ULTRALIFE CORP - Quarter Report: 2020 September (Form 10-Q)

The accompanying notes are an integral part of these consolidated financial statements.

The accompanying notes are an integral part of these consolidated financial statements.

ULTRALIFE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands except share and per share amounts)

(Unaudited)

1.     BASIS OF PRESENTATION

The accompanying unaudited Consolidated Financial Statements of Ultralife Corporation and its subsidiaries (the “Company” or “Ultralife”) have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Rule 8-03 of Regulation S-X. Accordingly, they do not include all 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 Consolidated Financial Statements have been included. Results for interim periods should not be considered indicative of results to be expected for subsequent interim periods or a full year. Reference should be made to the Consolidated Financial Statements and related notes thereto contained in our Form 10-K for the year ended December 31, 2019.

The December 31, 2019 consolidated balance sheet information referenced herein was derived from audited financial statements but does not include all disclosures required by GAAP.

Certain items previously reported in specific financial statement captions have been reclassified to conform to the current presentation.

Effective January 1, 2020, the Company’s interim fiscal periods are reported on a calendar month-basis to better align with fiscal period changes of our customer base. Prior to 2020, the Company’s monthly closing schedule was a 4/4/5 week-based cycle for each fiscal quarter. We do not believe this change materially impacts quarterly comparisons.

Recently Adopted Accounting Guidance

Effective January 1, 2020, the Company adopted Accounting Standards Update (“ASU”) 2017-04, “Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment”. The new standard eliminates the two-step process that required the identification of potential impairment and a separate measure of the actual impairment. Adoption of the new standard will not materially impact the Company’s consolidated financial statements.

Recent Accounting Guidance Not Yet Adopted

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326) – Measurement of Credit Losses on Financial Instruments”, which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. This guidance is effective for the Company for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. The Company is currently assessing the impact that adopting this new accounting standard will have on our consolidated financial statements.

2.     ACQUISITION

On May 1, 2019, the Company completed the acquisition of 100% of the issued and outstanding shares of Southwest Electronic Energy Corporation, a Texas corporation (“SWE”), for an aggregate purchase price of $26,190 inclusive of $942 cash acquired and post-closing adjustments.

SWE is a leading independent designer and manufacturer of high-performance smart battery systems and battery packs to customer specifications using lithium cells. SWE serves a variety of industrial markets, including oil & gas, remote monitoring, process control and marine, which demand uncompromised safety, service, reliability and quality. The Company acquired SWE as a bolt-on acquisition to further support our strategy of commercial revenue diversification by providing entry to the oil & gas exploration and production, and subsea electrification markets, which were previously unserved by Ultralife. Another key benefit of the acquisition includes obtaining a highly valuable technical team of battery pack and charger system engineers and technicians to add to our new product development-based revenue growth initiatives in our commercial end-markets particularly asset tracking, smart metering and other industrial applications.

The acquisition of SWE was completed pursuant to a Stock Purchase Agreement dated May 1, 2019 (the “Stock Purchase Agreement”) by and among Ultralife, SWE, Southwest Electronic Energy Medical Research Institute, a Texas non-profit (the “Seller”), and Claude Leonard Benckenstein, an individual (the “Shareholder”). The Stock Purchase Agreement contains customary terms and conditions including representations, warranties and indemnification provisions.

The aggregate purchase price for the acquisition was funded by the Company through a combination of cash on hand and borrowings under the Credit Facilities (see Note 3).

The purchase price allocation was determined in accordance with the accounting treatment of a business combination pursuant to FASB ASC Topic 805, Business Combinations ("ASC 805"). Accordingly, the fair value of the consideration was determined, and the assets acquired and liabilities assumed have been recorded at their fair values at the date of the acquisition. The excess of the purchase price over the estimated fair values has been recorded as goodwill.

The allocation of the purchase price to the assets acquired and liabilities assumed at the date of the acquisition is presented in the table below. Management is responsible for determining the fair value of the tangible and intangible assets acquired and liabilities assumed as of the date of acquisition. Management considered several factors, including reference to an analysis performed under ASC 805 solely for the purpose of allocating the purchase price to the assets acquired and liabilities assumed. The Company’s estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management’s assumptions, which would not reflect unanticipated events and circumstances that may occur.

