Ultralife Corporation

Good day and welcome to this Ultralife Corporation's third quarter 2021 earnings release conference call. At this time, for opening remarks and introductions, I'd like to turn the call over to Ms. Jodi Berthning. Please go ahead.

Thank you, Catherine, and good morning, everyone. Thank you for joining us this morning for Ultralife Corporation's earnings conference call for the third quarter of fiscal 2021. On today's call are Mike Popolek, Ultralife's President and Chief Executive Officer, and Phil Fain, Ultralife's Chief Financial Officer. The earnings press release was issued earlier this morning. If anyone has not yet received a copy, I invite you to visit the company's website, www.ultralifecore.com, where you'll find the real investor news in the investor relations section. Before turning the call over to management, I would like to remind everyone that some statements made during this conference call contain forward-looking statements based on current expectations. Actual results could differ materially from those projected as a result of various risks and uncertainties. The potential risks and uncertainties that could cause actual results to differ materially include the impact of COVID-19, potential reductions in revenue from key customers, acceptance of new products on a global basis, and uncertain global economic conditions. The company cautions investors not to place undue reliance on forward-looking statements, which reflect the company's analysis only as of today's date. The company undertakes no obligation to publicly update forward-looking statements to reflect subsequent events or further information on these factors and other factors that affect ultrafinancial results is included in Ultralife's filings with the Securities and Exchange Commission, including the latest annual report on Form 10-K. In addition, on today's call, management will refer to certain non-GAAP financial measures that management considers to be useful metrics that differ from GAAP. These non-GAAP measures should be considered as supplemental to corresponding GAAP figures. With that, I would now like to turn the call over to Mike. Good morning, Mike.

Good morning, Jody, and thank you, everyone, for joining the call. Today I'll start by making some brief overall comments about our Q3 2021 operating performance, after which I'll turn the call over to Phil, who will take you through the detailed financial results. When Phil is finished, I'll provide an update on the progress against our 2021 revenue initiatives, then open it up for questions. For the third quarter of 2021, COVID supply chain challenges negatively impact our customers as well as our own product manufacturing schedules affecting quarterly shipments, revenue, and earnings. We estimate the COVID supply chain issues for the third quarter of 2021 to have had an adverse impact on revenue of approximately $4.1 million, on operating profit of $1.3 million, and EPS of $0.06. As such, total company revenue was down 11%, or $2.6 million year-over-year, which drove a slight operating loss and negative earnings per share. Revenues in our core end markets of government, defense, and medical were both down year-over-year. However, we did continue to see improvement in our oil and gas and China revenues of 90% and 86%, respectively, year-over-year, which drove our total company commercial revenues up 5%. Coincident with the COVID supply chain related revenue impact, customer demand remained high, and our ending Q3 total company firm order backlog increased by 22%, or $7.7 million, over the end of Q2, and not including the $4.2 million leader radio add-on contract received and announced just a few days ago. To address these supply chain challenges, we have leveraged our established relationships with our suppliers and customers, working side by side to acquire and qualify required materials, managing freight and logistical costs as best as possible, transparently adjusting delivery expectations, tightening overhead spending, and in many cases, raising prices. Though difficult, we do not view the current COVID supply chain challenges as permanent. And while closely monitoring cost and worldwide supply chain developments, given our solid liquidity position, we presently continue to aggressively pursue completion of our transformational projects and to support new contracts in order to realize the expected new revenue growth streams they will bring despite the near-term pressure on profitability and year-over-year comparisons. In a few minutes, I'll give you a further update on our revenue initiatives. But first, I'd like to ask Ultralife CFO, Phil Thain, to take you through additional details of the Q3 2021 financial performance.

