ULBI - NASDAQ

Good day and thank you for standing by. Welcome to the Ultralife Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jody Burfening. Please go ahead.

Thank you, Jada, and good morning, everyone. And thank you for joining us this morning for Ultralife Corporation's earnings conference call for the second quarter of fiscal 2023. With us on today's call are Mike Manna, Ultralife's President and CEO; and Phil Fain, Ultralife's Chief Financial Officer. The earnings press release was issued earlier this morning, and if anyone has not yet received a copy, I invite you to visit the company's website, www.ultralifecorp.com, where you'll 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. The potential risks and uncertainties that could cause actual results to differ materially include supply chain disruptions, potential reductions in revenue from key customers, acceptance of our new products on a global basis and uncertain global economic conditions. The company cautions investors not to place undue reliance on forward-looking statements, which reflects 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 the company's filings with the Securities and Exchange Commission, including the latest annual report on Form 10-K. In addition, on today's call, management will refer to certain non-GAAP financial measures. The management considers to be useful metrics and differ from GAAP. These non-GAAP measures should be considered supplemental to corresponding GAAP figures. With that, I would now like to turn the call over to Mike. Good morning, Mike.

Good morning. Welcome to the call on Ultralife's Q2 2023 operating results. Let me first say I'm very proud of our internal team and valued supplier network, which after a slow start to the quarter due to the lingering impact of the previously reported Q1 cyber-attack, the teams rallied. Both businesses delivered strong Q2 performance with revenue up 33% and operating profit increasing over 360% year-over-year, highlighting the leverage of our business model. We increased gross margin for the total business over Q1, even with a slow start to the period. I am pleased that even with the strong revenue, our total backlog was not only replenished, but increased to the highest in company's history exiting Q2. I will now turn it over to Phil to talk through the Q2 financial results.

