Ultralife Corporation (ULBI) - Description of business

Company Description
     Ultralife Batteries, Inc. is a global provider of high-energy power systems for diverse applications. The Company develops, manufactures and markets a wide range of non-rechargeable and rechargeable batteries, charging systems and accessories for use in military, industrial and consumer portable electronic products. Through its portfolio of standard products and engineered solutions, Ultralife is at the forefront of providing the next generation of power systems. 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.b. Principles of Consolidation     The consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States and include the accounts of the Company and its wholly owned subsidiary, Ultralife Batteries UK, Ltd. (“Ultralife UK”). Intercompany accounts and transactions have been eliminated in consolidation. Investments in entities in which the Company does not have a controlling interest are accounted for using the equity method, if the Company’s interest is greater than 20%. Investments in entities in which the Company has less than a 20% ownership interest are accounted for using the cost method.c. Management’s Use of Judgment and Estimates     The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at year end and the reported amounts of revenues and expenses during the reporting period. Key areas affected by estimates include: (a) reserves for excess and obsolete inventory, warranties, and bad debts, (b) profitability on development contracts and (c) various expense accruals. Actual results could differ from those estimates.d . Cash and Cash Equivalents     For purposes of the Consolidated Statements of Cash Flows, the Company considers all demand deposits with financial institutions and financial instruments with original maturities of three months or less to be cash equivalents. For purposes of the Consolidated Balance Sheet, the carrying value approximates fair value because of the short maturity of these instruments.e. Available-for-Sale Securities     Management determines the appropriate classification of securities at the time of purchase and re-evaluates such designation as of each balance sheet date. Marketable equity securities and debt securities are classified as available-for-sale. These securities are carried at fair value, with the unrealized gains and losses, net of tax, included as a component of accumulated other comprehensive income. The Company had available-for-sale securities amounting to $0 at December 31, 2005 and $1,000 at December 31, 2004, consisting of auction rate securities. There were no unrealized gains or losses related to securities included in other comprehensive income at December 31, 2005 or 2004.     The amortized cost of debt securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. The cost of securities sold is based on the specific identification method. Interest on securities classified as available-for-sale is included in interest income. Realized gains and losses, and declines in value judged to be other-than-temporary on available-for-sale securities, if any, are included in the determination of net income (loss) as gains (losses) on sale of securities. There were no realized gains or losses included in net (loss) income for the years ended December 31, 2005, 2004, or 2003.f. Inventories     Inventories are stated at the lower of cost or market with cost determined under the first-in, first-out (FIFO) method.g. Property, Plant and Equipment     Property, plant and equipment are stated at cost. Estimated useful lives are as follows:       Buildings   10 – 20 years Machinery and Equipment   5 – 10 years Furniture and Fixtures   3 – 7 years Computer Hardware and Software   3 – 5 years Leasehold Improvements   Lesser of useful life or lease term      Depreciation and amortization are computed using the straight-line method. Betterments, renewals and extraordinary repairs that extend the life of the assets are capitalized. Other repairs and maintenance costs are expensed when incurred. When disposed, the cost and accumulated depreciation applicable to assets retired are removed from the accounts and the gain or loss on disposition is recognized in operating income (expense).h. Long-Lived Assets and Intangibles     The Company regularly assesses all of its long-lived assets for impairment when events or circumstances indicate their carrying amounts may not be recoverable. This is accomplished by comparing the expected undiscounted future cash flows of the assets with the respective carrying amount as of the date of assessment. Should aggregate future cash flows be less than the carrying value, a write-down would be required, measured as the difference between the carrying value and the fair value of the asset. Fair value is estimated either through the assistance of an independent valuation or as the present value of expected discounted future cash flows. The discount rate used by the Company in its evaluation approximates the Company’s weighted average cost of capital. If the expected undiscounted future cash flows exceed the respective carrying amount as of the date of assessment, no impairment is recognized. In 2004, the Company recorded an impairment charge of $1,803 consisting of $664 of the net book value of the Company’s own assets, and $1,139 of the present value of remaining payments for certain assets under operating leases. The Company did not record any impairment of long-lived assets in the calendar years ended December 31, 2005 or 2003.i. Technology License Agreements and Royalties     Technology license agreements consist of the rights to patented technology and related technical information. The Company acquired a technology license agreement for an initial payment of $1,000 in May 1994. Royalties are payable at a rate of 8% of the fair market value of each battery using the technology if the battery is sold or otherwise put into use by the Company. The royalties can be reduced under certain circumstances based on the terms of this agreement. The agreement is amortized using the straight-line method over 10 years, the term of the agreement. As of December 31, 2004, the technology license agreements were fully amortized. Amortization expense was $0, $33, and $100 in the years ended December 31, 2005, 2004 and 2003, respectively.j. Translation of Foreign Currency     The financial statements of the Company’s foreign affiliates are translated into U.S. dollar equivalents in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, “Foreign Currency Translation”. Exchange (losses) gains included in net (loss) income for the years ended December 31, 2005, 2004 and 2003 were $(330), $345, and $316, respectively.k . Revenue Recognition     Battery Sales – In general, revenues from the sale of batteries are recognized when products are shipped. When products are shipped with terms that require transfer of title upon delivery at a customer’s location, revenues are recognized on date of delivery. Sales made to distributors are recognized at time of shipment. A provision is made at the time the revenue is recognized for warranty costs expected to be incurred. Customers, including distributors, do not have a general right of return on products shipped.     Technology Contracts – The Company recognizes revenue using the proportional effort method based on the relationship of costs incurred to date to the total estimated cost to complete the contract. Elements of cost include direct material, labor and overhead. If a loss on a contract is estimated, the full amount of the loss is recognized immediately. The Company allocates costs to all technology contracts based upon actual costs incurred including an allocation of certain research and development costs incurred. Under certain research and development arrangements with the U.S. Government, the Company may be required to transfer technology developed to the U.S. Government. The Company has accounted for the contracts in accordance with SFAS No. 68, “Research and Development Arrangements”. The Company, where appropriate, has recognized a liability for amounts that may be repaid to third parties, or for revenue deferred until expenditures have been incurred.l. Warranty Reserves     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. In the event the actual results of these items differ from the estimates, an adjustment to the warranty obligation would be recorded.m. Shipping and Handling Costs     Costs incurred by the Company related to shipping and handling are included in Cost of products sold. Amounts charged to customers pertaining to these costs are reflected as revenue.n. Advertising Expenses     Advertising costs are expensed as incurred and are included in selling, general and administrative expenses in the accompanying Consolidated Statements of Operations. Such expenses amounted to $248, $208, and $142 for the years ended December 31, 2005, 2004 and 2003, respectively.o. Research and Development     Research and development expenditures are charged to operations as incurred. The majority of research and development costs have included the development of new cylindrical cells and batteries for various military applications, utilizing technology developed through its work on pouch cell development. The Company is directing its rechargeable battery research and development efforts toward design optimization and customization to customer specifications. The majority of research and development expenses pertain to salaries and benefits, developmental supplies, depreciation and other contracted services.p. Environmental Costs     Environmental expenditures that relate to current operations are expensed or capitalized, as appropriate, in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 96-1, “Environmental Remediation Liabilities”. Remediation costs that relate to an existing condition caused by past operations are accrued when it is probable that these costs will be incurred and can be reasonably estimated.q. 