Phil? Thank you, Mike, and good morning, everyone. Earlier this morning, we released our third quarter results for the quarter ended September 30th, 2021. We also filed our Form 10-Q with the SEC and have updated our investor presentation, which you can find in the investor relations section of our website. I would like to thank all those that helped make this happen. Consolidated revenues for the 2021 third quarter totaled $21.8 million, compared to $24.4 million reported for the third quarter of 2020, a decrease of 10.7%. Commercial sales increased 5.1%, reflecting a rebound in oil and gas and international industrial markets, partially offset by a reduction in medical sales from the initial surge of batteries for ventilators, respirators, and infusion pumps in response to COVID-19 last year. Government defense sales declined 39.7%, relative to the shipment of an order for 5390 batteries in last year's period and lower shipments for our communication systems business. As Mike mentioned, for the 2021 third quarter, increased lead times on components from suppliers and other COVID-19 related logistics matters significantly impacted both our internal and our customers' manufacturing schedules resulting in delays in our shipments to future periods. Of the 4.1 million adverse revenue impact, 2.5 million was related to our government defense business, with the remaining 1.6 million related to our commercial business. On a segment basis, battery and energy products accounted for 2.5 million of the 4.1 million revenue impact, and communication systems for 1.6 million. Revenues from our battery and energy product segment were 20.0 million compared to 21.8 million last year, a decrease of 8.3%. Attributable to a 2.9 million or 28.3% decrease in medical sales and a 2.6 million or 43.3% decrease in government defense, partially offset by a 2.0 million or 89.5% increase in oil and gas market sales, and a 1.2 or 86.2% increase in sales from our China operations, primarily driven by our new ER and thin-cell products. The decline in government defense sales resulted from a large shipment in last year's third quarter of a 5390 battery order placed in December 2019 by the US Department of Defense and delayed sales to a large global defense prime. The sales split between commercial and government defense for a battery business was 83-17 compared to 72-28 for the 2020 third quarter, and the domestic to international split was 40-60 compared to 50-50 last year, accentuating both the delays in U.S. government defense sales in the combined success of our global revenue diversification strategy. Revenues from our communication system segment were 1.8 million compared to 2.5 million last year, a decrease of 31.1%, reflecting shipments delayed to future periods due to increased lead times on components from suppliers and other COVID-19 related logistics matters. On a consolidated basis, The commercial to government defense sales split was 76.24 versus 65.35 for the year earlier quarter. Our consolidated gross profit was 5.1 million compared to 6.5 million for the 2020 period. As a percentage of total revenues, consolidated gross margin was 23.5% versus 26.7% for last year's third quarter. Gross profit for our battery and energy products business was 4.8 million compared to 5.7 million last year. Gross margin was 24.0%, a decrease of 200 basis points from 26% reported last year, reflecting sales product mix and lower factory volume. For our communication system segment, gross profit was 0.3 million compared to 0.8 million for the year earlier period. gross margin of 18.0% compared to 32.8% last year, reflecting lower factory throughput in the 2021 period. Operating expenses were $5.9 million compared to $5.8 million last year, reflecting investment in engineering resources for new product development, including resources dedicated to the conformal wearable battery IDIQ contract announced on May 17th. As a percentage of revenues, operating expenses were 27.1% compared to 23.8% for last year's third quarter. Operating loss for the third quarter of 2021 was 0.8 million compared to income of 0.7 million for the 2020 quarter, reflecting lower sales and gross margins resulting from supply chain delays in our continued investments in new product development. Adjusted EBITDA, defined as EBITDA including non-cash stock-based compensation expense, was 0.3 million or 1.3% of sales compared to 1.7 million or 6.8% for the third quarter of 2020. On a trailing 12-month basis, adjusted EBITDA was 8.3 million or 8.0% of sales. Our tax benefit for the third quarter was 0.2 million compared to a provision of 0.2 million for the 2020 quarter computed at statutory rates for GAAP reporting purposes. Accordingly, our reported tax benefit for the third quarter is based on an effective rate of 22.4%, which is reduced to 5.5% when we pay our taxes. Using the 22.4% statutory tax rate, Net loss was 0.6 million or 4 cents per share on a diluted basis for the 2021 third quarter. This compares to net income of 0.4 million or 3 cents per share on a diluted basis for the 2020 quarter. We utilize adjusted EPS to reflect actual cash taxes paid or to be paid and define adjusted EPS as EPS excluding the provision for non-cash U.S. taxes expected to be fully offset by our net operating loss carry-forwards and other tax credits. As noted in the supplementary table in our earnings release, adjusted EPS on a diluted basis with a loss of $0.05 per share for the 2021 third quarter compared to a positive $0.04 for the 2020 third quarter. Ultralife maintained its solid balance sheet and liquidity in the third quarter, with cash on hand slightly increasing, from 15.8 million to 15.9 million and debt decreasing from 0.7 million to 0.3 million from the second quarter. We ended the 2021 third quarter with working capital of 47.9 million and a current ratio of 3.9 compared to 45.8 million and 3.4% for year end 2020. As a result, We remained well positioned to fund organic growth initiatives, including new product development and strategic capital expenditures, while expediting our organic growth through accretive M&A. Going forward, with our growing backlog, ample liquidity, diversified end markets, and growth initiatives, we remain steadfastly focused on realizing the full leverage potential of our business model. I will now turn it back to Mike. Thank you, Phil.

