Ultralife Corporation
Q1 2013 Earnings Call Transcript

Published: 3 May 2013

[Operator:]

Good day and welcome to this Ultralife Corporation First Quarter 2013 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.

[Jody Burfening:]

Thank you, Tim, and thank you everyone and good morning. This is Jody Burfening of LHA. Thank you for joining us for Ultralife's earnings conference call for the first quarter of fiscal 2013. With us on today’s call are Mike Popielec, Ultralife’s President and CEO 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 potential reductions in U.S. military spending, uncertain global economic conditions and acceptance of the company’s new products on a global basis. 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. Further information on these factors and other factors that could affect Ultralife’s financial results is included in Ultralife’s filings with the SEC including the latest annual report on Form 10-K. 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.

[Mike Popielec:]

Good morning, Jody and thank you everyone for joining the call this morning. I plan to start today by making some high level observations about our first quarter 2013 operating performance. Then I will turn the call over to Phil, who will take you through the detailed financial results. After Phil has finished, I will take the call back to provide an update on our top 2013 priorities and then share with you our thoughts on the full year financial outlook for 2013 before opening it up for questions. In the first quarter of 2013, by ensuring operating expense reductions track net revenue decline while significantly improving operating efficiency and product mix, solid execution by the teams reversed the prior year's first quarter $1.3 million operating loss, and delivered a third profitable quarter in a row. Reported first quarter 2013 gross margin of 30.3%, an increase of 630 basis points year-over-year and a 24% reduction in year-over-year operating expenses offset the impact of the revenue decline and led to an operating margin achievement of 1.8%, up 650 basis points year-over-year. Our communications systems business revenue was up 7% year-over-year, its third consecutive quarter of year-over-year revenue growth, while our battery and energy product revenues continue to be challenged and were down 35%. Looking a little closer at our B&E products business, the negative revenue comparable was driven by a year-over-year reduction in charger orders from one of our large U.S. government defense OEM and some end of life legacy product buys that occurred in Q1 or last year, associated with our next generation 9-volt product line transition. Noteworthy, is that although the aforementioned 9-volt revenue decline represented approximately 25% of the total B&E revenue drop, given the higher gross margin associated with the new next generation 9-volt battery, the gross profit dollars generated by 9-volt were actually higher this year despite the lower 9-volt revenue. This and other manufacturing variable cost productivity improvements for B&E operations groups drove to a solid execution, helped increased gross margins by 410 basis points to 23.7% despite the lower revenue in Q1 2013. At communications systems, similar execution success and mix led to a gross margin improvement of 550 basis points from 35.7% to 41.2%. We look forward to the significant operating leverage, the discipline that has been established by our business model and lean initiatives will provide when market conditions, expected sales force productivity and potential future acquisitions contribute towards higher manufacturing volumes. In Q1 2013, the reported total company expenses of 28.6% to sales was about what we had expected. Again, this ratio is still several points higher than our long term goal of 20%, as we continue to invest in new product development and improving our sales force productivity to drive revenue growth. In summary, we are pleased with the solid execution that is driving the variable cost productivity and gross margin improvement trends in both businesses, as well as our disciplined operating expense control and cash management. Our validated business model which guided once again to quarterly profitability and reverse the prior year's first quarter operating loss, positions us well for further operating leverage gains as both businesses return to top line revenue growth. In a few minutes, I will talk more about 2013 but first I would like to ask Ultralife’s CFO, Phil Fain, to take you through additional details of the first quarter 2013 financial results. Phil?

[Phil Fain:]

Thank you, Mike and good morning everyone. Earlier this morning, we released our first quarter results for the period ended March 31, 2013. For purposes of reviewing our first quarter financial results, I will discuss operating results from continuing operations for 2013 compared to 2012. Consolidated revenues for the first quarter totaled $21 million, representing a $6.5 million or 24% decline from the $27.5 million for the first quarter of 2012. Revenues from our battery and energy products segment were $13.1 million, a decline of $7 million or 35% from last year. This decrease is primarily attributable to the continued slow down in the U.S. government and defense order rate for rechargeable and non-rechargeable batteries and charger systems, as well as the selloff of our legacy 9-volt batteries with the introduction of the newly designed in the product in the first quarter of 2012. The sales mix of our battery sales were split 50

[Mike Popielec:]

