10-Q 1 e18556_10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 26, 2004 or [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________________ to ________________ Commission file number 0-20852 ULTRALIFE BATTERIES, INC. (Exact name of registrant as specified in its charter) Delaware 16-1387013 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 2000 Technology Parkway, Newark, New York 14513 (Address of principal executive offices) (Zip Code) (315) 332-7100 (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock, $.10 par value - 14,198,825 shares of common stock outstanding, net of 727,250 treasury shares, as of June 26, 2004. 1 ULTRALIFE BATTERIES, INC. INDEX -------------------------------------------------------------------------------- Page PART I FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets - June 26, 2004 and December 31, 2003 ........................... 3 Condensed Consolidated Statements of Operations - Three and Six months ended June 26, 2004 and June 28, 2003 ............................................. 4 Condensed Consolidated Statements of Cash Flows - Three and Six months ended June 26, 2004 and June 28, 2003 ............................................. 5 Notes to Consolidated Financial Statements ...................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................. 14 Item 3. Quantitative and Qualitative Disclosures About Market Risk. ........................................... 22 Item 4. Controls and Procedures ......................................... 22 PART II OTHER INFORMATION Item 1. Legal Proceedings ............................................... 23 Item 4. Submission of Matters to a Vote of Security Holders ............. 24 Item 6. Exhibits and Reports on Form 8-K ................................ 24 Signatures ...................................................... 26 Index to Exhibits ............................................... 27 2 PART I FINANCIAL INFORMATION Item 1. Financial Statements ULTRALIFE BATTERIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in Thousands, Except Per Share Amounts) (unaudited) June 26, December 31, ASSETS 2004 2003 --------- ------------ Current assets: Cash and cash equivalents $ 941 $ 830 Restricted cash 51 50 Trade accounts receivable (less allowance for doubtful accounts of $223 at June 26, 2004 and $168 at December 31, 2003) 20,205 17,803 UTI note receivable -- 2,350 Inventories 16,131 10,209 Prepaid expenses and other current assets 1,662 1,314 --------- --------- Total current assets 38,990 32,556 --------- --------- Property, plant and equipment, net 19,169 18,213 Other assets: Investment in UTI -- 1,550 Technology license agreements (net of accumulated amortization of $1,451 at June 26, 2004 and $1,418 at December 31, 2003) -- 33 --------- --------- -- 1,583 --------- --------- Total Assets $ 58,159 $ 52,352 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Short-term debt and current portion of long-term debt $ 5,439 $ 8,295 Accounts payable 7,720 6,385 Income taxes payable 13 106 Other current liabilities 3,828 3,068 --------- --------- Total current liabilities 17,000 17,854 Long-term liabilities: Debt and capital lease obligations 68 68 Commitments and contingencies (Note 10) Shareholders' equity: Preferred stock, par value $0.10 per share, authorized 1,000,000 shares; none outstanding -- -- Common stock, par value $0.10 per share, authorized 40,000,000 shares; issued - 14,926,075 at June 26, 2004 and 14,302,782 at December 31, 2003 1,493 1,430 Capital in excess of par value 124,276 120,626 Accumulated other comprehensive loss (638) (723) Accumulated deficit (81,662) (84,525) --------- --------- 43,469 36,808 Less -- Treasury stock, at cost -- 727,250 shares 2,378 2,378 --------- --------- Total shareholders' equity 41,091 34,430 --------- --------- Total Liabilities and Shareholders' Equity $ 58,159 $ 52,352 ========= ========= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 3 ULTRALIFE BATTERIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Per Share Amounts) (unaudited)
Three Months Ended Six Months Ended June 26, June 28, June 26, June 28, 2004 2003 2004 2003 -------- -------- -------- -------- Revenues $ 28,439 $ 20,110 $ 55,427 $ 35,538 Cost of products sold 21,391 15,379 42,047 27,648 -------- -------- -------- -------- Gross margin 7,048 4,731 13,380 7,890 -------- -------- -------- -------- Operating expenses: Research and development 560 646 1,063 1,231 Selling, general, and administrative 2,858 2,187 5,329 4,149 -------- -------- -------- -------- Total operating expenses 3,418 2,833 6,392 5,380 -------- -------- -------- -------- Operating income 3,630 1,898 6,988 2,510 Other income (expense): Interest income 27 4 47 5 Interest expense (150) (110) (235) (242) Write-off of UTI investment and note receivable (3,951) -- (3,951) -- Miscellaneous 32 397 93 187 -------- -------- -------- -------- (Loss) income before income taxes (372) 2,149 2,942 2,460 -------- -------- -------- -------- Income taxes -- -- 79 -- -------- -------- -------- -------- Net (loss) income $ (372) $ 2,149 $ 2,863 $ 2,460 ======== ======== ======== ======== (Loss) earnings per share - basic $ (0.03) $ 0.17 $ 0.21 $ 0.19 ======== ======== ======== ======== (Loss) earnings per share - diluted $ (0.03) $ 0.16 $ 0.19 $ 0.19 ======== ======== ======== ======== Weighted average shares outstanding - basic 14,115 12,927 13,930 12,895 ======== ======== ======== ======== Weighted average shares outstanding - diluted 14,115 13,651 15,109 13,266 ======== ======== ======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 4 ULTRALIFE BATTERIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (unaudited) -------------------------------------------------------------------------------- Six Months Ended June 26, June 28, 2004 2003 OPERATING ACTIVITIES Net income $ 2,863 $ 2,460 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 1,705 1,504 Gain on asset disposal (14) -- Foreign exchange gain (87) (192) Write-off of UTI investment and note receivable 3,951 -- Write-down of inventory damaged in fire 543 -- Write-down of fixed assets damaged in fire 112 Non-cash stock-based compensation 10 26 Changes in operating assets and liabilities: Accounts receivable (2,402) (6,940) Inventories (6,465) (916) Prepaid expenses and other current assets 399 (142) Insurance receivable relating to fires (798) -- Income taxes payable (93) -- Accounts payable and other current liabilities 2,095 3,957 --------- --------- Net cash provided by (used in) operating activities 1,819 (243) --------- --------- INVESTING ACTIVITIES Purchase of property and equipment (2,628) (3,278) Proceeds from asset disposal 16 -- Purchase of securities (1) -- --------- --------- Net cash used in investing activities (2,613) (3,278) --------- --------- FINANCING ACTIVITIES Change in revolving credit facilities (2,456) 2,440 Proceeds from issuance of common stock 3,703 1,128 Proceeds from issuance of debt 500 -- Principal payments on long-term debt and capital lease obligations (400) (401) Proceeds from grant 117 -- --------- --------- Net cash provided by financing activities 847 3,784 --------- --------- Effect of exchange rate changes on cash 58 27 --------- --------- Increase in cash and cash equivalents 111 290 Cash and cash equivalents at beginning of period 830 1,322 --------- --------- Cash and cash equivalents at end of period $ 941 $ 1,612 ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION Taxes paid $ 255 $ -- ========= ========= Interest paid $ 173 $ 116 ========= ========= The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. 5 ULTRALIFE BATTERIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar Amounts in Thousands - Except Share and Per Share Amounts) (unaudited) -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair presentation of the condensed consolidated financial statements have been included. Results for interim periods should not be considered indicative of results to be expected for a full year. Reference should be made to the consolidated financial statements contained in the Company's Form 10-K for the twelve-month period ended December 31, 2003. The Company's monthly closing schedule is a weekly-based cycle as opposed to a calendar month-based cycle. While the actual dates for the quarter-ends will change slightly each year, the Company believes that there are not any material differences when making quarterly comparisons. 2. WRITE-OFF OF UTI INVESTMENT AND NOTE RECEIVABLE In June 2004, the Company recorded a $3,951 non-cash, non-operating charge related to the Company's ownership interest in Ultralife Taiwan, Inc. ("UTI") that consisted of a write-off of its $2,401 note receivable from UTI, including accrued interest, and the book value of its $1,550 equity investment in UTI. The Company decided to record this charge due to recent events that have caused increasing uncertainty over UTI's near-term financial viability, including a failure by UTI to meet commitments made to the Company and its other creditors to secure additional financial support before July 1, 2004. Based on these factors, and UTI's operating losses over several years, the Company's investment has had an other than temporary decline in fair value and the Company believes that the probability of being reimbursed for the note receivable is nominal. The Company continues to hold a 9.2% equity interest in UTI, and it is working with UTI to help it through its financial difficulties in an effort to ensure a satisfactory outcome for all parties involved. The Company does not believe the write-off poses a risk to its current operations or future growth prospects because UTI continues to manufacture product for it and the Company has taken steps to establish alternate sources of supply. 3. EARNINGS (LOSS) PER SHARE Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share are calculated by dividing net income, adjusted for interest on convertible securities, by potentially dilutive common shares, which include stock options, warrants and convertible securities. Net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. The impact of conversion of dilutive securities, such as stock options and warrants, are not considered where a net loss is reported as the inclusion of such securities would be anti-dilutive. As a result, basic loss per share is the same as diluted loss per share. 6 The computation of basic and diluted earnings per share is summarized as follows:
