Ultralife Corporation
Q2 2008 Earnings Call Transcript
Published:
- Operator:
- Good day, and welcome to this Ultralife Batteries Second Quarter Earnings Release Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Ms. Jody Burfening. Please go ahead.
- Jody Burfening:
- Thank you. Good morning, everyone. This is Jody Burfening of Lippert/Heilshorn and Associates. Thank you all for joining us this morning for Ultralife's earnings conference call for the second quarter of fiscal 2008. The earnings press release was issued earlier this morning and if anyone has not yet received a copy, I invite you to visit the Ultralife website at Ultralife.com, where you will find the release under Investor News in the Investor Relations section. In a minute, I will turn the call over to John Kavazanjian, Ultralife's President and CEO, who, along with Bob Fishback, Ultralife's Chief Financial Officer, will provide their formal remarks. Management will then take questions until 11
- John Kavazanjian:
- Thank you, Jody. Good morning, everybody, and welcome to the Ultralife Corporation conference call for the second quarter of 2008. And I would like to point out that this is our first call, thanks to the approval that our shareholders gave of our name change, first call as Ultralife Corporation. With me today are Bob Fishback, our Chief Financial Officer, and Julius Cirin, our Vice President of Corporate Marketing and Technology. Bill Schmitz, our Chief Operating Officer, who usually joins us, is traveling on Company business. Today, we reported revenue of $87.9 million for the second quarter of 2008. These results are in line with our guidance of $88 million in revenue given on our July 9 preannouncement. The operating profit of $9.9 million included non-cash expenses of $1.2 million from the amortization of intangible assets and the expensing of stock-based compensation. The second-quarter revenue was fueled by $62 million of sales in our communications systems business. The main reason for this was the more than $120 million in orders that we received in the second half of 2007 for advanced communications systems. But sales of other products in our McDowell product line showed strong growth as well. Gross margin in this segment was 27%, up from 25% in the first quarter, as we further improved the efficiency of our supply chain. We are now in what we would consider a normal flow of products, and we anticipate no further supply disruptions. We expect to make further progress toward our goal of 30% gross margin in this segment in the second half of the year. Our rechargeable segment was lower than first quarter, with revenue of $4.5 million. Gross margins were still only 18%, mostly due to the effect of lower volumes and overhead rates. This revenue decrease was mostly due to timing on several new contracts, but with a solid backlog already in the third quarter, we expect this segment to be strong in the second half of the year, and margins to grow toward our target range of 25% to 30%. Non-rechargeable product revenue was up slightly from the first quarter. During the second quarter, we took steps to reduce lead times on products, as supply line improvements and communications products allowed us to redeploy resources. This is important, as demand is strong for the second half of the year and into next year, as evidenced by the $11 million order that we received last week for our BA-5390 battery. Gross margin was down due to approximately $750,000 in restructuring charges connected with the refocusing of activities in our U.K. operation. While we are maintaining all of our capability in cell production and battery assembly, we are changing our U.K. operations into more of a distribution and service location to address the rapid growth in our communications systems business that we see in Europe. Design and installation services accounted for close to $4 million in revenue. Gross margins grew to 22% as we started to capitalize on the investments that we're making to grow this business. We will continue to grow this segment in revenue and expand gross margin above the 30% range. In our communications systems segment, work that we are doing in that product line is building a base for future growth. This growth will come from both expansion of our product capabilities and from international expansion. For example, several weeks ago, in both Singapore and Australia, we demonstrated our new McDowell MRC-200A and MRC-200L repeaters, the latest versions of our tactical repeater product line. These products not only work as range extenders for handheld radios, but the link repeater version will also enable the creation of radio networks. With advanced features, including smart power management and remote monitoring, our new link repeater extends the range of handheld radios for soldiers and provides the ability to communicate with headquarters locations via satellite. Of course our satcom systems business will continue to grow, and we believe this will be a standard part of all advanced radio programs. We see further demand through funded programs with all branches of the U.S. military, as well as increased interest from foreign militaries with which we have relationships. We anticipate significant revenue on a continuing basis for this family of products. Because of our strategic relationships with key rechargeable cell suppliers, we have stayed on the forefront of technology. Together with our SmartCircuit technology, this has enabled us to have the best-performing rechargeable batteries in the world. Our introduction of a new, higher-energy 2.9 amp-hour cell in our product has now allowed the launch of our newest versions of many of our rechargeable products. For instance, our new 8.8 amp-hour UBI-2590 lithium-ion battery now delivers performance 20% higher than the non-rechargeable BA-5590 lithium sulfur dioxide battery. It's also equal to any other competitors' lithium-manganese dioxide products. Together with our 13 amp-hour version of BA-5390, it gives us well ahead of our competition and capability. Demand is strong for our BA-5390 battery and we continue to gain market share. Added to this, our new 13 amp-hour D cell is starting to get attention in defense markets as its industry-leading capacity now enables new applications such as thermal imaging, and unattended ground sensors to increase both capability and critical operating time. In automotive telematics, a commercial application for our non-rechargeable products, we see both growth in platform penetration and in demand from new designs. And we expect to see continued growth in this market. In services, further geographic expansion of our Stationary Power Services unit will help us to accelerate the growth of our battery and services business in standby power. Overall, this quarter, growth in revenue has enabled us to demonstrate double-digit operating margins. With our expanded products and services offerings and our higher-value applications focus, we believe we have the platform for both revenue and gross margin growth, with the opportunity to demonstrate further expansion of operating margins. Both to fuel and to prepare for this growth, we made significant investments in the second quarter. Included in this was added R&D to develop and qualify new products and capabilities. This includes additional rechargeable products for the U.K. MoD and other overseas customers. It also included continued development of new RF amplifiers, both to increase our communications systems offerings and to enable us to broaden the capabilities that RedBlack Communications brings to customers. We made investments in sales and marketing infrastructure to broaden coverage for Stationary Power Services and to sell our new RPS Power line of standby power batteries. And we are adding new equipment into both China and India to broaden the capability of those operations. On top of all of this, we expanded our base of technical talent in RedBlack Communications, in China, in our Newark engineering operation, and in our development work at Mississippi State University, and our new operation in Mississippi. With this diverse set of capabilities, operations, and offerings, a challenge that we face is quarter-to-quarter forecasts. As a result, going forward, we will provide guidance on an annual revenue basis along with business model guidance for earnings forecasting. For the second half of the year, we believe we will have revenue in the range of $130 million. And as a result, we are raising our revenue guidance for the year to approximately $270 million. This would imply gross margins which average between 22% and 25%, depending on mix, and operating expenses to range between $10 million and $11 million per quarter. Many people have asked about our projections for 2009. At this time, we are prepared to say that our preliminary plans indicate that we are forecasting a revenue base in 2009 of about $250 million, based both on our order outlook and demand for our products. As we are only halfway through 2008, we would stress that this is still preliminary. Now, I would like to turn it over to Bob, after which we will open it up for questions.
