API Technologies' CEO Discusses Q1 2013 Results - Earnings Call Transcript

|
 |  About: API Technologies (ATNY)
by: SA Transcripts

API Technologies (NASDAQ:ATNY)

Q1 2013 Results Earnings Call

April 10, 2013 10:00 ET

Executives

Tara Condon - VP, Corporate Marketing & IR

Phil Rehkemper - EVP and CFO

Bel Lazar - President and CEO

Analysts

Michael Crawford - B. Riley

Bhakti Pavani - C.K. Cooper & Company

Edward H. Schwartz - Schwartz Benefit Services, Inc.

Operator

Good morning and welcome to the API Technologies' 2013 Fiscal First Quarter Conference Call and webcast. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note also, that this event is being recorded.

I would now like to turn the conference over to Tara Condon. Please go ahead.

Tara Condon

Thank you, Chad. Good morning everyone and thanks for joining us today. With us from management are Bel Lazar, President and CEO; and Phil Rehkemper, EVP and Chief Financial Officer. Before starting the call, I'd like to read the Safe Harbor statement.

This conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words anticipates, believes, estimates, expects, intends, may, plans, projects, will, would and similar expressions are all intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.

Forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ possibly materially from what the company now anticipates. Management has outlined the risk about the company's business in the section titled Risk Factors and Management Discussion and Analysis of financial conditions and results of operations in the fiscal year report on Form 10-K and quarterly report on Form 10-Q. These reports are on file with the Securities and Exchange Commission, and they should be reviewed with great care, because all forward-looking statements that management makes during this conference call or otherwise should be interpreted in light of the risks comprised in those reports. API Technologies is not under any obligation to update of any guidance or any statements discussed on this conference call, and investors should not assume that the company would update any of these statements.

With that, I'll turn the call over to Phil Rehkemper, who would discuss the company's financial results; Bel Lazar will then address API's end-markets and overall operations. Please go ahead Phil.

Phil Rehkemper

Thanks Tara and good morning everyone. For the quarter ended February 28, 2013, API reported revenue of $67.2 million, which increased from $62.7 million in the previous quarter, compared to $70.7 million in the prior fiscal year's first quarter. This $4.5 million quarter-over-quarter revenue increase is primarily due to higher revenue and API's Electronics Manufacturing Services or EMS and Secure Systems and Information Assurance or SSIA segment. Bel will review these areas further in a moment.

Our bookings were $65.2 million, resulting in a book to bill ratio of 0.97. GAAP gross margin for the fiscal first quarter of 2013 improved to 22.4% from 20.2% in the fourth quarter of fiscal 2012, compared to 24.9% in the first quarter last year. Excluding restructuring charges, gross margin for the first quarter of 2013 improved to 22.5% from 21.4% in the fourth quarter of 2012, compared to 25.4% in the first quarter of last year.

Quarter-over-quarter GAAP gross margin increased across all three of our business segments. Our Systems, Subsystems & Components or SSC segment gross margin percentage improved by 2.0% to 26.0%, primarily due to manufacturing overhead cost reductions. Our EMS segment gross margin percentage improved by 4.4% to 6.2%, primarily due to higher revenue, which lowers our fixed overhead as a percentage of revenue; and our SSIA segment gross margin percentage improved by 15.1% to 39.6%, primarily due to lower restructuring costs and direct material cost reductions.

In Q1, we recorded a total restructuring cost of $0.3 million compared to $3.3 million in Q4, and it compares to $0.6 million in Q1 of last year. The company reported GAAP operating income of $0.9 million in Q1, compared to a GAAP operating loss of $3.9 million in Q4, and compared to a GAAP operating income of $4.3 million in Q1 of last year. Excluding restructuring charges, the company reported an operating income of $1.2 million in Q1, compared to a $0.5 million operating loss in Q4, versus an operating income of $4.9 million in last year's Q1.

As a reminder, we refinanced our term loan on February 5 with a new $165 million term loan and $50 million asset base loan revolver. During Q1, we recorded a $10.3 million non-cash write-off of deferred financing costs associated with our old term loan.

For Q1 of fiscal 2013, the company's effective income tax rate was negative 7.5% compared to a blended US Federal and State statutory income tax rate of about 36%. The primary difference between the Q1 effective tax rate and the blended statutory tax rate, is due to the existence of valuation allowances for deferred tax assets, including net operating losses, additional valuation allowances in connection with the tax amortization of goodwill and income from foreign subsidiaries tax that rates lower than US statutory rates.

