our growth acceleration goals, our near-term focus has been in three key areas. Sales force structure and productivity, new product development, and China. In terms of the sales force, we mentioned during last quarter's call that we had made some structural changes to our sales leadership. The objective was to provide a stronger line of site leadership focus for our sales teams and align them by targeted business area, meeting with both our core government defense customers and our emerging commercial customer base.

Though still early in the process I'm pleased that the teams were able to deliver respectable second quarter results despite the distraction of sales leadership transitions. We also plan to invest in additional tools, training, and sales feet on the street to keep the momentum going. Year to date we've increased the number of our sales personnel by 20% and we have a target for our 40% total increase in sales personnel by year end.

In addition to the sales structure changes, the newly established strategic growth counsel continues to meet weekly and has developed a high priority list for new product development. We look forward to talking about some exciting new products to serve both our military and commercial customers over the coming months. Included are products focused on the military soldier modernization program and the energy utilization as well as commercial products serving utility metering, medical devices, and safety and security applications.

Our third top level priority at this time is to more fully leverage our China operations to accelerate growth and cost competitiveness. The Ultralife China team has made a strong contribution to our battery and energy product sales increase by growing revenues at a high double digit rate through the first half of 2011. We are now working closely with them to establish plans based on a lean principle to expand manufacturing capacity within our existing footprint which will help the battery business continue to grow both its margins and revenue. Whereas most of our recent China growth successes come from serving multinational metering device OEMs located in China. We're excited about growing their participation worldwide as we pursue other global opportunities in utility metering, RFID, and smart cars.

Relative to the financial outlook for 2011, we are maintaining our total year guidance per revenue from continuing operations of $162 million and operating profit of $7.8 million. Looking at the battery and energy products segment, total year organic growth is still expected in the high single digits, driven primarily by rechargeable batteries, chargers, and China.

In our communications segment, we expect non-SATCOM year over year revenue to grow by over 25% from increased sales of our specialty amplifiers. As a reminder, we shipped a significant SATCOM order in the third quarter of 2010 and consistent with our comments on previous calls, we are not expecting shipments of that magnitude to recur in 2011.

Although we are pleased with the increase of recent government defense business activity, in the face of the debt ceiling legislative debate and its potential fallout and our backend loaded revenue curve, we are cautious about the timing of second half order placements and shipments. To maximize revenue achievement by year end we are prudently positioning our supply chain for short cycle order fulfillment.

Our mission for 2011 continues as we stated in the beginning of the year. We will continue to refine our business model for increased profitability and position the Company with more dynamic and deliberate plans for future product development and sustainable sales growth. We look forward to reporting the progress of our efforts with you in future calls.

Operator, this concludes my prepared remarks. We'd be happy to open up the call for questions.

(Operator Instructions) We'll take our first question from Zach Larkin with Stephens Inc.

Good morning, gentlemen. Thanks for taking the call and congratulations on the quarter.

Thank you, Zach.

First off, just wanted to see if we could talk about guidance in a little bit more detail. If I look at the $162 million kind of revenue target and what we've done so far through the year it would imply that the third and fourth quarters are going to hover somewhere on the revenue line around what we've seen this quarter and just wondered if that's a decent way to think about it and if you could provide some color as to the seasonality on the segment that you might expect in 3Q and 4Q?

I think your starting point, Zach, is pretty good. I believe what we're going to see is even a greater skewing of the sales based on the order patterns into the fourth quarter so that we could see a 40-60, 45-55 split between the third quarter and the fourth quarter. Again, this is based on converting the activity we're seeing into sales orders for the second half of the year and that's our best estimate at this point.

Great. That's very helpful. And also kind of knowing that the communications tends to be backend loaded, the distribution split between battery and communications is going to be a little more weighted towards communications also, is that a safe assumption to make?

Yes. It is a safe assumption. It's not different than what we've seen in previous years.

Great. That's very helpful. Also it's great to see the resumption of the DLA. Could you give us a little more color on how that contract, maybe what expectations you've built into guidance and maybe how you're thinking that customer might work going forward?

Sure. We go back to the IDIQ contract we signed in September of 2010 which called for four successive one-year contracts way back in September 2010 when we came out with the press release we said that we have POs in hand that would ship -- I believe we said in the May to June timeframe. For the most part they have. And we've taken a very conservative posture with our shipments to the DLA. Our forecast has this year a focus on what we know.