- Bob Fishback:
- Thank you, John, and good morning. Earlier this morning, we released our second quarter results for our fiscal period ended June 28, 2008. Consolidated revenues totaled $87.9 million, a $52.7 million increase or 2.5 times the revenue in the comparable quarter last year. This impressive revenue growth resulted from a significant increase in shipments of advanced communications systems driven by deliveries on the three large orders we received in the latter part of 2007. In addition, revenue in our design and installation services segment increased, reflecting the contributions from RedBlack and Stationary Power acquisitions, which added approximately $3.4 million. Offsetting these increases, in part, was a decrease in our non-rechargeable revenue from last year's strong level of high-rate battery shipments to international customers. Gross margin in the second quarter of '08 was $20.6 million, an increase of $12 million from the prior year. As a percentage of total revenues, consolidated gross margins were 23.5% in 2008 compared with 24.5% in last year's second quarter. Gross margin in our communications systems segment increased to 27% from 19% last year as production volumes rose and premium cost inventory issues from last year and the supply chain issues that we faced earlier this year have been resolved. Margins in our design and installation services segment were 22% in the second quarter of '08, reflecting ongoing integration initiatives and investments in geographic expansion with RedBlack and Stationary Power. Last year's 16% gross margin in this segment related only to certain technology contracts. Offsetting these improvements in communications systems and design and installation services, the margins in our non-rechargeable segment declined from 27% to 13% as a result of unfavorable product mix and increasing raw material costs related to higher energy and transportation costs. In addition, we recorded a restructuring charge of approximately $750,000 in this segment related to an initiative to refocus our U.K. operation toward being more responsive to the needs of the market. Operating expenses in the second quarter totaled $10.7 million versus $6.9 million in 2007, an increase of $3.8 million. Nearly $1.2 million of this increase related to additional costs associated with RedBlack and Stationary Power. $700,000 of the increase resulted from higher incentive-based compensation tied to higher sales. $500,000 related to an increased investment in product design and development activities. $200,000 pertained to higher non-cash stock compensation expenses. And the remainder of the increase in operating expenses resulted from higher sales, marketing, and administrative costs associated with running a more diverse organization. Included in our operating expenses in 2008 are approximately $1.2 million of non-cash expenses related to intangible asset amortization and stock compensation expenses compared with $1 million one year ago. As a result of the above, we reported $9.9 million in operating income for the second quarter of 2008 compared with $1.7 million last year, more than a five-fold improvement. Operating margins were 11% for the quarter versus 5% in 2007. Below operating earnings, net interest expense for the quarter was $200,000, down from $600,000 last year, due to the conversion of convertible notes pertaining to our financing of the McDowell acquisition, lower revolver borrowings, and declining interest rates. Income tax expense amounted to $3.4 million in the second quarter of 2008. In the press release this morning we inadvertently labeled our deferred income tax provision as a benefit. We will correct this label when we file our form 10-Q next week. The deferred tax expense mainly pertained to a non-cash charge of $3.1 million due to the recognition of a deferred tax liability related to book tax differences for goodwill and intangible assets. Every quarter, in accordance with accounting standards, we conduct a detailed review of the valuation allowance against our net deferred tax asset. And in this quarter, our analysis determined that we needed to make an adjustment. At June 28, 2008, we continued to essentially reflect the full reserve for our deferred tax asset. Again, we will be reviewing our assessment of the valuation allowance very carefully next quarter and beyond. It is important to note that while we are subject to certain annual limitations for the utilization of our U.S. NOLs, net operating loss carryforwards, we do not expect this limitation to impact us in 2008. In other words, our cash taxes in 2008 are expected to be nominal. We reported net income of $6.4 million or $0.36 per common share, compared with $1.3 million or $0.08 per share last year. Average shares outstanding were $17.7 million, up from $15.3 million a year ago. This share increase reflects the 1 million shares issued in our limited public offering completed in November of 2007; 700,000 shares issued from the conversion of our 10.5 million convertible notes in January 2008 that pertain to the financing of the McDowell acquisition; as well as the impact of various stock option and warrant exercises. Moving to cash flows for the second quarter, our adjusted EBITDA, defined as EBITDA excluding non-cash stock-based compensation expense, amounted to $12.3 million. During the quarter, we used approximately $5.3 million in cash for working capital needs, as inventory levels and receivable balances rose in support of our communications systems business, offset in part by higher accounts payable balances. Our asset utilization metrics improved significantly during the quarter, enhanced by our ability to manage our supply chain and customer relationships as evidenced by our annualized rate of inventory turnover that exceeded six times for the quarter, compared to approximately three turns for all of 2007. And our DSOs improved from 52 days in the first quarter to 45 days in the second quarter. Investing activities included approximately $1.2 million in additions to property, plant, and equipment. Financing activities included cash inflows of $400,000 from stock option exercises and cash outflows from payments to reduce outstanding debt, including $500,000 on our bank term loan and $5.6 million to reduce our revolver debt. We completed the quarter with an outstanding balance on our revolving credit facility