The goodwill included in the Company’s purchase price allocation presented above represents the value of SWE’s assembled and trained workforce, the incremental value that SWE engineering and technology will bring to the Company and the revenue growth which is expected to occur over time which is attributable to increased market penetration from future new products and customers. The goodwill acquired in connection with the acquisition is not deductible for income tax purposes.

The operating results and cash flows of SWE are reflected in the Company’s consolidated financial statements from the date of acquisition. SWE is included in the Battery & Energy Products segment.

For the nine months ended September 30, 2020, SWE contributed revenue of $13,382 and net income of $858, inclusive of interest expense of $273 directly related to the financing of the SWE acquisition and amortization expense of $182 on identifiable intangible assets acquired from SWE.

For the nine months ended September 29, 2019, from the May 1, 2019 acquisition date, SWE contributed revenue of $11,993 and net income of $740, inclusive of a $264 increase in cost of products sold for the fair value step-up of acquired inventory sold during the period, non-recurring expenses of $165 directly related to the acquisition, interest expense of $289 directly related to the financing of the SWE acquisition, amortization expense of $101 on acquired identifiable intangible assets, a $55 reduction of depreciation expense as a result of fair value adjustments and useful life changes, and stock-based compensation charges of $49 for stock options and restricted stock awarded to certain SWE employees.

The following supplemental pro forma information presents the combined results of operations, inclusive of the purchase accounting adjustments and one-time acquisition-related expenses described above, as if the acquisition of SWE had been completed on January 1, 2018, the beginning of the comparable prior period.

The supplemental pro forma results are presented for informational purposes only and should not be considered indicative of the financial position or results of operations had the acquisition been completed as of the dates indicated and does not purport to indicate the future combined financial position or results of operation.

Set forth below are the unaudited supplemental pro forma results of the Company and SWE for the nine-month periods ended September 30, 2020 and September 29, 2019 as if the acquisition had occurred as of January 1, 2018.

3.     DEBT

Credit Facilities

On May 1, 2019, Ultralife, SWE, and CLB, INC., a Texas corporation and wholly owned subsidiary of SWE (“CLB”), as borrowers, entered into the First Amendment Agreement (the “First Amendment Agreement”) with KeyBank National Association (“KeyBank” or the “Bank”), as lender and administrative agent, to amend the Credit and Security Agreement by and among Ultralife and KeyBank dated May 31, 2017 (the “Credit Agreement”, and together with the First Amendment Agreement, the “Amended Credit Agreement”).

The Amended Credit Agreement, among other things, provides for a five-year, $8,000 senior secured term loan (the “Term Loan Facility”) and extends the term of the $30,000 senior secured revolving credit facility (the “Revolving Credit Facility”, and together with the Term Loan Facility, the “Credit Facilities”) through May 31, 2022. Up to six months prior to May 31, 2022, the Revolving Credit Facility may be increased to $50,000 with the Bank’s concurrence.

Upon closing of the SWE acquisition on May 1, 2019, the Company drew down the full amount of the Term Loan Facility and $6,782 under the Revolving Credit Facility. As of September 30, 2020, the Company had $3,855 outstanding principal on the Term Loan Facility, of which $1,537 is included in current portion of long-term debt on the balance sheet, and no amounts outstanding on the Revolving Credit Facility. As of September 30, 2020, total unamortized debt issuance costs of $128 associated with the Amended Credit Agreement are classified as a reduction of long-term debt on the balance sheet.

The Company is required to repay the borrowings under the Term Loan Facility in sixty (60) equal consecutive monthly payments commencing on May 31, 2019, in arrears, together with applicable interest. All unpaid principal and accrued and unpaid interest with respect to the Term Loan Facility is due and payable in full on April 30, 2024. All unpaid principal and accrued and unpaid interest with respect to the Revolving Credit Facility is due and payable in full on May 31, 2022. The Company may voluntarily prepay principal amounts outstanding at any time subject to certain restrictions.

In addition to the customary affirmative and negative covenants, the Company must maintain a consolidated fixed charge coverage ratio of equal to or greater than 1.15 to 1.0, and a consolidated senior leverage ratio of equal to or less than 2.5 to 1.0, each as defined in the Amended Credit Agreement. The Company was in full compliance with its covenants as of September 30, 2020.

Borrowings under the Credit Facilities are secured by substantially all the assets of the Company. Availability under the Revolving Credit Facility is subject to certain borrowing base limits based on receivables and inventories.