(In thousands, except per share data) Three Months Ended Six Months Ended -------------------------------------------------------------------- June 26, 2004 June 28, 2003 June 26, 2004 June 28, 2003 -------------------------------------------------------------------- Net (Loss) / Income (a) $ (372) $ 2,149 $ 2,863 $ 2,460 Effect of Dilutive Securities: Stock Options / Warrants -- 44 -- 44 Convertible Note -- 6 -- 9 ----------------------------------------------------------------- Net (Loss) / Income - Adjusted (b) $ (372) $ 2,199 $ 2,863 $ 2,513 ================================================================= Average Shares Outstanding - Basic (c) 14,115 12,927 13,930 12,895 Effect of Dilutive Securities: Stock Options / Warrants -- 557 1,179 246 Convertible Note -- 167 -- 125 ----------------------------------------------------------------- Average Shares Outstanding - Diluted (d) 14,115 13,651 15,109 13,266 ================================================================= EPS - Basic (a/c) $ (0.03) $ 0.17 $ 0.21 $ 0.19 EPS - Diluted (b/d) $ (0.03) $ 0.16 $ 0.19 $ 0.19
The Company also had the equivalent of 1,056,880 options and warrants outstanding for the three-month period ended June 26, 2004 which were not included in the computation of diluted EPS because these securities would have been anti-dilutive for that period. 4. STOCK-BASED COMPENSATION The Company has various stock-based employee compensation plans. The Company applies Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations which require compensation costs to be recognized based on the difference, if any, between the quoted market price of the stock on the grant date and the exercise price. As all options granted to employees under such plans had an exercise price at least equal to the market value of the underlying common stock on the date of grant, and given the fixed nature of the equity instruments, no stock-based employee compensation cost is reflected in net (loss) income. The effect on net (loss) income and (loss) earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of SFAS No. 123", to stock-based employee compensation is as follows: 7
(In thousands, except per share data) Three Months Ended Six Months Ended ---------------------------------------------------------------------- June 26, 2004 June 28, 2003 June 26, 2004 June 28, 2003 ---------------------------------------------------------------------- Net (loss) income, as reported $ (372) $ 2,149 $ 2,863 $ 2,460 Add: Stock-based employee compensation expense included in reported net (loss) income, net of related tax effects -- -- -- -- Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (467) (317) (681) (540) ----------------------------------------------------------------- Pro forma net (loss) income $ (839) $ 1,832 $ 2,182 $ 1,920 (Loss) earnings per share: Basic - as reported $ (0.03) $ 0.17 $ 0.21 $ 0.19 Basic - pro forma $ (0.06) $ 0.14 $ 0.16 $ 0.15 Diluted - as reported $ (0.03) $ 0.16 $ 0.19 $ 0.19 Diluted - pro forma $ (0.06) $ 0.13 $ 0.14 $ 0.14
During the first six months of 2004, the Company issued 623,293 shares of common stock as a result of exercises of stock options and warrants. The Company received approximately $3,703 in cash proceeds as a result of these transactions. 5. COMPREHENSIVE (LOSS) INCOME The components of the Company's total comprehensive (loss) income were:
Three Months Ended Six Months Ended June 26, June 28, June 26, June 28, 2004 2003 2004 2003 ----------------------------------------------------------------- Net (loss) income $ (372) $ 2,149 $ 2,863 $ 2,460 Foreign currency translation adjustments 15 (124) 85 (65) ----------------------------------------------------------------- Total comprehensive (loss) income $ (357) $ 2,025 $ 2,948 $ 2,395 =================================================================
8 6. INVENTORIES Inventories are stated at the lower of cost or market with cost determined under the first-in, first- out (FIFO) method. The composition of inventories was: June 26, 2004 December 31, 2003 -------------------------------- Raw materials $ 6,368 $ 5,946 Work in process 4,004 2,306 Finished goods 6,266 2,699 ------------------------- 16,638 10,951 Less: Reserve for obsolescence 507 742 ------------------------- $ 16,131 $ 10,209 ========================= 7. PROPERTY, PLANT AND EQUIPMENT Major classes of property, plant and equipment consisted of the following: June 26, 2004 December 31, 2003 -------------------------------- Land $ 123 $ 123 Buildings and leasehold improvements 2,540 1,845 Machinery and equipment 34,053 33,207 Furniture and fixtures 371 358 Computer hardware and software 1,664 1,554 Construction in progress 2,762 1,748 ------------------------- 41,513 38,835 Less: Accumulated depreciation 22,344 20,622 ------------------------- $ 19,169 $ 18,213 ========================= 8. DEBT As of June 26, 2004, the Company had $867 outstanding under the term loan component of its credit facility with its primary lending bank, and had $4,209 of borrowings outstanding under the revolver component of the credit facility. The Company's additional borrowing capacity under the revolver component of the credit facility as of June 26, 2004 was approximately $5,900, net of outstanding letters of credit of $3,600. At June 26, 2004, the Company's net worth was $41,091, compared to the debt covenant requiring a minimum net worth of approximately $22,406. (See Note 13 for information on the Company's new credit facility.) As of June 26, 2004, the Company's wholly-owned U.K. subsidiary, Ultralife Batteries (UK) Ltd., had approximately $345 outstanding under its revolving credit facility with a commercial bank in the U.K. This credit facility provides the Company's U.K. operation with additional financing flexibility for its working capital needs. Any borrowings against this credit facility are collateralized with that company's outstanding accounts receivable balances. There was approximately $476 in additional borrowing capacity under this credit facility as of June 26, 2004. 9 9. INCOME TAXES The liability method, prescribed by SFAS No. 109, "Accounting for Income Taxes", is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that may be in effect when the differences are expected to reverse. The Company recorded an income tax expense of $79 for the six months ended June 26, 2004 relating to alternative minimum tax calculations. As of December 31, 2003, the Company had foreign and domestic net operating loss carryforwards totaling approximately $76,829 that are available to reduce future taxable income. The Company has not reported a deferred tax asset on its Consolidated Balance Sheet due to prior operating losses. It is reasonably possible the Company's profitability in 2003 and 2004 would result in the recognition of a deferred tax asset during 2004. The Company has determined that a change in ownership as defined under Internal Revenue Code Section 382 occurred during the fourth quarter of 2003. As a result, the net operating loss carryforwards will be subject to an annual limitation, currently estimated to be in the range of approximately $14,000 to $18,000. Such a limitation could result in the possibility of a cash outlay for income taxes in a future year when earnings exceed the amount of NOLs that can be used by the Company. 