net of cash of approximately $5.7 million, down from $11.4 million at the end of March. As we look forward to the remainder of 2008, we're projecting revenues for the full year to reach approximately $270 million, nearly doubling the $138 million in revenue we realized in 2007. This means that the second half of 2008 will result in revenue of roughly $130 million, with continued strength in communications systems shipments in addition to growth in all other segments. We are currently forecasting operating earnings in the range of $22 million for the entire year, resulting in an adjusted EBITDA in excess of $30 million. Operating earnings in the second half of 2008 then are projected to be in the range of $10 million. As we move closer to 2009, we have better visibility on a base level of revenue in the range of $250 million. Quarterly fluctuations due to the timing of contract awards and order releases make quarterly forecasts challenging. So in the future, we intend to provide annual guidance for revenue and earnings with quarterly updates on our full-year outlook. I said this statement last quarter, and it continues to hold. The financial health of our Company has never been better. The balance sheet is continuing to strengthen, and our current expectation is to be out of our revolving credit facility by the end of Q3, putting cash on our books. We are looking forward to another very strong quarter as we continue our efforts to improve profit margins and leverage our overhead structure. That concludes my remarks. And now I will turn back to John.
- John Kavazanjian:
- Thank you, Bob. Now I would like to ask the operator to open it up for questions.
- Operator:
- (Operator instructions) We will go first to Ted Kundtz with Needham and Company.
- Theodor Kundtz:
- Yes, hello everyone.
- John Kavazanjian:
- Good morning, Ted.
- Theodor Kundtz:
- A couple of questions for you. Maybe you could go over the โ John, you talked about this outlook for '09. Can you kind of put a little more substance behind that? What gives you โ what kind of visibility do you have this early in the game for the '09 outlook?
- John Kavazanjian:
- Yes, okay, so looking forward (inaudible) I will give you some gross numbers on it, Ted. Of the business that we got, the large chunk of communications systems business that we got, our going assumption in '09 โ and this is based on our communications with our customers, what we believe the funding in place is there for, and a fairly โ we think a fairly prudent outlook, we think it will be about half of what it was. So we got about $120 million in orders; call that about $60 million versus 120.
- Theodor Kundtz:
- Okay.
- John Kavazanjian:
- Programs are still there. Vehicles and radios are still being procured, and the plans are right now to have them with our equipment. And by the way, I will tell you in addition to that, we also have outlook from some overseas militaries that we haven't really included in there because we don't have confirmation on their plans yet. So that is about 40 down โ about 60 down. That is a net of about 40, because we're saying 270 this year, 250 next year. Our services business โ and these are very round numbers. Our services business will grow about $10 million. We are growing very rapidly now, with good backlog going into this quarter. We are booking into the fourth quarter already. And we are looking โ one of our strategies is as we expand to go after national contracts, we're looking at national contracts for next year, which โ we are very comfortable with a growth of about $10 million year-over-year.
- Theodor Kundtz:
- Okay.
- John Kavazanjian:
- Our battery business, there are several large opportunities we started in our battery business. We only just started supplying customers like Harris, U.K. Ministry of Defense. There are some major procurement out there from them and other overseas military. In addition, we just booked a pretty good sized order that goes into next year for the 5390. That demand has been high. Our market share there is increasing, and has been increasing. There is evidence that stocks are being replenished in that as well. They have been pretty low. We have actually pulled in orders โ that's one of the areas where we have pulled in orders. So our battery business next year we think will be up about $20 million across the board. And that includes commercial opportunities as well as defense opportunities. Telematics is also growing in demand.
- Theodor Kundtz:
- Okay.
- John Kavazanjian:
- And then lastly, in the communications area, we see about $10 million in growth from a couple of different things. First, we have a base out there now of โ I don't know, 70,000 systems by the end of this year. And there is a โ we're already seeing replacement business. We have a base out there in the IED jammer world. We're already seeing replacement business and some of the accessories and products. And on top of that, with our new tactical โ our repeater product that's starting to sell, we did a pretty good piece of business โ I think we did probably did $3 million or $4 million worth of business this year. But we are starting to see some fairly โ and that was a small number of units. We're seeing a pretty large opportunity there next year. So we are saying that our base communications business is going to grow about another $10 million into next year. And that is really kind of our bottoms-up analysis.
- Theodor Kundtz:
- Okay, thatโs great. Just remind me for a second, what is the base communications business? How big is that? Because I'm grouping it with the whole thing. And you have got this โ 120 million.
- John Kavazanjian:
- Well, this quarter was about $62 million, the total business. If I take out those sitcom-type systems, it probably runs about โ it used to run about $22 million last year. It probably ran about $30 million this year. It will probably run about โ the base run close to $40 million next year.
- Theodor Kundtz:
- Got it, okay. Terrific, okay, thatโs great. And I wonder if, Bob, you could just give us kind of a little sketch on this tax situation here. Is this โ you say you're going to review this every quarter. Is there โ how do we think about this? I mean this is kind of a โ obviously a surprise to me. I didn't have that forecasted in my model. What can we โ how do we think about this going forward, this deferred tax issue?
