ULBI Ultralife Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollar amounts in thousands – except share and per share amounts)

(unaudited)

The accompanying unaudited Consolidated Financial Statements of Ultralife Corporation (the “Company”) and its subsidiaries 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 of the information and footnotes for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair presentation of the Consolidated Financial Statements have been included. Results for interim periods should not be considered indicative of results to be expected for a full year. Reference should be made to the Consolidated Financial Statements and related notes thereto contained in our Form 10-K for the year ended December 31, 2016.

The December 31, 201 6 consolidated balance sheet data referenced herein was derived from audited financial statements, but does not include all disclosures required by GAAP.

Our monthly closing schedule is a 4/4/5 weekly-based cycle for each fiscal quarter, as opposed to a calendar month-based cycle for each fiscal quarter. While the actual dates for the quarter-ends will change slightly each year, we believe that there are not any material differences when making quarterly comparisons.

On January 13, 2016, Ultralife UK Limited (the “Merger Subsidiary”), a U.K. corporation and a wholly-owned subsidiary of Ultralife Corporation (the “Company”), completed the acquisition of all of the outstanding ordinary shares of Accutronics Limited (“Accutronics”), a U.K. corporation based in Newcastle-under-Lyme, U.K., from Intrinsic Equity Limited, Catapult Growth Fund Limited Partnership, MJF Pension Trustees Limited, Robert Andrew Phillips and Michael Allen (collectively, the “Sellers”). There are no material relationships between the Company or Merger Subsidiary and any of the Sellers, other than pertaining to this acquisition. Accutronics is a leading independent designer and manufacturer of smart batteries and charger systems for high-performance, feature-laden portable and handheld electronic devices and is classified in the Battery & Energy Products segment. The acquisition of Accutronics advances our strategy of commercial revenue diversification and expands our geographic reach within European OEM ’s.  With industry experts predicting mid-to-high single digit growth through 2020 in the global medical batteries market, this strategic investment positions Ultralife well for further penetration of and growing revenue streams from an attractive commercial market.

The acquisition was completed pursuant to the terms of the Share Purchase Agreement dated January 13, 2016 by and among the Merger Subsidiary and the Sellers. The Merger Subsidiary paid at the time of closing an aggregate purchase price of £7,575 ($10,976) in cash, and in exchange the Merger Subsidiary received all of the outstanding shares of Accutronics ordinary stock. Monies to fund the purchase price were advanced to the Merger Subsidiary from the Company ’s general corporate funds.

The purchase price was subject to adjustment based on the difference between actual and estimated amounts of working capital of Accutronics as well as the amount of net cash of Accutronics. The adjustment resulted in a final payment to the Sellers in the amount of £133 on February 24, 2016, bringing the total aggregate purchase price to £7,708 ($11,161).

The purchase price allocation was determined in accordance with the accounting treatment of a business combination in Financial Accounting Standards Board (“FASB”) ASC Topic 805, Business Combinations. Under the guidance, 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 consideration paid over the estimated fair values has been recorded as goodwill.

The final allocation of purchase price to the assets acquired and liabilities assumed 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 a number of factors, including reference to an analysis performed under FASB ASC Topic 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. 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 Accutronics assembled and trained workforce, the incremental value that Accutronics engineering and technology will bring to the Company and the revenue growth expected to occur over time 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 identifiable intangible assets included in the Company ’s purchase price allocation represent customer contracts and relationships of $2,821, intellectual property of $1,132 and trade name of $421 that are amortized straight-line over a period ranging from 10 to 15 years.

During the nine-month period ended September 25 , 2016, direct acquisition costs of $251 and increased cost of sales related to purchase accounting adjustments of $96 for inventory acquired were recorded in the Company’s Consolidated Statement of Income and Comprehensive Income. Accutronics contributed revenue of $7,551 and an operating loss of $61 during the nine-month period ended September 25, 2016 reflecting the purchase accounting adjustments and non-recurring costs directly related to the acquisition.

Set forth below are the unaudited pro forma results of the Company for the nine-month period ended September 25, 2016, as if the acquisition occurred as of January 1, 2015. The unaudited pro forma results for the nine months ended September 25, 2016 exclude direct acquisition costs of $251 and cost of sales of $96 related to the purchase accounting adjustments for inventory acquired. The operating results of Accutronics were not material for the period from January 1, 2016 to the acquisition date.

The unaudited pro forma results do not reflect the realization of any expected cost savings or other synergies from the acquisition of Accutronics as a result of restructuring activities, other cost savings initiatives or sales synergies following the completion of the business combination. Accordingly, these unaudited pro forma results are presented for informational purposes only and not necessarily indicative of what the actual results of operations of the combined Company would have been if the acquisition had occurred at the beginning of the 2015 period presented, nor are they indicative of future results of operations.

