Aeroflex Holding's CEO Discusses F4Q13 Results - Earnings Call Transcript

| About: Aeroflex Holding (ARX)

Aeroflex Holding Corp. (NYSE:ARX)

F4Q13 Earnings Conference Call

August 15, 2013 8:15 AM ET

Executives

Andrew F. Kaminsky – Senior Vice President - Corporate Development, Investor Relations & Human Resource

Len Borow – President and Chief Executive Officer

John Adamovich, Jr. – Senior Vice President, Chief Financial Officer and Secretary

Analysts

James Covello – Goldman Sachs

Patrick Newton – Stifel Nicolaus

Mark Moskowitz – JPMorgan Chase & Co.

Quinn Bolton – Needham & Company

Operator

Good morning, ladies and gentlemen, and welcome to the Aeroflex Holdings Corp. webcast and conference call where management will discuss the Company’s financial results for the fourth quarter and full fiscal year which ended June 30, 2013. If you do not have a copy of this earnings press release, you may access it through the Investor Relations section of the Company’s website at aeroflex.com.

This call is being recorded for future playback and will be available later today in the Events tab of the Investor Relations section on the Company’s website. At this time all participants are in the listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) I would now like to turn the call over to Andrew Kaminsky, Senior Vice President of Corporate Development and Investor Relations for opening remarks. Please proceed sir.

Andrew F. Kaminsky

Good morning and thank you for joining us. With me on the call today are Len Borow, Aeroflex’s Chief Executive Officer; John Adamovich, Aeroflex’s Chief Financial Officer; and John Buyko, Aeroflex’s Executive Vice President and President of AMS.

Please note that during this conference call, we may make forward-looking statements regarding future events or financial performance and outlook that are based on information currently available to management. You are cautioned that any forward-looking statements are not a guarantee of future performance and are subject to a number of uncertainties and other factors, which could cause the actual results to differ materially from those currently expected.

For a more detailed description of these uncertainties and factors, please see Aeroflex’s filings with the Securities and Exchange Commission. Aeroflex undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results.

Also note that all dollar figures and percentages are approximations and that the detailed reconciliations of GAAP to non-GAAP results can be found in the press release we issued this morning that is posted on our website. After we review the results of the fourth quarter and fiscal year, we will open the lines for questions.

At this time, I’d like to turn the conference call over to Len.

Len Borow

Thank you, Andrew. Good morning and thank you for joining us today. Fiscal 2013 was the year of change and improved execution at Aeroflex. We made significant operational changes throughout the entire organization by restructuring and consolidating activities primarily in our ATS AVComm and wireless businesses.

These changes have positioned us to drive growth and increase profitability while we continue to invest in our future. Our core businesses help drive our strong sales of profitability this past quarter giving us confidence that we will continue to perform in fiscal 2014.

We are still operating in a challenging environment with the need for our products across all of our commercial aerospace and defense markets is critical to the success of our customers. This year, our wireless test business completed a dramatic turnaround with increased growth, improved profitability, continued technical enhancements, and deeper market penetration. Currently our wireless group is supporting multiple leading infrastructure providers as they go through LTE trials in China.

As these deployments come to fruition, we will be in a position to capitalize on the build out of the largest LTE network in the world. Our wireless team has done an outstanding job with our products and customers and has positioned us well for continued growth through out fiscal 2014.

Despite the challenges of sequestration as posed to our ATS AVComm business. The need for our products has become evident in the number of new opportunities we are seeing across all branches of our Armed Forces and certain U.S. government agencies and foreign agencies and governments.

For instance in Q4 of this fiscal year, the Marine Corp. renewed the balance of the original IDIQ. They added $15 million of our GRMATS products and released approximately $6 million of orders in the first quarter of fiscal 2014, which is very encouraging in the current market environment.

In AMS, we continue to execute on our strategy moving up to food chain with our HiRel customers and demonstrated by recent RadHard product bookings for key satellite programs. We have also continued to show strength in our HiRel and microwave products businesses, with additional bookings, the new radar and missile defense programs.

AMS had multiple meaningful orders across its HiRel product portfolio this quarter, including over $4 million of high voltage motor drivers used on a strategic missile defense program approximate $3.5 million of microwave multifunction modules used in payload applications and $4 million of our proprietary battery electronic units, which for the first time will be used in low Earth orbit, or LEO, applications which expands the use of our cell balancing technology. Despite continued delays in government funding, we are cautiously optimistic about our growth prospects doing a leading-edge proprietary market position on key programs and strong customer relationships.

I would like to now turn the call over to John Adamovich to discuss our financial results. John?