- Bob Fishback:
- Yes, good question. And let me just comment that this is looked at โ and we have looked at this every quarter. It has to do with our valuation allowance against our net deferred tax asset. And it's something that we analyze and determine each quarter what the effect needs to be. And you might recall back a couple of years ago we released that reserve. It had a significant income tax benefit run through the P&L in 2004. And then we reversed that allowance back in 2006. And so there's a lot of variability, and it is a complex issue. But it's something that for accounting standards, we just need to review every quarter based on the FAS 109 literature and so forth.
- Theodor Kundtz:
- How much more is at risk here? How much more can we possibly see?
- Bob Fishback:
- Well, it's a constant evaluation. And I think what โ the appropriate answer is that this is related toward the termination of our deferred tax liability. And this was the quarter that we looked carefully at that. There were some things that โ assumptions we looked at differently and determined that we needed to book in that deferred tax liability in this quarter. The key to this, in my view, is that it's non-cash. Alright? It's a non-cash effect. We may decide in next quarter or the following quarter, looking ahead to our determination of whether we think we'll be able to utilize our net operating losses in the future โ and again, per FAS 109 standards, that we might release some of that allowance against the reserve and have another adjustment that may be a benefit against this tax expense. So I can tell you it's very difficult to predict. Itโs a constant evaluation and โ but the main point from my perspective is that it's a non-cash expense.
- John Kavazanjian:
- Yes, Ted, you used the word "at risk." This is not a risk item. This is an item that we have to adjust. It has to do with goodwill amortization. It has to do with some of the acquisition accounting and our valuation of differences in treatment of book versus tax on there. And so it is really a tax accounting issue of how we do our tax accounting reserves. So we have to do these periodic โ we do periodic reviews on this. And it really has to do with adjustments in reserves more than anything. Well, in fact, it totally has to do with adjustments in reserves.
- Theodor Kundtz:
- Okay. Maybe I will talk to you more off-line on it. And then one final question is just on the non-rechargeable side, the margins there were a bit low, and you mentioned why, because of the volumes, I guessโ
- John Kavazanjian:
- Well, no; non-rechargeable was mostly hit โ we took a $750,000 charge on our U.K. operationโ
- Theodor Kundtz:
- That's right. And so that should โ that comes out, so margins should get back to normal levels there.
- John Kavazanjian:
- Yes.
- Theodor Kundtz:
- Yeah, okay. Fairly quickly, I would assume, in this quarter?
- John Kavazanjian:
- Yes.
- Theodor Kundtz:
- Okay.
- John Kavazanjian:
- There may be a little bit โ is there some a little bit this quarter? But I don't think so. I think that we are done. We took what we had to.
- Bob Fishback:
- Yes, we took the additional charges. We are winding some things down โ
- John Kavazanjian:
- And there is a little bit of benefit going forward as we adjust where we build product.
- Theodor Kundtz:
- Right, right, okay. Terrific. Thanks very much. Very nice quarter.
- Operator:
- We will go next to Colin Rusch with Broadpoint Capital.
- Colin Rusch:
- Good morning. So I want to start with the services business. Other than the national service offering, how are you differentiating Ultralife from the Stationary Power business? And how do you see the technology evolving in that segment as you open up the portfolio of technologies that you're selling through that channel?
- John Kavazanjian:
- Well, good question. First, our differentiation โ we are โ we have several things that are different about us. Number one, while we source batteries from other people, we also have our own line of products. So, as a manufacturer, we have access โ we think we have access to better technology and better prices for people just in the components we use; not just batteries, but also electrical components. Second, one of the reasons we bought Stationary Power Services, in particular, is they have excellent technical capability. They're very good at design. Their logistics and their implementation is very good. So the technical capability both on the design side and the implementation side is excellent. The customer reviews are great. They get return business on a regular basis, and all of the metrics you would want to use in terms of satisfying customers. And we have taken that and expanded it geographically. We're bringing the same things to markets in Texas and Atlanta. And we're going to expand that to other places. So our real โ we saw them with more opportunity than they could execute on, and they really didn't have the wherewithal to expand the business. We're doing that. And what that does is, as we expand the footprint, we not only get the installation, design and installation work, but we also get the regular maintenance, because you have to be there to get the maintenance. They were doing work in places like Atlanta and not picking up the contract maintenance. And that is really the other thing we will add to that. In terms of technology, it's not just access to products and our ability to do that with electronics and with batteries, but it is also โ we have been very clear that we're going to bring lithium ion batteries to that marketplace. That's something probably โ that's something thatโs going to happen in the '09 timeframe. But lead acid batteries have some problems. They do not do well in high-temperature environments. They don't last very long at all. We think that lithium ion is a real value proposition there, and not monitorable very easily. You only know that they are dead once they are used, and they don't charge again. And so lithium ion batteries can be much more predictive in maintenance, being able to predict as much as months and even years in advance what their lifetime is, and when they need to be replaced. So we have a real opportunity to extend our reach on maintenance without having to have service operations exactly where we do installations of lithium ion batteries. And we think the economics are getting better and better depending โ again, depending on the installation, the characteristics, the demographics. And that's where we excel is really understanding the application and what the customer โ the problem the customer is trying to solve, and engineering something to solve it. So that is where we are there in that business.
- Colin Rusch:
- Fantastic. And can you give us an update on the U.K. military business segmented into batteries and communication and where you are in that sales process looking at '09?