We posted a net loss of $14.4 million in Q1, this compares to a net loss of $12.3 million in Q4 of fiscal 2012, and a net income of $0.8 million in last year's Q1. In Q1, adjusted EBITDA was $7.6 million or 11.4% of revenue, compared to adjusted EBITDA of $8.3 million or 13.2% in Q4 of 2012. Adjusted EBITDA was $10.8 million or 15.3% of revenue on last year's Q1.

Moving on to the balance sheet, as of February 28, 2013, the company had $10.1 million of cash and cash equivalents and $194.2 million of debt obligation, which primarily includes a $165 million term loan and $27.1 million drawn on the $50 million asset based loan revolver.

Cash used by operating activities was $6.1 million for Q1, driven primarily by growth in accounts receivable and inventory, in support of our higher revenue. Our cash, capital expenditures for the quarter were $0.2 million. DSO or days sales outstanding were 67 in Q1, compared to 66 days in Q4 2012. Inventory at the end of Q1 was $71 million versus $58.0 million in Q4 2012. This inventory growth is driven primarily by a higher raw material and work-in-process inventory within our EMS segment, supporting our higher EMS revenue levels and expected growth from current backlog. Days of inventory in Q1 were flat with Q4 at 124.

Subsequent to Q1, we sold our Palm Bay, Florida facility which netted $0.7 million cash proceeds, all of which was used to pay down our term loan balance for Q2.

And with that, let me turn the call over to Bel. Bel?

Bel Lazar

Thanks Phil. Good morning everyone and thank you for joining us today. During our Q4 earnings call, I said that revenue has bottomed out. I am pleased to report that in Q1, our revenue increased 7% quarter-over-quarter. Given the challenges presented by the onset of sequestration, this revenue growth represents a key achievement for API.

While we remain cautiously optimistic in the current defense atmosphere. We continue to see top line growth, as the electronic content in defense system increases. Also, as I will discuss later on, our commercial business increased quarter-over-quarter, notwithstanding the overall macroeconomic uncertainties.

We continue to achieve key design wins, particularly within our RF microwave and microelectronics, and power solutions product line. This is complemented by a broad install base on [doing] defense and high reliability commercial programs, which positions us well for continued growth, revenue growth in FY 2013.

Book-to-bill for Q1 was 0.97. Our fully funded backlog remains strong at [$152 million], which gives us good visibility for the year. Our strong backlog and robust sales funnel of $217 million combined with a reliable book-and-ship business of approximately 20% at quarter, adds credence to our business model, and bodes well for future performance.

For Q1, adjusted EBITDA was $7.6 million or 11.4% of revenue. EBITDA was down compared to Q4, primarily due to the conclusion of C-MAC pro forma cost reductions and Q4 cost savings that did not reoccur in Q1, which offset the benefit of improved gross margins, and as I will discuss in a few moments, we are seeing positive strength across our business segments and end markets.

Now, let me shift to our segment results and trends in our end markets. I will start with our SSC segment. In our Systems, Subsystems & Components or SSC segment, we posted revenue of $48.4 million in Q1, a slight decline from $48.7 million in Q4. To give you some background, we had some customer demand delays in our European business, which was substantially offset by increased demand for RF microwave and microelectronics products in the US end markets.

Adjusted EBITDA for this segment was down from 16.3% in Q4 to 13.6% in Q1. As was the case with the companywide EBITDA, the SSC quarter-over-quarter decline was related to the conclusion of C-MAC pro forma cost reductions and Q4 cost reductions, cost savings that did not reoccur in Q1, offsetting the benefit of improved gross margins. Book-to-bill for this segment was approximately 1.

Despite sequestration, we continue to see strong booking activity across major programs, spanning [Mill Arrow] C4ISR and Missile Defense, as well as in commercial aerospace and communication. Overall, we are pleased with the performance of this segment. Our customer base is diverse, program involvement is widespread and backlog is strong. Our SSC segment offers a number of flagship products, including sophisticated modules, integrated assemblies, and highly engineered components, as well as passive components, sensors and power products.

Q1 bookings included key design wins for new product platforms, including advanced RF microwave modules and subsystems, radar products and sophisticated microwave and EMI filters. The customer adoption of these products reflects APIs steady rise as a strategic supplier.