Interest will accrue on outstanding indebtedness under the Credit Facilities at the Base Rate or the Overnight LIBOR Rate, as selected by the Company, plus the applicable margin. The Base Rate is the higher of (a) the Prime Rate, (b) the Federal Funds Effective Rate plus 50 basis points, and (c) the Overnight LIBOR Rate plus one hundred basis points. The applicable margin ranges from zero to negative 50 basis points for the Base Rate and from 185 to 215 basis points for the Overnight LIBOR Rate and are determined based on the Company’s senior leverage ratio.

The Company must pay a fee of 0.1% to 0.2% based on the average daily unused availability under the Revolving Credit Facility.

Payments must be made by the Company to the extent borrowings exceed the maximum amount then permitted to be drawn on the Credit Facilities and from the proceeds of certain transactions. Upon the occurrence of an event of default, the outstanding obligations may be accelerated and the Bank will have other customary remedies including resort to the security interest the Company provided to the Bank.

4.     EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed by dividing earnings attributable to the Company’s common shareholders by the weighted-average shares outstanding during the period.  Diluted EPS includes the dilutive effect of securities, if any, and is calculated using the treasury stock method.  For the three-month period ended September 30, 2020, 831,244 stock options and 19,165 restricted stock awards were included in the calculation of diluted EPS as such securities are dilutive.  Inclusion of these securities resulted in 181,270 additional shares in the calculation of fully diluted earnings per share.  For the comparable three-month period ended September 29, 2019, 914,535 stock options and 31,666 restricted stock awards were included in the calculation of diluted EPS resulting in 377,200 additional shares in the calculation of fully diluted earnings per share. For the nine-month periods ended September 30, 2020 and September 29, 2019, 831,244   and 914,535 stock options and 19,165 and 31,666 restricted stock awards, respectively, were included in the calculation of diluted EPS as such securities are dilutive.  Inclusion of these securities resulted in 213,574 and 382,711 additional shares, respectively, in the calculation of fully diluted earnings per share. 

There were 898,167 and 703,250 outstanding stock options for the three-month periods ended September 30, 2020 and September 29, 2019, respectively, which were not included in EPS as the effect would be anti-dilutive. There were 898,167 and 703,250 outstanding stock options for the nine-month periods ended September 30, 2020 and September 29, 2019, respectively, which were not included in EPS as the effect would be anti-dilutive.

5.     SUPPLEMENTAL BALANCE SHEET INFORMATION

Fair Value Measurements and Disclosures

The fair value of financial instruments approximated their carrying values at September 30, 2020 and December 31, 2019. The fair value of cash, trade accounts receivable, trade accounts payable, accrued liabilities, and the current portion of long-term debt approximates carrying value due to the short-term nature of these instruments. The carrying value of long-term debt approximates fair value, as the variable interest rates approximate current market rates.

Cash

The composition of the Company’s cash was as follows:

As of September 30, 2020 and December 31, 2019, restricted cash included $87 and $82, respectively, of euro-denominated deposits withheld by the Dutch tax authorities and third-party VAT representatives in connection with a previously utilized logistics arrangement in the Netherlands. As of December 31, 2019, restricted cash included $188 for a government grant awarded in the People’s Republic of China to fund specified technological research and development initiatives. The grant proceeds are realized as a direct offset to qualifying expenditures as incurred. For the nine-month period ended September 30, 2020, grant proceeds of $188 were used to fund qualifying capital expenditures and material and labor costs incurred. Restricted cash is included as a component of the cash balance for purposes of the consolidated statements of cash flows.

Inventories

Inventories are stated at the lower of cost or market, net of obsolescence reserves, with cost determined under the first-in, first-out (FIFO) method. The composition of inventories, net was:

Property, Plant and Equipment, Net

Major classes of property, plant and equipment consisted of the following:

Depreciation expense for property, plant and equipment was as follows:

Goodwill

The following table summarizes the goodwill activity by segment for the nine-month period ended September 30, 2020.

Other Intangible Assets, Net

The composition of other intangible assets was:

The change in the cost of total intangible assets from December 31, 2019 to September 30, 2020 is a result of the effect of foreign currency translations.

