API Technologies' CEO Discusses F2Q 2013 Results - Earnings Call Transcript

| About: API Technologies (ATNY)

API Technologies Corp (NASDAQ:ATNY)

F2Q 2013 Earnings Call

July 11, 2013 10:00 am ET


Tara Condon - VP, IR and Corporate Marketing API Technologies

Phil Rehkemper - Executive Vice President & Chief Financial Officer

Bel Lazar - President & Chief Executive Officer


Mike Crawford - B. Riley & Company


Good morning and welcome to the API Technologies' 2013 Fiscal Second 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, this event is being recorded.

I would now like to turn the conference over to Ms. Tara Flynn Condon, Vice President, Investor Relations and Corporate Marketing. 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, Executive Vice President and CFO. Before starting the call, I'd like to read the Safe Harbor statement.

This conference call will contain certain 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 can 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 our quarterly report, 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 appraised in these reports. API Technologies is not under any obligation to update any guidance or any other 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. Good morning, everyone. Before I review our financial results, I would like to summarize our two recent asset sale transactions. As we previously announced on April 17th, we've sold our Sensors business for $51.4 million. The net proceeds from this transaction were used to pay down our term loan debt by $44.9 million. Beginning in the quarter ended May 31, 2013, we began reporting our Sensors business, previously a component of our systems, subsystems and components or SSC segment as a discontinued operation. All comparable historical periods for the Sensors business are now reported as discontinued operations. The financials I will be discussing do not include the Sensors business unless I am specifically commenting on discontinued operations.

Subsequent to the end of our second quarter on July 5th, we sold the Data Bus product line a subset of our SSC operating segment for $32.5 million. Net proceeds of $28.8 million from this transaction were used to pay down our term loan during the third quarter.

Beginning in the third quarter, the results from the Data Bus product line will be reported as a discontinued operation. Both, the Sensors and Data Bus product transactions are subject to working capital related to adjustments which will adjust our final sales proceeds. We expect to pay about $2.7 million in cash taxes associated with these two transactions as we will use our net operating losses to offset our taxable gains. Bel will speak more about these transactions later on the call.

Now, I would like to review our Q2 financial results. For the quarter ended May 31, 2013, API Technologies reported revenue of $68.1 million. Second quarter revenue increased over the prior quarter revenue of $51 million due to higher revenue across all the API's business segments. Revenue in the second quarter last fiscal year was $72.2 million.

Bookings were $72.4 million, resulting in a book-to-bill ratio of 1.1. GAAP gross margin for the fiscal second quarter of 2013 increased to 23.3%, up from 22.2% in the first quarter versus 11.5% in the second quarter last year.

Quarter-over-quarter GAAP gross margin improved due to higher revenue, which reduced our fixed cost as a percentage of revenue. Our SSC gross margin percentage improved from 26.2% in Q1 to 26.7% in Q2.

Our Secure Systems and Information Assurance, or SSIA segment, gross margin percentage declined by 5% from Q1 to 34.6% in Q2, primarily due to product mix and timing of certain programs.

Our Electronic Manufacturing Services or EMS segment gross margin percentage improved by 3.4% from Q1 to 9.6% in Q2. This quarter-over-quarter improvement in EMS gross margin was due primarily to higher revenue which lowered our fixed cost as a percentage of revenue.

In Q2, we recorded total restructuring cost of approximately $0.4 million compared to $0.3 million in Q1 and $11.5 million in Q2 of 2012. The company reported GAAP operating income of $2 million compared breakeven operating income in Q1 versus an operating loss of $10.5 million in fiscal Q2 of last year.

For the second quarter of 2013, the company's effective income tax rate was 2.7% compared to a blended U.S. Federal and State statutory income tax rate of about 37%. The primary difference between the Q2 effective tax rate and the blended statutory tax rate is due to the existence of valuation allowances for deferred tax assets and income from foreign subsidiaries tax that rates lower than the U.S. statutory rates.

Income tax expense was allocated between continuing and discontinued operations with an income tax benefit recognized in continuing operations especially with the current year operating losses and in income tax expense in discontinued operations, primarily related to the gain on the sales of Sensors business.

We recorded income from discontinued operations of $10.8 million in Q2, compared to $0.5 million of income in Q1 versus income from discontinued operations of $0.8 million in last year's Q2. Included in the Q2 income from discontinued operations was a gain on the sale of the Sensor business for $12 million and a tax expense of $1.4 million.

The company posted net income of $7.5 million in Q2. During Q2, we recorded $0.3 million of dividend on preferred stock that were paid in time resulting in net income attributable to common shareholders of $7.2 million.