John Adamovich, Jr.

Thanks, Len and good morning. I’m going to briefly discuss the financial results for the quarter and full year and give a quick update on our balance sheet. I’ll then turn the call back to Len, who will discuss our business outlook before opening the lines for questions. For purposes of this call, my statement of operations related comments will focus on our non-GAAP metrics.

These non-GAAP metrics eliminate certain non-recurring charges and non-cash charges. As Andrew mentioned at the outset of the call, the detailed reconciliations of our GAAP to non-GAAP results can be found in the press release, we issued this morning. Before getting into the details let me mention that as part of our reorganization activities, we have reclassified our frequency synthesizer business from our ATS segment to our AMS segment.

This reflects recent changes that leveraged the synthesizer group’s engineering, sales and marketing functions with existing capabilities within AMS’s or FMW Group. From an accounting perspective all of our prior year, prior segment reporting in the 10-K that we will file later this month will reflect this change. As a point of reference the synthesizer business is an approximately $20 million a year operation.

Concerning the line item specifics, net sales were up 2% in the fourth quarter to $189 million compared to the fourth quarter last year. Net sales for the year were down 4% to $647 million compared to $673 million in fiscal 2012.

As Len mentioned earlier, wireless test performed well in the quarter and for the full year. Overall, sales in the quarter and full year were tempered by the impact of sequestration and a loss of the material AMS customer who ceased operations.

Net sales in the fourth quarter comprised $110 million from AMS and $79 million from ATS. For the full year, AMS sales amounted to $361 million and for ATS, they totaled $286 million. Gross margin for quarter was 54.7%, up 290 basis points from 51.8% in the fourth quarter of fiscal 2012. The increase was driven primarily by the performance of a commercial wireless business in ATS.

As you know from prior earnings conference calls, we’ve been actively making operational changes predominantly on the ATS side of the business that will enhance our operating leverage and increase profitability.

In our ATS wireless business, the actions necessary to consolidate our European operations into the United Kingdom are nearly complete. In ATS’s AVComm business, we have begun to consolidate facilities, proven product lines and reorganize our labor force. The AVComm actions will be completed over the next few quarters. These actions and those contemplated in other areas will continue to benefit us in fiscal 2014.

SG&A was $36 million down from $37 million in the fourth quarter of 2012 and down approximately $6 million for the full fiscal year, compared to fiscal 2012. R&D for the quarter was $22 million versus $21 million in fiscal 2012s quarter, but decreased by almost $3 million for the full fiscal year.

The quarter’s improved gross margins and cost containment efforts enabled us to generate non-GAAP operating income of $46 million in Q4, an 18% improvement when compared to $39 million last year. The improved gross margin in cost profile propelled Q4s adjusted EBITDA to $51 million, a margin of 27% compared to $44 million or 24% last year.

Our customer diversity has remained strong. For the quarter and year, no customer accounted for more than 10% of net sales. For the year 20% of net sales were in APAC, 22% Europe, and 54% in the U.S. Net sales for the U.S government or to prime defense contractors or subcontractors of the U.S. government dropped to approximately 28% for the year from 33% for fiscal 2012, primarily due to sequestration and agreement shipments made last year that have not repeated.

Our geographic mix of non-GAAP pretax income for the quarter resulted in a non-GAAP effective tax rate of 33%. Before turning to the balance sheet, I want to discuss the goodwill impairment charge we took in our GAAP financial statements this quarter. As you know from our public filings, when Aeroflex was purchased in August 2007, a significant amount of goodwill was created.

Valuations were performed at that time to allocate goodwill to each of our reporting units based on the respective results and projected financial performance. At that time our AVComm business was allocated a significant amount of goodwill. Based on the current earnings forecasts for AVComm, the impairment test performed this quarter resulted in a non-cash impairment charge of $94.1 million to write-down its goodwill and other intangibles. This impairment charge is non-cash will not impact our financial profile, our non-GAAP financial results or our existing credit agreement.

To briefly address the balance sheet, as projected at the beginning of the year, we repaid $60 million of debt in fiscal 2013 including $25 million in the fourth quarter, bringing our gross debt balance down to $587 million at June 30.

With cash on hand at June 30, we have net debt of $548 million. Our current expectation is that we will repay a similar amount of debt in fiscal 2014.

As we announced at the end of May, we amended and repriced our credit agreement on terms more favorable to Aeroflex. In addition to extending the maturity of the loan by 18 months, we eliminated the total leverage ratio covenant, relating to our term loan and reduced our interest rate by 125 basis points. These changes provide us with greater operating flexibility as well as the $7.3 million annual reduction in cash interest expense based on our current debt level.