10. COMMITMENTS AND CONTINGENCIES As of June 26, 2004, the Company had $51 in restricted cash in support of a corporate credit card account. As of June 26, 2004, the Company had open capital commitments to purchase approximately $2,071 of production machinery and equipment. The Company estimates future costs associated with expected product failure rates, material usage and service costs in the development of its warranty obligations. Warranty reserves, included in other current liabilities on the Company's Consolidated Condensed Balance Sheet, are based on historical experience of warranty claims and generally will be estimated as a percentage of sales over the warranty period. In the event the actual results of these items differ from the estimates, an adjustment to the warranty obligation would be recorded. Changes in the Company's product warranty liability during the first six months of 2004 were as follows: Balance at December 31, 2003 $ 278 Accruals for warranties issued 237 Settlements made (147) ----- Balance at June 26, 2004 $ 368 ===== The Company is subject to legal proceedings and claims which arise in the normal course of business. The Company believes that the final disposition of such matters will not have a material adverse effect on the financial position or results of operations of the Company. In conjunction with the Company's purchase/lease of its Newark, New York facility in 1998, the Company entered into a payment-in-lieu of tax agreement which provides the Company with real estate tax concessions upon meeting certain conditions. In connection with this agreement, a consulting firm performed a Phase I and II Environmental Site Assessment which revealed the existence of contaminated soil and ground water around one of the buildings. The Company retained an engineering firm which estimated that the cost of remediation should be in the range of $230. This cost, however, is merely an estimate and the cost may in fact be much higher. In February, 1998, the 10 Company entered into an agreement with a third party, which provides that the Company and this third party will retain an environmental consulting firm to conduct a supplemental Phase II investigation to verify the existence of the contaminants and further delineate the nature of the environmental concern. The third party agreed to reimburse the Company for fifty percent (50%) of the cost of correcting the environmental concern on the Newark property. The Company has fully reserved for its portion of the estimated liability. Test sampling was completed in the spring of 2001, and the engineering report was submitted to the New York State Department of Environmental Conservation (NYSDEC) for review. NYSDEC reviewed the report and, in January 2002, recommended additional testing. The Company submitted a work plan to NYSDEC in October 2003, which was approved shortly thereafter. The Company sought proposals from engineering firms to complete the remedial work outlined in the work plan. A firm was selected to perform the tasks associated with the remediation activities, which were completed in December 2003. The test results were then forwarded to NYSDEC for comment. NYSDEC responded to the Company in March 2004 requesting a report summarizing the data, findings, discussions and conclusions. The report has been submitted to NYSDEC who will review and make recommendations as to whether additional remediation is required. Because the Company believes that the source of the contamination has been removed, NYSDEC recommended that the Company conduct quarterly monitoring of the groundwater for one year. The Company believes that the final cost to remediate will not exceed the original estimate. The Company awaits final comments from the NYSDEC and will begin the additional sampling upon approval of the conclusions stated in the report. Because this is a voluntary remediation, there is no requirement for the Company to complete the project within any specific time frame. The ultimate resolution of this matter may have a significant adverse impact on the results of operations in the period in which it is resolved. Furthermore, the Company may face claims resulting in substantial liability which could have a material adverse effect on the Company's business, financial condition and the results of operations in the period in which such claims are resolved. A retail end-user of a product manufactured by one of Ultralife's customers (the "Customer") has made a claim against the Customer wherein it is asserted that the Customer's product, which is powered by an Ultralife battery, does not operate according to the Customer's product specification. No claim has been filed against Ultralife. However, in the interest of fostering good customer relations, in September 2002, Ultralife agreed to lend technical support to the Customer in defense of its claim. The claim between the end-user and the Customer has now been settled. Ultralife has renewed its commitment to the Customer to honor its warranty by replacing any batteries that may be determined to be defective. In the event a claim is filed against Ultralife and it is ultimately determined that Ultralife's product was defective, replacement of batteries to this Customer or end-user may have a material adverse effect on the Company's financial position and results of operations. 11. BUSINESS SEGMENT INFORMATION The Company reports its results in three operating segments: Primary Batteries, Rechargeable Batteries, and Technology Contracts. The Primary Batteries segment includes 9-volt, cylindrical and various other non-rechargeable specialty batteries. The Rechargeable Batteries segment includes the Company's lithium polymer and lithium ion rechargeable batteries. The Technology Contracts segment includes revenues and related costs associated with various government and military development contracts. The Company looks at its segment performance at the gross margin level, and does not allocate research and development or selling, general and administrative costs against the segments. All other items that do not specifically relate to these three segments and are not considered in the performance of the segments are considered to be Corporate charges. 11 Three Months Ended June 26, 2004
Primary Rechargeable Technology Batteries Batteries Contracts Corporate Total ----------------------------------------------------------------------------- Revenues $ 26,321 $ 1,691 $ 427 $ -- $ 28,439 Segment contribution 7,048 (82) 82 (3,418) 3,630 Interest expense, net (83) (83) Write-down of UTI investment and note receivable (3,951) (3,951) Miscellaneous 32 32 Income taxes -- -- -------- Net loss $ (372) Total assets $ 48,928 $ 4,179 $ 243 $ 4,809 $ 58,159
Three Months Ended June 28, 2003
Primary Rechargeable Technology Batteries Batteries Contracts Corporate Total ----------------------------------------------------------------------------- Revenues $ 19,570 $ 258 $ 282 $ -- $ 20,110 Segment contribution 5,008 (389) 112 (2,833) 1,898 Interest expense, net (146) (146) Miscellaneous 397 397 Income taxes -- -- -------- Net income $ 2,149 Total assets $ 31,956 $ 3,249 $ 140 $ 6,191 $ 41,536
Six Months Ended June 26, 2004
Primary Rechargeable Technology Batteries Batteries Contracts Corporate Total ----------------------------------------------------------------------------- Revenues $ 51,643 $ 3,065 $ 719 $ -- $ 55,427 Segment contribution 13,822 (567) 125 (6,392) 6,988 Interest expense, net (188) (188) Write-down of UTI investment and note receivable (3,951) (3,951) Miscellaneous 93 93 Income taxes (79) (79) -------- Net income $ 2,863 Total assets $ 48,928 $ 4,179 $ 243 $ 4,809 $ 58,159
Six Months Ended June 28, 2003
Primary Rechargeable Technology Batteries Batteries Contracts Corporate Total ----------------------------------------------------------------------------- Revenues $ 34,202 $ 638 $ 698 $ -- $ 35,538 Segment contribution 8,172 (596) 314 (5,380) 2,510 Interest expense, net (237) (237) Miscellaneous 187 187 Income taxes -- -- -------- Net income $ 2,460 Total assets $ 31,956 $ 3,249 $ 140 $ 6,191 $ 41,536
12 12. FIRES AT MANUFACTURING FACILITIES In May 2004 and June 2004, the Company experienced two fires that damaged certain inventory and property at its facilities. The May 2004 fire occurred at the Company's U.S. facility and was caused by cells that shorted out when a forklift truck accidentally tipped the cells over in an oven in an enclosed area. Certain inventory, equipment and a small portion of the building where the fire was contained were damaged. The June 2004 fire happened at the Company's U.K. location and mainly caused damage to various inventory and the U.K. company's leased facility. The fire was contained mainly in a bunkered, non-manufacturing area designed to store various material, and there was additional smoke and water damage to the facility and its contents. It is unknown how the U.K. fire was started. The fires caused relatively minor disruptions to the production operations, and had no impact on the Company's ability to meet customer demand during the quarter. The Company maintains replacement cost insurance on the property and equipment it owns or rents, with relatively low deductibles. The total of the two losses related to company-owned assets, including expenditures required to repair and clean up the facilities, is expected to be in the range of $2,000. The Company is working closely with the insurance companies on these matters, and it expects to be fully reimbursed by the insurance companies for these losses. The impacts on the Consolidated Statement of Operations and the net cash outflows from the Company are expected to be negligible. At June 26, 2004, the Company's prepaid and other current assets