Our Q2 net income improved by $21.9 million from Q1 net loss of $14.4 million. The quarter-over-quarter net income improvement was due to the $12 million gain on the sale of Sensors business, partially offset by higher tax expense, a $10.2 million reduction in expenses especially with the amortization of note discounts and deferred financing costs and improved operational results from our higher revenue during Q2.

In last year's second quarter, we reported a $109.5 million net loss, primarily due to the write-down of $87 million of goodwill related to the restructuring of our EMS segment and the write-down of approximately $12.6 million of discounts related to conversion of a note to Series A preferred stock. Revenues from discontinued operations in Q2 was $3.1 million and adjusted EBITDA was $0.4 million.

Moving onto the balance sheet, as of May 31, 2013, the company had $10.2 million of cash and cash equivalents, including $1.5 million of restricted cash and $137.7 million in debt obligation net of discounts. Subsequent to the end of Q2, we paid down our term loan by the $28.8 million net proceeds from the Data Bus product line sale. As of July 10, the company's term loan balance was $89.1 million.

Cash provided by operating activities were $0.6 million for Q2, driven primarily due by lower inventory and accounts receivable and higher operating income, mostly offset by a reduction in our accounts payable and accrual. Our cash capital expenditures for the May ending quarter were $0.9 million.

DSO or days sales outstanding were 57 in Q2, compared to 68 days in Q1. At the end of Q2, inventory was $63.7 million versus $55.1 million in Q1. Days of inventory were 111 in Q2 compared to 125 in Q1.

With that I will turn the call over to Bel. Bel?

Bel Lazar

Thanks, Phil. Hello, everyone, and thank you for joining us today. Just a quick note, that all of the numbers that will share with you shortly, exclude the Sensors business.

I am pleased to report another quarter of consecutive revenue growth with revenue increasing 11.6%. In spite of challenging macroeconomic conditions and sequestration, our continued top line growth is a testament to our differentiated product portfolio and market leadership position.

We've also expanded our adjusted EBITDA margins. Adjusted EBITDA increased from $6.5 million in Q1 to $8.7 million in Q2, an increase of $2.2 million. This reflects our continued emphasis on top line growth complemented by judicious cost reductions. We had a strong bookings quarter with book-to-bill coming in at 1.1. Our total bookings were $72.4 million and our sales funnel continues to grow coming in at $333 million in Q2 compared to $311 million in Q1.

Just to clarify, our previously reported sales funnel, only included new and major business opportunities. We have now added short-term bookings and minor opportunities. We are pleased by the continuous growth in new business opportunities as more customers leverage API's high reliability products for their existing and new platforms.

Now let me shift to our segment results and trends in our end markets. Let's begin with our SSC segment. Our SSC segment, we posted revenue of $46.7 million in Q2, an increase of 10.5% when compared to $42.3 million in Q1. The increase was due to strong sales across all of our SSC product lines, including RF microwave and microelectronics, Electromagnetic Integrated Solutions and power systems solutions.

Adjusted EBITDA for the SSC segment increased from $5.5 million, or 12.9% of revenue in Q1 to $7.0 million, or 15% of revenue in Q2. Book-to-bill for the SSC segment came in at 1.1. We are driving strong bookings momentum for our new products, including our AESA Radar solutions and power amplifiers. Also, we continue to achieve strategic design wins for advanced sets of solutions for commercial wireless applications.

We achieved increased bookings in Europe, including a $6 million order to provide microwave subassemblies for a major European weapons program announced earlier this week. As I have shared before, this segment offers many of our flagship products, so we are looking forward to continued growth from this segment.

Shifting to our SSIA segment, for the SSIA segment, revenue increased from $3.8 million in Q1 to $5.1 million in Q2 and adjusted EBITDA increased from $0.8 million or 21.1% of revenue to $1.1 million or 20.5% of revenue. Book-to-bill for our SSIA segment was 0.5, mainly due to short-term push out of certain Canadian and U.K. programs into Q3.

This quarter, we launched several new secure access and encryption products for the remote management of enterprise communication system, which has been well received by key customers in the market. Look at our secure communications and emanation security product, we continue to innovate and outperform our competitors in the Canadian and European markets. Recently API was awarded a significant U.K. contract for secure communication solutions in support of C4ISR systems. Furthermore, we are beginning to see some good traction for our secure communication product in U.S. market.