- John Kavazanjian:
- Yes. We have done โ we did a โ we announced, I think, a $7 million program where we redesigned their chargers to put intelligence in the chargers and be able to charge all their batteries. And we did a design for them of one of their battery types โ one of their largest selling battery types. And the field response has been excellent. There is an open solicitation they have on the streets for their next two years' supply, which is valued over $100 million over two years. And itโs our goal to get part of that. Itโs an opportunity. I guess I could not forecast past that. They have to make their decision based on their evaluation of their suppliers. But thus far, I think we have shown them that we have capability, and we would hope to get part of that business. On the communications systems side, we started selling our tactical repeater to them through a program that we announced, and I think โ what was the size of that? I forget that. We announced it โ I think $6 million contract, where we have sold our initial version of tactical repeater product in there. And that really is the communication accessories business we've seen there. But subsequent to there, I think if you have seen the U.K.'s announced program called FRES which is their new vehicle program. They're going to be procuring a new vehicle, an MRAP type vehicle from Switzerland, from a Swiss supplier. With that, they're looking at how they're going to outfit it. And so we're actively involved in trying to secure part of that communications systems business. Along with that โ and along with some of the inroads we've made with the repeater, there's other business there in the U.K. Along with the U.K. MoD, we also have relationships with other defense organizations in Europe and in Asia like Australia and New Zealand. And so they are also looking at some of these programs. Some of them use the same type of equipment. Some of them are on box similar programs. And when I say international business that is what I'm talking about. One of our goals when we bought McDowell product line โ they were primarily a US-based business โ was to bring them internationally. And that is what we're doing.
- Colin Rusch:
- Fantastic. And then the last question is just about material cost. How are you seeing the material cost going into your battery manufacturing fluctuating over the last quarter, and how are you hedging out some of that risk?
- John Kavazanjian:
- Yes, I think โ what I said on the last conference call still holds, which is we have seen probably โ between inbound freight, which I will call part of material costs, because it's acquisition costs of material and material cost increases โ we've seen an effect of somewhere between 1% and 2%, overall. It has crept up as 0.2%, 0.3% at a time. And we finally โ I don't want to say we finally realized it, but it got to the point where we said, we have to do something about this. Because we had been driving down other costs to counteract that, but you can only do so much in the area of material costs. So we โ I said last quarter, we're going to have to do some selective pricing actions where we can. Some of that will occur and affect us in the second half of the year. But some of our larger contracts, like those with some of the automakers and with the government really aren't up until the end of this year. So some of them we can't effect until next year. So it's pretty much stabilized. That effect has not changed. Itโs an effect of between 1% and 2%, pretty much. We are doing some things on the logistics end to really match up and say on some of the parts, should we be looking at a local supplier? Should we be arranging our own freight? And so we will get a little bit there also. But nothing has changed from what I said last quarter. And we haven't seen any more increases. It has pretty much stabilized.
- Colin Rusch:
- Perfect. Thanks so much, and congratulations on the execution this quarter.
- John Kavazanjian:
- Thanks, Colin.
- Operator:
- Weโll go next to Jim Mcllree with Collins Stewart.
- Jim Mcllree:
- Thanks, good morning. John, you are talking about $130 million in revenues in the second half and $10 million operating income. I would have thought that on an average of $65 million a quarter, you would have had higher operating margins. Can you update us on what your ultimate goals are for operating margin in that kind of revenue level, and then what you need to do to get there?
- John Kavazanjian:
- Yes, we have been really โ I mean that's a good question. I mean we've been very clear that our goal is to be in double-digit operating margins. And there is a chance we can do it. But we are having to give forward-looking guidance on a six-month basis. Given the market today with material costs, given some of the adjustments we are trying to make, and given some of the mix of sensitivity along with some of the investments we want to make โ I mean, last quarter we had double-digit, but we took a reserve for some changes we made that we think in the long run are going to improve our margin and make us more efficient. We have made some investments in coverage and in other areas. And I want to leave us a little room to be able to keep making those investments as we see them. And so, if we stopped everything in terms of investments and said, let's just milk the business, we certainly should have double-digit operating margins on $130 million in revenue. But we're going to continue to expand standby power business to other locations. I can't tell you third quarter, fourth quarter, how that's going to fall; if we're still making some of those decisions. We have to leave ourselves a little room for that. So just being frank about it, we have to. I think โ what I tried to do is give you a little โcommentary is give you a little of the flavor of kind of where we see the margin ranges. We are 23.5% this quarter. Throw back in the 750,000 of reserve we took, thatโs it we are over 24%. We have some other areas where we are working on doing some things to improve that. We're working on some things also to get our overheads down. For example, this quarter โ I'll give you an example of the kind of thing that can crop up. This quarter, in the second quarter, the shareholders approved some stock options for some of the executives as part of the stock plan approval. Accounting standards dictated that for a couple of us who were subject to the retirement plan of the Company, those expenses had to be taken right away. So $200,000 of the stock option expense is a one-time hit โ and I think it's me and Julius, actually, because he is sitting here looking at me โ that we had to take because the surrender portion of it is deemed to not be operative, since we could retire and still get the vesting on our share options based on the retirement policy of the Company. Julius has been here 15 years; I will be here 10 years next year. So those are the kinds of things that can be ups and downs. And I'm a little sensitive because last quarter we did 49.7 against 50, and people called it a miss. I was a little afraid that 87.9 versus 88 would be called a miss. We're just not that precise. And there are things that do come up. This tax provision โ it's non-operating. It's based on all of the right accounting standards. We have to look at things every quarter and evaluate it. It's just adjustments to reserves we have to flow through the P&L. Actually, some of those things, like the stock option thing go through operating. So we're leaving ourselves a little room, to be frank with you.
- Jim Mcllree:
- Okay. But it sounds like theโ
- John Kavazanjian:
- If we did 25% and we had $10 million in expenses, if you do the math, we are at a much higher number.
- Jim Mcllree:
- Right, right, and so that is what I was getting at. In order to get โ let's call it down to the 7.5%, you need to have lower gross margins. But it sounds like all your gross margin trends are the opposite direction.