Thanks, Phil. The top three priorities that we have established to drive efficient operational execution and to reposition the company for growth, have evolved from the prior years but in 2013 fundamentally remain, one, improving profitability; two, executing on a growth game plan; and three, leveraging our China operations for global growth and competitiveness. Regarding improving profitability, we continued to be mindful of our 30, 5, 5 10 equals 10% operating margin business model goal. Achieving 30% gross margins is a key element in having the cost headroom to spend roughly 5% of sales on each, the new product and selling initiatives, we view critical to increasing competitive advantage and driving growth. We will continuously drive new lean projects to improve variable cost productivity and offset any labor or material cost increases and mix fluctuations. As our first half of the year tends to see less revenue throughput than the second half, with one quarter behind us, we are off to a good start. We [pulse] manufacturing P&L metrics and actions plans weekly and have added a formal sales and operations planning process to gain better inventory efficiency, cycle time reduction, and of course more variable cost productivity. Today we have been aggressively returning the company to profitability without sacrificing our investment towards future organic revenue growth opportunities. We are seeing the approach start to pay off in the quarterly, year-over-year revenue growth of our communications systems business that has now delivered in four of the last five quarters. And we are acutely focused on achieving a similar outcome in our battery and energy products business. Whereas we are pleased with the operation execution and productivity gains to date, we know that by far the biggest impact we can have on our overall company profitability going forward is to capture the operating leverage available from consistent top line growth. This fact leads us to our next top priority for 2013, and that is achieving total company revenue growth. The core components of our revenue growth plan include, expanding our market and sales reach, developing new products, and added for 2013d, pursuing acquisitions. In our communications systems business, over the last few years the team has expanded their focus on larger project opportunities, improved channel management and growing internationally. In Q1 of 2013 once again, the international to domestic mix of total revenue was approximately 41%, well above historically single digit levels prior to 2012. Also, in terms of widening the aperture of customer opportunities, again both domestically and internationally, we have nearly tripled the number of OEMs and doubled the number of special forces groups that we are engaged with on a regular basis. While doing so, the team has been very focused on pursuing funded opportunities, and this has helped us more efficiently allocate our resources to projects with realistic timeframes for near term revenue capture. For the battery and energy products business, we have been focused on the government defense, safety, security and medical, and energy and infrastructure market segments. To drive deeper penetration into these markets, within the last year we have brought on board two senior executive level sales and business development talent. And we also recently announced the appointment of one of our own proven business veterans as a senior executive dedicated to the global expansion of our primary battery sales. One of our missions is to develop an aggressive world class sales team capable of efficiently identifying niche application opportunities and structuring win-win transactions for both the customer and the company. As a company that has been strongly positioned in the U.S. government defense business, and it was now more assertively diversifying into the commercial markets, we had in some cases needed to develop from scratch, the skill sets, value proposition and customers relationships to effectively serve these markets and customers, and that has required some time to do. At the same time, we have been very active in developing and closing meaningful transaction with new strategic business partners, such as the multi-year, million dollars contracts mentioned last year, with two medical device companies, as well as strategic long-term partnerships with customers in the energy storage space. Our strategy is to leverage the proven military grade reliability of our batteries and chargers to grow our business outside of our core government defense business segments and into commercial markets, where they also demand the highest level of performance and reliability, given the mission critical demands they serve. In the area of business development, the focus has been on accelerating or new product development and go to market and revenue realization. To date, we have been very busy putting the platform in place for flexible and repeatable new product development processes that specifically leverage our core competencies, and vetting target markets where these solutions result in a fastest time to market and best competitive advantage to accelerate growth. Near term, this means markets that place a high value on small, lithium ion energy solutions such as small [motor], internal combustion engine replacement, telecom and portable power markets. Longer-term, we expect this to mean small to medium sized energy and power solutions with the power capability that will support to bridge to backup and certain reserve applications. We are also strengthening our product marketing function, a crucial component of any new product development and product launch process. Even the most skeptical expert in the field of energy storage, predicts extremely strong growth in the industry going forward. However, the timing and technologies are hotly debated. Certain niche markets have already seen the early stages of that growth, such as in high power or [RAID] applications. Whereas to date several of our products are more geared towards energy or capacity type applications, our new business development focus is helping us better understand these trends, so that we can position ourselves to take full advantage of the strong industry growth expected over the next three to five years. Having been highly focused in the past on the U.S. government defense market and given our manufacturing business model, we are making sure that the new products we are developing are flexible enough to be applied across multiple markets. This will maximize our opportunities for success. The third prong of the B&E sales and market expansion portion of our revenue growth strategy, is to drive global market penetration of the primary cells that we manufacture in our own plants in both the U.S. and China. Whereas officially, our new global primary sales leader is still finishing up his assignment as the in-country General Manager of our China operations, he has already started developing some initial focus areas. These include, taking our proven smart electric [metering] cells worldwide, broadening our penetration of thin cells for RFID tracking, medical, asset management and smart cards applications, and taking our new next generation 9-volt lithium battery into the growing number of countries that have mandated completely sealed smoke alarms for all rentals and public buildings. As an update on new product development, in our communications systems business, we have been driving several revenue growth opportunities. These include our new light weight portable amplification system, or LPAS. The new A-320 handheld vehicle adaptor or HVA. Our A-301-150 satellite radio combiner, and for the new rifleman radio, our vehicle integrated power enhanced rifleman's system, or VIPER. Regarding the LPAS, which as an ASP of approximately $10,000 each, to date we have shipped orders for over 150 units with more orders forthcoming from both U.S. and