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 basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. For the year ended December 31, 2005, the Company’s balance sheet reflected a balance of $23,729 associated with its net deferred tax asset. In the year ended December 31, 2004, the Company recorded a $23,501 net deferred tax asset associated with its U.S. net operating loss carryforwards, due to the determination that it was more likely than not that the Company would be able to utilize these benefits in the future. The Company recorded no income tax benefit relating to the net operating loss generated during the year ended December 31, 2003 as such income tax benefit was offset by an increase in the valuation allowance. A valuation allowance is required when it is more likely than not that the recorded value of a deferred tax asset will not be realized. A valuation allowance was required for the years ended December 31, 2004 and 2005 related to the Company’s U.K. subsidiary and the history of losses at that facility.r. Concentration of Credit Risk     The Company has one major customer, the U.S. Department of Defense, that comprised 25%, 56%, and 51% of the Company’s revenue in the years ended December 31, 2005, 2004, and 2003, respectively. There were no other customers that comprised greater than 10% of the total company revenues in those years.     Currently, the Company does not experience significant seasonal trends in non-rechargeable battery revenues. However, a downturn in the U.S. economy, which affects retail sales and which could result in fewer sales of smoke detectors to consumers, could potentially result in lower Company sales to this market segment. The smoke detector OEM market segment comprised approximately 8% of total non-rechargeable revenues in 2005. Additionally, a lower demand from the U.S. and U.K. Governments could result in lower sales to military and government users.     The Company generally does not distribute its products to a concentrated geographical area nor is there a significant concentration of credit risks arising from individuals or groups of customers engaged in similar activities, or who have similar economic characteristics. While sales to the U.S. military have been substantial during 2005, the Company does not consider this customer to be a significant credit risk. The Company does not normally obtain collateral on trade accounts receivable.s. Fair Value of Financial Instruments     SFAS No. 107, “Disclosure About Fair Value of Financial Instruments”, requires disclosure of an estimate of the fair value of certain financial instruments. The fair value of financial instruments pursuant to SFAS No. 107 approximated their carrying values at December 31, 2005 and 2004. Fair values have been determined through information obtained from market sources.t . Derivative Financial Instruments     Derivative instruments are accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” which requires that all derivative instruments be recognized in the financial statements at fair value. The fair value of the Company’s interest rate swap at December 31, 2005 resulted in an asset of $91, all of which was reflected as short term. The fair value of the Company’s interest rate swap at December 31, 2004 resulted in a liability of $100, of which $78 was reflected as long-term.u. (Loss) Earnings Per Share     The Company accounts for net (loss) earnings per common share in accordance with the provisions of SFAS No. 128, “Earnings Per Share”. SFAS No. 128 requires the reporting of basic and diluted earnings per share (EPS). Basic EPS is computed by dividing reported earnings available to common shareholders by weighted average shares outstanding for the period. Diluted EPS includes the dilutive effect of securities, if any, calculated using the treasury stock method. There were 1,516,906 outstanding stock options and warrants as of December 31, 2005 that were not included in EPS as the effect would be anti-dilutive. For this period, diluted earnings per share was the equivalent of basic earnings per share due to the net loss. The dilutive effect of 1,738,648 and 1,995,486 outstanding stock options and warrants were included in the dilution computation for the years ended December 31, 2004 and 2003, respectively. (See Note 7.)     The computation of basic and diluted earnings per share is summarized as follows:                               Year Ended December 31,     2005   2004   2003       Net (Loss) / Income (a)   $ (4,345 )   $ 22,332     $ 6,447   Effect of Dilutive Securities:                         Stock Options / Warrants     —       10       44   Convertible Note     —       —       9         Net Income – Adjusted (b)   $ (4,345 )   $ 22,342     $ 6,500                                   Average Shares Outstanding – Basic (c)     14,551,000       14,087,000       13,132,000   Effect of Dilutive Securities:                         Stock Options / Warrants     —       987,000       722,000   Convertible Note     —       —       63,000         Average Shares Outstanding – Diluted (d)     14,551,000       15,074,000       13,917,000                                   EPS – Basic (a/c)   $ (0.30 )   $ 1.59     $ 0.49   EPS – Diluted (b/d)   $ (0.30 )   $ 1.48     $ 0.46   v. Stock-Based Compensation     The Company has various stock-based employee compensation plans, which are described more fully in Note 7. 