on its Consolidated Balance Sheet included a receivable from insurance companies for approximately $800 for equipment losses, inventory losses and clean-up costs incurred to date. 13. SUBSEQUENT EVENT - NEW CREDIT FACILITY On June 30, 2004, the Company closed on a new secured $25,000 credit facility, comprised of a five-year $10,000 term loan component and a three-year $15,000 revolving credit component. This agreement replaces the Company's $15,000 credit facility that expired on the same date. On June 30, 2004, the Company drew down the full $10,000 term loan. The proceeds of the term loan, which is to be repaid in equal monthly installments over five years, are to be used for the retirement of outstanding debt and capital expenditures. Availability under the revolving credit component is subject to a debt to earnings ratio, whereas availability under the previous facility was limited by various asset values. The lenders of the new credit facility are JP Morgan Chase Bank and Manufacturers and Traders Trust Company, with JP Morgan Chase Bank acting as the administrative agent. On July 1, 2004, the Company entered into an interest rate swap arrangement to be effective on August 2, 2004, related to the $10,000 term loan, in order to take advantage of historically low interest rates. The Company received a fixed rate of interest in exchange for a variable rate. The swap rate received was 3.98% for five years and will be adjusted accordingly for a Eurodollar spread incorporated in the agreement, which is dependent upon a debt to earnings ratio within a predetermined grid. At July 1, 2004, the total adjusted rate of interest that the Company will pay on the outstanding portion of the $10,000 term loan was 5.23%. 13 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In whole dollars) The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This report contains certain forward-looking statements and information that are based on the beliefs of management as well as assumptions made by and information currently available to management. The statements contained in this report relating to matters that are not historical facts are forward-looking statements that involve risks and uncertainties, including, but not limited to, future demand for the Company's products and services (particularly from the U.S. Government for BA-5390 batteries), the successful commercialization of the Company's advanced rechargeable batteries, general economic conditions, government and environmental regulation, competition and customer strategies, technological innovations in the primary and rechargeable battery industries, changes in the Company's business strategy or development plans, capital deployment, business disruptions, including those caused by fires, raw materials supplies, environmental regulations, and other risks and uncertainties, certain of which are beyond the Company's control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may differ materially from those described herein as anticipated, believed, estimated or expected. This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying consolidated financial statements and notes thereto contained herein and the Company's consolidated financial statements and notes thereto contained in the Company's Form 10-K for the year ended December 31, 2003. The financial information in this Management's Discussion and Analysis of Financial Condition and Results of Operations is presented in whole dollars. General Ultralife Batteries, Inc. develops, manufactures and markets a wide range of standard and customized lithium primary (non-rechargeable), lithium ion and lithium polymer rechargeable batteries for use in a wide array of applications. The Company believes that its technologies allow the Company to offer batteries that are flexibly configured, lightweight and generally achieve longer operating time than many competing batteries currently available. The Company has focused on manufacturing a family of lithium primary batteries for military, industrial and consumer applications, which it believes is one of the most comprehensive lines of lithium manganese dioxide primary batteries commercially available. The Company also supplies rechargeable lithium ion and lithium polymer batteries for use in portable electronic applications. The Company reports its results in three operating segments: Primary Batteries, Rechargeable Batteries, and Technology Contracts. The Primary Batteries segment includes 9-volt, cylindrical and various other non-rechargeable specialty batteries. The Rechargeable Batteries segment includes the Company's lithium polymer and lithium ion rechargeable batteries. The Technology Contracts segment includes revenues and related costs associated with various government and military development contracts. The Company looks at its segment performance at the gross margin level, and does not allocate research and development or selling, general and administrative costs against the segments. All other items that do not specifically relate to these three segments and are not considered in the performance of the segments are considered to be Corporate charges. 14 Results of Operations (in whole dollars) Three months ended June 26, 2004 and June 28, 2003 Revenues. Consolidated revenues for the three-month period ended June 26, 2004 amounted to $28,439,000, an increase of $8,329,000, or 41%, from the $20,110,000 reported in the same quarter in the prior year. Primary battery sales increased $6,751,000, or 34%, from $19,570,000 last year to $26,321,000 this year, as a result of strong shipments of HiRate(R) battery products, including sales of BA-5390 batteries used mainly in various military communications and weapons applications. Modestly lower sales of 9-volt batteries partially offset this increase. Rechargeable revenues rose $1,433,000 to $1,691,000, primarily due to higher shipments to military and commercial customers of various rechargeable battery packs to an increasing customer base. Technology Contract revenues were $427,000 in the second quarter of 2004, attributable to work on the Company's $2,700,000 development contract with General Dynamics. Compared with the same period a year ago, technology contract revenues increased $145,000 related to contracts with different customers in each period. Cost of Products Sold. Cost of products sold totaled $21,391,000 for the quarter ended June 26, 2004, an increase of $6,012,000, or 39% over the same three-month period a year ago. The gross margin on consolidated revenues for the quarter was $7,048,000, or 25% of revenues, an improvement of $2,317,000 over the $4,731,000, or 24% of revenues, reported in the same quarter in the prior year. Gross margins in the Company's primary battery operations improved $2,040,000, from $5,008,000 in 2003 to $7,048,000 in 2004 due to volume increases and improved manufacturing efficiencies. In the Company's rechargeable operations, the gross margin loss amounted to $82,000 in the second quarter of 2004, compared to a loss of $389,000 in 2003, an improvement of $307,000 due to the increased volumes. Gross margins in the Technology Contract segment were $82,000 in the second quarter of 2004 compared to $112,000 in 2003, a decrease of $30,000 mainly due to the timing and realized margins of different technology contracts. Operating Expenses. Operating expenses for the three months ended June 26, 2004 totaled $3,418,000, a $585,000 increase over the prior year's amount of $2,833,000. Research and development charges decreased $86,000 to $560,000 in 2004 due to the consolidation of all R&D efforts to the U.S. facility in order to reduce costs and combine efforts. Although the R&D line reflects a decline, the Company also considers its efforts in the Technology Contracts segment to be related to key battery development efforts. Selling, general, and administrative expenses increased $671,000 to $2,858,000 due mainly to planned resource additions in sales and marketing and information systems to support the Company's commitment to support a higher volume of development opportunities. In addition, various administrative costs associated with running a larger business also increased, including insurance and professional fees. Overall, operating expenses as a percentage of sales improved, declining from 14% in the June 2003 quarter to 12% in the June 2004 quarter. Other Income (Expense). Interest expense, net, for the second quarter of 2004 was $83,000, a decrease of $63,000 from the comparable period in 2003, mainly as a result of lower balances of debt outstanding. Miscellaneous income / expense decreased from income of $397,000 in 2003 to income of $32,000 in 2004 mostly due to changes in foreign currency in connection with the Company's intercompany loan with its U.K. subsidiary. The strength of the U.K. pound against the U.S. dollar rose more rapidly in 2003 as compared with 2004. In June 2004, the Company recorded a $3,951,000 non-cash, non-operating charge related to the Company's ownership interest in Ultralife Taiwan, Inc. ("UTI") that consisted of a write-off of its $2,401,000 note receivable from UTI, including accrued interest, and