For 2021, we continue to focus on driving revenue growth by market and sales reach expansion, primarily through diversification, new product development and strategic capex for competitive advantage, and a disciplined approach to accretive acquisition. For the battery energy products business, the strategy for market and sales reach expansion is about diversifying more into the global commercial markets and international government defense markets to lessen our historical concentration in the U.S. government defense market. For Q3 2021, overall global B&E medical revenue represented 37% of total battery energy products revenue. Demand from current customers was for applications such as ventilators, respirators, infusion pumps, digital x-ray, and surgical robots. We also received over $4.3 million in delivery orders from existing medical customer blanket and or multi-year agreements. A new emerging medical device application that we are very excited about is in the area of wearable thin cell batteries, such as used to power devices for vital signs monitoring. For a product line for which we were just shipping testing samples in 2019 and 2020, in Q3, we received initial production orders for shipments in Q4, and we are now ramping up the production to serve demand, which is expected to grow significantly over multiple customers in the 2022-2023 timeframe. Q3 oil and gas and subsea electrification commercial revenue was approximately 21% of total B&U sales. As mentioned earlier, we continue to see encouraging signs of improvement in our core oil and gas business, which drove up total Q3 oil and gas revenues at a strong double-digit rate year-over-year. In Q3, B&E's U.S. government business represented approximately 15% of total B&E product sales, with shipments primarily for radio batteries and chargers to OEM primes. Revenue is down year-over-year, as stated earlier, due to OEM COVID supply chain shipment delays and the non-recurrence of prior year DLA-5390 shipments as the main drivers. The first article testing for the next generation BA5390 primary battery is now fully approved and signed off, and we do have a small delivery order to supply under this current IDIQ with shipments expected in the first half of 2022. We are also now eligible for additional delivery orders under this IDIQ, subject to the discretion of the DoD. Though there's no guarantees of future delivery orders for government IDIQ contracts, the historical revenue over the last decade in any given year has ranged from hundreds of thousands of dollars to up to several million dollars. Regarding the wearable conformal battery IDIQ contract, which we announced on May 17th, and supports the U.S. Army's new integrated visual augmentation system, we are currently executing the development sourcing phase of the process while navigating through the supply chain challenges to best meet an ambitious first article testing schedule. As the Army recently announced, the overarching IVAS program was delayed up to one year due to technical challenge in the IVAS heads-up digital display. Despite this, we continue to aggressively work towards the key first article testing completion milestone for the associated conformal wearable battery, now more likely to occur in the latter part of 2022 with potential production awards thereafter. The actual timing of deliveries and quantities are at the discretion of the U.S. Army and include successful completion of first article testing, demonstrating full compliance with the contractual product specifications and program requirements. As new product development remains a core element of our organic growth strategy, in addition to the next generation 5390 and conformal wearable batteries, during the quarter we continue to advance several of our multi-year development new products including but not limited to an next-generation hot swappable medical battery, a new smart U1 battery, new 5790 and XR123A CFX blend primary batteries, OEM public safety radio batteries, and next-generation ruggedized modular large-format energy storage batteries. It is worth noting that with some easing of the COVID restrictions, we have begun to once again attend public industry events and we were delighted to introduce our new hot swappable medical cart battery at the August 2021 Healthcare Information and Management System Society trade show in Las Vegas. The showcase resulted in several specific customers requesting product for formal technical evaluations later this year, with production deliveries beginning as early as the first half of next year. We are also very proud of the fact that this product was conceived, designed, sourced, and manufactured over multiple ultralight locations, leveraging our worldwide technical talent and delivering a product suitable for a global customer base. As access to our key customers opens up post-COVID, we are seeing a return to more opportunities for new product development and collaboration across all of our locations. New product development and multi-generational product planning continues to keep us current with market needs and gives us the opportunity to remain close with and provide value to our key customers. Regarding the efforts to strengthen our competitive differentiation, we also continue to invest in strategic capex. The new manufacturing line at our Newark, New York facility for our new high-performance lithium manganese dioxide three-bolt cell is now fulfilling initial customer orders. Voice of the customer feedback is showing positive responses for our product's performance, safety, contribution to the owing devices competitiveness as well as its U.S. manufacturing location. Performance differentiation has been demonstrated in a high rate or power capability, which is particularly useful in illumination devices and medical devices with short, high pulse rate applications. In China, the performance attributes expected from the completion of the first phase of our project to upgrade our thionyl chloride ER cell continue to be confirmed by customer testing. For this product line, which can be in operation anywhere from 5 to 10 to 20 years, customers have long testing and qualification periods, so their feedback provides valuable validation of our product and leads to sticky customer relationships. As you may recall, this overall project involves several steps of product and