On April 28, 2014, the Company ’s Board of Directors approved a share repurchase program (the “Share Repurchase Program”) which became effective on May 1, 2014 and authorized the Company to repurchase up to 1.8 million shares of its outstanding common stock over a period not to exceed twelve months. The Share Repurchase Program was extended through June 2, 2016, and the maximum number of shares authorized to be repurchased under the program was increased to 3.4 million shares.  Share repurchases under this program were made in accordance with SEC Rule 10b-18 using a variety of methods, which included open market purchases and block trades in compliance with applicable insider trading and other securities laws and regulations. With the exception of repurchases made during stock trading black-out periods under 10b5-1 Plans, the timing, manner, price and amount of any repurchases were determined at the Company’s discretion. The Share Repurchase Program expired on June 2, 2016 and did not obligate the Company to repurchase any specific number of shares.  From the inception of the Share Repurchase Program on May 1, 2014 through its expiration on June 2, 2016, the Company repurchased 2,592,095 shares for an aggregate cost (excluding fees and commissions) of $10,480.  During the nine-month period ended September 25, 2016, the Company repurchased 149,904 shares under this program for a total cost (excluding fees and commissions) of $603.

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

a. Goodwill

The following table summarizes the goodwill activity by segment for the nine-month periods ended October 1, 2017 and September 25, 2016:

b. Intangible Assets

The composition of intangible assets was:

Amortization expense for intangible assets was as follows:

The change in the cost value of total intangible assets from December 31, 201 6 to October 1, 2017 is a result of the effect of foreign currency translations.

On May 31, 2017, Ultralife Corporation entered into a Credit and Security Agreement (the “Credit Agreement”) and related security agreements with KeyBank National Association (“KeyBank” or the “Bank”) to establish a $30 ,000 senior secured, cash flow-based, revolving credit facility that includes a $1,500 letter of credit subfacility (the “Credit Facility”). The Credit Agreement provides that the Credit Facility may be increased with the Bank’s concurrence to $50,000 prior to the last six months of the term and is scheduled to expire on May 30, 2020. The Credit Facility replaces the Company’s asset-based revolving credit facility with PNC Bank National Association which expired in accordance with its terms on May 24, 2017 (the “Prior Credit Agreement”).

The Credit Facility provides the Company with an aggregate of up to $30 ,000 of loan and letter of credit availability determined based on a borrowing base formula. The Company may use advances under the Credit Facility for general working capital purposes, to reimburse drawings under letters of credit and to fund capital expenditures and acquisitions, all subject to the terms of the Credit Agreement. The Company had no amounts drawn under the Prior Credit Agreement at the time of its expiration and has not borrowed under the Credit Facility.

Interest will accrue on outstanding indebtedness under the Credit Agreement at the Overnight LIBOR Rate plus the applicable margin, or at the Base Rate plus the applicable margin, as selected by the Company. During the period beginning May 31, 2017 and ending April 1, 2018, the applicable margin for Overnight LIBOR Loans is 185 basis points, the applicable margin for Base Rate Loans is negative 50 basis points and applicable margin for the Unused Fee is 20 basis points. Beginning April 2, 2018 and thereafter, the applicable margins will be determined based on the chart below.

The Company must pay a fee on its unused availability equal to the applicable margin for the Unused Fee and customary letter of credit fees.

In addition to the affirmative and negative covenants, the Company must maintain a fixed charge coverage ratio of 1.15 to 1.0, tested each fiscal quarter for the trailing four fiscal quarters, and a minimum tangible net worth of $40,000, tested as of the end of each calendar year. The Company was in full compliance with its covenants as of October 1, 2017.

Any outstanding borrowings must be repaid upon expiration of the term of the Credit Facility. Payments must be made during the term to the extent outstanding borrowings exceed the maximum amount then permitted to be drawn as borrowings under the Credit Facility and from the proceeds of certain transactions. Upon the occurrence of an event of default, the outstanding obligations of the Company under the Credit Facility may be accelerated in addition to the other remedies available to the Bank under the terms of the Credit Agreement. The Credit Facility is secured by substantially all the assets of the Company.

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 October 1, 2017, there was $508 of total unrecognized compensation cost related to outstanding stock options, which is expected to be recognized over a weighted average period of 1.2 years.

The following table summarizes stock option activity for the nine-month period ended October 1, 2017:

The following assumptions were used to value stock options granted during the nine months ended October 1, 2017:

The weighted average grant date fair value of options granted during the nine months ended October 1, 2017 was $2.47.

On April 19, 2017, the Company ’s Board of Directors extended the expiration date from December 30, 2017 to December 30, 2020 of options previously granted (and fully vested at the time of modification) to the Company’s President and Chief Executive Officer to purchase an aggregate 300,000 shares of the Company’s common stock. Pursuant to Accounting Standards Codification Topic 718, Compensation – Stock Compensation, the transaction was accounted for as an equity award modification. During the second quarter, the Company recognized compensation cost of $193 representing the incremental fair value of the modified award computed as of the modification date as the difference between the fair value of the modified award and the fair value of the original award immediately before it was modified.

FASB ’s guidance for share-based payments requires cash flows from excess tax benefits to be classified as a part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for exercised stock options in excess of the deferred tax asset attributable to stock compensation costs for such stock options. We did not record any excess tax benefits in the first nine months of 2017 or 2016.

Cash received from stock option exercises under our stock-based compensation plans for the three-month periods ended October 1, 2017 and September 25, 2016 was $131 and $106, respectively. Cash received from stock option exercises for the nine-month periods ended October 1, 2017 and September 25, 2016 was $1,120 and $181, respectively.