Moving on to our Secure Systems and Information Assurance or SSIA segment. In Q1, our SSIA segment posted revenue of $3.8 million, an increase from $3.4 million in Q4. Adjusted EBITDA increased sharply quarter-over-quarter moving from 12.2% in Q4 to 21.3% in Q1. This increase is primarily due to lower material costs and operational efficiencies.

By employing our innovative technical solutions, we were able to reduce material costs and labor hours. Book-to-bill for SSIA segment was 1.75. We saw strong bookings from national government agencies, in both the UK and Canada. Additionally, we received significant orders from European customers, including the Council of Europe, which we competitively won due our strong technical and cost effective solutions.

Shifting over to our EMS or Electronics Manufacturing Services segment, we have seen a revenue rebound increasing from $10.7 million in Q4 to $14.9 million in Q1. Adjusted EBITDA also improved from negative 0.7% of revenue in Q4, to 1.5% of revenue in Q1. This quarter's positive result represents another step in the right direction, as we strive to meet our long term EBITDA goal of 10% for the segment.

Book-to-bill was 0.59 for Q1. As a reminder, we had a strong book-to-bill in Q4 of 2.1. Our EMS backlog at the end of Q1, stands at over $30 million strong. Moreover, we are beginning to see clients reconsider their outsourcing strategies related to manufacturing, which offers opportunities for API.

Now let me provide some additional color on our end market and trends. Our US defense end market revenue was up sequentially from $32.6 million in Q4 to $36 million in Q1, equating to 54% of total revenues, as a result of strong demand in electronic warfare, and radar programs within the SSC segment.

Moving on to our government and security end markets, quarter-over-quarter revenue increased, moving from $6.3 million in Q4 to $7.2 million in Q1, reflecting strong communication product sales in Canada and Europe. On a percentage basis, government and security remains steady at 10% of total revenue.

Now on to our medical, industrial and commercial end market; revenue was $14.6 million in Q1, down from $16.2 million in Q4, primarily due to lower sales in Asia, adversely affected by Chinese New Year. The medical, industrial and commercial end market accounted for 22% of total sales in Q1.

Finally, within our communications and consumer end market, revenue was up from $7.6 million in Q4, to $9.4 million in Q1, mainly due to an increase in demand for our power solutions product. This end market accounted for [14%] of total sales in Q1.

Now let me talk to our operational accomplishments and goals. In Q1, our Electromagnetic Integrated Solutions business group was recognized by Lockheed Martin for 100% on-time delivery and zero defects, for the second year in a row. Honors like this demonstrates the company's continued commitment to quality and demonstrates why API is a provider of choice for customers seeking high reliability solutions.

Q1 showcased a turnaround in our EMS business, the direct business of a targeted restructuring effort. We now have an operationally efficient EMS business model, which provides a platform, [let's say] to achieve our 10% EBITDA long term goal. Our operational efficiencies extend beyond EMS for the rest of our business. While most of the heavy lifting (inaudible) as cost reductions and business rationalization, was conducted in FY 2011 and 2012, we still execute this in addition of $2.2 million of net annualized cost reductions in Q1.

Our method of operations net of efficiency, consistently seeking ways to further streamline our operations without sacrificing new product development, customer experience or quality. Even in current economic conditions, we have consistently grown our sales funnel at a robust $217 million, up from $212 million in Q4 and $205 million in Q3. This speaks well of our diversified product portfolio and our ability to capably deliver technically advanced solutions to our customers for both defense and commercial applications.

Now let me highlight some of our new products and recent design wins. Since the introduction of our GaN-based power amplifier product line, we have booked over $2.6 million of business. This leading edge product offering includes both [pulse] and continuous power solutions. This new product family added $250 million of serviceable available markets, and accelerates API up the value chain.

I am also very excited about our UK design and manufactured AESA radar systems. Within this space, API offers system level ready -- active (inaudible) used in AESA radar and command control data links, which incorporate RF, DC, logic, control function, system bus interface and local pooling from land, sea and air defense platforms. API has strategic international AESA platform design wins, that provide long term revenue growth. We expect revenue from this product offering to reach $14 million to $15 million per year, starting in the year 2015.