I will now turn the call back to Len for some closing remarks. Len?

Len Borow

Thank you, John. Although bookings activity has become more challenging especially as many programs for our RadHard products, it pushed out. We are beginning to see increased opportunities for growth in our core businesses and are expecting to capitalize on many of these throughout fiscal 2014.

The first quarter has been our seasonally lowest quarter. During the fiscal year for over 20 years and that trend will continue in fiscal 2014. We expect that the first quarter of fiscal 2014 will be comparable to that of fiscal 2013. For the year, we expect our performance to continue to improve and deliver better results in fiscal 2014. For the first quarter of fiscal 2014 ending September 30, we expect net sales of between $135 million and $141 million and adjusted EBITDA to be between $18 million and $21 million.

I would like to now turn the call back to the operator to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of James Covello from Goldman Sachs. Please proceed.

James Covello – Goldman Sachs

Good morning, guys. Thanks so much for taking the question, I appreciate it. Len, you referred there at the end to a more challenging bookings environment. Is that related to macro, market share, sequestration, what are your thoughts about that more challenging environment?

Len Borow

Well, in general, Jim, it is sequestration. I mean it’s on the mill programs. We’re seeing the commercial world being pretty good matter of fact. Our wireless group is doing very, very well. We’ve been able to get out of some of the dogfights, concentrate on where we and we’ve been winning tremendously there. So those are good margins. And we picked up some new product lines activity that’s going very strong.

Where we’re having problems, but everybody is the slowness of the U.S. government in reacting to getting purchase orders placed. But that seems to be getting a little bit better. Hopefully, things will keep that way and that will solve the budget situation.

James Covello – Goldman Sachs

Yeah and I think I had asked this question the last call as well. I mean do you have an estimate on what inning we’re in there?

Len Borow

No.

James Covello – Goldman Sachs

Moving target, right?

Len Borow

Yeah. But again we’re very optimistic that we’re going to do pretty well this year. Things are trending that way and barring any disasters, we should have good year.

James Covello – Goldman Sachs

Maybe if I could just ask that one other way, because I know it’s a very difficult question to answer definitively. But are we seeing the maximum amount of impact that we could see? In other words, we don’t know how long it might last, but it’s not likely to get any worse than it is already or could it still have another leg down?

Len Borow

That’s a good question. I think for us, it’s about as bad as it could have gotten.

James Covello – Goldman Sachs

Okay.

Len Borow

Because it was indecision; if you looked at what the new Secretary of Defense just stated. They’re not going to be cutting bodies and people. That doesn’t affect us and that have been cut have been replaced again by upgrading older platforms, where we have a lot of content going.

So we have net positive there. But we were very excited that the Marine Corp. deemed our products worthy enough that they were able to get the money and place just soon as things started this quarter approximately $6 million order and they have got about another $8 million or $9 million left to spend on that contract and we’re keeping our fingers crossed. We get another release in this fiscal year, and we believe that that same product should be the product for all the tri-services. So once they get those things going that could be a big, big push for us.

James Covello – Goldman Sachs

That’s really helpful. Thanks a lot, Len. Good luck.

Len Borow

Thank you, Jim.

Operator

Thank you for your question. Your next question comes from the line of Patrick Newton from Stifel. Please proceed.

Patrick Newton – Stifel Nicolaus

Thank you, good morning, Len and John. I guess, given the bookings comments that you had or the challenging bookings level, is it fair to say that book to bill is below one in both AMS and ATS?

Len Borow

Well no for the year, we were about flat that one-to-one…

Patrick Newton – Stifel Nicolaus

And in the quarter?

Len Borow

The quarter was fairly close to being flat too, just a little bit down.

Patrick Newton – Stifel Nicolaus

Okay. And that was for the company as a whole?

Len Borow

Yes.

Patrick Newton – Stifel Nicolaus

All right. And then, Len, you alluded to in your prepared remarks it looks like we’re finally seeing some movement pertaining to the Chinese LTE rollout with China Mobile in the process of making some supplier selections. Could you comment on your competitive position to win that business? Can you help us quantify how we should think about the revenue opportunity this rollout represents to Aeroflex? And I know it’s still a wildcard, but thoughts on timing of when it could impact your business?

Len Borow

No, we being the leader in the infrastructure test especially in layers and RF pipe of layers, we believe that we’ll have a good position with all of the players in China. We’re just waiting to see as they get further along in the process.

Patrick Newton – Stifel Nicolaus

Can you help us quantify the revenue opportunity?