In September 2014, 49,200 shares of restricted stock were awarded to certai n of our employees. These shares have now fully vested over three years, and we estimated their weighted average grant date fair value to be $3.24 per share. In September 2017, 15,900 shares of the awarded restricted stock vested and the Company repurchased 3,959 shares at a total cost of $26 to satisfy the statutory tax withholding on shares vested for certain employees. There is no unrecognized compensation cost related to these restricted shares at October 1, 2017.

We use t he asset and liability method 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 three-month periods ended October 1, 2017 and September 25, 2016, we recognized $104 and $92, respectively, in income tax expense. For the nine-month periods ended October 1, 2017 and September 25, 2016, we recorded $370 and $213, respectively, in income tax expense. These are detailed as follows:

The deferred income tax provision is primarily due to the recognition of deferred tax liabilities relating to goodwill and certain intangible assets that cannot be predicted to reverse for book purposes during our loss carryforward periods. The current income tax provision is primarily due to the income generated by our foreign operations and estimated U.S. federal alternative minimum taxes.

Our effective co nsolidated tax rates for the nine-month periods ended October 1, 2017 and September 25, 2016 were:

The overall effective tax rate is the result of the combination of income and losses in each of our tax jurisdictions, which is particularly influenced by the fact that we have recorded a full reserve against our deferred tax assets pertaining to cumulative historical losses for our U.S. operations and certain foreign subsidiaries, as management does not believe, at this time, that it is more likely than not that we will realize the benefit of these losses.

As of December 31, 201 6, we have domestic and foreign net operating losses (“NOL”) totaling approximately $70,976 and $12,760, respectively, and domestic tax credits of approximately $1,704, available to reduce future taxable income. Included in our NOL carryforwards are foreign loss carryforwards of approximately $12,760, nearly all of which can be carried forward indefinitely. The domestic NOL carryforward of $70,976 expires from 2019 through 2034.

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. Our U.S. tax matters for the years 200 2 through 2016 remain subject to examination by the Internal Revenue Service (“IRS”) and various state and local tax jurisdictions due to our NOL carryforwards. Our tax matters for the years 2009 through 2016 remain subject to examination by the respective foreign tax jurisdiction authorities.

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 October 1, 2017, 1,481,844 stock options and no restricted stock units were included in the calculation of Diluted EPS as such securities are dilutive. Inclusion of these securities resulted in 407,668 additional shares in the calculation of fully diluted earnings per share. For the comparable three-month period ended September 25, 2016, 758,953 stock options and 15,900 restricted stock units were included in the calculation of Diluted EPS resulting in 91,041 additional shares in the calculation of fully diluted earnings per share. For the nine-month periods ended October 1, 2017 and September 25, 2016, 1,066,844 and 1,139,843 stock options and zero and 15,900 restricted stock units, respectively, were included in the calculation of Diluted EPS as such securities are dilutive. Inclusion of these securities resulted in 323,217 and 184,564 additional shares, respectively, in the calculation of fully diluted earnings per share.

There were 569,000 and 1,733,083 outstanding stock options for the three-month periods ended October 1, 2017 and September 25, 2016, respectively, which were not included in EPS as the effect would be anti-dilutive. There were 984,000 and 1,351,833 outstanding stock options for the nine-month periods ended October 1, 2017 and September 25, 2016, respectively, which were not included in EPS as the effect would be anti-dilutive.

a. Purchase Commitments

As of October 1, 2017, we have made commitments to purchase approximately $640 of production machinery and equipment.

b. Product Warranties

We estimate future costs associated with expected product failure rates, material usage and service costs in the development of our warranty obligations. Warranty reserves are based on historical experience of warranty claims and generally will be estimated as a percentage of sales over the warranty period. In the event the actual results of these items differ from the estimates, an adjustment to the warranty obligation would be recorded. Changes in our product warranty liability during the first nine months of 2017 and 2016 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 fin al disposition of such matters will not have a material adverse effect on our financial position, results of operations or cash flows.

Dreamliner Litigation

In July 2013, an unoccupied Boeing 787 Dreamliner aircraft operated by Ethiopian Airlines was damaged by a fire while parked at London Heathrow Airport. We participated in and provided technical assistance in support of an investigation of this incident conducted by U.K. and U.S. regulatory authorities as well as by the manufacturer of the aircraft, as we are one of many downstream suppliers to that manufacturer.  A final report was issued by the Air Accidents Investigative Branch – UK Civil Aviation regulatory authority, with findings indicating that the fire was primarily caused by circumstances related to the plane’s emergency locator transmitter (“ELT”) manufactured and installed by another company.  

A component of the ELT is a battery pack which incorporates Ultralife ’s industry-standard lithium manganese dioxide non-rechargeable D-cell. Ultralife has had this cell in production since 2001, with millions of units produced and this cell is widely-used for global defense and commercial applications. This battery product has gone through rigorous safety and qualification testing, including United Nations Transport of Dangerous Goods, Manual of Tests and Criteria, and is authorized for use in aerospace applications under Technical Standard Order C142.

On May 4, 2015, we were notified of a lawsuit in which we were named, along with other suppliers to the aircraft manufacturer, concerning that 2013 fire. The suit was filed by Ethiopian Airlines Enterprise in the Commercial Court, Queen ’s Bench Division of the High Court of Justice, London. The suit seeks as damages $42,000 plus other unspecified amounts, including those for loss of use and diminution in value of the aircraft. We maintain liability and products liability insurance through reputable providers, and in accordance with our corporate practices, immediately advised and referred this matter to our insurers. We are working with those insurers and their counsel to respond to and actively defend against this action, which is ongoing.