Amortization expense for other intangible assets was as follows:

6.     STOCK-BASED COMPENSATION

We recorded non-cash stock compensation expense in each period as follows:

We have stock options outstanding from various stock-based employee compensation plans for which we record compensation cost relating to share-based payment transactions in our financial statements. As of September 30, 2020, there was $720 of total unrecognized compensation cost related to outstanding stock options, which is expected to be recognized over a weighted average period of 1.4 years.

The following table summarizes stock option activity for the nine-month period ended September 30, 2020:

The following assumptions were used to value stock options granted during the nine months ended September 30, 2020:

The weighted average grant date fair value of options granted during the nine months ended September 30, 2020 was $2.78.

Cash received from stock option exercises under our stock-based compensation plans for the three-month periods ended September 30, 2020 and September 29, 2019 was $142 and $388, respectively. Cash received from stock option exercises under our stock-based compensation plans for the nine-month periods ended September 30, 2020 and September 29, 2019 was $218 and $866, respectively.

In April 2019, 20,000 shares of restricted stock were awarded to certain of our employees at a weighted-average grant date fair value of $11.12 per share. In January 2018, 17,500 shares of restricted stock were awarded to certain of our employees at a weighted-average grant date fair value of $7.16 per share. All outstanding restricted shares vest in equal annual installments over three years. Unrecognized compensation cost related to these restricted shares was $63 at September 30, 2020, which is expected to be recognized over a weighted average period of 1.5 years.

7.     INCOME TAXES

Our effective tax rate for the nine-month periods ended September 30, 2020 and September 29, 2019 was 23.9% and 20.5% respectively. The period-over-period change was primarily attributable to the geographic mix of earnings and lower discrete tax benefits realized on disqualifying dispositions of incentive stock options exercised by employees as compared to the prior period.

As of December 31, 2019, we have domestic net operating loss (“NOL”) carryforwards of $58,400, which expire 2020 thru 2035, and domestic tax credits of $1,907, which expire 2028 thru 2039, available to reduce future taxable income. As of September 30, 2020, management has concluded it is more likely than not that these domestic NOL and credit carryforwards will be fully utilized.

As of September 30, 2020, for certain past operations in the U.K., we continue to report a valuation allowance for NOL carryforwards of approximately $10,000, nearly all of which can be carried forward indefinitely. Utilization of the net operating losses may be limited due to the change in the past U.K. operation and cannot currently be used to reduce taxable income at our other U.K. subsidiary, Accutronics Ltd.

As of September 30, 2020, we have not recognized a valuation allowance against our other foreign deferred tax assets, as realization is considered to be more likely than not.

As of September 30, 2020, the Company maintains its assertion that all foreign earnings will be indefinitely reinvested in those operations.

There were no unrecognized tax benefits related to uncertain tax positions at September 30, 2020 and December 31, 2019.

As a result of our operations, we file income tax returns in various jurisdictions including U.S. federal, U.S. state and foreign jurisdictions.  We are routinely subject to examination by taxing authorities in these various jurisdictions.  In August 2020, the Internal Revenue Service (“IRS”) completed its examination of the Company’s federal tax returns for 2016-2018 with no material adjustments identified.  Our U.S. tax matters for 2019 remain subject to IRS examination.  Our U.S. tax matters for 2001, 2002, 2005-2007 and 2011-2015 also remain subject to IRS examination due to the remaining availability of net operating loss carryforwards generated in those years. Our U.S. tax matters for 2001, 2002, 2005-2007 and 2011-2019 remain subject to examination by various state and local tax jurisdictions. Our tax matters for the years 2010 through 2019 remain subject to examination by the respective foreign tax jurisdiction authorities.

8.     OPERATING LEASES

The Company has operating leases predominantly for operating facilities. As of September 30, 2020, the remaining lease terms on our operating leases range from approximately 1 to 4 years. Renewal options and termination options are not reasonably certain of exercise by the Company. There is no transfer of title or option to purchase the leased assets upon expiration. There are no residual value guarantees or material restrictive covenants.

The components of lease expense for the current and prior-year comparative periods were as follows:

Supplemental cash flow information related to leases was as follows:

Supplemental balance sheet information related to leases was as follows:

Future minimum lease payments as of September 30, 2020 are as follows:

In August 2020, the Company entered into an agreement to extend the operating lease term of its Virginia Beach facility through April 2024.  Aggregate future minimum lease payments of $959 are required to be made over the three-year extension period. 