process improvements, which will help us multiply by several fold our total available market with newly identified final chloride ER cell commercial and industrial applications. Medical and other industrial customers also continue to tap into our China operations for supply of battery-packed solutions, not just ourselves, but just growing our value proposition. In Q3, our total China operations revenue is up 86% year over year, an indicator of growing global demand for our China capabilities. Our goal remains to produce the highest value proposition, best quality, and safest products in whichever one of our global locations best serves the supply chain of the particular end market and or OEM customer. Looking at our communication systems business, Q3 new product development revenue from products less than or equal to three years old represented approximately 51% of communication systems revenues. Regarding the U.S. Army's handheld man-packed small-form pit and leader radio programs, we just received and announced a follow-on order for $4.2 million with delivery starting in Q2 2022. And as the Army is moving into full-rate production, we expect potentially another round of awards for the leader radio program in the first half of 2022. As radios are the critical enable of the communications systems business, The team is continually focused on the technology innovations, market trends, and customer requirements to position us for future business supporting both handheld and MANPAC radios and integrated systems. The effects of COVID-19 continue to impact the communication systems business. Supply chain issues are affecting electronic component availability, resulting in extended material lead times and manufacturing timelines, clouding revenue forecasts. For supply chain components that are available, the shortage of global transport resources is causing delayed deliveries, often compounded with increased transportation and logistics costs. Our teams continue to work closely with customers and suppliers to actively manage sales and operations planning to mitigate the supply chain and manufacturing impact to the extent possible. Communication systems also continue working to expand into the commercial market. with multiple system integration product initiatives for several key customers. For the mobile data cart, which will enable analysis of autonomous vehicle data during testing and manufacturing of the vehicles, initial purchases of low rate production quantities for test and evaluations are received and will be delivered in Q4. We are pleased to have reached this milestone and are working steadily with the customer to position for successful test and evaluation with production orders to follow. This product is the first purely commercial product offering for communication systems and a significant milestone for the communication systems team. Separately, communication systems has also continued the prototype phase for a virtualized radio access network enclosure supporting 5G network deployments worldwide. This is the second all commercial business opportunity. We have experienced delays in material acquisition for finalizing prototypes but anticipate completion soon with delivery to customer for test and evaluation in Q4 with production volume orders to initiate in early 2022. The award of additional HMS MANPAC handheld amplifier systems, ongoing dialogue with other government defense OEMs, initial order in a commercial business program with a second quickly to follow are all opportunities for increased revenue which insist in mitigating the often inconsistent or lumpy defense sales to which communications systems has been traditionally dependent. The diversification of commercial products, combined with our participation in ongoing military radio programs, anchors our optimism about the long-term growth of the communications systems business. In closing, for the third quarter of 2021, though our financial results were challenged on several fronts, we were pleased with our overall total company commercial growth, progress on transformational projects, addition of new orders to our backlog, and positive operational cash flow. We are also glad to now have the next Leader Radio following award in hand. Most importantly, I want to thank each and every one of our employees, channel partners, and customers for their tremendous effort and cooperation in fulfillment execution given the present extraordinary supply chain hurdles. Our top priority remains to achieve revenue realization from our transformational projects, delivering new meaningful, sustainable annual revenue streams and attractive growth markets from new competitively differentiated products. Our communication systems included our additional potential leader radio follow-on awards, new OEM MANPAC radio ancillaries, next generation 21 amplifiers, and integrated computing, 5G, and AI solutions. At B&E, included are the new 3-volt product line, the new ER product line, the smart U1 battery product line, the wearable conformal battery, the 5790 and XR123A CFX blend primary batteries, and several new public safety, thin cell, medical, and subsea electrification battery packs. We are also monitoring several potential new U.S. government budget and infrastructure package opportunities for each of our business units should that legislation pass through Congress. As we approach the end of 2021, we will continue to optimize our financial performance, targeting total year profitability, solid cash flow from operations, and maintaining our strong balance sheet while supporting transformational products and investments. Though we expect the current COVID supply chain challenges to potentially continue at least a few more quarters, it is imperative that we stay keenly focused on completing our current multi-year transformational projects in order to unleash the new revenue streams each will bring. We continue to focus our time and effort on completing these transformational projects as we believe they are the elements which are most under our control to improve our organic revenue growth rate and revenue and EPS consistency. We will also continue to evaluate acquisition opportunities where we can quickly gain scale and achieve further operating leverage. Operator, this concludes my prepared remarks and will be happy to open up the call for questions.