the book value of its $1,550,000 equity investment in UTI. The Company decided to record this charge due to recent events that have caused increasing uncertainty over UTI's near-term financial viability, including a failure by UTI to meet commitments made to the Company and its other creditors to secure additional financial support before July 1, 2004. Based on these factors, and UTI's operating losses over several years, the Company's investment has had an other than temporary decline in fair value and the 15 Company believes that the probability of being reimbursed for the note receivable is nominal. The Company continues to hold a 9.2% equity interest in UTI, and it is working with UTI to help it through its financial difficulties in an effort to ensure a satisfactory outcome for all parties involved. The Company does not believe the write-off poses a risk to its current operations or future growth prospects because UTI continues to manufacture product for it and the Company has taken steps to establish alternate sources of supply. Income Taxes. The Company did not record income tax expense for the three months ended June 26, 2004 due to the loss that was reported for the quarter. Net (Loss) Income. Net loss and loss per share were $372,000 and $0.03, respectively, for the three months ended June 26, 2004, compared to net earnings and earnings per share of $2,149,000 and $0.16, respectively, for the same quarter last year, primarily as a result of the reasons described above. Average common shares outstanding used to compute basic and diluted loss per share increased to 14,115,000 in 2004 mainly due to the impact of stock options and a private equity placement of 200,000 common shares during the fourth quarter of 2003. The impact from "in the money" stock options and warrants resulted in an additional 724,000 shares for the average diluted shares outstanding computation in 2003. Six months ended June 26, 2004 and June 28, 2003 Revenues. Consolidated revenues for the six-month period ended June 26, 2004 amounted to $55,427,000, an increase of $19,889,000, or 56%, from the $35,538,000 reported in the same period in 2003. Primary battery sales increased $17,441,000, or 51%, from $34,202,000 last year to $51,643,000 this year, as a result of strong shipments of HiRate(R) battery products, led by sales of BA-5390 batteries to military customers. Somewhat lower sales of 9-volt batteries partially offset this increase. Rechargeable revenues rose $2,427,000 to $3,065,000, primarily due to higher shipments of various rechargeable battery packs to a growing number of customers. Technology Contract revenues were $719,000 in the first half of 2004, attributable mainly to work on the Company's $2,700,000 development contract with General Dynamics. Compared with the same period a year ago, technology contract revenues increased $21,000 related to contracts with different customers in each period. Cost of Products Sold. Cost of products sold totaled $42,047,000 for the six months ended June 26, 2004, an increase of $14,399,000, or 52% over the same six-month period a year ago. The gross margin on consolidated revenues for the first half of 2004 was $13,380,000, or 24% of revenues, an improvement of $5,490,000 over the $7,890,000, or 22% of revenues, reported in the same period in 2003. Consolidated gross margins rose 70% for the first half of 2004 compared with 2003 on the 56% increase in revenue. Gross margins in the Company's primary battery operations improved $5,650,000, from $8,172,000 in 2003 to $13,822,000 in 2004. In the Company's rechargeable operations, the gross margin loss amounted to $567,000 in the first two quarters of 2004, improving slightly from a loss of $596,000 in 2003. The 2004 results included a $250,000 charge for increasing reserves for obsolete rechargeable inventory. Gross margins in the Technology Contract segment were $125,000 in the first half of 2004, decreasing $189,000 from $314,000 in 2003, mainly due to the timing and realized margins of different technology contracts. Operating Expenses. Operating expenses for the six months ended June 26, 2004 totaled $6,392,000, a $1,012,000, or a 19% increase over the prior year's amount of $5,380,000. Research and development costs decreased $168,000 to $1,063,000 in 2004 due to the consolidation of all R&D efforts to the U.S. facility in order to reduce costs and combine efforts. Although the R&D line reflects a decline, the Company also considers its efforts in the Technology Contracts segment to be related to key battery development efforts. Selling, general, and administrative expenses increased $1,180,000 to $5,329,000 due mainly to planned resource additions in sales, marketing and administrative functions that are necessary for the company to execute on its target growth opportunities, in addition to higher costs 16 associated with a growing business. Overall, operating expenses as a percentage of sales improved, declining from 15% in the first half of 2003 to 12% in the same period in 2004. Other Income (Expense). Interest expense, net, for the first six months of 2004 was $188,000, a decrease of $49,000 from the comparable period in 2003, mainly as a result of lower outstanding debt balances. Miscellaneous income / expense decreased from income of $187,000 in 2003 to income of $93,000 in 2004 mostly due to changes in foreign currency in connection with the Company's intercompany loan with its U.K. subsidiary. The strength of the U.K. pound against the U.S. dollar rose more rapidly in 2003 as compared with 2004. In June 2004, the Company recorded a $3,951,000 non-cash, non-operating charge related to the Company's ownership interest in Ultralife Taiwan, Inc. ("UTI") that consisted of a write-off of its $2,401,000 note receivable from UTI, including accrued interest, and the book value of its $1,550,000 equity investment in UTI. The Company decided to record this charge due to recent events that have caused increasing uncertainty over UTI's near-term financial viability, including a failure by UTI to meet commitments made to the Company and its other creditors to secure additional financial support before July 1, 2004. Based on these factors, and UTI's operating losses over several years, the Company's investment has had an other than temporary decline in fair value and the Company believes that the probability of being reimbursed for the note receivable is nominal. The Company continues to hold a 9.2% equity interest in UTI, and it is working with UTI to help it through its financial difficulties in an effort to ensure a satisfactory outcome for all parties involved. The Company does not believe the write-off poses a risk to its current operations or future growth prospects because UTI continues to manufacture product for it and the Company has taken steps to establish alternate sources of supply. Income Taxes. The Company recorded income tax expense of $79,000 for the first half of 2004. While the Company has significant net operating loss carryforwards (NOLs) related to past years' cumulative losses, it is subject to a U.S. alternative minimum tax where NOLs can offset only 90% of taxable income. Net Income. Net income and diluted earnings per share for the first six months of 2004 were $2,863,000 and $0.19, respectively, compared to $2,460,000 and $0.19, respectively, for the same six months in 2003, primarily as a result of the reasons described above. Average common shares outstanding used to compute basic earnings per share increased from 12,895,000 in the first half of 2003 to 13,930,000 in 2004 mainly due to stock option exercises, as well as the conversion of a short-term note into 125,000 common shares in the second quarter of 2003 and a private equity placement of 200,000 common shares during the fourth quarter of 2003. The impact from "in the money" stock options and warrants resulted in an additional 1,179,000 and 371,000 shares for the average diluted shares outstanding computation in 2004 and 2003, respectively. Liquidity and Capital Resources (in whole dollars) As of June 26, 2004, cash and cash equivalents totaled $941,000, excluding restricted cash of $51,000. During the six months ended June 26, 2004, the Company provided $1,819,000 of cash in operating activities as compared to using $243,000 for the six months ended June 28, 2003, mainly due to the increase in net income offset by an increase in inventory due to higher production volumes. In the six months ended June 26, 2004, the Company used $2,628,000 to purchase plant, property and equipment, a decrease of $650,000 from the prior year's capital expenditures. This decrease was mainly attributable to the timing of various projects. During the six month period ended June 26, 2004, the Company generated $847,000 in funds from financing activities. The financing activities included inflows from the issuance of stock, mainly as stock options were exercised during the period, and outflows resulting from a reduction in the Company's revolving loan balance. During the first six months of 2004, the Company issued 623,293 shares of common stock as a result of exercises of stock options and warrants, and the Company