international customers. For the A-320 HVA, which carries an ASP of roughly $4000 each, we have shipped over 250 units thus far. And for the A-301-150 satellite radio combiner which has an ASP of about $20,000 each, we have shipped approximately 20 units to date. To put it in perspective, for our communications systems business, since the launching of just these three new products less than a year ago, we have generated close to $3 million in new revenue for a business unit whose total revenue in 2012 was $13 million. This demonstrates the strong influence these new products can have on achieving organic revenue growth for communications systems. When we consider the revenue trends coming from the new products already launched and think forward about the revenue growth opportunities from several other new products under development for integrated radio accessory and vehicle solutions such as the VIPER system for the rifleman radio which is expected to be released this quarter, we like our prospects for continued communications systems revenue growth. In our battery and energy products business, you will recall that we have been focused on taking to market the Ultralife GSE GenSet Eliminator. Our MKM large format batteries, the new high capacity 5390, 2590 and CFX batteries and cells, and a new (inaudible) battery, to name just a few. With our GSE, we now have four different customers evaluating our full system. The proof of concept demonstrated by these units out in the marketplace is leading to more potential direct sales of the Ultralife branded innovative systems. It is also driving even more request from third party providers selling similar generator set solutions for our MKM large format battery. The MKM is an integral component of our GSE, but also a product we sell separately. To date, we have now approximately a dozen different customers for the Ultralife MKM, to which we have shipped 70 units. Customer applications include genset efficiency systems for the U.S. Marines, U.S. Army and several other end users. A border security system for international customer and a micro grid battery bank for a sustainability facility. Derivations of the MKM, have led to orders for portable power systems, applications serving respondents in disaster relief, and for medical card application. Regarding our new high capacity 5390, 2590 and CFX batteries and cells, we have now shipped just 1000 units to a wide cross-section of highly interested customers for evaluation. And lastly, our new (inaudible) battery is gaining traction with approximately 12 customers evaluating close to 70 shipped units. To put the importance of new product development for B&E into perspective, as stated during our last call, 35% of our 2012 total B&E products revenue came from products that were less than or equal to three years old. Admittedly, the revenue obtained from several of the new products mentioned today still represents a small overall number. However, when tracing the year to year revenue growth rate from all of our B&E new products, it's in the double-digit range. Meaning, the contribution from new product development is growing at a healthy rate. We like this trend and are looking forward to how this will results in future year-over-year revenue growth as we [lap] some of the larger legacy revenue components that are no longer part of the B&E revenue base due to customer product lifecycle, lack of profitability or DoD spending levels. Lastly, in the area of revenue growth, we are now seriously pursuing acquisition opportunities for both for our communications systems and battery and energy products business units. Our goal is to add key technology, capability, market access, reach or brand recognition with companies where an acquisition will provide us with faster speed to market and revenue realization than a normal organic approach would afford. As stated earlier, or third top priority is to leverage our China operations for global commercial business growth and improve cost competitiveness. Also our China team will continue to drive operational excellence and variable cost productivity improvements by building on the successful projects completed in 2012, as well as executing our new projects identified for 2013. While we will continuously and aggressively pursue operational productivity improvements projects in China, going forward on future calls, I will talk mostly about the revenue opportunities that we are developing by leveraging our China produced primary battery products into global markets, rather than discuss the operational improvements that are a now a normal course of business. Regarding the financial outlook for 2013, we are confirming our prior guidance and still expect them to see low to mid-single digit, year-over-year organic revenue growth reflecting solid growth in our communications systems business. Offset somewhat by modest gains in the battery and energy products business. And with ongoing operational productivity improvements and plans to continue prudent investment in new product development, we expect to increase year-over-year operating profitability and achieve an operating margin rate in the mid-single digit range. We continue to take a conservative outlook for revenue in the operational execution of our business model, so that we can maintain profitability while funding our new product development and sales force productivity activities. Identified customer buying patterns and pending projects timing, continue to suggest a softer first half followed by a stronger second half in 2013. For communications systems, our pending business opportunity funnels for both domestic and international projects remain strong, and as such we are optimistic for continued growth and expect communications systems revenue to increase by high-single digits to low-double digits over 2012. This growth trajectory could be skewed based on the timing of pending large projects, so we will be sure to announce any particularly large contract awards. Despite the budget pressures confronted by our U.S. government defense customers, our plans to diversify our revenue by driving international and commercial opportunities are proceeding and we are still planning for modest revenue gains in our battery and energy products business in 2013. As stated earlier, the B&E pipeline of future market opportunities from our new products continues to widen and grow. However, much of our B&E U.S. government defense business depends upon some large OEM for end customers, who have been public about downward volume trends. We continue to hold the view that B&E volume gains from our new products, new market segment, and new customers, may not be able to fully offset the U.S. government defense revenue decline. That said, with the new sales and business development leadership in place, we are doing all we can to cross over the line for year-over-year B&E revenue growth. With respect to operating profit, we were pleased to deliver operating profitability in Q1, typically a slow revenue quarter for us. We said during our last call that in 2013, we plan to take the next step towards our interim 10% operating margin goal by achieving profitability improvement each quarter year-over-year and achieving a mid-single digit operating margin rate for the entire year. We believe we are on track after Q1. In closing, through solid execution in both of our business units in the face of ongoing softness in our battery and energy products business, we delivered our third consecutive profitable quarter consistent with our internal expectations and reversed last year's operating loss. Revenue growth continues to be the top priority of our leadership team and with an efficient and profitable business model and strong cash generation, we remain well positioned to realize operating leverage gains on revenue growth during 2013. Operator, this concludes my prepared remarks and we would be happy to open the call for questions.