Thank you. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow the signal to reach your equipment. Again, press star one to ask a question. We'll pause just for a moment to allow everyone the opportunity to signal for a question. Thank you. Phil, we'll take the first question from Gary Sipperstein at Elliott Rose Wealth Management. Please go ahead.

Good morning, Mike and Phil. How are you?

Good morning, Gary.

Mike, on the COVID and supply chain, you mentioned you put through some price increases. Do you feel that will offset most of the added expenses? I know it's not going to necessarily change any delays, but do you think that'll help with, you know, half the expense increases or a quarter of the expense increases?

I think generally, yes. I mean, I think we've been working extremely close with our customers. I mean, in some cases, our customers are stepping right up to help us with some of the premiums that we've been subject to in freight and the like. Some of our contracts are existing contracts, and so you have to go in after the fact and make some changes. But for the most part, as indicated in my prepared remarks, our customers are right there side by side and helping us try and address some of these cost increases and some of these delays. So from a standpoint purely of the cost increases, I think we are doing a pretty good job of knocking those down. But as you indicate, it's the delays that are the bigger impact at this point.

Okay. And did those – Did those price increases go through later in the third quarter, so we'll have a full quarter effect in Q4, or did they just go through recently so it'll be more of a Q1 part of the fourth quarter and more of a Q1 opportunity?

Gary, they went through earlier in Q3.

Okay, thank you. And in terms of the leader radio, I saw one of the prime contractors say, recently got a $200 million contract, and they said they went into full-rate production. And in the news release, it said the ceiling on that contract over the next 10 years is $16 billion, and they talked about 100,000 liter radios and 65,000 man-pack radios. And that was just one of the contractors. And then the other contractor, I guess for the amplifiers, is where you just got that $4.2 million contract. So my first question is, does the government give out equal contracts to both prime contractors, or is it different? Did the amplifier customer also get a $200 million contract as they went into full rate production, or is it hard to know who gets what?

Yeah, it's really hard to know what goes into the final details of each of those individual contracts. I mean, we read the news headlines as well. Sometimes they split them. Sometimes they allocate bigger portions to one versus the other, at least from our own experiences. Sometimes they just give a single award. So what we try to do is not try to figure out too much what's going into our OEM partners' contracts, but really just whenever we're called upon by the OEM partners, do our very, very best job to help make them as competitive as possible so we can get the biggest share possible for us.

Okay, and in trying to come out with a potential figure for Ultralife, you know, $16 billion over 10 years is $1.6 billion a year for that one contractor, right? So even if you haircut it by 50%, it's still almost a billion a year, you know, 800 million or something like that for that one contractor. And I know you guys supply batteries and chargers to one and amplifiers to the other. So if indeed it is worth 800 million annually to at least that one contractor on batteries and chargers. Does that mean the opportunity for Ultralife is $5 to $10 million a year, or is it $10 to $15 million a year? I'm just trying to get a sense for the battery and chargers if that contractor does continue to go into full production with the government.

Gary, I wish life was that easy that we could straight line this across the years, but the $100,000 figure that you gave is accurate. That was issued three years ago, and just using math from the initial press release by the U.S. Army, it's 20 or 22 percent of all those leader radios have the VAA type of system with it. So that magnifies the opportunity, and you're correct. We supply batteries to batteries and our VAA systems. But then again, predicting the annual impact of government and defense contracts, the timing of those, the magnitude of those is, I used to call it four-dimensional chess. It's now five-dimensional chess. Very difficult to do. So the opportunity is there on both the battery side and the VAA side.

Okay, and on the recently won $4.2 million contract for amplifiers, Mike, you said they would start shipping in Q2 next year. Is it going to take two quarters to ship that, or does that all get shipped in one quarter?

I mean, it really depends on the supply chain, and that's probably the biggest obstacle we have is really getting firm commitments from our suppliers to construct the units and to ship them. So it would be just having received this contract a few days ago, it would be premature to try to guess exactly when everything would ship. But we believe it to be starting in Q2 2022. Okay.

Okay. And have there been any indications from that customer on follow-on orders after that point? Did they give you any color on, you know, what kind of orders the government's expecting from them and what, therefore, they expect from you so you can improve the supply chain, have, you know, six months notice, that kind of thing, nine months notice?

You know, we try to keep close ear to what we are told by our channel partners as well as what we read in various media. And it's just really too early to say. I mean, we believed, as was mentioned in my prepared remarks, that the fact that it's going to a full rate production is a positive sign. But there's just a lot of variables, government budgeting and various things going on in the world that would make it almost impossible to predict right now what the next steps would be. But at this point, we're very pleased that they've gone to full-rate production because that potentially creates another opportunity for us.

Okay, moving to the 3-volt product line. I think last quarter's conference call, you mentioned different discussions for products with customers. I think you said there were up to 20 potential customers in different applications, and you mentioned some of the customers are six-figure orders, some are million-unit orders, or even more. Can you give us any color on what's going on there?

No, those continue, as I mentioned, last quarter, and that's why I didn't cover it again this quarter, but we're continuing to work through final tweaks on the products and making initial shipments and continuing to work the customer funnel of new opportunities. And as I mentioned in the remarks, getting good feedback on some of the characteristics of the product, bringing it to the marketplace. And so we're very optimistic about its future.