received approximately $3,703,000 in cash proceeds as a result of these transactions. The 17 Company reduced its debt by $2,856,000 during the first six months of 2004 as loan principal was paid and revolving debt was reduced. Inventory turnover for the first half of 2004 was at an annualized rate of 6.0 turns per year, a decline from the 6.7 turns reflected during the full year of 2003, mainly due to the timing of production and shipments and a modest buildup of inventory related to higher production volumes, a semi-annual shutdown week at the beginning of the third quarter, and a production conversion project at the U.K. operation. The Company's Days Sales Outstanding (DSOs) was an average of 50 days for the first half of 2004, remaining constant with the 50 days reflected for the full 12-month period in 2003. At June 26, 2004, the Company had a capital lease obligation outstanding of $86,000 for the Company's Newark, New York offices and manufacturing facilities. As of June 26, 2004, the Company had open capital commitments to purchase approximately $2,071,000 of production machinery and equipment. In May 2004 and June 2004, the Company experienced two fires that damaged certain inventory and property at its facilities. The May 2004 fire occurred at the Company's U.S. facility and was caused by cells that shorted out when a forklift truck accidentally tipped the cells over in an oven in an enclosed area. Certain inventory, equipment and a small portion of the building where the fire was contained were damaged. The June 2004 fire happened at the Company's U.K. facility and mainly caused damage to various inventory, and to contained, non-manufacturing area in the building that is leased by the Company. It is unknown how the U.K. fire was started. The fires caused relatively minor disruptions to the production operations, and had no impact on the Company's ability to meet customer demand during the quarter. The Company maintains replacement cost insurance on the property and equipment it owns or rents, with relatively low deductibles. The total of the two losses related to company-owned assets, including expenditures required to repair and clean up the facilities, is expected to be in the range of $2,000,000. The Company is working closely with the insurance companies on these matters, and it expects to be fully reimbursed by the insurance companies for these losses. The impacts on the Consolidated Statement of Operations and the net cash outflows from the Company are expected to be negligible. At June 26, 2004, the Company's prepaid and other current assets on its Consolidated Balance Sheet included a receivable from insurance companies for approximately $800,000 for equipment losses, inventory losses and clean-up costs incurred to date. As of June 26, 2004, the Company had $867,000 outstanding under the term loan component of its credit facility with its primary lending bank, and had $4,209,000 of borrowings outstanding under the revolver component of the credit facility. The Company's additional borrowing capacity under the revolver component of the credit facility as of June 26, 2004 was approximately $5,900,000, net of outstanding letters of credit of $3,600,000. At June 26, 2004, the Company's net worth was $41,091,000, compared to the debt covenant requiring a minimum net worth of approximately $22,406,000. On June 30, 2004, the Company closed on a new secured $25,000,000 credit facility, comprised of a five-year $10,000,000 term loan component and a three-year $15,000,000 revolving credit component. This agreement replaces the Company's $15,000,000 credit facility that expired on the same date. On June 30, 2004, the Company drew down the full $10,000,000 term loan. The proceeds of the term loan, which is to be repaid in equal monthly installments over five years, are to be used for the retirement of outstanding debt and capital expenditures. Availability under the revolving credit component is subject to a debt to earnings ratio, whereas availability under the previous facility was limited by various asset values. The lenders of the new credit facility are JP Morgan Chase Bank and Manufacturers and Traders Trust Company, with JP Morgan Chase Bank acting as the administrative agent. On July 1, 2004, the Company entered into an interest rate swap arrangement to be effective on August 2, 2004, related to the $10,000,000 term loan, in order to take advantage of historically low interest rates. The Company received a fixed rate of interest in exchange for a variable rate. The swap 18 rate received was 3.98% for five years and will be adjusted accordingly for a eurodollar spread incorporated in the agreement which is dependent upon a debt to earnings ratio within a predetermined grid. At July 1, 2004, the total adjusted rate of interest that the Company will pay on the outstanding portion of the $10,000,000 term loan was 5.23%. As of June 26, 2004, the Company's wholly-owned U.K. subsidiary, Ultralife Batteries (UK) Ltd., had approximately $345,000 outstanding under its revolving credit facility with a commercial bank in the U.K. This credit facility provides the Company's U.K. operation with additional financing flexibility for its working capital needs. Any borrowings against this credit facility are collateralized with that company's outstanding accounts receivable balances. There was $476,000 of additional borrowing capacity under this credit facility as of June 26, 2004. The Company continues to be optimistic about its future prospects and growth potential. However, the recent rapid growth of the business has created a near-term need for certain machinery, equipment and working capital in order to enhance capacity and build product to meet demand. The recent positive financial results during 2003 have enhanced the Company's ability to acquire additional financing, as evidenced by the new credit facility entered into as of June 30, 2004. The Company continually explores various sources of capital, including issuing new or refinancing existing debt, and raising equity through private or public offerings. While it continually evaluates these alternatives, the Company believes it has the ability over the next 12 months to finance its operations primarily through internally generated funds, or through the use of financing that currently is available to the Company. As described in Part II, Item 1, "Legal Proceedings", the Company is involved in certain environmental matters with respect to its facility in Newark, New York. Although the Company has reserved for expenses related to this, there can be no assurance that this will be the maximum amount. The ultimate resolution of this matter may have a significant adverse impact on the results of operations in the period in which it is resolved. The Company typically offers warranties against any defects due to product malfunction or workmanship for a period up to one year from the date of purchase. The Company also offers a 10-year warranty on its 9-volt batteries that are used in ionization-type smoke detector applications. The Company provides for a reserve for this potential warranty expense, which is based on an analysis of historical warranty issues. While the Company believes that its current warranty reserves are adequate, there is no assurance that future warranty claims will be consistent with past history. In the event the Company's experiences a significant increase in warranty claims, there is no assurance that the Company's reserves are sufficient. This could have a material adverse effect on the Company's business, financial condition and results of operations. Outlook (in whole dollars) For the full year of 2004, the Company is reaffirming its guidance provided last quarter of $106,000,000 in revenues, compared with $79,450,000 in 2003, an increase of approximately 33%. Overall, military sales are continued to comprise at least 60% of the total revenues for the year, and rechargeable revenues are expected to reach approximately $7,000,000 for the full 12-month period ending December 31, 2004. Compared to the $55,427,000 in revenues for the first half of 2004, management anticipates a modest flattening of order flow from the military in the second half of the year compared to the first half, consistent with the Company's outlook at the beginning of fiscal 2004. Management cautions that uncertainties exist arising from the pending October transfer of procurement authority from the U.S. Army Communications and Electronics Command (CECOM) to the Defense Logistics Agency (DLA) and the outcome of the Next Gen II Phase IV award. 