At this time, we believe that there is not a reasonable possibility that this incident will result in a material financial exposure to the Company.

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 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.

The components of segment performance were as follows:

In November 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-17, “Income Taxes: Balance Sheet Classification of Deferred Taxes”, which requires that deferred tax liabilities and assets be netted against each other and classified as non-current in a classified statement of financial position. ASU 2015-17 is effective for public companies for annual and interim periods beginning after December 15, 2016. During the first quarter of 2017, we adopted ASU 2015-17 on a retrospective basis. As such, we reclassified $94 of foreign current deferred tax assets to non-current on the consolidated balance sheets as of April 2, 2017 and December 31, 2016. The deferred tax liabilities relate to U.S. tax obligations which cannot be netted against foreign deferred taxes. The adoption of ASU 2015-17 did not affect our consolidated statements of income.

In March 2016, the FASB iss ued ASU 2016-09, “Compensation – Stock Compensation (Topic 718)”, which identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU 2016-09 is effective for public companies for annual and interim periods beginning after December 15, 2016. We adopted the new accounting standard in the first quarter of 2017 and will maintain our policy to estimate forfeitures expected to occur to determine stock-based compensation expense. Adoption of this new accounting standard resulted in the recognition of an increase in the Company’s gross deferred tax asset of approximately $1,200 and an offsetting increase in the valuation allowance. There was no impact to the Company’s retained earnings as a result of adopting this new accounting standard.

In July 2015, the FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory," which simplifies the subsequent measurement of inventory by using only the lower of cost and net realizable value. This standard is effective for fiscal years and interim periods within those years beginning after December 15, 2016, and must be applied on a retrospective basis. We adopted the new accounting standard in the first quarter of 2017. There was no material impact to the Company's financial statements as a result of adopting this new accounting standard.

There have been no developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company ’s consolidated financial statements and disclosures, from those disclosed in the Company’s 2016 Annual Report on Form 10-K, except for the following:

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

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, our reliance on certain key customers; potential costs because of the warranties we supply with our products and services; our efforts to develop new commercial applications for our products; possible future declines in demand for the products that use our batteries or communications systems; the unique risks associated with our China operations; reduced U.S. and foreign military spending including the uncertainty associated with government budget approvals; our ability to comply with changes to the regulations for the shipment of our products; variability in our quarterly and annual results and the price of our common stock; possible impairments of our goodwill and other intangible assets; possible breaches in security and other disruptions; safety risks, including the risk of fire; negative publicity of lithium-ion batteries; our resources being overwhelmed by our growth prospects; our ability to retain top management and key personnel; potential disruptions in our supply of raw materials and components; our exposure to foreign currency fluctuations; our customers ’ demand falling short of volume expectations in our supply agreements; 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; 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 utilize our net operating loss carryforwards; 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” or “expect” 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, 2016.

Undue reliance should not be placed on our 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, 2016 to reflect new information or risks, future events or other developments.

The following discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-Q and the Risk Factors and our Consolidated Financial Statements and Notes thereto contained in our Form 10-K for the year ended December 31, 2016.

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. All figures presented below represent results from continuing operations, unless otherwise specified.

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, manufacture, install and maintain power and communications systems including rechargeable and non-rechargeable batteries, communications and electronics systems and accessories and custom engineered systems. 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 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 various other non-rechargeable batteries, in addition to rechargeable batteries, uninterruptable power supplies, charging systems and accessories, such as cables. The Communications Systems segment includes RF amplifiers, power supplies, cable and connector assemblies, amplified speakers, equipment mounts, case equipment, integrated communication system kits 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.

Overview

Consolidated revenues of $21,047 for the three-month period ended October 1, 2017, increased by $1,416 or 7.2%, from $19,631 during the three-month period ended September 25, 2016, despite $2,270 of revenues attributable to shipments under the Vehicle Installed Power Enhanced Rifleman Appliqué (“VIPER”) Program in the year-earlier period.  Excluding the VIPER shipments, the Company’s revenues increased 21% driven by a 25% increase for Battery & Energy Products sales. Communications Systems core product sales such as our 20-watt amplifiers, universal vehicle adaptors and power supplies, were flat with the year-earlier period. 

Gross profit for the three-month period ended October 1, 2017 was $6,255, or 29.7% of revenues, compa red to $5,997, or 30.5% of revenues, for the same quarter a year ago.  The 80 basis point decline primarily reflects the mix of products sold and supply chain variances.  

Operating expenses in creased to $4,992 during the three-month period ended October 1, 2017, compared to $4,859 during the three-month period ended September 25, 2016. The increase of $133 or 2.7% was primarily attributable to an accrual related to executive variable compensation reflecting year-to-date operating results. Management continues to maintain their strict control over all discretionary spending.

Operating income for the three-month pe riod ended October 1, 2017 was $1,263 or 6.0% of revenues, compared to $1,138 or 5.8% for the year-earlier period. The year-over-year increase in operating income reflects the impact of the higher sales and operating expense leverage.