- John Kavazanjian:
- We believe so, we believe so. But we have to demonstrate it. We are โ and rightfully so โ we are in "show me" mode. Everybody is saying "show us." And so we will show you.
- Jim Mcllree:
- If we just split that $130 million in half and called it $65 million per quarter, whatโs the gross margin leverage or reverse leverage from going from $88 million to $65 million?
- John Kavazanjian:
- Depending on the product line, it's probably between 25% and 35%, depending on what product line, what kind of mix we have there.
- Bob Fishback:
- Yes, mix. Yes.
- Jim Mcllree:
- When you say 25% to 35%, you're saying gross profit dollars could fall 25% to 35%?
- John Kavazanjian:
- You asked about the revenue fall. If we fell $20 million in revenue, we could fall โ it wouldn't be that โ yes, if we fell $20 million in revenue, we could conceivably fall 25% of that, or $5 million of that. Alright. Now, it's not totally that, because there's sales expense. We have moved to more of a variable sales plan where people are a lot lower base, higher commissions. So there's a commission part of that. There are things that we do โ that can do โ you have to go look at production rates to see our overhead flow and stuff, what are you shipping out of inventory versus what you're shipping out of production. So, itโs not a perfect formula. Best we can do is build it from the bottom up as we have done. It's hard to go forward and backward on this thing. We're going to have to build it from the bottom up. And that is how we do our guidance.
- Jim Mcllree:
- Okay. I just want to make sure, Bob, I understand the tax thing. So every quarter, you're going to evaluate this. And at some point, I would assume that the accountants say, okay, you need to reverse this and put your deferred taxes and asset on the balance sheet again, and then start accruing for taxes on a regular basis. Is that right? So you have some interim period of evaluating it quarter-by-quarter, and then you reach that day when you do the reversal again?
- Bob Fishback:
- I would like to think it's that simple. But itโs going to be dependent upon what our โ as we look back in recent history, there is a metric that we look at for looking back at the last 12 quarters, whether itโs profitable or not, and then looking out with confidence to โ or reliability on forecasting out into the future, and how reliable our forecasts have been in the past, looking ahead. So I would like to think it was that simple, that we could say โ we get to the end of this year, for example, and say, okay, everything looks rosy on out in the future. And we have a high level of confidence, the more likely than not standard for accounting for income taxes that we're going to be able to utilize all of our net operating loss carryforwards. But we may, in consultation with our audit firm, decide that maybe we will only look at only the next year, only into 2009, and potentially reverse the allowance related to our deferred tax asset or something. But I wish it was a very simple answer. But unfortunately itโs very complex. And I just don't have a real pat answer to deal with that.
- Jim Mcllree:
- Right. But it sounds like โ assuming you have a respectable level of profitability in the quarters going forward, that there will be some sort of accrual for, although not cash payment of taxes.
- Bob Fishback:
- Yes.
- Jim Mcllree:
- Okay.
- Bob Fishback:
- Yes.
- Jim Mcllree:
- Alright, thank you very much.
- Bob Fishback:
- Okay, Jim.
- Operator:
- Weโll go next to Richard Baxter with Ardour Capital.
- Richard Baxter:
- Good morning. Just a quick question. What was the total international sales as a percentage?
- John Kavazanjian:
- Well, we didnโt break that out. But probably this quarter, since the large contracts we got were with the U.S. government, it probably was more like 20%.
- Bob Fishback:
- Yes.
- John Kavazanjian:
- It's around 30% to 40% in the past. It probably was more like 20% this quarter. But let me stress that we're giving you that off the top of our head.
- Richard Baxter:
- Correct. I mean, do you have any long-term goal on that orโ?
- John Kavazanjian:
- Well, you know, again, this is the quarter-to-quarter question. In the long term, we think our international business, if you look back, has run 30%, kind of, in the ballpark. It gets increasingly hard to measure, though, because some of our products โ now we are finding some of our products could ship to China or Asia or Malaysia for integration that may come back to the U.S. So is that domestic business, or is that overseas business? I'm not trying to fudge it. I'm just trying to tell you, it gets hard. But 30% is kind of the number. Do we have a goal? I don't think we say, oh, we want our international business to be a certain percentage. I think we look at the markets and see look we think there is significant growth to be had in communications systems internationally. We thought that for batteries in the past in international defense, for example. And we really, really went after that. We saw that in the 9-volt, and we went after it. We really have grown our international business in the 9-volt business very heavily. Now we see it in defense and in communications accessories. So I think that's โ we do have a goal to sell more. I'm sure in our budget we split it out and have a goal. I can't tell what that is offhand, but itโs a very low number right now in communications accessories. It's mostly U.S. And our goal is to make that a pretty good number, because we think there is good market share there.
- Richard Baxter:
- Great, thank you. And I guess you had given some, a little โ run over some of the investments you had done in the second quarter like the R&D, the sales in China, and some of the engineering and technical. Can you give a little bit more depth โ the discussion on that?