Okay. And moving to the conformal, so you said they're The schedule has changed a bit. So previously you had talked about maybe getting into testing starting in the first quarter of next year and maybe shipments or orders in the second half. So now testing is delayed to the second half of next year, is that correct?

Yes. The overall program, due to a part of the program that we're not involved with, has been delayed publicly up to a year. And so it sort of pushed the whole program out a little bit. So we're trying to still work as aggressively as possible. We're spending extra money to do it, frankly, to make sure that when the time comes that we're in a good position to pass the first article testing and hopefully be first in line to some of the deliberators that would follow that.

Okay. And has the government given you any color on when they can start first article testing?

No, we have no new updates on our specific schedule.

Okay. In terms of the operating model for the company, originally it was, I think, 30, 10, 10, 5 equals 10, something like that. The company's been challenged, you know, for a while now to get to the 30% gross margin. Can you talk to that model, if it's still effective, and what it's going to take to get to it?

Yeah, I think it's still very much effective. I think the overall principles still hold firm. As I mentioned in the battery side of the business, as you could glean from some of the comments that Phil's made over the last couple quarters, is that with the number of new products going through the factory that are brand new, there's certainly some inefficiencies associated with that, extra production of scrap and so on and so forth. And so that's taken a hit a little bit on our gross margins. It hasn't necessarily been anything related to do with price, per se, or the value proposition. It has more to do with just the development cycle and getting up to full volumes, going through some of the growing pains with some of the complex products that we make. In the case of communication systems, you know, tends to be a higher margin type of an activity and also, you know, frankly, a higher level of investment technically for capabilities, you know, it's very susceptible to volume. And so, in the last quarter, you saw that the volume was low and that had an adverse effect on overall gross margin. So, collectively, you know, we know what's causing the gross margin challenges We know that these are not permanent situations, but they are having an impact on gross margin. It hasn't been priced, though. I want to emphasize that. Mostly, it's just sort of going through the growing pains of new products getting through the factory and getting up to a very efficient production manufacturing.

Okay, so if the revenue levels start picking up and you have the right mix between you know, the base business and the battery business and the communications business. So as you get back to $25 million on a quarterly run rate and then move, hopefully, to $30 million, do you think that would get us to the 30%?

Directionally, it would certainly help through March. I don't know if those exact figures are 30% accurate, but directionally, it's more of mine, but it will be growth.

Okay, but you still believe you can get to 30%?

Yeah, yeah. I mean, there's no reason why we can't. Most of it has to do with our aspirations and simultaneously putting through a lot of new products all at the same time. You know, short term, there's some impact, as we talked about earlier in the call, about inflation from some of the supply chain issues we have. But again, those won't last forever. We don't know how long they're going to last, but they won't last forever. but fundamentally we still believe that our business model that we put together is achievable.

Okay, so if indeed the COVID pressures, you know, start to mitigate over the next, you know, six, nine months, you know, with the booster shot, with the upcoming approval for kids five to 11 years old, with the new Merck drug, and I think they mentioned antidepressant having some success with people who already have COVID, So if COVID starts to peak and wane over the next six to nine months, and if supply chain lingers, but you get better at dealing with it and some of the parts of the supply chain get addressed, the government is getting some of these ports and logistic operations working 24-7. So maybe that starts to peak and wane over the next six to nine months. So as those go away, or mitigate, maybe they don't go away completely, but they mitigate, coupled with the backlog being up over $7 million, and that's not including the $4.2 million contract. So with the $4.2, there's over $11 million in ultimate backlog for the next 12 months. It seems like there's a strong possibility that that third quarter could mark the nadir could be the bottom and things start to slightly improve in Q4 and then as we get into next year, coupled with all the new products starting to come out, starting to go from testing to production. So that'll slowly ramp maybe one or two products a quarter as you go through the year. So with all that being said and you sticking firm to the potential for the model to hold, it seems like the future is you know, a lot brighter than what the stock price is telling us in the last two quarters, which are both revenue and earnings challenging. So I guess my question is, maybe it's time for the company to look at the buyback program. Because if I remember the last time, when you guys bought back stock just under $5, at that time, the company was trading at one-time sales or more And the book value, I think, was $4.50, $4.75, and you bought back a lot of stock just under $5. So right now, on an enterprise basis, market cap minus the cash, and we're looking at a revenue rebound starting next year, we're clearly under one-time sales. Plus, we're at more of a discount to book value than you were when you bought back stock several years ago in the $4 range. So with almost $16 million cash and a $35 million line of credit, this $50 million in potential availability, it seems to make sense to take advantage of the fact that the future continues to be bright, nothing's gone away, and the stock price, the stock is giving you an opportunity to buy, you know, and presumably we continue to go lower. People are disappointed, you know, with the quarterly results, plus we're getting into tax loss selling time. And then obviously a lot of people, a lot of hot money bought the stock on the conformal announcement at higher prices, $9, $10, $11. So there's going to be some tax selling. And the company's also had over the last 12 months several insider buys at higher prices than where the stock is now and some option exercise without corresponding selling to pay for the exercise at higher prices. So in terms of capital allocation, I'm not saying instead of buying another company and keeping M&A alive, which you just mentioned, M&A is still part of the plan. But in addition to M&A, because as we know, the last two times you bought companies, you paid about one time sales. So here you can buy your own stock, you know, less than one time sales and less than book. And again, more than likely, the two companies you previously bought, at one time sales are more, I'm sure we're over book value. So your stock, you know, seems to be the best bargain instead of M&A, etc. But I'm not saying buy your stock and don't do M&A. I'm just saying as part of capital allocation program, in addition to looking for, you know, decent accretive acquisitions with $50 million in capacity, to take $5 million and buy your stock back in between now and year end with tax selling, it seems to be a plan that would accrue to all our benefits going forward, especially if third quarter mocks the nadir, mocks the bottom, and things start to get better as we go into the new year and all the different transformational opportunities you're talking about. So maybe it takes two or three or three or four quarters to get back to the you know, $25 million to $30 million, but it seems possible and likely as some of the headwinds start to mitigate and diminish and as some of these products go from testing into production. So can you talk to that, Mike, the possibility of using some of the cash and to take advantage of this opportunity?