[Operator:]

(Operator Instructions) We will take our first question from Walter Nasdeo with Ardour Capital.

[Walter Nasdeo:]

Obviously, you have had some good results on the cost cutting side and increasing the margins. I am still a little shady though, on how you are going to -- for the rest of this year, get the mid to upper single digit growth over the last year, considering where we are starting the year off in the low $20 million level. So can you kind of talk about that? I understand that second half is going to be better than first half but that’s still kind of a pretty big increase that we need to see. And can you kind of maybe walk me through that a little slower maybe, I guess. I don’t know, because I had a hard time following it.

[Mike Popielec:]

That’s correct. Let's take at the top level. We are expecting the communication systems business to show the growth rate that we mentioned in the prepared remarks. The first quarter of this year for our B&E products business, we knew it was going to be another tough comparable. The comparables for the rest of the year quarter by quarter for the B&E business, look more favorable versus our internal pending projects pipeline such that with some things happening the way we think they could happen, continue expansion of our new product development driven revenue opportunities and some commercial customers that are getting more and more engaged with some of our new products. We are looking to try to get B&E by the end of the year, really to trip over the flat to slightly up year-over-year revenue. And that when combined with the communications systems business revenue, would yield the overall guidance level we have for revenue improvement year-over-year. Most of the --- when you break down the pieces of the B&E business, historically there was a pretty large chunk of business associated with telematics in our commercial segments which we have now lapped. We had to lap the Iraq and Afghanistan draw down, decline in some of our core battery packs. Those are now starting to be fully lapped. And then now we have some lumpiness in terms of some large charger orders that happened about a year ago. All those considered, we have to say that we are expecting to have more reasonable comparable opportunities to the rest of the year. And all up all in , we are hoping to our guidance for mid-single digit revenue growth.