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 option-based employee compensation cost is reflected in net income (loss). The effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of SFAS No. 123” (as discussed below in Recent Accounting Pronouncements), to stock option-based employee compensation is as follows:                               2005     2004     2003   Net (loss) income , as reported   $ (4,345 )   $ 22,332     $ 6,447   Add: Stock option-based employee compensation expense included in reported net (loss) income, net of related tax effects     —       —       —   Deduct: Total stock option-based employee compensation expense determined under fair value based method for all awards, net of related tax effects     (3,236 )     (1,150 )     (1,348 )                     Pro forma net (loss) income   $ (7,581 )   $ 21,182     $ 5,099     (Loss) earnings per share:                         Basic – as reported   $ (0.30 )   $ 1.59     $ 0.49   Diluted – as reported   $ (0.30 )   $ 1.48     $ 0.46   Basic – pro forma   $ (0.52 )   $ 1.50     $ 0.39   Diluted – pro forma   $ (0.52 )   $ 1.41     $ 0.37        In December 2005, the Board of Directors of the Company approved the acceleration of vesting of certain “underwater” unvested stock options held by certain current employees of the Company, including some of its executive officers. Options held by the Company’s President and Chief Executive Officer were not included in the acceleration. Options held by non-employee directors also were not included as those options vest immediately upon grant. A stock option was considered “underwater” if the exercise price was $12.90 per share or greater. A total of 346,186 options were impacted by this acceleration. The effect on net loss in 2005 resulting from this acceleration, if theCompany had applied the fair value recognition provisions of SFAS No. 148 to stock option-based employee compensation, was approximately $1,500 net of related tax effects. (See Note 7).w. Segment Reporting     The Company reports segment information in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”. The Company has three operating segments. The basis for determining the Company’s operating segments is the manner in which financial information is used by the Company in its operations. Management operates and organizes itself according to business units that comprise unique products and services across geographic locations.x. Recent Accounting Pronouncements     In January 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments.” SFAS No. 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155 also resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS No. 155 eliminates the exemption from applying SFAS No. 133 to interests in securitized financial assets so that similar instruments are accounted for in the same manner regardless of the form of the instruments. SFAS No. 155 allows a preparer to elect fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a remeasurement (new basis) event, on an instrument-by-instrument basis. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The fair value election provided for in paragraph 4(c) of SFAS No. 155 may also be applied upon adoption of SFAS No. 155 for hybrid financial instruments that had been bifurcated under paragraph 12 of SFAS No. 133 prior to the adoption of this Statement. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year. Provisions of SFAS No. 155 may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis. The Company is currently assessing any potential impact of adopting this pronouncement.     In June 2005, the FASB issued FASB Staff Position No. FAS 143-1 (“FSP FAS 143-1”), Accounting for Electronic Equipment Waste Obligations. FSP FAS 143-1 addresses the accounting for obligations associated with the Directive 2002/96/EC on Waste Electrical and Electronic Equipment (the Directive) adopted by the European Union (EU). FSP FAS 143-1 is effective the latter of the first reporting period that ends after June 8, 2005 or the date that the EU-member country adopts the law. As of December 31, 2005, the United Kingdom, the only EU-member country in which the Company has significant operations, had not yet adopted the law.     In June 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (“SFAS 154”), Accounting Changes and Error Corrections-a replacement of APB No. 20 and FAS No. 3. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle and applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will apply the provisions of this statement effective January 1, 2006. The adoption of this pronouncement will have no impact on the Company’s financial statements.     In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of SFAS No. 143” (“FIN 47”). This statement clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred, if the liability’s fair value can be reasonably estimated. The provisions of FIN 47 are effective for fiscal years ending after December 15, 2005. The adoption of this pronouncement had no impact on the Company’s financial statements.     In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”. This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The provisions of this statement were previously to become effective for interim or annual periods beginning after June 15, 2005. However, in April 2005, the Securities and Exchange Commission announced the adoption of a new rule which amends the effective date for SFAS No. 123R. As a result, the Company will adopt the accounting provisions of SFAS No. 123R as of January 1, 2006. The Company currently accounts for stock option-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and has adopted the disclosure-only alternative of SFAS 123 and SFAS 148. The Company expects the adoption of this pronouncement will result in the recognition of a non-cash expense of approximately $1,000 for 2006 based on current options outstanding and normal quarterly grants.     