Additionally, product advancement in the areas of GPS LNA, solutions for power distribution and management, and our suite of secured communication product sets us apart, and strategic focus on selected commercial applications, including medical [highlighters] in ultra high temperature microelectronics offers strong growth potential.

A question I am always -- or I think I would be asked is why focus in RF and microwave. My answer is this, the RF spectrum is finite. While demand for wireless broadcast television, satellite and related defense technology is explosive, increasingly sophisticated technology such as microwave filters, frequency-sources EMI filters, (inaudible) solutions, phased-array modules and related RF and microwave products are absolutely critical to making this limited spectrum more usable.

We offer one of the world's broadest selection of RF and microwave products, spanning from simple components to technically advanced solutions, and as one of the largest RF and microwave merchant suppliers, we enjoy a solid position in the market, and we look to aggressively expand in the days ahead.

As I shared with you in the past, the company is continuing to explore a number of strategic alternatives, including the sale of one or more business units. The net proceeds from which would be used to pay down debts. We look forward to sharing the outcome of these activities in the near future.

With that, we will turn the call over to questions. Please go ahead, operator.

Question-and-Answer Session

Operator

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Michael Crawford with B. Riley. Please go ahead.

Michael Crawford - B. Riley

Thank you. Bel, just to start up where you left off. Could you provide any further insight into that process on the search to sell one or more business units? Has that changed at all in the last few months, or is that continuing to strike through, since you first saw unsolicited interest?

Bel Lazar

This is a -- I can't share much information, Mike, this is a Board process. It's continuing and we will provide you with an update -- the board will provide us with an update, as soon as we have some results.

Michael Crawford - B. Riley

Okay. Thank you. Regarding some of the products you mentioned a couple in your comments. One, you didn't talk about, are these new security appliances you have, is that something that can be meaningful this year?

Bel Lazar

A little bit, but not in a significant way, Mike. Probably, we are talking about maybe $0.5 million to $1 million, but the significance is more in the FY 2014 and beyond.

Michael Crawford - B. Riley

Okay. Regarding the defense business, have you seen any change in behavior or demand from your customers, subsequent to March 27, when we have a little bit more clarity on the budget this year?

Bel Lazar

We actually have not seen any changes in behavior. We have seen more [ARPU] activities few months back, and our defense end market (inaudible) in Q1. But no significant change in behavior.

Michael Crawford - B. Riley

The sales funnel that has increased now, couple of quarters in a row. Is that more a function of your new products, or is it something else?

Bel Lazar

It's actually a function of new products. We are also starting to reap the benefits of design in our -- the gestation period for our product launch, it sometimes could be three, four years long. We are reaping the benefits of five years' efforts in our new products, and our heritage and quality, as I stated, quality and heritage has been outstanding and so as more customers rely on our products, our sales growth, in addition to the new product introduction.

Michael Crawford - B. Riley

Okay. Thank you and then last question relates to business model and your targets, assuming the EMS business stays at similar percent of sales, is there any change in what kind of margins you expect to be able to achieve, once you've hit certain revenue thresholds, and can you just walk through the --?

Bel Lazar

Actually Mike, no change from prior calls. We are still committed to the 20% and assuming the EMS, as we said before, is about 20% of the total revenue, we are still marching towards and committed to achieving the 20% overall EBITDA for the company.

Michael Crawford - B. Riley

Okay. Thank you.

Bel Lazar

Sure.

Operator

[Operator Instructions]. Our next question comes from Bhakti Pavani with C.K. Cooper. Please go ahead.

Bhakti Pavani - C.K. Cooper & Company

Hi Phil. Hi Bel.

Bel Lazar

Hello.

Bhakti Pavani - C.K. Cooper & Company

A quick question on the EMS business segment. The EMS business has, you know, sequentially improved, taking into consideration the third quarter and the fourth quarter revenues. So would you comment or share some color on what has caused that change or increase in revenues, was it seasonal or was it related to the restructuring efforts that you have taken?

Bel Lazar

Well I mean, to the revenue growth, has a little bit of effect on the -- the impact had a little bit effect on the revenue growth, but in general, it's the revenue growth that's program driven. However, the profitability is directly related to the restructuring.

Bhakti Pavani - C.K. Cooper & Company

Okay. So do you expect that business segment to continue at this level and maybe grow from this point or -- how is it expected to perform?