[Walter Nasdeo:]

Okay. But as the battery segment increases, we should look for the margins to pull back a little bit, right?

[Mike Popielec:]

You know in terms of mix, I guess logically you could say that. But certainly we will continue to try to eke out 100 to 150-200 basis points each year in the businesses such that, yeah, the mix maybe is more favorable at this point but hopefully the EPS number is much more favorable.

[Operator:]

We just had a question from Gary Siperstein with Eliot-Rose Asset Management.

[Gary Siperstein:]

Mike, can you give us any color of where we stand with Harris. I saw that they -- I guess their IDQ was increased by $0.5 billion and I know they have been a big customer in the past. Can you talk about that relationship and the potential going forward?

[Mike Popielec:]

No, we don’t typically respond too much about any specific customers. But relative to Harris, we continue to enjoy a very closer relationships. We now are [OEM] partners in terms of number of the activities we pursue together. They have been very public in some of their business challenges. That gives us visibility if you will, maybe not always positive as some of the potential trends for our revenue, which have been well factored into our operational plans so we maintain profitability. So we work closely with them. We are not expecting the things that they have been announcing publicly to affect us more than what we had already anticipated and for the large part have been factored into our business model.

[Gary Siperstein:]

Okay. And the decline in the inventories, Phil, for the quarter. Is that sort of -- now that you have got the low hanging fruit, is that sort of a quarterly decline in inventories that we can expect and where do you see normalized inventories bottoming out?

[Phil Fain:]

Gary, I would a expect a continued improvement quarter-over-quarter that’s going to lead us to the goal that we had talked about earlier. And there is a couple of different ways to look at it. One way is the traditional way that I spend a lot of time looking at, and that is reducing the dollar value of the inventory because it provides the cheapest financing that the company could ever wish for. Second of all, we look very closely to inventory turns for the total company, by business segment, and down to specific product lines. And as I think you are aware of, this has been a major initiative, the next step of our lean experts, and they have extensive plans at the product line basis that are coming together, that we monitor weekly and that we should expect to see continued results going forward. So I would say at this point, we are in line with our internal expectations for inventory.

[Gary Siperstein:]

Okay. And Mike, back to getting sales to move in the right direction. So you mentioned the new products over the past 12 to 18 months, and the seeds you have planted and the products better, many large companies are looking at and may go into bigger orders for us. Plus this sales team, you have improved. What else is there? I mean is it new additional products coming forward from those that you have mentioned or is it you know the sequester or the government slow down sort of bottoming. Maybe not growing, but at least not hurting us anymore. Can you talk to that point a little bit?

[Mike Popielec:]

Yeah, I think in a nutshell, we are targeting customers not to just similar to our core U.S. government defense customers who tend to take a long time to specify, evaluate tests and be very comfortable with our products before ordering in large quantities. And to the extent that, as I stated in my prepared remarks, we are going after those types of commercial customers, there is still that lengthy process. And you can show your [case] ideas on a PowerPoint slide and still they have chance to go through a really demo and get a lot of, voice the customer feedback on it, you really don’t have a product that is going to be able to be bought in in large quantity. So it's really just getting through that process. But what I like about where we are, is that the interest level is growing widely. And as long as we are focused on making sure that we spend our precious financial and human resources on products that -- actually we have a clear competitive advantage and some stickiness with the customer, I am confident about our growth prospects. It's when it gets too diluted and try to serve too many different customers with too many different ideas, given the small size of our company that we can sort floor ourselves down. So the irony of it is, that with the more opportunities we have to be even more selective so we can get some revenue to bottom line.

[Gary Siperstein:]

Okay. My recollection was in the last conference call, you guys implied that there could be, I guess a larger potential order out there? And obviously there has been no news yet. So has that disappeared or has it just moved to the right?

[Mike Popielec:]

Those opportunities are still on play.

[Operator:]

(Operator Instructions) And at this time there are no other questions in queue and I will turn it back to our presenters for any closing remarks.

[Mike Popielec:]

Thank you once again everyone for joining us for our first quarter 2013 earnings call. I look forward to meeting up with several of you in person over the next week or so and to sharing with you our quarterly progress in each quarter’s conference call in the future. Thank you very much.

[Operator:]

And that concludes today's conference call. We appreciate your participation.