Net income attributable to Ultralife was $ 1,098 or $0.07 per share for the three-month period ended October 1, 2017, compared to $1,019 or $0.07 per share for the three-month period ended September 25, 2016.

Adjusted EBITD A, defined as net income attributable to Ultralife before net interest expense, provision for income taxes, depreciation and amortization, stock-based compensation expense, plus/minus expense/income that we do not consider reflective of our ongoing operations, amounted to $1,985 in the third quarter of 2017 compared to $2,046 in the third quarter of 2016. See the section “Adjusted EBITDA from Continuing Operations” on Page 25 for a reconciliation of Adjusted EBITDA to Net Income Attributable to Ultralife.

Primarily as a result of our operating performance, we generated cash of $ 3,978 for the nine month period ended October 1, 2017. Accordingly, cash increased from $10,629 at December 31, 2016 to $14,607 at October 1, 2017.

Having more than doubled both operating profit and EPS for the first nine months of the year, we are well positioned towards delivering another year of profitable growth.   In addition, the BA-5390 $21.4 million indefinite-delivery / indefinite-quantity (“ IDIQ”) award received in March 2017 , the VIPER $4.7 million contract received in August 2017 , and the recent BA-5790/5795 CFx $49.8 million IDIQ award received in September 2017 serve as positive indicators of future growth potential as we finish out 2017 and head into 2018.”

Results of Operations

T hree-Month Periods E nded October 1 , 201 7 and September 2 5 , 201 6

Revenues. Consolidated revenues for the three-month period ended October 1, 2017 amounted to $21,047, an increase of $1,416 or 7.2%, from the $19,631 reported for the three-month period ended September 25, 2016.

Battery & Energy Products revenues increased $3,673 or 24.6%, to $18,616 for the three-month period ended October 1, 2017 from $14,943 for the three-month period ended September 25, 2016.   Government and defense sales increased 57.5% from the 2016 period due primarily to higher battery demand from both U.S. and international customers which were up 58.0 % and 56.1%, respectively. Commercial revenues for the third quarter of 2017 increased 8.3% over the prior year period, reflecting a 14.2% increase in the shipment of medical batteries and chargers and 1.3% increase for other commercial applications. 

Communications Systems revenues decreased $2,257 or 48.2%, from $4,688 during the three-month period ended September 25, 2016 to $2,431 for the three-month period ended October 1, 2017.  This decrease is due to revenues attributable to shipments of VIPER systems of $2,270 in the 2016 period.  Excluding VIPER, sales of core products such as our 20-watt amplifiers, universal vehicle adaptors and power supplies were essentially flat with the prior-year period.

Cost of Products Sold.   Cost of products sold totaled $14,792 for the quarter ended October 1, 2017, an increase of $1,158, or 8.5%, from the $13,634 reported for the same quarter a year ago.  Consolidated cost of products sold as a percentage of total revenue increased to 70.3% for the three-month period ended October 1, 2017 from 69.5% for the three-month period ended September 25, 2016.  Correspondingly, consolidated gross margin was 29.7% for the three-month period ended October 1, 2017, compared with 30.5% for the three-month period ended September 25, 2016, primarily reflecting the mix of products sold and incremental supply chain variances for the Battery & Energy Product business in the 2017 period.  

In our Battery & Energy Products segment, the cost of products sold increased $3,010 or 28.9%, to $13,430 for the three-month period ended October 1, 2017 from $10,420 during the three-month p eriod ended September 25, 2016.  Battery & Energy Products’ gross profit for the third quarter of 2017 was $5,186 or 27.9% of revenues, an increase of $663 or 14.7%, from gross profit of $4,523 or 30.3% of revenues for the third quarter of 2016.  Battery & Energy Products’ gross margin as a percentage of revenues decreased for the three-month period ended October 1, 2017 by 240 basis points, primarily reflecting the mix of products sold , incremental supply chain variances and manufacturing variances incurred on the start-up of certain new products in the 2017 period .  

In our Communications Systems segment, the cost of products sold decreased by $1, 852 or 57.6% from $3,214 during the three-month period ended September 25, 2016 to $1,362 during the three-month period ended October 1, 2017 due to the VIPER shipments in 2016 as well as core product mix. Communications Systems’ gross profit for the third quarter of 2017 was $1,069 or 44.0% of revenues, a decrease of $405 or 27.5%, from gross profit of $1,474 or 31.4% of revenues, for the third quarter of 2016. The gross margin of 44.0%, an increase of 1,260 basis points over the 2016 period, was driven by the sales growth of high-value proposition core amplifier and integrated solutions products.

Operating Expenses.   Operating expenses for the three-month period ended October 1, 2017 totaled $4,992, an increase of $133 or 2.7% from the $4,859 incurred during the three-month period ended September 25, 2016.  The increase was due primarily to an accrual related to executive variable compensation based on the year-over-year improvement in operating results. Management continues to maintain their strict control over all discretionary spending. 