Moving onto the EMS segment, it has been a year since we initiated the restructure of our EMS segment, or EMS business. At that time, we said we would grow the top line and improve profitability and we did just that. Q2 revenue grew to $16.2 million versus $14.9 million in Q1, an increase of 9.2%. This revenue expansion is complemented by a strong book-to-bill ratio of 1.2. We also delivered an adjusted EBITDA increase to $1.7 million, or 4.1% of revenue in Q2 from $0.2 million, or 1.3% of revenue in Q1.

We continue to leverage our defense and high liability heritage and expand into new markets for our EMS business. To that end, we recently achieved ISO-13485 medical certification for our Windber EMS location, which provide access to new opportunities within this growing medical end market.

Now let me provide some additional color on our end markets and trends. The following data represents our best estimate of our end market percentage breakout. Our U.S. defense end markets revenue increased to $36.1 million in Q2, or 53% of quarterly revenue, compared to $34.2 million in Q1, primarily related to demand in electronic warfare, military aviation, radar and military communication programs.

People always ask me about sequestration. Recently, we have noted a culture change, where defense customers are approaching the buying process with more of a commercial mindset. We've seen them getting more price conscious and wanting shorter lead times. Due to our competitive cost structure, we are well positioned to competitively bid on numerous defense electronic opportunities.

Moving onto our government and security end market, quarter-over-quarter revenue increased from $7.2 million in Q1 to $9.9 million in Q2, or 14% of revenue, primarily related to increase of shipments of secure communication products in the U.K. tying to the U.K. government yearend.

Shifting to our medical, industrial and commercial end markets, Quarterly revenue decreased to $12.8 million in Q2 or 19% of revenue from $13.3 million in Q1. Lastly, for our communications and consumer end markets revenue increased to $9.3 million in Q2, or 14% of revenue from $6.5 million in Q1, due to increased demand for our power and systems solutions product.

Now, let me talk for few minutes about our operational accomplishments and goals. We continue to see great progress on many fronts. As I shared last quarter, we are clearly positioned as a technology-focused product company that offers advanced solutions to adjust wide spectrum of high reliability requirement.

As one of the world's largest commercial suppliers of RF microwave and millimeter wave products, we have one of the broadest solutions or selections of award winning RF microwave products in the world ranging from high reliable composites to advanced subsystems. As customer seek increasingly sophisticated tools that enable them to work within a limited RF spectrum, we are there with the innovation solutions that help them best.

In the second quarter, roughly 25% of our total product revenue was from new products across all of our product categories. We see this as a very healthy percentage as these are products that will contribute to our organic growth for quarters to come. That said, we have managed to balance innovation and product development with prudent CapEx spending. This emphasis on new product is complemented by strong backlog of $146.2 million at the end of Q2, a reliable book and ship business and a robust sales funnel of $333 million.

Now, let me talk briefly about our recent divestitures. While successfully managing the business, we have divested one business unit and one product line for a total of $83.9 million as part of the previously announced an ongoing strategic review. These activities included the Q2 sale of non-core Sensors business unit to Measurement Specialties, Inc. for $51.4 million and the sale of the Data Bus product line to Data Device Corporation for $32.5 million, subsequent to the end of Q2.

Now, to give you a picture of what our business would look like without Sensors business and Data Bus product line, here's an estimate. For the Sensors' business, you can look at Q1. Our last full quarter was that business and see that revenue was $6.1 million and adjusted EBITDA was $1.2 million, including overhead, shared overhead cost.

For the Data Bus product line, on an annual basis, revenue and adjusted EBITDA are approximately $13 million and $4 million, respectively. These EBITDA includes corporate and shared overhead costs. Using these numbers, our Q2 adjusted EBITDA without these product lines would have been approximately $7.7 million. The sale of these two businesses will help us focus on our energies and resources towards continued investment in our core technology development.

In closing, I am very pleased with this quarter's performance. We generated 11.6% of quarter-over-quarter top line growth and $8.7 million of adjusted EBITDA, which is a profitability growth of $2.2 million quarter-over-quarter, all while executing to divestitures.

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

Question-and-Answer Session


Certainly. We will now begin the question and answer session. (Operator Instructions) Our first question comes from Mike Crawford with B. Riley & Company. Please go ahead.

Mike Crawford - B. Riley & Company

Thank you, and thank you for giving the financial information regarding the Data Bus product sold at $13 million revenue and $4 million in EBITDA, so you sold it for over an 8X multiple. Was that a very seasonal products business or is that pretty consistent per quarter and what has been the expected growth rate of those products?