9.     COMMITMENTS AND CONTINGENCIES

a. Purchase Commitments

As of September 30, 2020, we have made commitments to purchase approximately $783 of production machinery and equipment.

b. Product Warranties

We estimate future warranty costs to be incurred for product failure rates, material usage and service costs in the development of our warranty obligations. Estimated future costs are based on actual past experience and are generally estimated as a percentage of sales over the warranty period. Changes in our product warranty liability during the first nine months of 2020 and 2019 were as follows:

c. Contingencies and Legal Matters

We are subject to legal proceedings and claims that arise from time to time in the normal course of business. We believe that the final disposition of any such matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows. However, recognizing that legal matters are subject to inherent uncertainties, there exists the possibility that ultimate resolution of these matters could have a material adverse impact on the Company’s financial position, results of operations or cash flows. We are not aware of any such situations that are reasonably possible at this time.

10.     REVENUE RECOGNITION

Revenues are generated from the sale of products. Performance obligations are met and revenue is recognized upon transfer of control to the customer, which is generally upon shipment. When contract terms require transfer of control upon delivery at a customer’s location, revenue is recognized on the date of delivery. Revenue is measured as the amount of consideration we expect to receive in exchange for shipped product. Sales, value-added and other taxes billed and collected from customers are excluded from revenue. Customers, including distributors, do not have a general right of return. For products shipped under vendor managed inventory arrangements, revenue is recognized and billed when the product is consumed by the customer, at which point control has transferred and there are no further obligations by the Company.

Revenues recognized from prior period performance obligations for the nine-month periods ended September 30, 2020 and September 29, 2019 were not material. Deferred revenue, unbilled revenue and deferred contract costs recorded on our consolidated balance sheets as of September 30, 2020 and December 31, 2019 were not material. As of September 30, 2020 and December 31, 2019, the Company had no unsatisfied performance obligations for contracts with an original expected duration of greater than one year. Pursuant to ASC Topic 606, we have applied the practical expedient with respect to disclosure of the deferral and future expected timing of revenue recognition for transaction price allocated to remaining performance obligations.

11.     BUSINESS SEGMENT INFORMATION

We report our results in two operating segments: Battery & Energy Products and Communications Systems. The Battery & Energy Products segment includes Lithium 9-volt, cylindrical and various other non-rechargeable batteries, in addition to rechargeable batteries, uninterruptable power supplies, charging systems and accessories. The Communications Systems segment includes RF amplifiers, power supplies, cable and connector assemblies, amplified speakers, equipment mounts, case equipment, man-portable systems, integrated communication systems for fixed or vehicle applications and communications and electronics systems design. We believe that reporting performance at the gross profit level is the best indicator of segment performance. 

The components of segment performance were as follows:

Three-month period ended September 30, 2020:

Three-month period ended September 29, 2019:

Nine-month period ended September 30, 2020:

Nine-month period ended September 29, 2019:

The following tables disaggregate our business segment revenues by major source and geography.

Commercial and Government/Defense Revenue Information: 

Three-month period ended September 30, 2020:

Three-month period ended September 29, 2019:

Nine-month period ended September 30, 2020:

Nine-month period ended September 29, 2019:

U.S. and Non-U.S. Revenue Information¹:

Three-month period ended September 30, 2020:

Three-month period ended September 29, 2019:

Nine-month period ended September 30, 2020:

Nine-month period ended September 29, 2019:

¹ Sales classified to U.S. include shipments to U.S.-based prime contractors which in some cases may serve non-U.S. projects.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