Overall, operatin g expenses as a percentage of revenues were 23.7% for the quarter ended October 1, 2017 compared to 24.8% for the quarter ended September 25, 2016.  Amortization expense associated with intangible assets related to our acquisitions was $106 for the third quarter of 2017 ($64 in selling, general and administrative expenses and $42 in research and development costs), compared with $129 for the third quarter of 2016 ($80 in selling, general, and administrative expenses and $49 in research and development costs).  Research and development costs were $1,355 for the three-month period ended October 1, 2017, essentially flat with $1,357 for the three months ended September 25, 2016.  Selling, general, and administrative expenses increased $135 or 3.9% to $3,637 during the third quarter of 2017 from $3,502 during the third quarter of 2016.  The increase is primarily attributable to an accrual related to executive variable compensation reflecting year-to-date operating results.

Other Expense . Other expense totaled $58 for the three-month period ended October 1, 2017 compared to $30 for the three-month period ended September 25, 2016. Interest and financing expense was $38 for the third quarter of 2017 compared to $50 for the 2016 period. The decrease is primarily due to the more favorable terms of our Revolving Credit Agreement which was executed on May 31, 2017. Miscellaneous income (expense) amounted to ($20) for the third quarter of 2017 compared with $20 for the third quarter of 2016, primarily due to transactions impacted by foreign currency fluctuations between the U.S. dollar relative to Pounds Sterling and the Euro.

Income Taxes.   We recognized a tax provision of $104 for the third quarter of 2017 compared to $92 for the third quarter of 2016, an increase of $12 or 13.0%.  The increase is primarily due to the increased amounts and geographic mix of earnings for the quarter .  See Note 9 in the Notes to Consolidated Financial Statements in this Form 10-Q for additional information regarding our income taxes.

Net Income Attributable to Ultralife. Net income attributable to Ultralife and Net income attributable to Ultralife common shareholders per diluted share was $1,098 and $0.07, respectively, for the three months ended October 1, 2017, compared to $1,019 and $0.07, respectively, for the three months ended September 25, 2016. Average common shares outstanding used to compute diluted earnings per share increased from 15,297,718 in the third quarter of 2016 to 15,971,243 in the third quarter of 2017 due to the exercise of stock options and the vesting of restricted stock under our Long-Term Incentive Plans, and the increased stock price.

Nine -Month Periods Ended October 1 , 201 7 and September 2 5 , 201 6

Revenues.   Consolidated revenues for the nine-month period ended October 1, 2017 amounted to $63,022, an increase of $2,187 or 3.6%, from the $60,835 generated during the nine-month period ended September 25, 2016.

Battery & Energy Products revenues increased $5,835, or 12.4%, from $47,142 for the nine-month period ended September 25, 2016 to $52,977 for the nine-month period ended October 1, 2017.  Commercial revenues of this business segment increased 7.3% over the 2016 nine-month period and now comprise 58.5% of total segment sales versus 60.7% last year.  The increase in commercial revenues resulted from 12.1% year-over-year growth in the shipment of medical batteries and chargers, supplemented by a 2.5% increase across our expanding non-medical commercial customer base. Government and defense sales of the Battery & Energy Products business segment increased 20.3% from the 2016 nine-month period and now comprise 41.5% of total segment sales versus 39.3% last year.  The increase reflects the higher overall demand across our U.S. and international customer base.

Communications Systems revenues decreased $3,648, or 26.6%, from $13,693 during the nine-month period ended September 25, 2016 to $10,045 for the nine-month period ended October 1, 2017.   Revenues attributable to VIPER shipments were $8,219 in the nine-month period in 2016.  In the comparable period in 2017, there was $133 of revenues attributable to VIPER shipments.  Excluding the VIPER shipments, sales of core amplifiers and integrated solutions products increased $4,438 or 81.1 % over the first nine months of 2016 driven by an increased demand for our core products such as our 20-watt amplifiers, universal vehicle adaptors and power supplies.

Cost of Products Sold.   Cost of products sold totaled $43,656 for the nine-month period ended October 1, 2017, an increase of $1,123 or 2.6%, from the $42,533 reported for the same nine-month period a year ago.  Consolidated cost of products sold as a percentage of total revenue decreased from 69.9% for the nine-month period ended September 25, 2016 to 69.3% for the nine-month period ended October 1, 2017.  Correspondingly, consolidated gross margin was 30.7% for the nine-month period ended October 1, 2017, compared with 30.1% for the nine-month period ended September 25, 2016, due primarily to favorable product mix for our Communications Systems segment for the 2017 period.  

For our Battery & Energy Products segment, the cost of products sold increased $5,381 or 16.4%, from $32,738 during the nine-mon th period ended September 25, 2016 to $38,119 during the nine-month period ended October 1, 2017.  Battery & Energy Products’ gross profit for the 2017 nine-month period was $14,858 or 28.0% of revenues, an increase of $454 or 3.2% from gross profit of $14,404, or 30.6% of revenues, for the 2016 nine-month period.  Battery & Energy Products’ gross margin as a percentage of revenues decreased for the nine-month period ended October 1, 2017 by 260 basis points, primarily reflecting the mix of products sold and incremental supply chain variances .  

For our Communications Systems segment, the cost of products sold decreased by $4,258 or 43.5% from $9,795 during the nine-month period ended September 25, 2016 to $5,537 during the nine-month period ended October 1, 2017.  Communications Systems’ gross profit for the first nine months of 2017 was $4,508 or 44.9% of revenues, an increase of $610 or 15.6% from gross profit of $3,898 or 28.5% of revenues, for the third quarter of 2016.  The 1,640 basis point increase in gross margin during 2017 is due to growth in core product sales and favorable product mix.