- John Kavazanjian:
- Well, yes โ RedBlack Communications is an operation that, when we bought, was running about $4 million a year. We think that's a $10 million to $20 million a year business. And it really hinges on having technical capabilities to do certain things. So, for example, they did a very advanced surveillance van โ and they've done them in the past, that included satellite communications in it. And when we brought them, they had lost their satellite communications expert. So we're bringing that kind of expertise back in house, because it makes us eligible for more opportunities. And so there are things like that in secure communications where, whether itโs IP switching or other things, where we are adding technical talent so that we qualify. People are saying, we'd love to have you do this, but you need to have this capability to get this contract. So thatโs one example of things we're doing. In China, we do a lot of business, a lot of work in battery packs. And a lot of those battery packs, as I said earlier, are going to places in Asia, because thatโs where they are integrated. And we want to move that production to China. And we want to add the capability to do those kinds of designs there, plain and simple, because they are not that complicated. And if we're going to have the customer there served with production out of there, we need the design expertise there. In Newark, the investments we're making are more in large โ we are making investments in design of large-scale batteries. The things that we are doing for smart โ larger-scale smart modular batteries that we're using for standby power, we're going to bring to that market. We're doing more work in that area. But also in RF communications. We have a lot more of our integrated systems that are using amplifiers in RF communications that require EMI shielding and a lot of other expertise which we have, but we need more of. And so that's kind of where we're beefing ourselves up in that kind of capability. So those are the kinds of things we're adding. In the standby power business, we're expanding our technical base there, so we have more people โ as we get more opportunities, we need to do more designs, and we need more technician capability for installations. Those are the kinds of investments we're making.
- Richard Baxter:
- Great, thank you.
- Operator:
- (Operator instructions) Weโll go next to Harper Stephens, Thompson Davis Asset Management.
- Harper Stephens:
- Hi, how are you all today?
- John Kavazanjian:
- Hi, Harper.
- Harper Stephens:
- Quick question โ not to spend too much time on the tax question, but I was curious, you mentioned the word "miss" as you were talking about top line numbers. But I was wondering why you didn't break out the tax charge on a per-share basis this quarter because of course all the newswires pick up a "miss," because that was included in the numbers, and it's not in any of the analyst estimates. And then also, in the future, you said it might be possible to have a tax โ you know, for that to go the other way, and have a benefit. Do you intend on breaking that out, or would you just include that in net income when you report as well?
- John Kavazanjian:
- Well, first of all, we only guide to operating. And the reason we only guide to operating is because there are a lot of exogenous variables like interest rates, like what the tax-free rate is in the Black-Scholes calculation, like who options get given to, and like these regular evaluations of our tax assets and liabilities that can affect โ below the line that we have no operating control over, that are part of our review after the quarter is over. And so we guide to operating, because thatโs what we can control, and thatโs what we can predict. So that โ we want to be very clear on that. Thatโs exactly why we only guide to operating. And I cannot control what the financial press calls a โmissโ on bottom line. We do not โ itโs not โ we only guide to operating, so we only measure ourselves against that. As far as the question about the deferred tax asset, where we put that, thatโs below the line also. That never would go in operating, rightโ
- Bob Fishback:
- Yes โ Harper, you asked whether we break that out separately. I mean, we comply with GAAP. And the presentation of financial statements is in compliance with generally accepted accounting principles. It's included in the income tax section of the P&L in this particular instance. And to take that out and say what the per-share amount related to that is โ that's not compliance with GAAP. So that's why we don't talk about it that way. And again, as John pointed out, we focus on guiding to operating earnings.
- Harper Stephens:
- Okay, no, I understand, and I know that many, many, many companies out there do pro forma numbers. And I just think it would be a better service to your shareholders to allow apples-to-apples comparison with analyst estimates, because they are out there.
- John Kavazanjian:
- I will be frank with you and tell you that the SEC has overtly discouraged pro forma estimates from companies. And it is very difficult to do. You have all kinds of obligations on how you do it, what you have to explain, and so it just makes it tough. I mean, I hear what you are saying. But it just makes it tough. I'll give you one other example, which is we do intangible asset amortization. Once we buy a company, we have to estimate that until we have a formal accounting. Sometimes it takes up to a year to get the appraisal and all the formal accounting for it. And sometimes that may require an adjustment. Thatโs all done below the line because thatโs where it goes.
- Harper Stephens:
- Right, okay. I understand โ just from shareholder perspective, and what people think just from seeing headlines. I appreciate it very much. Thank you.
- John Kavazanjian:
- Okay.
- Operator:
- (Operator instructions) Weโll go next to Steve Sanders with Stephens Incorporated.
- Steve Sanders:
- Good morning. Good quarter.
- John Kavazanjian:
- Thank you.
- Steve Sanders:
- John, maybe first, can you just give us an example of the value proposition for the new repeater product? And then talk a little bit about what you see as the incremental market or customer opportunities there? And then finally, just give us a sense of pricing and margin potential for that product versus what we have seen with the satcom orders?
