ULBI

Business Context and Reporting Period

Company: Ultralife Batteries, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: April 1, 2006
Business Overview: Ultralife is a global provider of power solutions, manufacturing non-rechargeable and rechargeable batteries for military, industrial, and consumer applications. The company operates in three segments: Non-rechargeable Batteries, Rechargeable Batteries, and Technology Contracts.

Key Financial Metrics

Note: All dollar amounts in thousands, except per share data.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 19% year-over-year, driven by a 22% increase in Non-rechargeable battery sales (automotive telematics and military) and a 21% increase in Rechargeable battery sales.
• Profitability Turnaround: The company returned to profitability with $140k net income, compared to a $1.55M net loss in Q1 2005. This was aided by a $148k gain on an insurance settlement for a prior U.K. facility fire.
• Margin Expansion: Gross margin improved significantly from 13% to 22% due to favorable product mix and production efficiencies. Non-rechargeable margins rose to 21% and Rechargeable margins to 27%.
• Accounting Change: Effective Jan 1, 2006, the company adopted FAS 123R, recognizing $258k in stock-based compensation expense. Without this non-cash charge, operating income would have been $486k.
• Cash Flow: Operating cash flow turned positive ($956k) compared to a negative $187k in the prior year, primarily due to reduced inventory build-up and higher net income.

Guidance, Outlook, and Risks

Outlook and Guidance

• Q2 2006: Management expects revenues of approximately $20,000k and operating income in the range of $500k (including $300k of stock-based compensation).
• Full Year 2006: Reiterates an outlook of at least $90,000k in base business revenue, with significant growth expected in the second half driven by military sales (specifically BA-5390 batteries).
• Acquisitions:
  • Able New Energy: Agreed to acquire this Chinese lithium battery manufacturer for ~$4,200k (cash, stock, warrants). Expected to close May 2006.
  • McDowell Research: Agreed to acquire this military communications accessories manufacturer for ~$25,000k ($5,000k cash, $20,000k convertible note). Expected to close July 2006.

Risks and Contingencies

• Debt Covenant Compliance: As of April 1, 2006, the company was not in compliance with the EBIT-to-interest covenant of its $25,000k credit facility. A waiver was obtained on May 3, 2006. Due to uncertainty regarding future compliance, all debt is classified as current.
• Government Contract Audits: The Defense Contracting Audit Agency (DCAA) suggested a potential pricing adjustment of ~$1,400k on past exigent contracts. The company disputes the net impact but notes potential margin reduction if adjustments are finalized.
• Environmental Liability: Ongoing remediation of contaminated soil at the Newark, NY facility. Estimated final costs are modest, with $45k reserved as of April 1, 2006.

Investor Verification Checklist

• Debt Covenant Status: Verify the terms of the May 3, 2006 waiver and the likelihood of obtaining future waivers if EBIT targets are not met.
• Acquisition Financing: Confirm the ability to secure the $5,000k cash portion for the McDowell Research acquisition from existing lenders.
• Government Audit Resolution: Monitor the finalization of DCAA audits on exigent contracts to assess potential revenue adjustments.
• Inventory Levels: Review the reduction in BA-5390 inventory build-up and the impact on future working capital requirements.
• Stock-Based Compensation: Assess the impact of the new FAS 123R standard on future operating expenses ($1,025k of unrecognized costs remaining).