Operating Expenses.   Total operating expenses for the nine-month period ended October 1, 2017 totaled $14,940, a decrease of $1,243 or 7.7% from the $16,183 incurred during the nine-month period ended September 25, 2016.  This decrease was attributable to reductions in discretionary costs completed during and subsequent to the 2016 second quarter, cost synergies associated with our acquisition of Accutronics, and one-time costs incurred in January 2016 to complete the acquisition. 

Overall, operating expenses as a percentage of revenues were 23.7% for the nine-month period ended October 1, 2017 compared to 26.6% for the comparable 2016 period.   Amortization expense associated with intangible assets related to our acquisitions was $315 for the first nine months of 2017 ($192 in selling, general and administrative expenses and $123 in research and development costs), compared with $403 for the first nine months of 2016 ($251 in selling, general, and administrative expenses and $152 in research and development costs).  Research and development costs were $3,678 for the nine-month period ended October 1, 2017, a decrease of $760, or 17.1%, from $4,438 for the nine months ended September 25, 2016.  The decrease primarily reflects the timing of development and testing costs associated with the shipment of VIPER units in 2016 and discretionary cost reduction actions completed during and subsequent to the second quarter of 2016, including synergies with Accutronics. Selling, general, and administrative expenses decreased $483 or 4.1%, from $11,745 during the first nine months of 2016 to $11,262 during the first nine months of 2017. The decrease is attributable to one-time costs incurred to complete the acquisition of Accutronics in January 2016 and discretionary cost reductions.

Other Expense.   Other expense totaled $200 for the nine-month period ended October 1, 2017 compared to $167 for the nine-month period ended September 25, 2016.  Interest and financing expense decreased $66 to $147 for the 2017 period from $213 for the comparable period in 2016 .  The decrease is attributable to one-time costs of $48 associated with the acquisition of Accutronics and more favorable terms of our Revolving Credit Agreement which was executed on May 31, 2017.  Miscellaneous income (expense) amounted to ($53) for the first nine months of 2017 compared with $46 for the first nine months of 2016, primarily due to transactions impacted by foreign currency fluctuations between the U.S. dollar relative to Pounds Sterling and the Euro.

Income Taxes.   We recognized a tax provision of $370 for the first three quarters of 2017 compared with a tax provision of $213 for the first three quarters of 2016.  The increase of $157 or 73.7% is primarily due to the increased amounts and geographic mix of earnings for the 2017 period.  The effective consolidated tax rates for the nine-month periods ended October 1, 2017 and September 25, 2016 were 8.8% and 10.9%, respectively. See Note 9 in the Notes to Consolidated Financial Statements for additional information regarding our income taxes.

Net Income Attributable to Ultralife.   Net income attributable to Ultralife and Net income attributable to Ultralife common shareholders per diluted share was $3,848 and $0.24, respectively, for the nine months ended October 1, 2017, compared to $1,764 and $0.11, respectively, for the nine months ended September 25, 2016.    Average common shares outstanding used to compute diluted earnings per share increased from 15,446,290 in the 2016 period to 15,817,961 in the 2017 period, mainly due to the exercise of stock options and the vesting of restricted stock under our Long-Term Incentive Plans and the increased price of our common stock.

Adjusted EBITDA from Continuing Operations

In evaluating our business, we consider and use Adjusted EBITDA, a non-GAAP financial measure, as a supplemental measure of our operating performance. We define Adjusted EBITDA as net income (loss) attributable to Ultralife before net interest expense, provision (benefit) for income taxes, depreciation and amortization, and stock-based compensation expense, plus/minus expenses/income that we do not consider reflective of our ongoing continuing operations. We also use Adjusted EBITDA as a supplemental measure to review and assess our operating performance and to enhance comparability between periods. We also believe the use of Adjusted EBITDA facilitates investors’ use of operating performance comparisons from period to period by backing out potential differences caused by variations in such items as capital structures (affecting relative interest expense and stock-based compensation expense), the book amortization of intangible assets (affecting relative amortization expense), the age and book value of facilities and equipment (affecting relative depreciation expense) and other significant non-operating expenses or income. We also present Adjusted EBITDA from operations because we believe it is frequently used by securities analysts, investors and other interested parties as a measure of financial performance. We reconcile Adjusted EBITDA to Net income (loss) attributable to Ultralife; the most comparable financial measure under U.S. generally accepted accounting principles (“U.S. GAAP”).

We use Adjusted EBITDA in our decision-making processes relating to the operation of our business together with U.S. GAAP financial measures such as income (loss) from operations. We believe that Adjusted EBITDA permits a comparative assessment of our operating performance, relative to our performance based on our U.S. GAAP results, while isolating the effects of depreciation and amortization, which may vary from period to period without any correlation to underlying operating performance, and of stock-based compensation, which is a non-cash expense that varies widely among companies. We believe that by limiting Adjusted EBITDA, we assist investors in gaining a better understanding of our business on a going forward basis. We provide information relating to our Adjusted EBITDA so that securities analysts, investors and other interested parties have the same data that we employ in assessing our overall operations. We believe that trends in our Adjusted EBITDA are a valuable indicator of our operating performance on a consolidated basis and of our ability to produce operating cash flows to fund working capital needs, to service debt obligations and to fund capital expenditures.