Great. Thank you very much. Then also wondered if you could talk a little bit more about the metering business? Obviously China's been a great market for you guys. I think a lot of the world's focus is shifting towards Europe with a lot of the smart AMI roll outs looking to be in maybe second half 2012 with big ramps going into 2013. So, obviously a big market. I wondered if you could provide some color on talks that you've had with meter providers, utilities and the like, and what you think your potential to penetrate European and other markets -- how that's looking?

Thank you for the question. At this time our China operations have been extensively involved in the electric metering growth that they're seeing in China. If you were to think about it as a five year type of plan they're probably only into the first year of it and they're a little bit below the speed of which they would try to make conversions to these type of meters and we're getting a fairly solid share of that. As a result of that success, we're talking to other multinational OEMs, not only in China but also in Latin and South America and to some extent to Europe.

So, our biggest opportunities near-term would be continuing to serve what I would say is early cycle China markets and to continue to penetrate more deeply in Latin and South America and with some of their OEMs there it's going to take a little bit longer likely to penetrate into the US market but that's certainly on our list as well.

Thanks for the color on that. Again, congratulations on the quarter.

Thank you.

We will take our next question from Jim McIlree with Merriman Capital.

Thanks. Good morning. Can you talk about on a pro forma basis what the percent of revenues coming from military is and the different margin profiles of the products -- military versus commercial?

Sure, Jim. What we've seen is this year is pretty consistent with what we've seen in the past from a percentage of sales -- percentage of sales breakdown. What we're seeing is approximately 60% to 64%, 65% of military sales -- global department of defense sales -- the margin profile is again pretty consistent with what we've seen in the past depending on the product. Primary products, non-rechargeables, have a lower margin than rechargeable products. There has been a great -- the change in the profile has been a larger demand for rechargeable products, meaning additional charger sales as well. The good news with that is that rechargeables and chargers do carry a higher gross margin and it's certainly helpful for our going forward.

Then given the growth in China, is that 60% to 65% a good number going forward or is that expected to change dramatically going forward?

As we may have mentioned on an earlier call, we're definitely trying to continue to expand our penetration into our core US government defense business but recognize given the cyclicality of budgeting processes, et cetera, the need to diversify in the commercial space, we're getting some pretty significant growth in China and other places in their businesses, virtually 100% commercial but still just as a percentage of the whole it's rather a small piece.

So, just in simple terms, for about every 20% of growth we get in China, we get about a total -- 1% total Company growth organically. So, the mix will start to shift a little bit but I don't think you'll see an appreciable difference of that ratio, sort of 65-35 in the next year or so. We're doing a little bit at a time -- maybe 100 basis points a year, maybe 200 basis points a year in that kind of magnitude.

The interim operating margin goal of 10%, when do you think you can hit that?

That's -- of a sustainable basis, we're trying on an annual basis improve operating margin rates anywhere from 75 basis points to 150 basis points. It's sort of an annualized type of basis. We'd like to try to at least touch the 10% a few times here in the next 18 to 24 months but our goal is really to reside there which means sometimes we'll be higher than 10%, sometimes we'll be slightly lower. So, I'm thinking more of an 18 to 24 month timeframe before the first few touches at 10%.

Great, thanks a lot.

We will go next to Walter Nasdeo with Ardour Capital.

Thank you. Good morning, guys. A lot of the stuff I wanted to talk about has already been asked and answered. I appreciate that. One of the things that I'm thinking about, when you kind of look out, kind of scanning the environment, you see opportunities and some of them appear to be relatively significant. Can you kind of go into what your plan is now and then into the future to make sure that your capacity is online as close to its need as possible and how you're going to manage kind of balancing resources given that your capital situation is good now but maybe a little challenged in the future as business grows?

I'll let Phil talk about the capital structure, but relative to a deployment of resources on a global manufacturing footprint, as we lean out our own Company, we're trying to lean out our supply chain relative to our customers. And one of the reasons why we're so excited about the opportunities in China is that our customers are for the most part in China. These are the electronic metering OEMs and so we think we're really well positioned there. On the other hand, a lot of the stuff we're doing, obviously the US government defense business is going to be closer to home and so the footprint that we have in our Newark operations and in Virginia beach I think are uniquely situated to serve that supply chain.

As we continue to expand on a global basis which we'll do very, very selectively, we'll look at putting in the appropriate supply chain mechanism whether it be a manufacturing point -- distribution point, or a third-party, to be as close as we can to our end user. But at this point we're looking at the overall portfolio and trying to line that up as best as we can and our two main vehicles we have to do that now are decisions on what we build in the United States versus what we build in China.