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: the effects of the novel coronavirus disease of 2019 (“COVID-19”) or other infectious disease pandemics which may arise in the future; our reliance on certain key customers; possible future declines in demand for the products that use our batteries or communications systems; the unique risks associated with our China operations including changes in U.S. tariffs and trade disputes with China; potential costs because of the warranties we supply with our products and services; potential disruptions in our supply of raw materials and components; our efforts to develop new commercial applications for our products; reduced U.S. and foreign military spending including the uncertainty associated with government budget approvals; possible breaches in security and other disruptions; variability in our quarterly and annual results and the price of our common stock; safety risks, including the risk of fire; our entrance into new end-markets which could lead to additional financial exposure; fluctuations in the price of oil and the resulting impact on the level of downhole drilling by our oil & gas customers; our ability to retain top management and key personnel; our resources being overwhelmed by our growth prospects; our inability to comply with changes to the regulations for the shipment of our products; our customers’ demand falling short of volume expectations in our supply agreements; possible impairments of our goodwill and other intangible assets; negative publicity of Lithium-ion batteries; our exposure to foreign currency fluctuations; the risk that we are unable to protect our proprietary and intellectual property; rules and procedures regarding contracting with the U.S. and foreign governments; our ability to utilize our net operating loss carryforwards; exposure to possible violations of the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act or other anti-corruption laws; our ability to comply with government regulations regarding the use of “conflict minerals” possible audits of our contracts by the U.S. and foreign governments and their respective defense agencies; known and unknown environmental matters; technological innovations in the non-rechargeable and rechargeable battery industries; and other risks and uncertainties, certain of which are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may differ materially from those forward-looking statements described herein. When used in this report, the words “anticipate,” “believe,” “estimate,” “expect,” “seek,” “project,” “intend,” “plan,” “may,” “will,” “should,” or words of similar import are intended to identify forward-looking statements. For further discussion of certain of the matters described above and other risks and uncertainties, see Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, and Item 1A, “Risk Factors” in Part II of this Form 10-Q.

Although we base these forward-looking statements on assumptions that we believe are reasonable when made, we caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industries in which we operate may differ materially from those made in or suggested by the forward-looking statements contained herein. In addition, even if our results of operations, financial condition and liquidity and the development of the industries in which we operate are consistent with the forward-looking statements contained in this quarterly report, those results or developments may not be indicative of results or developments in subsequent periods. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data. Given these risks and uncertainties, you are cautioned not to place undue reliance on these forward-looking statements. 

Except as required by law, we disclaim any obligation to update any risk factors or to publicly announce the results of any revisions to any of the forward-looking statements contained in this Quarterly Report on Form 10-Q or our Annual Report on Form 10-K for the year ended December 31, 2019 to reflect new information or risks, future events or other developments.

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto in Part I, Item 1 of this Form 10-Q, the Risk Factors in Part II, Item 1A of this Form 10-Q, and the Consolidated Financial Statements and Notes thereto and Risk Factors in our Form 10-K for the year ended December 31, 2019.

The financial information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations is presented in thousands of dollars, except for share and per share amounts.

General

We offer products and services ranging from power solutions to communications and electronics systems to customers across the globe in the government, defense and commercial sectors. With an emphasis on strong engineering and a collaborative approach to problem solving, we design and manufacture power and communications systems including rechargeable and non-rechargeable batteries, charging systems, communications and electronics systems and accessories, and custom engineered systems. We continually evaluate ways to grow, including the design, development and sale of new products, expansion of our sales force to penetrate new markets and geographies, as well as seeking opportunities to expand through acquisitions.

We sell our products worldwide through a variety of trade channels, including original equipment manufacturers (“OEMs”), industrial and defense supply distributors, and directly to U.S. and international defense departments. We enjoy strong name recognition in our markets under our Ultralife^® Batteries, Lithium Power^®, McDowell Research^®, AMTI^TM, ABLE^TM, ACCUTRONICS™, ACCUPRO™, ENTELLION™, SWE Southwest Electronic Energy Group™, SWE DRILL-DATA™, and SWE SEASAFE™ brands.  We have sales, operations and product development facilities in North America, Europe and Asia.

We report our results in two operating segments: Battery & Energy Products and Communications Systems.  The Battery & Energy Products segment includes Lithium 9-volt, cylindrical, thin cell and other non-rechargeable batteries, in addition to rechargeable batteries, uninterruptable power supplies, charging systems and accessories. The Communications Systems segment includes RF amplifiers, power supplies, cable and connector assemblies, amplified speakers, equipment mounts, case equipment, man-portable systems, integrated communication systems for fixed or vehicle applications and communications and electronics systems design. We believe that reporting performance at the gross profit level is the best indicator of segment performance.  As such, we report segment performance at the gross profit level and operating expenses as Corporate charges.  See Note 11 in the Notes to Consolidated Financial Statements in Item 1 of Part I of this Form 10-Q.