19 The results in each quarter can be subject to fluctuations as the timing of some customer orders is not often easy to predict. In particular, 9-volt revenues depend upon continued demand from the Company's customers, some of which depend upon retail sell-through. Similarly, revenues from sales of cylindrical products, primarily to military customers, depend upon a variety of factors, including the timing of the battery solicitation process within the military, the Company's ability to successfully win contract awards, successful qualification of the Company's products in the applicable military applications, the timing of shipments related to lot acceptance, and the timing of order releases against such contracts. Additionally, there is always a risk that Congressional appropriations might vary from what is needed or expected. Some of these factors are outside of the Company's direct control. At the present time, there is some uncertainty with military order activity as it relates particularly to the BA-5390 batteries. In October 2004, the battery procurement responsibility for the U.S. military is scheduled to be shifting from CECOM to DLA. Due to this change, and the impending award for Next Gen Phase IV contract (discussed below), it is unclear at this time what the level of orders for the BA-5390 batteries will be from the military during the remainder of 2004. Current orders for the BA-5390 by the U.S. military provide for production to take place into the early part of the fourth quarter. The above guidance assumes that the military will place an order for additional BA-5390's within the next couple of months for production and delivery during the fourth quarter, at a slightly lower level than what the Company produced and shipped during the first half of 2004. The guidance assumes no more than a minimal disruption from the transfer to DLA and that the Company will be successful in receiving an award under the Next Gen II Phase IV contract. As a result of the uncertainty with the military orders at this time, we believe that the second half results will likely be evenly split between the third and fourth quarters. Over the next three to five years, with anticipated growth in various target markets, such as military, medical, automotive telematics, and search and rescue, the Company has targeted an annual growth rate in revenues of 20% - 30%, heading toward annual revenues of $200 million. While the Company's revenues are expected to be comprised of approximately 60% from military sales in 2004, this percentage is expected to decline over time as the Company generates sales from customers in commercial markets. For 2005, the Company currently expects consolidated revenues to range from $125 million to $135 million, including business comprised of approximately 50% military and a doubling of rechargeable revenues from 2004 in the range of $14 million. Significant growth in commercial markets such as medical and automotive telematics is also expected to contribute significantly to the 2005 outlook. As discussed in the Company's Form 10-K for the year ended December 31, 2003, the solicitation for the Next Gen II Phase IV lithium battery procurement, referred to as the "Rectangular" phase, was issued in January 2004. This phase was split into two pieces, one of which included the BA-5390 battery that the Company is already manufacturing under exigent, or non-bid, contracts. The other piece consisted of the BA-5347 battery, for which the solicitation will result in a small business set-aside contract. Bids were submitted for these products in mid-March 2004. At this time, the Company is expecting that awards will be made on this contract in August or September of 2004; however, the Company cannot predict precisely when final awards will be made or what the final outcome may be. The total amount for this phase of Next Gen II is expected to be in the range of up to approximately $200-$300 million over five years. In the meantime, the Company plans to continue to fulfill its current obligations related to exigent contracts, and to pursue other such contracts as the opportunity arises. The Company's current guidance incorporates ongoing BA-5390 contracts. The Company has a fairly substantial fixed cost infrastructure to support its overall operations. As sales continue to grow, manufacturing efficiencies are realized, and operating expenses (R&D and SG&A) are closely controlled, the Company believes it can generate favorable returns in the range of 30%, and possibly as high as 50%, on incremental revenues, depending on product mix. Conversely, decreasing volumes will likely result in the opposite effect. Gross margins in 2004 are expected to be in the range of 23% - 24%. Within the next couple of years, the Company believes that its gross margins 20 can reach a range of 26%-27% as operating efficiencies improve and the mix of products with higher margins increases. It has set a target of 30% gross margins for the longer-term, i.e. within the next five years. The interest from potential customers for various types of new batteries continues to increase significantly. As a result, management made a commitment to increase resources in the R&D area, mainly related to new product development, all of which will be done at the Company's U.S. facility. The Company plans to continue its recent successful efforts related to new cylindrical battery development for applications that initially have a military focus, but often have sizeable commercial applications as well. In addition, it is committing funds for the development of various Thin Cell and rechargeable products. In order to keep up with this increase in opportunities, R&D costs are now expected to be in the range of $600,000 to $700,000 per quarter for the remainder of 2004. While the R&D expense line is now expected to increase somewhat, it is also important to note that the Company also enhances its R&D efforts with technology contracts, the revenues and related costs for which are reported as a part of the Technology Contracts segment. While the Company continues to monitor its operating costs very tightly, it expects that SG&A costs will increase modestly in 2004 over 2003 as it invests in additional sales and marketing efforts, and general administrative costs rise to support increasing efforts for new product development opportunities as well as to support the growth of the business. Overall, the Company expects that total quarterly operating expenses (R&D and SG&A) for the last two quarters of 2004 will remain roughly around the amount reported for the second quarter. For the full year, operating expenses are expected to amount to approximately 12% of total revenues during 2004, compared with 14% in 2003. Within the next couple of years, the Company believes that its operating expenses will be in the range of 11%-12% of revenues, and it has set a target to reach 10% of revenues in the longer-term. At this time, the Company expects to achieve operating income in the second half of 2004 of approximately $5,500,000. For the full year 2004, the Company expects operating income to amount to approximately $12,500,000, reaffirming its previous guidance. With second half revenues expected to be fairly evenly split between the third and fourth quarters, second half operating income is similarly expected to be split proportionately. Within the next couple of years, operating income as a percentage of revenues, is projected to be in the range of 15%, with a longer-term target of 20%, resulting from higher gross margins and lower operating expenses as a percentage of sales. At December 31, 2003, the Company had approximately $76,829,000 in net operating loss (NOL) carryforwards available to offset current and future taxable income. The Company determined there was not sufficient positive evidence in accordance with FAS 109 to record a deferred tax asset at December 31, 2003. The Company has not reported a deferred tax asset on its Consolidated Balance Sheet due to prior operating losses. It is reasonably possible the Company's profitability in 2003 and 2004 would result in the recognition of a deferred tax asset during 2004. In addition, in early 2004, the Company determined that a change in ownership, as defined under Internal Revenue Code Section 382, had occurred during fourth quarter of 2003, resulting in an annual limitation on the utilization of the net operating loss carryforwards. The Company currently estimates that the amount of such limitation will be in the range of approximately $14,000,000 to $18,000,000 annually. If the Company's U.S. taxable income were to exceed this annual limitation, it could result in a higher than anticipated current tax expense for any year in which this occurs. During 2004, the Company projects that it will spend approximately $5,000,000 to $6,000,000 on capital expenditures for machinery and equipment. Nearly one-half of these expenditures are expected to be for projects that enhance manufacturing productivity, with relatively quick returns. The remainder of these expenditures will be used to alleviate bottlenecks and increase capacity, as well as for tooling of new products. 