Walter, with regard to the capital structure, I pointed out in my comments that our outstanding revolver was with $3.7 million at the end of the second quarter, I will share with everybody that it's down significantly since then and access to capital from the seat I sit in is not something I'm losing any sleep over at this point.

Okay. That's good to know because you need to be alert over there. I don't want you losing sleep. Given though that the 60% to 65% military, which is kind of a somewhat historical mix for the Company, how do you manage if there's another big -- not unexpected but kind of a big military order that comes in that really kind of puts some pressure on your existing resources, how do you manage the continued growth on the commercial side because in the past, it almost shut down commercial growth to manage the military type of orders that were coming in. How are you planning for that?

That's the perfect question and the basis for our putting in very distinct sales leadership roles. We had a full sales force with some outstanding individuals that were covering both the military defense as well as the commercial market segments and that, as you know, sometimes the military defense business can be lumpy and depending on which side of the lump you're on, you would either rob or support the development of the commercial business. We recognize that up front.

So, from a go-to-market perspective, we put in place and took one of our very top sales leaders who had done an outstanding job in the place that he was working and put him in charge of our commercial business really from scratch. We think we deployed our sales force accordingly to make sure that regardless of what's going on in the military defense area, that we're getting a continuous focus in the commercial segment. Also when it comes to new product development, the same kind of logic would apply. If you consume 100% of your technical resources, fulfilling existing and very attractive military government defense type contracts and there's no bandwidth or commercial new product development, you sort of get what you get if you know what I mean.

On a development standpoint, from an engineering standpoint, we're trying to restructure the allocation of our resources by leaning out our existing processes to create some more head room for development of commercial products and so far we're about one quarter into it. We like what we see. But we have to have that discipline to recognize that there are going to be times when we may be tempted to just go after solely some of the large major transactions available in government defense but on a long-term basis we recognize that in order to mute the cyclicality of that curve, we need to be strong in the commercial business. So, I think we need to have the discipline to stay in it and stay focused. And so far, one quarter, we're doing that.

Good. Thanks a lot. I appreciate it.

(Operator Instructions) We'll go next to Sam Bergman with Bayberry Asset Management.

Good morning, Mike and Phil. How are you? Nice quarter. A couple questions. What was the employee count at the beginning of the quarter and the employee count at the end of the quarter?

The employee count at the beginning of the quarter was approximately 1,100 individuals, primarily the large piece of that certainly is for the labor-intensive China operation. At the end of the quarter it had dipped to approximately 1,000 individuals. Let me just go into some of the metrics here, Sam.

First of all, through lean, the lean initiatives, we took out our temporary work force which was approximately 70 people. In addition, through our reductions, I mentioned severance. We have taken out approximately 60 individuals -- full-time individuals -- combining the first quarter as well as the second quarter, about 20 in the first quarter, approximately 40 in the second quarter.

What is the forecast for R&D for the next six months, for the rest of 2011? How do you expect that -- how much to tick up?

Are you looking at it from a percent of the sales base, Sam?

Yes.

Generally speaking we have a simple mnemonic we're using internally where we're trying to achieve a 30% gross margin rate. We're trying to deploy approximately 5%, 5.5% of our SG&A percent to sales type dollars to R&D, 5% in sales, and then took all of our overhead G&A with another 10%. So, 30% gross margins, 5% R&D new product development, 5% sales force, 10% overhead G&A and that gets us our 10% operating margin. We'll stay pretty within those channels.

And can you also comment at all on the DOD rev Qs that are out there this quarter versus last year this quarter or even compare it to the first quarter? What's the pipeline look like?

The activity level's been robust and so our people are working extremely hard and we're very pleased with the level of activity. The challenge is that we had a five month staggered start with the delay of the budget approval. So, no lack of activity. The issue is will that physically be able to come out of the procurement offices, be finalized in terms of formal awards, and our ability to convert and ship sales for fiscal year 2011 revenue. So, we're cautiously optimistic about the activity level, but we know we're playing on a short clock.

Okay. Thank you very much.

(Operator Instructions) At this time there are no further questions. I'd like to turn the conference back over to Mr. Popielec for any additional or closing remarks.

Thank you. Once again, thank you from all of us joining for our second quarter earnings call. I look forward to meeting up with several of you in person over the next week or so and to share with you all our quarterly progress on each quarter's conference call in the future. Thank you very much for your participation and have a nice day.

This concludes today's conference, we thank you for your participation.