Bel Lazar

Yes. I mean, for the Data Bus product line that $13 million is a steady number. Within that $13 million there's seasonality within quarters, but in general it's a $13 million figure. It's probably around 3% to 5%. It depends like DDC would be a perfect fit for this. This is an addition to their existing Data Bus product. This was not an RF/Microwave product within API, but obviously was still core and part of microelectronics. So, I would say 3% to 5% depending on the overall economics.

Mike Crawford - B. Riley & Company

Okay. Thank you, Bel. And then, Phil, since this is going to be restated as a discontinuing operation when we next see a 10-Q from you, can you just give us a little bit more sense of what assets and liabilities are going with it as well, went with it as well?

Phil Rehkemper

Yes. It's part of the transaction. We kept the AR and accounts payable, so that's staying with the company. We'll continue to collect on that AR, and the net asset associated with the business were about $9 million.

Mike Crawford - B. Riley & Company

Okay. Thank you. Then on the EMS business, it's nice to see some continued progression there and with the improving gross margin as you layer more revenue on top of that business covering the fixed cost, what is the incremental EBITDA margin you would associate with incremental EMS revenue, now that you have got the fixed cost pretty well covered in that business.

Phil Rehkemper

About 25%.

Mike Crawford - B. Riley & Company

So, with the continued restructurings the company's had and now these two sales, has that changed the targeted corporate EBITDA margins.

Phil Rehkemper

No, Mike. We are still shooting for 20%. Our SSC segment including corporate allocation and shared overhead was about 15% last quarter. We are striving to get to that 20% and that remains our goal for our non-EMS business and for overall company. EMS target is still 10% EBITDA target.

Mike Crawford - B. Riley & Company

And, to achieve those margins at what approximate quarterly or annual revenue would you expect to need to hit barring further restructuring?

Phil Rehkemper

As we said last time if you recall, we had talked about mid-70s, but that included the Sensors and NHi or the Data Bus product line I should say, we have taken other look at it, but I would say it's probably around $70 million assuming the mix is correct at 20% to 22% EMS and 80% non-EMS.

Mike Crawford - B. Riley & Company

Okay. Thank you. Then the last question relates to sequestration, so you are seeing your DoD customers act like more like commercial customers.

Bel Lazar

Mike, one point of clarification, this is a recent development for us. I mean, we've seen this during the last three or four months. We've seen them very price conscious. They want shorter lead time and get less inventory, et cetera.

Mike Crawford - B. Riley & Company

Are you seeing your customers have any flexibility in purchases or are they really stuck to their potential across the board cutbacks that could be required if sequestration occurs?

Bel Lazar

What is seen on the majority of the programs actually, the procurement continues, but they are more careful in terms of what they are procuring and how much they are paying, but we haven't seen any programs being, were affected by any programs that were either eliminated or to be eliminated. We haven't seen that. We had seen a slight impact on our secure access business, but that's what, $200,000, but in general we haven't seen any major effect on our revenue.

Mike Crawford - B. Riley & Company

Okay. Thank you. Then one final question. So, you've gotten nice prices for a couple parts of your business. How would you describe the cadence of that strategic process that the company has been undergoing? Is there still a lot of activity there or have we seen much of what maybe born from the strategic review.

Bel Lazar

As you know, Mike, this is a board process. This is continuing, but our focus here me and my team is to continue to run the business and operation and execute and try to grow the top line.

Mike Crawford - B. Riley & Company

Okay. Thank you. Bel.

Bel Lazar

Sure. No problem.


Thank you. Our next question comes from Mike Katz, who is a private investor. Please go ahead.

Unidentified Analyst

Just in terms of your NOLs. It sounds like you used some of your NOLs. One question is, how much of your NOLs do you have remaining? And as far as interest payments, you've reduced your debt down to, I guess, $100 million or so. What's the impact on your interest expense going forward?

Bel Lazar

Thanks, Michael. I'll let Phil answer that question. Go ahead, Phil.

Phil Rehkemper

Yes. Michael. The NOL after both of these transactions are about $12 million and our debt post the transaction was about $116.8 million.

Unidentified Analyst

What is your anticipated or what's your interest expense on that $116 million. Do you provide that?

Phil Rehkemper

About $2.5 million a quarter.

Unidentified Analyst

Okay. So that $10 million. Okay. Thank you, guys.

Phil Rehkemper



There are no further questions in the queue, so this will conclude our question and answer session and I would like to turn the conference back over to Bel Lazar for any closing remarks.

Bel Lazar

We appreciate your time today. I would like to thank you again for participating in today's earnings call. Thank you very much.


This conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Thank you.

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