- John Kavazanjian:
- Yes. I mean companies like โ everybody โ people pretty much I know that companies like Harris and Tallis [ph] have been shipping lots and lots of handheld radios. There are hundreds of thousands of them โ 200,000, 300,000 some of the estimates I have seen, deployed throughout the world. Not just the US Defense Department, but it is the mainstay for Kenya, Indonesia, Colombia, Chile, the Philippines โ you name it. And so those radios are usually five watts โ sometimes 10, but usually five watts, and they are line of site. And they get a range โ best-case range may be a one-mile radius โ so a two-mile range, but usually, it is a one-mile range. And what we have done โ what a repeater does is it puts up a good-sized antenna that can receive over a much better range than the small antenna that a radio has and retransmit that signal after boosting it up โ we use a 30-watt amplifier on ours โ boosting it up with an RF amplifier, and send it to somebody. So basically, you can extend the radius up to five miles โ so give a 10-mile range, possibly. Itโs very important over long distances. Itโs very important where there are physical obstacles. So you might put this on top of a mountaintop, for example. So our tactical repeater did that. It did that in a suitcase that weighed โ I don't know, 20 to 30 pounds; easily carried. So it's the first time somebody had something truly portable. Power โ of course, it's very important these things need power. We have the ability to run it from vehicle power, generator power, you name it. We have batteries. We have feeds on it. Itโs smart, and it can query โ it knows how to turn off the batteries and charge them or not charge them depending on whether the vehicle is running or not. We have done a phenomenal job of power to give them โ optimized operation on this thing. So thatโs the base repeater product. It sells in the area of $20,000 and has wide applicability. I mean just every vehicle โ a light jeep-type vehicle with four people in it who are going to fan out somewhere in a jungle would want to have one of these, for example, not to mention a unit might want multiple of them. What the link repeater actually allows you to do is actually build a network of repeaters. So one repeater can send to another repeater. So you can really โ you can put โ you can station these things strategically in an area either high or low or wherever you want to build a network of repeaters. And you can go โ soldiers can talk to each other over very long distances by hopping repeater to repeater. The other thing it lets you do is it lets you go to satcom. So we can send that repeater to satcom. So a guy with a handheld radio can grab a satcom circuit all of a sudden, which is kind of how we leverage our satcom capability into that. So those kinds of repeaters can sell for upwards of $50,000 โ just the repeater. Sometimes โ bundled with radios and other power accessories, we back up the batteries. We have โ itโs radio-agnostic. It doesn't care what the radio is. We have designed it to be universal, which is another real amazing feature of it. In the future, there are other smarts we could put in it. We could actually have the ability โ we have enough smarts in it that we could develop this potentially to have one type of radio speak to another type of radio, which would be really interesting. So to our mind, this is just the start of the kinds of things we can do with these. And that's the basis for a whole family of products. Did I answer your question there?
- Steve Sanders:
- Yes, you did. And then just a follow-up, where are you in terms of developing the orders for the product? Kind of describe the activity. How are you thinking about that over the balance of 2008 going into '09?
- John Kavazanjian:
- We promised the U.K. defense organization we were working with that we would get this product to their spec first. Everybody has different needs. And so we got them โ they bought about 300 units, I believe. They were part of our initial implementation. They helped us in โ you never get it perfectly right ergonomically and all the first time. And we finally got to the point where we have just started selling these worldwide. We just started this โ actually, I think May or June selling them worldwide. And the link repeater product, we just bought out in the last couple of weeks. It showed up for the first time in Singapore at a defense exhibition, and then went down and demonstrated it in Australia. So we are at very early stages here, Steve, and there is nothing in our revenue for this year that we are counting on for. But we think it is going to be, as I said, an important part of our revenue stream next year.
- Steve Sanders:
- Okay. And then on the auto telematics side, can you just bring us up-to-date on what you are seeing in terms of shipment and revenue trends with existing customers? And I think you were expecting to add some other customers here over the next couple of quarters going into '09. Just give us on update on that.
- John Kavazanjian:
- Yes, with our existing customers โ we haven't added customers. We have added platforms. I think starting this second half of the year, we have two additional platforms, two additional car platforms that will have this battery in it, the backup in it. Even I know โ everybody knows that one of our good-sized customers is General Motors. And everybody knows they have had difficulties, and they are tightening down. But they are still very committed to the OnStar program. We are still โ even if vehicle production is down, we are still in a very low percentage of the number of cars that have this system, so that platform penetration is much more important than absolute number of cars sold in total. So that's going along pretty well. We are going to go into an extra โ two more platforms there. And then โ I said in the past we have had several designs with some European customers for their crash notification system. None of that is in our numbers right now. And we don't know yet if that's going to be in their plans for the '09 model year or not. We don't have that in the basis for any of our plans. We know โ we believe they are going to do it eventually. We don't know if '09 is the year, or 2010 is the year.
- Steve Sanders:
- Okay, alright, thanks. And then, Bob, can you just give us a little bit more color on the U.K. charge? You mentioned it a couple of times about making it more of a service facility. But did you write off some equipment, or take a facility charge โ or what's in there?
- Bob Fishback:
- There is a combination of things related โ just as we evaluated the overhead structure over there, there were some people costs that we took for termination, which is a little more than half of that charge. And then there were some inventory adjustments as well as some valuation adjustments for certain fixed assets that made up the rest of that.
- Steve Sanders:
- Okay. All right. And then last question, just CapEx outlook for the year?
- Bob Fishback:
- CapEx outlook for the year is in the range of $5 million for the year. We are at $1.6 million year-to-date for the first half right now. We are probably going to do a little bit more in the second half with some of these initiatives that we have got on target to continue to grow the business.
- John Kavazanjian:
- Yes. $5 million is our plan. Our history is that we end up spending 75%, 80% of that, because even when we approve the project, sometimes, we don't end up spending the actual cash out until the next year.
- Steve Sanders:
- And then, actually, one follow-up question, on the $125 million or so of satcom orders, just roughly, what have you shipped? And what do we expect there over the back half, 3Q versus 4Q?
- John Kavazanjian:
- Yes, Steve, to be honest with you, we haven't tracked that. And we have been asked not to talk about that. So we have a decent โ we have shipped over โ all I can tell you is we have shipped over half of it, but we still have a bunch to go.
- Steve Sanders:
- Okay. Okay, thanks very much.
- John Kavazanjian:
- Thanks.
- Operator:
- And with no further questions in the queue, I would like to turn the conference back to our presenters for any additional or closing remarks.
- John Kavazanjian:
- Well, thanks, everybody. Ultralife Batteries is now Ultralife Corporation. But the Company changed well before the change of the name. And we are going to continue on that trend โ as you can see, continue to expand our offerings of products and services. And itโs all aimed at serving our customers and markets. And itโs all with our goal of rewarding long-term shareholders. We are going to continue to grow our revenue and improve our margins. And we really look forward to sharing our progress with you next quarter. Thank you for participating.
- Operator:
- This concludes today's conference. We appreciate your participation. You may now disconnect.
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