Thank you, Mike, and good morning, everyone. Earlier this morning, we released our second quarter results for the quarter ended June 30, 2023. We also filed our Form 10-Q with the SEC and updated our investor presentation, which you can find in the Investor Relations section of our website. I'd like to thank all those that help make this happen. Before starting the financial review, I want to point out that our business interruption insurance claim resulting from our first quarter cyber-attack is still in process. I look forward to sharing with you the details of our claim once the settlement has been finalized and funded, after which we will include the settlement amount in our financial results. Consolidated revenues for the 2023 second quarter totaled $42.7 million compared to $32.1 million for the second quarter of 2022, an increase of 32.9%. Government defense sales increased 111.5% and commercial sales increased 9.2% compared to the year earlier period. Our total backlog exiting the second quarter increased 2.6% over the first quarter to $110.9 million, the highest level in the company's history and representing a 40.1% increase over the comparable period last year. The backlog is diverse in nature across our commercial and government defense customer base and we expect approximately 70% of the backlog to ship during the second half of 2023. Revenues from our Battery & Energy Products segment were $33.9 million compared to $30.1 million last year, an increase of 12.3%, reflecting strong year-over-year growth in our three major markets that together accounted for approximately 83% of the segment revenues. Government/defense sales increased 26.6%, medical battery sales increased 25.2%, and oil & gas sales increased 17.9%. These increases were partially offset by an 18.8% decline in other commercial sales primarily in China due to the timing of certain industrial sales. The backlog for our Battery & Energy Products business exiting the second quarter increased 12.1% over the first quarter to $98.5 million, also the highest level in our company's history for this segment. The sales split between commercial and government/defense for our battery business was 80-20 compared to 72-28 (ph) reported for the 2022 year and the domestic to international split was 51-49 compared to 49-51 for last year, accentuating the continued success of our global revenue diversification strategy. The $27 million of commercial sales for the second quarter was the highest for any quarter in the company's history. Revenues from our Communications Systems segment were $8.8 million compared to $2.0 million last year, a more than four-fold increase, primarily attributable to shipments of vehicle amplifier adapters to a global defense contractor for the U.S. Army and integrated systems of amplifiers and radio vehicle amounts to a major international defense contractor under an ongoing allied country government/defense modernization program. The backlog for our Communications Systems business of $12.3 million was down 38.8% from the backlog of $20.2 million exiting the first quarter as we continue to deliver on existing programs while working towards securing the next round of defense program orders in the first round of significant commercial orders. On a consolidated basis, the commercial to government/defense sales split was 63-37 versus 71-29 reported for the 2022 full year. Our consolidated gross profit was $10.6 million for the 2023 second quarter, up 38.5% over the 2022 period. As a percentage of total revenues, consolidated gross margin was 24.8% versus 23.8% for last year's second quarter and increased by 150 basis points over the first quarter. Gross profit for our Battery & Energy Products business was $7.5 million compared to $7.2 million last year. Gross margin was 22.3%, a decrease of 60 basis points from 22.9% reported in the first quarter and a decrease of 140 basis points from 23% reported last year. The year-over-year decline was primarily due to lingering inefficiencies resulting from the Q1 cyber-attack, the disposition of certain nonconforming materials and continued investments in the transition of new products to high-volume production, partially offset by improved price realization. For our Communications Systems segment, gross profit was $3.0 million compared to $0.5 million for the year earlier period. Gross margin was 34.5% compared to 24.9% last year, reflecting higher factory throughput leading to higher cost absorption and favorable product mix. Operating expenses were $6.9 million, the same as that reported for the year earlier period. As a percentage of revenues, operating expenses were 16.2% compared to 21.3% for last year's second quarter, a 510 basis point improvement, demonstrating the sales leverage of our business model. The combined leverage of our gross margin improvement and flat operating expenses resulted in a $2.9 million or more than four-fold increase in operating profit to $3.7 million compared to $0.8 million for the 2022 second quarter. During the second quarter, the company confirmed its eligibility for the Employee Retention Credit, ERC, which is a refundable tax credit against certain employment taxes under the CARES Act of 2020 and the American Rescue plan of 2021 and filed the necessary amended payroll tax forms with the Internal Revenue Service to claim a refund for the credit. The ERC refund receivable of $1.5 million is reported in other current assets on our balance sheet and as other income, which is below operating profit in our income statement. Our tax provision for the second quarter was $1.4 million versus $0.2 million reported for the 2022 quarter computed on a GAAP basis, including the impact of interest expense to help finance the Excell acquisition, foreign currency losses associated with the strengthening of pound sterling to the U.S. dollar and the ERC. Net income was $3.3 million or $0.21 per share. The ERC net of taxes computed on a GAAP basis represented $0.07 per share with the remaining $0.145 per share resulting from operations. This compares to net income of $0.2 million or $0.03 per share for the 2022 quarter. Excluding the provision for non-cash U.S. taxes expected to be fully offset by our net operating loss carryforwards and other tax credits. Adjusted EPS was $0.29 for the second quarter of 2023, with operations contributing approximately $0.20 per share compared to $0.03 for the 2022 period. Adjusted EBITDA, defined as EBITDA, including noncash stock-based compensation expense was $6.3 million or 14.7% of sales for the 2023 quarter, including the ERC compared to $2.2 million or 6.8% for the prior year quarter. Turning to our balance sheet. We ended the 2023 second quarter with working capital of $58.6 million and a current ratio of 3.0 compared to $50.1 million and 2.7 for 2022 year-end. While inventory decreased 2.6% on a sequential basis, the 11.8% increase over 2022 year-end, primarily reflects the impact of the Q1 cyber-attack as well as continued actions to proactively influence our position to service our substantial backlog. With the cyber-attack in our rearview mirror, going forward, our backlog, diversified end markets, growth initiatives and ongoing actions to improve our gross margin position us well to continue to optimize the leverage potential of our business model. I will now turn it back to Mike.