The term Adjusted EBITDA is not defined under U.S.  GAAP, and is not a measure of operating income, operating performance or liquidity presented in accordance with U.S. GAAP. Our Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, Adjusted EBITDA should not be considered in isolation or as a substitute for net income (loss) attributable to Ultralife or other consolidated statement of operations data prepared in accordance with U.S. GAAP. Some of these limitations include, but are not limited to, the following:

We compensate for these limitations by relying primarily on our U.S. GA AP results and using Adjusted EBITDA only supplementally. Adjusted EBITDA is calculated as follows for the periods presented:

Liquidity and Capital Resources

As of October 1, 2017, cash totaled $14,607, an increase of $3,978 from the beginning of the year.   During the nine-month period ended October 1, 2017, we generated $3,657 of cash from our operating activities as compared to $3,568 of cash generated during the nine-month period ended September 25, 2016, an increase of $89.  Cash generated from operations in 2017 consisted of net income of $3,856, non-cash expenses (depreciation, amortization and stock-based compensation) totaling $2,393, and a net increase in accounts payable and other working capital items of $1,041 largely attributable to the timing of payroll.  This was partially offset by an increase in accounts receivable of $2,412 primarily due to the timing of shipments and an increase in inventory of $1,221 largely due to service 2017 backlog.

Cash provided by operations for the nine-month period ended September 25, 2016 included net income of $1,739 plus non-cash expenses (depreciation, amortization and stock-based compensation) totaling $2,711, and a decrease in inventory of $755, partially offset by a net decrease in accounts payable and other working capital items of $1,637 largely attributable to the payment for inventory procured.    

Cash used in investing activities for the nine-month period ended October 1, 2017 consisted of $971 for capital expenditures. For the nine months ended September 25, 2016, we used $10,787 of cash in investing activities primarily for the acquisition of Accutronics of $9,857 (final purchase price of $11,161, net cash acquired from Accutronics of $1,304) plus capital expenditures totaling $990.

Cash provided by financing activities for the nine months ended October 1, 2017 consisted of $1,120 of proceeds from stock option exercises. For the nine months ended September 25, 2016, net cash used in financing activities totaled $426, consisting of $607 used to repurchase shares under the Share Repurchase Program and partially offset by $181 of stock option exercise proceeds. See Note 3 in the Notes to Consolidated Financial Statements in this Form 10-Q for additional information on the Share Repurchase Program.

As of October 1, 2017, we had made commitments to purchase approximately $640 of production machinery and equipment, which we expect to fund through operating cash flows or debt borrowings.

In July 2017, the Company made a strategi c decision to invest up to $4,300 in our Newark, New York facility to modernize our manufacturing capability for production of premium 3-volt primary batteries for various applications in the rapidly growing, wireless Internet of Things (“IoT”) market.  This investment, in line with our strategy to diversify revenues outside of the core U.S. government/defense markets and focus on transformational commercial opportunities, will enable us to produce a premium product with performance differentiation and incorporate the manufacturing technology expertise required to deliver a clear competitive advantage in terms of product performance, volume, safety, value proposition and strategic supply chain access to the end market and OEM’s.  In addition to the IoT market, the product will also expand customer options in the legacy smoke detector market by providing our customers the choice between our industry leading next generation 9-volt battery, or a new premium 3-volt product.  We anticipate the capital investment project implementation and applicable new product certification will be completed by the end of 2018. 

Debt Commitments

We have financing through our Credit Facility with KeyBank, which provides a $30,000 secured, cash flow-based, revolving credit facility that includes a $1,500 letter of credit subfacility. There have been no borrowings under the Credit Facility. See Note 7 in the Notes to the Consolidated Financial Statements for additional information regarding our Credit Facility.

The Company currently believes that the cash flow generated from operations and when necessary, available borrowing from our Credit Facility, will be sufficient to meet its current and long-term funding requirements for the foreseeable future.

Critical Accounting Policies

Management exercises judgment in making important decisions pertaining to choosing and applying accounting policies and methodologies in many areas. Not only are these decisions necessary to comply with U.S. GAAP, but they also reflect management ’s view of the most appropriate manner in which to record and report our overall financial performance. All accounting policies are important, and all policies described in Note 1 (“Summary of Operations and Significant Accounting Policies”) to our Consolidated Financial Statements in our 2016 Annual Report on Form 10-K should be reviewed for a greater understanding of how our financial performance is recorded and reported.

During the nine months of 2017, there were no significant changes in the manner in which our significant accounting policies were applied or in which related assumptions and estimates were developed.

Evaluation Of Disclosure Controls And Procedures

Our President and Chief Executive Officer (Principal Executive Officer) and our Chief Financial Officer and Treasurer (Principal Financial Officer) have evaluated our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e)) as of the end of the period covered by this quarterly report. Based on this evaluation, our President and Chief Executive Officer and Chief Financial Officer and Treasurer concluded that our disclosure controls and procedures were effective as of such date.

Changes In Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting (as defined in Securities Exchange Act Rule 13a-15(f)) that occurred during the fiscal quarter covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.