In November 2004, the FASB issued SFAS No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4,” (“SFAS 151”) in an effort to conform U.S. accounting standards for inventories to International Accounting Standards. SFAS 151 requires idle facility expenses, freight, handling costs and wasted material (spoilage) costs to be recognized as current-period charges. It also requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the relevant production facilities. SFAS 151 will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this pronouncement will have no impact on the Company’s financial statements.Note 2 — Impairment of Long-Lived Assets     In December 2004, the Company recorded a $1,803 impairment charge related to certain polymer rechargeable manufacturing assets. This impairment consisted of $664 of the net book value of the Company’s own assets, and $1,139 of the present value of remaining payments for certain assets under operating leases. The Company determined that this manufacturing equipment would no longer be utilized, resulting from a strategic decision to no longer manufacture polymer rechargeable cells. The impairment charge was accounted for under Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets, and Financial Accounting Standard No. 146 “Accounting for Costs Associated with Exit or Disposal Activities”, which requires that a liability for a cost associated with an exit or disposal activity should be recognized at fair value when the liability is incurred. The $1,139 expense and liability related to the Company’s estimated net ongoing costs associated with its lease obligation for its polymer rechargeable manufacturing equipment requires the Company to make estimates and assumptions with respect to costs to satisfy commitments under the lease. The Company used a credit-adjusted risk-free rate of 6% to discount the remaining cash flows under the operating lease. The Company will review its estimates and assumptions on at least a quarterly basis, and make whatever modifications management believes necessary, based on the Company best judgment, to reflect any changed circumstances. As a result of the impairment of these assets, depreciation charges and lease expenses will be reduced by approximately $500 per year.Note 3 — Supplemental Balance Sheet Information     The composition of inventories was:                       December 31,       2005     2004   Raw materials   $ 8,817     $ 7,441   Work in process     8,648       4,184   Finished products     2,849       2,821               20,314       14,446   Less: Reserve for obsolescence     868       508             $ 19,446     $ 13,938                                      The composition of property, plant and equipment was:                       December 31,       2005     2004   Land   $ 123     $ 123   Buildings and Leasehold Improvements     4,229       3,223   Machinery and Equipment     37,876       36,300   Furniture and Fixtures     788       497   Computer Hardware and Software     2,197       1,882   Construction in Progress     1,059       2,185               46,272       44,210   Less: Accumulated Depreciation     26,341       24,008             $ 19,931     $ 20,202                    Depreciation expense was $3,112, $3,193, and $3,033 for the years ended December 31, 2005, 2004, and 2003, respectively.     Included in Buildings and Leasehold Improvements is a capital lease for the Company’s Newark, New York facility. The carrying value for this facility is as follows:                       December 31,       2005     2004    Acquisition Value   $ 553     $ 553   Accumulated Amortization     433       378                   Carrying Value   $ 120     $ 175                 Note 4 — Operating Leases     The Company leases various buildings, machinery, land, automobiles and office equipment. Rental expenses for all operating leases were approximately $768, $1,244 and $1,232 for the years ended December 31, 2005, 2004 and 2003, respectively. Future minimum lease payments under non-cancelable operating leases as of December 31, 2005 are as follows:                                                                     2010     2006 2007     2008     2009     and beyond     $ 1,239 $ 687     $ 307     $ 302     $ 1,036        In March 2001, the Company entered into a $2,000 lease for certain new manufacturing equipment with a third party leasing agency. Under this arrangement, the Company had various options to acquire manufacturing equipment, including sales / leaseback transactions and operating leases. In October 2001, the Company expanded its leasing arrangement with this third party leasing agency, increasing the amount of the lease line from $2,000 to $4,000. The increase in the line was used to fund capital expansion plans for manufacturing equipment that increased capacity within the Company’s Non-rechargeable business unit. At June 30, 2002, the lease line had been fully utilized. In December 2004, the Company recorded an impairment charge of $1,139 related to the present value of remaining payments for a portion of the assets under this lease. The Company determined that the polymer rechargeable manufacturing assets under the lease would no longer be utilized. The Company’s lease payment continues to be $226 per quarter. In conjunction with this lease