Thank you, Phil, for the detailed breakdown on the Q2 performance. As mentioned, we continue to focus on executing our backlog and improving gross margin. Several operational initiatives are in process to smooth production flow, better manage inbound and outbound materials, which improves cash flow. We realized some improvement in gross margin in Q2, but many of our initiatives are in the early stages of implementation, so I expect to see further improvement throughout this year and into 2024, subject to the stable mix of customer demand. Supply chain improved in Q2 where we were able to produce and procure parts needed to execute our ship backlog, except for some specialty parts that still have excessively logged lead times. Customer forecasts and orders remain strong, allowing us to order parts within lead time windows and eliminate expediting fees, which is expected to generate some cost side improvement by the end of the year. Direct labor remains tight in all locations, both internally and within our supply chain, but we were able to increase our headcount in Q2. To recap the top initiatives in progress, we continue price realization activities, experiencing some benefit in gross margin in Q2 and continue initiatives to improve and stabilize our gross margin performance for both businesses. Communication Systems, specifically as a backlog of contracts that are priced in some cases over a year earlier, which results in margin pressure from pricing than award to actual delivery. We expect to complete this heightened pricing initiative this year and return to normal cadence price reviews while transitioning focused to internal cost down activities. We continue our journey of extending the time horizon of our sales and operations planning process with both customers and suppliers, improving our end-to-end forecasting. This process is being refined, and we've experienced strong orders and forecast from most of our recurring customers, aiding our planning and procurement functions. Lastly, we continue to improve our process of launching new products and transitioning to higher volume production with appropriate design for manufacturing and lean principles. Next, I will give some brief updates on our organic growth strategy of new product development. First, on the Battery & Energy side of the business, we continue to develop and improve products for our branded general sales and for our important OEM customers. Our ThinCell product line continues to gain momentum in the rapidly growing medical wearable and product tracking market spaces. We have purchased additional CapEx, which began arriving in Q2 and should be operational by the end of Q3. This equipment should start qualification and validation in Q4 to support forecasted demand by our customers. On the UB123A cell line servicing the IoT market space, we continued cadence production shipments and expect volumes to ramp this year. The XR123A, our carbon monofluoride blend version of this cell with 20% to 30% more energy in the same size, just successfully completed UL safety testing last week, enabling us to start commercial sales in our target end markets. Both of the 123A cell variants, we continue to work multiple opportunities for cell sales, but ultimately believe battery pack assemblies will be a crucial piece of this product line, where custom solutions can offer added value and longer-term customer relationships. We have multiple partners evaluating our improved thionyl chloride product line, targeting monitoring and telemetry applications where this technology can power items across an extreme temperature range for up to 20 years. With a 20-year life expectancy, the qualification and validation time for these products can be excessive. In Q2, we received a follow-on purchase order for $2.5 million from an international partner for our X5 Power System for medical carts, initially launched in 2022. We launched a follow-on hot swappable power system for USB-powered devices, the X5-LITE earlier this year, which is currently sampling to prospective customers. The development of the conformal wearable battery used to power advanced dismounted soldier equipment was paused in Q2 temporarily to utilize our engineering resources to support near-term growth projects with committed revenue for this year. With a 90-day contract extension with the government in place, we anticipate the work will resume on conformal in Q4. This being an indefinite quantity, indefinite delivery contract with uncommitted volumes, we will continue to balance internal resources for this project with other known revenue generating and cost reduction projects. Secondly, on the Communications Systems side of the business, we anticipate commercial orders this year for our EL8000 server cases and power system as validations are complete. This will help diversify and scale to the business. Meanwhile, we continue to work on advanced amplification and power products with multiple partners to support air, ground and sea communications, primarily military in nature. Lastly, on growth. We continue developing strategies and relationships on how to best position us to take advantage of the electrification and 5G market spaces. Looking for niche applications and investments that will enhance our competitive advantage, leveraging our cell design expertise and power system capabilities. As an example, we currently have 1 commercial OEM development partner resident at our Newark facility and are in discussions with several other partners to collaborate on advanced cell chemistries and designs. In closing, after a strong Q2, we continue to be laser focused on our goal of returning to profitable growth, which is key to paying down our acquisition debt. Execution continues the main priority for both businesses. With Communication Systems increasing scale to achieve consistent profitability, Battery and Energy converting on multiple growth initiatives while driving gross margin improvements. Thanks, everyone for the attention. That concludes the prepared remarks. Now back to the operator for questions.

Thank you. At this time, we will conduct the question-and-answer session. [Operator Instructions] Our first question comes from Josh Sullivan of The Benchmark Company. Please go ahead.

Hey. Good morning. Impressive results here.

Good morning, Josh.

I know you're still working through the cyber-attack paperwork. But can you talk about how you were able to recover so quickly. And then any residual impact we should think about going forward at all?

Well, it's really a testament to our whole team and the external resources that we use to help us basically get through the event and back on our feet as quickly as we did. There's still some pockets of recovery going on. For the most part, the attack did not disrupt any of our technology or our manufacturing systems. It was mostly documentation and other things that can be recreated over time. And luckily, the team did a great job. Phil, do you have anything to add?

Yeah. We talked about the lingering effects of the cyber -- the Q1 cyber-attack. The lingering effect is that we -- both businesses and together, we regrouped in the month of April to figure out a course going forward. So the April results were -- what we did in April really helped drive a more successful May and June and more level loading, and that depth certainly is our hope going forward. But bottom line is the team is working 24/7 to recover the data, recover the systems and ultimately push the business in the right direction.

And then on the supply chain as things begin to ease, and I know we're in a new reality, but any detail you can provide where bottlenecks are starting to ease and allowing you to deliver on some of these backlogs?