Len Borow

We don’t want to take a guess yet. I mean again it’s going to be the largest rollout of LTE ever. So we should see a nice uptick in sales, but I can’t quantify the exact numbers.

Patrick Newton – Stifel Nicolaus

I think last night Agilent had pointed to, on their earnings call, the China Mobile opportunity alone being about a $30 million, plus or minus $10 million, type of opportunity. If you layer in the rest of the players and given your leadership position, is it fair to say that it is significantly higher than that?

Len Borow

Yeah, I think we should be able to do that - those kind of numbers also.

Patrick Newton – Stifel Nicolaus

Okay.

Len Borow

They’re not talking about just infrastructure.

Patrick Newton – Stifel Nicolaus

No, not at all.

Len Borow

Yeah, they are talking about all of the wireless, so that is handset testing and everything. I would say that our opportunity in APAC for those types of things should be equal to or greater than that.

Patrick Newton – Stifel Nicolaus

Great, great. And then I guess on the goal of improvement results in fiscal 2014, are we to think about that sequentially throughout the year or is that a comment on year-over-year fiscal 2014 and fiscal 2013 or both?

Len Borow

Well, I think what you’re going to see is that it always happens Patrick, that first quarter is the slowest, second quarter get better, third better, fourth is always a huge quarter and we expect growth in each of those quarters over the last year.

Patrick Newton – Stifel Nicolaus

And I guess the crux of the question that is, are you expecting 2014 on a revenue and earnings basis to be an improvement relative to 2013?

Len Borow

Yes, yes.

John Adamovich, Jr.

Well, better on every quarter. I should be better on the year.

Patrick Newton – Stifel Nicolaus

No, all right. Well, you’re staring the bogie that you are putting out in Q1 is actually down at the midpoint year-over-year, which is why I’m asking the question.

Len Borow

Well, we’re saying that the first quarter be comparable to last year’s first quarter. So it should be about the same.

Patrick Newton – Stifel Nicolaus

And then I guess John just one for you is you detailed some of the ongoing consolidation and restructuring in the quarter. Can you help us understand how to think about the financial benefits that you’re going to generate from the programs that are already in progress as we move through fiscal 2014? And then you alluded to some potential consolidations. Can you help us understand the magnitude of those that you have in your hip pocket if you need to?

John Adamovich, Jr.

Yeah, the things that we have in place at the current moment relate to AVComm and those will start to roll in over the next few quarters and as far as things beyond that I’m really not at a point that I can say anything about that was until we get further along.

Patrick Newton – Stifel Nicolaus

Okay. Any dollar impact you can help us understand that is coming from the AVComm?

John Adamovich, Jr.

No, we are still pulling things together, Patrick, so it’s a little early. We know that there are clearly going to be benefits but we’re not at a point yet that we’ve really quantified and rolled everything in.

Patrick Newton – Stifel Nicolaus

Great. Thank you for taking my questions. Good luck.

John Adamovich, Jr.

Okay.

Operator

Thank you for your question. Your next question comes from line of Mark Moskowitz from JPMorgan. Please proceed.

Mark Moskowitz – JPMorgan Chase & Co.

Yes, thank you. Good morning. I want to follow up on the outlook for the first quarter. If I take the midpoint, the implied quarter-on-quarter decline is a little bigger than usual, around 27% decline. Is that just conservatism, Len, or were there certain orders pulled into the June quarter so you had to kind of adjust for that this quarter or any other dynamic? That would really be helpful if you could explain that.

Len Borow

We got a little over enthusiastic and had such a huge fourth quarter that the guys drained the pipe a little bit and we’re trying to be cautious about the Q1.

Mark Moskowitz – JPMorgan Chase & Co.

And if I could follow up there; is that overzealousness driven by this concern or anxiety around some customers potentially maybe losing some of their budget later this year, any sort of budgetary dynamic at play?

Len Borow

No, the guys just put a good push on and we won a lot of orders and had a great question. I mean the EBITDA growth way above our expectations and yours so.

Mark Moskowitz – JPMorgan Chase & Co.

Definitely, okay. Well, good job there. And then if I could ask about the growth opportunities you mentioned in the prepared remarks and the press release. Can you talk a little about how we should think about that playing out in terms of the glide path? Is it a pretty consistent cadence throughout the year? Will you see these step functions up in certain parts of the growth opportunities, or is it more of a deferred burst in the second half of the fiscal year? Just kind of curious in terms of the linearity we should kind of expect with these growth opportunities.