Our website address is www.ultralifecorporation.com. We make available free of charge via a hyperlink on our website (see Investor Relations link on the website) our annual reports on Form 10-K, proxy statements, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports and statements as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). We will provide copies of these reports upon written request to the attention of Philip A. Fain, CFO, Treasurer and Secretary, Ultralife Corporation, 2000 Technology Parkway, Newark, New York, 14513. Our filings with the SEC are also available through the SEC website at www.sec.gov or at the SEC Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 or by calling 1-800-SEC-0330.

COVID-19

The COVID-19 pandemic has created significant economic disruption and uncertainty around the world.  The Company continues to closely monitor the developments surrounding COVID-19 and take actions to mitigate the business risks involved.  During this challenging time, we remain focused on ensuring the health and safety of our employees by implementing the protocols established by public health officials in addition to meeting the demand of our customers.  As an essential supplier currently exempt from government-mandated shutdown directives, we are striving to ensure an uninterrupted flow of our mission critical products serving medical device, first responder, public safety, energy and national security customers. For the 2020 year-to-date period, we have maintained normal operations at all our facilities with the exception of an approximately one-month closure of our China facility as was mandated by the Chinese government through early March 2020. 

For the quarter ended March 31, 2020, our operating results were adversely affected by COVID-19, particularly as a result of the temporary shutdown of our China operation and supply chain disruptions.  We estimated the effects of COVID-19 adversely impacted net income by approximately $500 for our first quarter.  For the quarter ended June 30, 2020, we estimated that the net impact of COVID-19 to net income was immaterial.  Demand for our medical batteries, especially those used in ventilators, respirators and infusion pumps, substantially increased during the second quarter; however, this increase was offset by delays in medical battery orders for devices used for elective surgeries and the overall disruptions in supply chains impacting both commercial and government/defense markets.  For the quarter ended September 30, 2020, we estimate that the net impact of COVID-19 to net income was a loss of approximately $1,000.  Demand for medical batteries, especially those used in ventilators, respirators and infusion pumps, substantially increased during the third quarter; however, this increase was more than offset by the revenue declines in oil & gas and international industrial markets.  Logistics disruptions also delayed certain shipments.

Refer to Item 1A “Risk Factors” in Part II of this Form 10-Q for risks and uncertainties related to COVID-19.

Overview

Consolidated revenues of $24,362 for the three-month period ended September 30, 2020, decreased by $3,131 or 11.4%, from $27,493 for the three-month period ended September 29, 2019, as a significant increase in battery sales to our medical and government/defense customers was offset by lower oil & gas market and Communications Systems sales.  We have estimated that COVID-19 adversely impacted our third quarter 2020 sales by approximately $2,900.

Gross profit was $6,511, or 26.7% of revenue, compared to $7,861, or 28.6% of revenue, for the same quarter a year ago. The 190-basis point decrease primarily resulted from costs associated with the transition of new products to higher volume production as well as the mix of products sold in our Communications Systems business.

Operating expenses decreased to $5,804 during the three-month period ended September 30, 2020, from $6,555 during the three-month period ended September 29, 2019.  The decrease of $751 or 11.5% was consistent with the overall percentage reduction in revenues, and included certain headcount reductions, lower travel expenses and strict control over all discretionary spending.  Operating expenses as a percentage of revenues was 23.8% for both the 2020 and 2019 periods. 

Operating income for the three-month period ended September 30, 2020 was $707 or 2.9% of revenues compared to $1,306 or 4.8% of revenues for the year-earlier period. The 45.9% decrease in operating income primarily resulted from revenue declines in oil & gas and international industrial markets and the overall disruptions in customer/third party logistics impacting both commercial and government/defense markets resulting from COVID-19.

Net income attributable to Ultralife was $407, or $0.03 per share – basic and diluted, for the three-month period ended September 30, 2020, compared to $1,124, or $0.06 per share – basic and diluted, for the three-month period ended September 29, 2019.  Adjusted EPS was $0.04 on a diluted basis for the third quarter of 2020, representing a 43.8% decrease from Adjusted EPS on a diluted basis of $0.07 for the 2019 period.  Adjusted EPS excludes the provision for deferred taxes of $188 and $165 for the 2020 and 2019 periods, respectively, which primarily represents non-cash charges for U.S. taxes which will be fully offset by net operating loss carryforwards and other tax credits for the foreseeable future.  See the section “Adjusted EPS” beginning on Page 27 for a reconciliation of EPS to Adjusted EPS.  The net adverse impact of COVID-19 on Adjusted EPS for the 2020 third quarter was approximately $0.06.