Well, I think as we commented, I mean, we've got a pretty strong backlog now and have had for a couple of quarters where it's really allowed us to get out in front of a lot of our supply chain problems, where things were out over 52 weeks. Now they're typically in the 24 to 36 weeks, which is manageable. I'm not going to say it's perfect, but it allows us to at least execute. Part of it, I will say, the cyber event from supply chain side might have helped us a little bit because we didn't ship everything we thought we would in Q1. So we had an inventory surge that we needed to plow through and execute and get out of the building. There's still some pockets of parts like especially on the RF side that pretty long lead, and there's not a lot of vendors. So you're pretty hostage to whom you're using and most of them are in qualified products where you really don't have an easy option to change. But other areas, MOSFETs and some of the things that were really difficult previously, seem to at least be within a 26-week lead time now.

And then just on the operating investments you've made, it sounds like hiring is getting a little easier at least. Can you help us think about the leverage going forward? And just how we might frame that?

Sure. I'll look at it purely on the financial side and the most important number ingrained in my brain is for each 100 basis point increase in gross margin, it's worth $0.07 of EPS and that's calculated on a GAAP tax basis, which we know isn't a reality for us. So it really comes down to just the basics, keep the revenue stream going, which I think we've been very successful at, improved gross margin. And when we say improved gross margin, we have a whole series of different actions that we're attacking that we meet -- when I say 3 times to 4 times a week, that's probably an understatement, but we're after that next 100 basis point increase in gross margin, and we can't get that soon enough, but these actions have to get to the root cause. They can't be Band-Aids, and that's what our focus is really all about the spending. Well, the spending we control. That's really what it comes down to. So when you look at the difference in the quarter, we went up 33% in sales, a 38.5% increase in gross profit, which defines to us leverage and then keeping operating expenses flat. So -- and then we look back, Josh, and we say, "Well, if this happened or that happened or these things happen." There's always things that you know that could happen that could have helped us out. But it really comes down to the basics. Improving operations and efficiencies that are sustainable and then going on to the next batch of issues.

Got it. And then maybe just turning over to some end market comments, up 25% in battery in the medical side. What are you seeing there? I mean, is that a supply chain getting easier? Is that demand coming through? Maybe just some comments on the medical supply market while that was so strong.

It's a combination of factors, Josh. Really the supply chain coming through has been a big piece of it. We've got some customers in the medical side that have been -- that have launched products and they're starting to see their market penetration and growth start back up now that we're through the COVID time and some of the supply chain issues that they've had as well. We're seeing some pull-through -- we have 1 major OEM that I know is benefiting from increased volume due to a competitor's recall situation. That, I think, has benefited us pretty dramatically. And then there's also some recurring revenue coming into that stream just for replacement products, where some of these products we put out in early COVID are due to have batteries replaced just by the normal course of maintenance. So I think it's been strong on a couple of different fronts.

Got it. And then the oil & gas sales of 18%. I mean are you seeing the offshore rig activity translate into demand for your products?

Yeah. We've seen a lot of international business. We've seen a lot of offshore business. We're kind of in a unique spot where we're servicing a lot of the bigger players and a lot of the smaller players. So we're kind of level loaded there. We -- hopefully, the natural gas price rebounds a little bit here in the fall because I think that may even help. But right now, that segment continues to be pretty strong. I mean, there was a few players that announced over the last couple of days, earnings that have been pretty strong, and their forecasts have looked pretty positive. So we're hoping that, that stays solid.

Got it. And I'll just wrap up on government/defense. I mean, really impressive here. I mean, how should we think about that going forward? And then you mentioned, as we think about the next round of defense backlog growth, what are some of the opportunities there and just what we're seeing in defense?

Well, on the defense side, obviously, in the Communications Systems side, there's been a substantial backlog for a while that we've been wanting to get out the door and execute on, that really was a supply chain bottleneck. We think that revenue is going to continue. They're embedded in some pretty long-term contracts that have year-over-year buys and named programs for either the U.S. government or others. On the Battery and Energy side of the business, a lot of our military sales right now have been direct OEM sales and pass-through sales. Our sales direct to DLA and others for products like the 5390 and others that we've talked about in the past have actually been very low. And we are in IDIQ contracts that could assist with some additional revenue if they were to actually have an order awarded.

Great. Well, again, congratulations on the quarter, and then thank you for the time.

Thank you, Josh.

Thank you. [Operator Instructions] There seems to be no further questions. I would now like to turn it back to Mike Manna for closing remarks.