Len Borow

Yeah, there won’t be any linearity usually. What happens is they are lumpy and they’ve always been lumpy. We could have one quarter that will be spectacular and another quarter that’s a little slower. So it’s not a linear type function.

Mark Moskowitz – JPMorgan Chase & Co.

Okay. And then just lastly for John, just kind of curious on the gross margin strength, how should we think about that in terms of sustainability? Will there be any areas where maybe you kind of reinvest or subsidize market share gains going forward so maybe that gross margin does come back down 100, 150 bps, or can it stay up?

John Adamovich, Jr.

The market…

Len Borow

Let me take this for a minute, John.

John Adamovich, Jr.

Okay.

Len Borow

It should given that fact that is a first quarter obviously is going to be lower than the fourth quarter that has an effect on it. But for quarter-over-quarter you should see better performance this year on a gross margin basis quarterly than last year. And the reason for that is that the wireless group has higher margins than most of the other groups and that’s the group that will be expanding the most.

Mark Moskowitz – JPMorgan Chase & Co.

Okay. Great, thank you.

Operator

So your question, your next question comes from the line of Quinn Bolton from Needham. Please proceed.

Quinn Bolton – Needham & Company

Good morning, gentlemen. That’s couple of quick questions for Len and then a couple of housekeeping items for John. Len, just a follow-up on Patrick’s question about the TD LTE rollout in China; can you give us any sense of when you think that activity will start for you? I think some other folks have sort of talked about the fourth quarter of the calendar 2013 being when they start to see that activity picking up. Would you echo that timing?

Len Borow

You should…

John Adamovich, Jr.

That will be our Q2. We’re seeing activity Q2, Q3.

Quinn Bolton – Needham & Company

Q2, Q3, okay.

Len Borow

We able to do that in December quarter and the March quarter…

Quinn Bolton – Needham & Company

Great, and then just looking through the numbers for AMS, I know you are seeing some overhangs from sequestration, but the numbers still look pretty good here in the June quarter. Was that really again just the salesforce getting after it in the June quarter or are there areas of strength outside of the effects of sequestration that you were positively surprised about in the AMS business?

John Adamovich, Jr.

Yeah, well, I mean we had pockets of goodness and there were pockets of disappointment. The most important thing about it was we didn’t lose anything. Anything that we saw, just delayed because worries on budget items, but in the end we believe that they’ll all be booked, it just a timing issue.

Len Borow

Yeah, we also we had very strong results Quinn in the mixed signal area where we’re in the medical as well as the industrial areas, where we’re very solid there and that also contributes to the positive results for the quarter.

Quinn Bolton – Needham & Company

Okay, great. Thanks for that. Then for John, just on the financials a couple of questions. One, it looks like the difference between GAAP and non-GAAP gross margin ticked up this quarter. I didn’t see reconciliation in the press release, specifically calling out the difference between GAAP and non-GAAP gross margin. Can you just walk us through that?

John Adamovich, Jr.

Yeah, I think the difference in the GAAP to non-GAAP gross margins, some of it relates to the non-cash charges that are taken with respect to stock comp, some of that’s got to wind up in that line item. It’s going to be partly part of it that went on the quarter.

Another some of the actions that we have taken with respect to restructuring activities benefit in the quarter and last but not least as a result of the way the accounting works at with some of those restructuring activities, some of the restructuring charges that relates specifically to what the product wind up on the cost of sales line as opposed to down on the restructuring line. It’s the way the GAAP requires the things be split out, so when you put all that together you’ve got for the most part the difference between the GAAP and non-GAAP gross margins.

Quinn Bolton – Needham & Company

Okay, great. Then last question, John, just on the – in the press release you talked about the first fiscal quarter guidance on a non-GAAP basis using a 24% tax rate. That is much lower than what you have seen historically. Is that a new rate for the full fiscal 2014? Or is there a reason why the first quarter would be at a lower rate and then we should come back up into the low 30s for the rest of the fiscal year?

John Adamovich, Jr.

Yeah, for the present time, you can expect that get 24% rate as right now we expect that to continue for the full year. And as you know, you know from prior calls, lot of it depends on the geographic mix of income between overseas and U.S. So the rate that we’re predicting right now for the first quarter, the way that we’re seeing the year unfold you can use that also in your modeling for the full year.

Quinn Bolton – Needham & Company

Great, thank you.

Operator

Thank you for your questions. There is no further question and now I would like to turn the call over to Mr. Len Borow for closing remarks.

Len Borow

Thanks everyone for listening. We’re optimistic and excited about the future and look forward to speaking to you next quarter. Thank you.

Operator

Thank you, ladies and gentlemen for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a good day.

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