Bel Lazar

You know, we actually have good results for this segment, where for the next quarter or two we expect them to be at a decent revenue level. But as you know, we don't give guidance, but this is what it looks like, it's going to be in this range of revenue, for the next quarter or two.

Bhakti Pavani - C.K. Cooper & Company

Okay. And also on the recent news that Pentagon might release funding for missile defense in 2014 by $550 million. Would you share your comment on how will that impact API or how are you preparing, or how are you targeting that particular business?

Bel Lazar

You know, we have substantial designing and products in the missile defense, and as you know, there are a lot more electronics, and we actually -- this will bode well for your growth, and we are ready, so we will be ready for any potential major new orders. Absolutely.

Bhakti Pavani - C.K. Cooper & Company

Okay. And also, taking into consideration the uncertainty in the military space, what kind of opportunities are you targeting on the commercial aerospace side, and if you could comment on any particular program or platforms that you guys are on?

Bel Lazar

On the commercial aerospace, we are on a lot of platforms and the customers are the Airbus, the UC Aerospace, CCC Aerospace, Boeing, but it's not a big percentage of our total revenue. I think it's about 3% or so and we [lump] as part of the medical, industrial and commercial aerospace.

Bhakti Pavani - C.K. Cooper & Company

Okay. That's (inaudible). Thank you very much.

Operator

Our next question comes from Ed Schwartz with Schwartz Investments.

Edward H. Schwartz - Schwartz Benefit Services, Inc.

Good morning gentlemen. Thank you for taking my call. You've combined a bunch of companies, and to the best of my mathematical skills, the combined companies, when you had a revenue somewhere around $330 million, now you have revenue of about $270 million, what's your strategy to get back to those $320 million, $330 million revenues?

Bel Lazar

Yeah I mean, actually our actual revenue for FY 2012 was closer to $280 million. Our strategy is to continue developing new products and getting more design wins, so we are in the forefront. We are (inaudible) customer, and our customers expect to see high quality, high engineered product that differentiates us from the competition. So we expect -- we continue our efforts to continue our design wins and position ourselves for growth, and as I stated in the call earlier, we have good visibility for this fiscal year to allow us to grow.

Edward H. Schwartz - Schwartz Benefit Services, Inc.

Let me add an add-on question, how long do you think it will take to get to that $320 million, $330 million revenue?

Bel Lazar

You know we don't give guidance for either quarter or the year, but you can look at our backlog as it stands right now, $150 million, our booking shift, as I stated before within the quarter, about 20%. So we are working hard to continue our current revenue growth.

Edward H. Schwartz - Schwartz Benefit Services, Inc.

Okay. Now I have a question on your debt. You refinanced the debt at what interest rate are you currently paying?

Phil Rehkemper

Hi Ed, this is Phil Rehkemper. For the term loan, it has an interest rate of 11% and ABL interest rate is about 33.7%.

Edward H. Schwartz - Schwartz Benefit Services, Inc.

Okay. Well, you know, it appears to me that's a very high interest rate to be paying, especially in this economic climate. So last conference call, I asked the question on your debt, because Standard and Poors had been downgrading, and you said you are working with Standard and Poors to change that, constantly contacting them. It would appear to me that the best way to reduce debt is to make a profit, and pay off the debt with profits. So how do you plan to do that?

Phil Rehkemper

We do have a plan to continue to pay down our debt. We paid down tons of debt, as I mentioned from the sale of our Palm Bay facility, and with the new refinancing, obviously, we are going to use any proceeds from cash from operations to pay down our term loan debt.

Bel Lazar

To add, this is Bel, obviously because as we had said, we need to continue to grow our top line and continue our margin enhancement, so we can generate more cash, pay down debt, obviously with potential sales of business units, the net proceeds will go into paying down debt.

Phil Rehkemper

And you benefit having both the term loan and the asset backed loan, is that if you pay down the term loan, the asset backed loan as you know, has a much lower interest rate, that will bring that interest rate down.

Edward H. Schwartz - Schwartz Benefit Services, Inc.

Okay. Well thank you very much.

Bel Lazar

No problem. Thanks.

Operator

There appears to be no further questions in the question queue. So I would like to turn the conference back over to management for any closing remarks.

Bel Lazar

Well, thank you all for joining us today. We appreciate your time. I'd like to thank you again for participating in today's earnings call and we will be talking to you in the near future. Thank you.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!