Thank you very much for those comments. I mean, when we look at our capital deployment, we do it on a regular basis. We look at a number of different things, and I would say sort of in the top category is what can we do for organic growth, organic revenue growth, anything we can to put capital towards increasing the trajectory of our organic revenue growth. And that's going to have a very high priority. We talk about, you know, transformational products and also capabilities, which has led us to spend more time and effort, obviously, in recent years on strategic APEX. So that's another organic growth initiative that we deploy capital towards. Next, we look at acquisitions. I think we've made some good buys in acquisitions and have accretive acquisitions to show for it. We now are almost debt-free again. So we continue, I think, to be good stewards of the cash that we are generating. And I think it gives us some flexibility, especially in typical times like these. And then, of course, we have the opportunity to return to our shareholders in the form of stock buyback. So those are all on the table at any given time. We discuss those internally. And I appreciate your suggestions about maybe the timing is being good. We'll take that under advisement. But generally speaking, look at the items I just mentioned on a regular basis. Our cash balance continues to grow, so we want to make sure we put it to good use to continue to drive the top and bottom line of the company.

Okay, thank you for that. I would just add, you know, you've done all that. You've invested in transformational products. You've invested in organic to position the company. You've made acquisitions. You've absorbed the COVID problems, you've absorbed supply chain problems, and you've still been EBITDA positive at what could prove to be the low for the company, and you've still increased your cash. So again, I'm not saying instead of inorganic opportunities, instead of transformational products, instead of, you know, CapEx, transformational CapEx, you've done all those things and still have gotten out of debt and cash keeps going up every quarter. So again, it seems to be an opportunity, and presumably as the future unfolds and all these things go into production, whether it's the second half of 2022 or 2023, when you're hitting on all cylinders, there could be an opportunity where the stock's back to $8, $10, $12, who knows, and you always have an opportunity for a secondary. So to buy stock in the five or six range with tax selling and with the recent poor results, It just seems like you can have your cake and eat it too, that it wouldn't prohibit you from any of the investments you talked about, any of the priorities that come before a buyback, and also your ability to find and buy a good M&A deal. All right, guys. Good luck. Thank you.

All right. Thank you, Gary. Thank you, Gary.

We'll now take the next question from Josh Sullivan of the Benchmark Company. Please go ahead.

Hey, good morning. Good morning, Josh. Just to your comment on predicting the five-dimensional chess that is the defense spending, if we get a longer continuing resolution, how does that impact you? What percentage of your defense contributions over the next three quarters or so are defined by new program spending?

I think it's an excellent question, Josh. I'm not an expert personally on continuing resolutions, but from what I understand, trying to understand as best I can, I know that with the continuing resolution, I think it's roughly 80% of the budgets are in play, and that existing projects continue to get funded, but it may have an impact on new projects. And at the same time, just from a behavioral perspective, because there's overall less money available, we see it sort of sometimes impacting us on the day-to-day flow business, if you will, which impacts both of our business units. So going forward, we are under the understanding that some of the large programs that we're currently involved with would be captured under existing funds, but some of the brand-new programs that may be bidding or in development with the customer may be potentially delayed. We're just probably on a Long-term basis, trying to understand what that impact will be, knowing that maybe from where we sit, we're not going to get it exactly right, but just the understanding of the possibilities. But I think the bigger issue short-term is trying to make sure that whatever funding is available is still flowing through the sort of the core flow business of our respective businesses.