21 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to various market risks in the normal course of business, primarily interest rate risk and changes in market value of its investments and believes its exposure to these risks is minimal. The Company's investments are made in accordance with the Company's investment policy and primarily consist of commercial paper and U.S. corporate bonds. At June 26, 2004, the Company did not invest in derivative financial instruments. In July 2004, the Company entered into an interest rate swap arrangement in connection with its new credit facility. (See Note 13 in Notes to Consolidated Financial Statements for additional information.) Item 4. Controls and Procedures Evaluation Of Disclosure Controls And Procedures - The Company's president and chief executive officer (principal executive officer) and its vice president- finance and chief financial officer (principal financial officer) have evaluated the disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report. Based on this evaluation, the president and chief executive officer and vice president - finance and chief financial officer concluded that the Company's disclosure controls and procedures were effective as of such date. Changes In Internal Controls Over Financial Reporting - There has been no change in the internal controls over financial reporting that occurred during the fiscal quarter covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, the internal controls over financial reporting. 22 PART II OTHER INFORMATION Item 1. Legal Proceedings The Company is subject to legal proceedings and claims which arise in the normal course of business. The Company believes that the final disposition of such matters will not have a material adverse effect on the financial position or results of operations of the Company. In conjunction with the Company's purchase/lease of its Newark, New York facility in 1998, the Company entered into a payment-in-lieu of tax agreement which provides the Company with real estate tax concessions upon meeting certain conditions. In connection with this agreement, a consulting firm performed a Phase I and II Environmental Site Assessment which revealed the existence of contaminated soil and ground water around one of the buildings. The Company retained an engineering firm which estimated that the cost of remediation should be in the range of $230,000. This cost, however, is merely an estimate and the cost may in fact be much higher. In February, 1998, the Company entered into an agreement with a third party which provides that the Company and this third party will retain an environmental consulting firm to conduct a supplemental Phase II investigation to verify the existence of the contaminants and further delineate the nature of the environmental concern. The third party agreed to reimburse the Company for fifty percent (50%) of the cost of correcting the environmental concern on the Newark property. The Company has fully reserved for its portion of the estimated liability. Test sampling was completed in the spring of 2001, and the engineering report was submitted to the New York State Department of Environmental Conservation (NYSDEC) for review. NYSDEC reviewed the report and, in January 2002, recommended additional testing. The Company submitted a work plan to NYSDEC in October 2003, which was approved shortly thereafter. The Company sought proposals from engineering firms to complete the remedial work outlined in the work plan. A firm was selected to perform the tasks associated with the remediation activities, which were completed in December 2003. The test results were then forwarded to NYSDEC for comment. NYSDEC responded to the Company in March 2004 requesting a report summarizing the data, findings, discussions and conclusions. The report has been submitted to NYSDEC who will review and make recommendations as to whether additional remediation is required. Because the Company believes that the source of the contamination has been removed, NYSDEC recommended that the Company conduct quarterly monitoring of the groundwater for one year. The Company believes that the final cost to remediate will not exceed the original estimate. The Company awaits final comments from the NYSDEC and will begin the additional sampling upon approval of the conclusions stated in the report. Because this is a voluntary remediation, there is no requirement for the Company to complete the project within any specific time frame. The ultimate resolution of this matter may have a significant adverse impact on the results of operations in the period in which it is resolved. Furthermore, the Company may face claims resulting in substantial liability which could have a material adverse effect on the Company's business, financial condition and the results of operations in the period in which such claims are resolved. A retail end-user of a product manufactured by one of Ultralife's customers (the "Customer"), has made a claim against the Customer wherein it is asserted that the Customer's product, which is powered by an Ultralife battery, does not operate according to the Customer's product specification. No claim has been filed against Ultralife. However, in the interest of fostering good customer relations, in September 2002, Ultralife agreed to lend technical support to the Customer in defense of its claim. The claim between the end-user and the Customer has now been settled. Ultralife has renewed its commitment to the Customer to honor its warranty by replacing any batteries that may be determined to be defective. In the event a claim is filed against Ultralife and it is ultimately determined that Ultralife's product was defective, replacement of batteries to this Customer or end-user may have a material adverse effect on the Company's financial position and results of operations. 23 Item 4. Submission of Matters to a Vote of Security Holders (a) On June 10, 2004 an Annual Meeting of Shareholders of the Company was held. (b) At the Annual Meeting, the Shareholders of the Company elected to the Board of Directors all seven nominees for Director with the following votes: DIRECTOR FOR AGAINST Patricia C. Barron 12,941,993 99,580 Anthony J. Cavanna 12,997,490 44,083 Paula H. J. Cholmondeley 12,997,290 44,283 Daniel W. Christman 12,941,993 99,580 John D. Kavazanjian 12,997,490 44,083 Carl H. Rosner 12,692,550 349,023 Ranjit C. Singh 12,926,390 115,183 (c) At the Annual Meeting, the Shareholders of the Company voted for the ratification of PricewaterhouseCoopers LLP as its independent registered public accounting firm for 2004 with the following votes: FOR AGAINST 12,826,320 35,673 (d) At the Annual Meeting, the Shareholders of the Company voted for the approval of the Company's 2004 Long -Term Incentive Plan: FOR AGAINST ABSTAIN UNVOTED 7,498,899 1,187,239 54,492 4,300,943 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.1 Credit Agreement dated as of June 30, 2004 with JPMorgan Chase Bank as Administrative Agent 10.2 General Security Agreement dated as of June 30, 2004 in favor of JPMorgan Chase Bank 31.1 Section 302 Certification - CEO 31.2 Section 302 Certification - CFO 32 Section 906 Certifications 24 (b) Reports on Form 8-K On April 14, 2004, the Company filed Form 8-K with the Securities and Exchange Commission announcing that it will report its first quarter 2004 results for the period ended March 27, 2004 before the market opens on Thursday, April 29, 2004.* On April 22, 2004, the Company filed Form 8-K with the Securities and Exchange Commission announcing it had received an order valued at approximately $1.5 million to supply custom lithium ion batteries and chargers to Cubic Defense Applications.* On April 27, 2004, the Company filed Form 8-K with the Securities and Exchange Commission announcing that it had received an order valued at $6 million from the U.S. Army Communications Electronics Command (CECOM) for its BA-5372/U military batteries.* On April 29, 2004, the Company filed a Form 8-K with the Securities and Exchange Commission announcing its financial results for the quarter ended March 27, 2004.* On April 29, 2004, the Company filed a Form 8-K with the Securities and Exchange Commission disclosing that two sitting directors would not stand for re-election to the Board of Directors at the Annual Meeting. On May 4, 2004, the Company filed a Form 8-K with the Securities and Exchange Commission announcing the election of Philip M. Meek, Vice President of Manufacturing, as an officer of the company. On May 27, 2004, the Company filed Form 8-K with the Securities and Exchange Commission indicating that it would hold its annual meeting of shareholders for the period ending December 31, 2003, at the JPMorgan Chase Conference Center in New York City on Thursday, June 10, 2004.* On June 15, 2004, the Company filed a Form 8-K with the Securities and Exchange Commission announcing the election of Paula H. J. Cholmondeley to its board of directors.* *This information was furnished but not filed in accordance with Regulation FD. 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ULTRALIFE BATTERIES, INC. (Registrant) Date: August 2, 2004 By: /s/ John D. Kavazanjian ----------------------------- John D. Kavazanjian President and Chief Executive Officer Date: August 2, 2004 By: /s/ Robert W. Fishback ----------------------------- Robert W. Fishback Vice President - Finance and Chief Financial Officer 26 Index to Exhibits 10.1 Credit Agreement dated as of June 30, 2004 with JPMorgan Chase Bank as Administrative Agent 10.2 General Security Agreement dated as of June 30, 2004 in favor of JPMorgan Chase Bank 31.1 Section 302 Certification - CEO 31.2 Section 302 Certification - CFO 32 Section 906 Certifications 27