Adjusted EBITDA, defined as net income attributable to Ultralife before net interest expense, provision for income taxes, depreciation and amortization, and stock-based compensation expense, plus/minus expenses/income that we do not consider reflective of our ongoing operations, amounted to $1,656 or 6.8% of revenues in the third quarter of 2020 compared to $2,307 or 8.4% of revenues for the third quarter of 2019. See the section “Adjusted EBITDA” beginning on Page 26 for a reconciliation of Adjusted EBITDA to net income attributable to Ultralife.

Supported by a solid balance sheet and resilient business model, we are committed to completing our strategic growth projects and are well positioned to withstand current economic headwinds.

Results of Operations

Three-Month Periods Ended September 30, 2020 and September 29, 2019

Revenues.  Consolidated revenues for the three-month period ended September 30, 2020 amounted to $24,362, a decrease of $3,131 or 11.4%, from $27,493 for the three-month period ended September 29, 2019.  Overall, commercial sales decreased 10.8% while government/defense sales decreased 12.5% from the 2019 period.  For the quarter ended September 30, 2020, we estimate that the net adverse impact of COVID-19 on revenues was approximately $2,900.  Demand for medical batteries, especially those used in ventilators, respirators and infusion pumps, substantially increased during the third quarter; however, this increase was more than offset by the revenue declines in oil & gas and international industrial markets, and the overall disruptions in customer and third-party logistics which delayed certain shipments.

Battery & Energy Products revenues decreased $759, or 3.4%, from $22,578 for the three-month period ended September 29, 2019 to $21,819 for the three-month period ended September 30, 2020. Excluding oil & gas sales, revenues increased 27.5% over the prior year reflecting a 102.1% increase in medical sales resulting from an increase in demand for our batteries used in ventilators, respirators, infusion pumps and other medical devices associated with COVID-19, and a 23.4% increase in government/defense sales due primarily to higher demand from a large global defense contractor and the shipment of our legacy 5390 batteries under a firm fixed price delivery order received in December 2019.  This increase was more than offset by a 68.7% decrease in oil & gas market battery sales representative of current market conditions for that sector. 

Communications Systems revenues decreased $2,372, or 48.3%, from $4,915 during the three-month period ended September 29, 2019 to $2,543 for the three-month period ended September 30, 2020. This decrease is primarily attributable to higher 2019 shipments of mounted power amplifiers to support the U.S. Army’s Network Modernization and other initiatives under the delivery orders announced in October 2018.  The October 2018 delivery orders to the U.S. Army were completed in the second quarter of 2020. 

Cost of Products Sold / Gross Profit. Cost of products sold totaled $17,851 for the quarter ended September 30, 2020, a decrease of $1,781, or 9.1%, from the $19,632 reported for the same three-month period a year ago. Consolidated cost of products sold as a percentage of total revenue increased from 71.4% for the three-month period ended September 29, 2019 to 73.3% for the three-month period ended September 30, 2020. Correspondingly, consolidated gross margin decreased from 28.6% for the three-month period ended September 29, 2019, to 26.7% for the three-month period ended September 30, 2020, primarily reflecting sales mix and costs associated with the transition of new products to higher volume production.

For our Battery & Energy Products segment, gross profit for the third quarter of 2020 was $5,677, a decrease of $440 or 7.2% from gross profit of $6,117 for the third quarter of 2019. Battery & Energy Products’ gross margin of 26.0% decreased by 110 basis points from the 27.1% gross margin for the year-earlier period, reflecting sales mix and incremental costs associated with the transition of new products to higher volume production.

For our Communications Systems segment, gross profit for the third quarter of 2020 was $834 or 32.8% of revenues, a decrease of $910 or 52.2%, from gross profit of 1,744 or 35.5% of revenues, for the third quarter of 2019. The 270-basis point decrease in gross margin during the third quarter of 2020 was driven by sales mix and lower factory throughput as compared to the third quarter of 2019.

Operating Expenses. Operating expenses for the three-month period ended September 30, 2020 were $5,804, a decrease of $751 or 11.5% from the $6,555 for the three-month period ended September 29, 2019. The 11.5% decrease in operating expenses, which is relatively consistent with the 11.4% decline in revenues, is attributable to certain headcount reductions, lower travel and strict control over all discretionary spending.