Right. Okay. And then any early reads into the 23 budget as it comes together? Any comments out of the Pentagon on if you're seeing some support for various programs in there?

Yeah, I mean, we have someone that's an expert on it, analyze what they can glean, and we think there's opportunities in both of our businesses. So, you know, we're cautiously optimistic about that, and we're trying to make sure that we understand, you know, what potential things are available so we can target, either direct participation or participation many times we would do through an OEM or another channel partner. So we're cautiously optimistic about at least what it says on the surface, but we'll wait until, you know, things actually completed, Congress signs off on them and comes reality versus speculation.

And then just on the vaccine mandate, I mean, you know, as, as, the deadline comes up, do you see it impacting your labor availability or your customers' labor availability? I mean, do you consider yourself high-touch labor or just curious how you're thinking about that?

You know, even without the vaccine availability, I think labor is challenging. You know, whether it be from availability of labor or wage and benefit rate inflation, let alone what the vaccine mandates are. To me, that's just another facet of an already challenging situation. What we're trying to do is try to be a good employer, trying to make sure that we don't whipsaw people in terms of headcount reductions and things like that just because there's a quarter or two of profitability pressure. We want to make sure we're sending the right message and we're taking care of our good employees. We're trying to make it attractive for new employees to come and work for us, both from a wage perspective as well as from a benefit portfolio. So to me, the vaccine potential is just another facet of an existing situation.

Got it. And then you talked a little bit about diversifying into international defense sales. What are those opportunities?

You know, most of the time, you know, we have relationships with other companies multinational companies than other countries, friendly to the United States. And so lots of times when a technology matures in the U.S., there's an opportunity in one of our allies around the world for that technology or a derivative of it. So there are also long cycles. Some of the countries that we've been participating in are large countries that you would know the well-names of. have gone through some of their own COVID shutdowns and lockdowns even more severe than we had at the time here. And so that's had an impact on us. But generally speaking, these are allied countries that have very positive relationships with our military and, as such, are involved in similar types of equipment or derivatives thereof. And like the case of comp systems, certainly there's – As a provider of ancillary equipment to radio, a lot of the modernization activities that are taking place in the U.S. are also taking place in their own right with a number of international companies. So we would be working with partners there as well to try to provide product in those modernization activities.

Got it. And then as far as passing prices on to customers, just be curious how you're balancing those conversations between what you might see as transitory costs versus structural inflational realities. How are you having those conversations with customers?

Well, I think we're very closely aligned with our customers, and I think that the customers themselves are dealing with the same pricing, cost pricing issues that we're dealing with, So I think there is, at first they were relatively difficult, but as it progressed, I think that there was a much better understanding because we're pretty much in the same boat. And you start out by talking about passing on costs to the customers, and instead of hearing their defense against that, they come back to you with their own personal stories. So there is a general understanding of what is driving the price increases, and I don't want to say it's easy conversations, but then again, in many cases, it seems like it's expected. So initially difficult with some outliers, but I think our folks have done a really terrific job based on the relationships, the deep relationships that we have with our clients with our customers.

And then just one on the oil and gas strength that you mentioned. What specific products are driving that? And then do you have an inventory in that segment, just given that it's kind of on the rebound here that might allow you to capture this environment?

Yeah, I think the main driver, Josh, is if you look year over year, You look at the U.S. right now, we closely follow on a weekly basis the U.S. rig count. So the U.S. rig count is 545 active rigs right now. You look at it a year ago, it's higher by 255 rigs. And I think more than anything, it's that rig count that's driving that. And where we see the largest portion of the increase is purely downhole drilling. Downhole drilling itself is up over the 90% that we mentioned. And with not a lot of lead time within this industry, we have to have inventory available or access to available inventory. So that's why you'll see that our inventory is pushing $28 million where under normal circumstances we would want that to be below $26 million, trending towards $25 million. So, again, those close relationships and just trying to anticipate what's going to happen next week is really what it's all about. But, again, it's driven by the rig count, U.S., which the numbers I gave you, and international as well, which is also up.

Got it. Thank you for the time.

Thank you, Josh.

That concludes today's questions and answer session. I'd now like to turn the conference back to Mike for any closing or additional remarks.

Great. Thank you once again for joining us for our third quarter 2021 earnings call. We look forward to sharing with you our quarterly progress on each quarter's conference call in the future. As mentioned earlier, also like you know, we update our investor presentation on our website. So please check that out. Everybody have a great day. Thank you so much for participating.

That concludes today's call. Thank you for your participation. You may now disconnect.