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API Technologies Corp (NASDAQ:ATNY)

Q4 2013 Earnings Conference Call

February 13, 2014 10:00 AM ET

Executives

Tara Flynn Condon - VP of Investor Relations and Corporate Marketing

Bel Lazar - President and CEO

Phil Rehkemper - EVP and CFO

Analysts

Mike Crawford - B. Riley & Company

Operator

Good morning and welcome to the API Technologies Fiscal Year 2013 and Fourth Quarter Earnings 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. Ms. Condon please go ahead.

Tara Flynn Condon

Thank you, Amy. 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 forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words anticipate, believe, estimate, expect, intend, may, plan, project, will, would and similar expressions are 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 appraised in those 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 will discuss the company's financial results. Bel Lazar will then discuss API's overall business and operations. Please go ahead, Phil.

Phil Rehkemper

Thanks Tara and hello, everyone. Before I review our financial results, I’d like to remind you that the fiscal 2013 divestitures of our Sensors business unit and Data Bus product line are reported as discontinued operations for Q4 and are reported historical periods. Also we report our results in three business segments, which are Systems, Subsystems, and Component or SSC, Electronic Manufacturing Services or EMS and Secured Systems and Information Assurance or SSIA.

Now I would like to review our Q4 financial results.

For the fourth quarter ended November 30, 2013 API technologies reported revenue of $59.1 million compared to $62.6 million in Q3. We saw a year-over-year Q4 revenue growth of 10.7%, our Q4 2012 revenue was $53.4 million. Q4 booking were $51.5 million, resulting in a book-to-bill ratio of 0.9 to 1. Bel will provide more color on our revenue and booking trends later on in this call.

GAAP gross margin for Q3 was 15.2% compared to 23.9% in the third quarter versus 20.1% in the fourth quarter last year. Quarter-over-quarter GAAP gross margin declined primarily due to a $4 million of inventory write-downs and $1.2 million of restructuring cost recorded during the fourth quarter.

The inventory write-downs were recorded in each of our three business segments to align inventory with customer demand. The Q4 restructuring cost were primarily associated with the product line move from Ottawa, Canada to our State College, Pennsylvania facility within the SSC segments. The gross margin percentages excluding restructuring for all segments were as follows.

The SSC segment was 22.7% in Q4 compared to 28.6% in Q3. The SSIA segment was 36.4% in Q4 compared to 35% in Q3. The EMS segment moved from 4.9% in Q3 to -13.7% in Q4. The quarter-on-quarter gross margin declined excluding restructuring in the SSC and EMS segments were driven primarily by the inventory write-downs I previously discussed.

In Q4 we recorded total restructuring cost of approximately $1.8 million as compared to $0.1 million in Q3 and $3.3 million in Q4 2012. The company reported a GAAP operating loss of $3.7 million in Q4 compared to an operating income of $2.3 million in Q3 versus an operating loss of $5.1 million in Q4 of 2012. The quarter-over-quarter decline in operating income was driven primarily by the inventory write-downs and restructuring charges.

For the fourth quarter 2013, the company’s effective income tax rate was 27.5% compared to a blended U.S. Federal and State statutory income tax rate of about 37%. The primary difference between the Q4 effective tax rate and the blended statutory rate is due to permanent differences, the existence of evaluation allowances for deferred tax assets and income from foreign subsidiaries taxed at rates lower than the U.S. statutory rate.

Income tax expenses allocated between continuing and discontinued operation with an income tax benefit recognizing continuing operation associated with the current year operating losses and income tax expense in discontinued operations primarily related with a gain on the sale of the Sensors business and Data Bus product line.

In Q4, we reported a loss from discontinued operations at $1.9 million due to income tax expense compared to income from discontinued operations of $5.3 million in Q3 versus a $0.7 million income from discontinued operations in Q4 of 2012. The quarter-over-quarter decline was due to income in Q3 from the gain on the sale of the Data Bus product line. The company posted a net loss of $7.2 million in Q4 compared to a net income of $7 million in Q3 and a net loss of $12.3 million in last year’s Q4. During Q4, we reported $0.04 million of dividend on preferred stock or [indiscernible] resulting in a net loss attributable to common shareholders of $7.6 million.

The quarter-over-quarter net income decline was due primarily to the gain on the sales of Data Bus product line in Q3 combined with Q4 inventory write-downs and restructuring charges. The year-over-year reduction in net loss was due to lower restructuring in business acquisition and divestiture of related expenses, lower interest expense and lower income taxes from the utilization of net operating losses.

Adjusted EBITDA for Q4 was $6.3 million compared to $8.4 million in Q3, the decline in adjusted EBITDA was driven primarily by lower revenue and associated margin in the SSC and EMS segments, partially offset by higher revenue and associated adjusted EBITDA in our SSIA segments.

Moving on to the balance sheet, as of November 30, 2013 the company had $7.9 million of cash and cash equivalents including $1.5 million of restricted cash and $104.8 million in total debt obligation net of discounts. Cash declined $6.2 million during the quarter, the cash declined during the quarter was primarily due to a $3.5 million pay down of our asset backed loans, $1.8 million payment to our term loan lender associated with an amendment to lower interest rate on the term loan and a $2.4 million final tax related payment associated with the 2011 SenDEC acquisition.

Our cash capital expenditures for Q4 were $0.4 million; these uses of cash were partially offset by $1.8 million of cash provided by operating activities during Q4. In Q4, DSO or day sales outstanding was 61 compared to 64 days in Q3. At the end of Q4, inventory was $58.2 million compared to $61.6 million in Q3. Days of inventory were 106 in Q4 versus 119 in Q3. Subsequent to the end of the quarter, we completed a sale lease back transit action for our State College, Pennsylvania location. The $14.2 million net proceeds from this transaction were used to pay down the company’s term loan facility.

After the debt pay down our term loan balance was $72.6 million. Since we refinanced our debt in February of 2013 we have paid down our term loan by $92.4 million.

And with that I will turn the call over to Bel. Bel?

Bel Lazar

Overall Q4 and FY13 showcased API Technologies ability to successfully weather the sequestration storm delivering year-over-year and Q4-over-Q4 revenue growth. At the same time we developed and launched new and well accepted products, drove efficiencies and to cost out through judicious cost reductions and substantially reduced our debt.

In FY13, we have continued to build on an already strong foundation and took steps necessary in terms of operations, product development and debt reductions. To better position the company for delivering both short-term and long-term growth and shareholder value.

Let me start by discussing our segment results and end market trends. I’ll start with the SSC segment. Our SSC segment revenue accounted for $42.6 million in Q4 compared to $45.7 million in Q3, with the decline primarily due to successful completion of a defense sub-system product shipment in Q3 and timing of certain programs in our RF and microwave business.

For Q4 adjusted EBITDA for our SSC segment was $5.3 million or approximately 12.5% of revenue, compared to $7.5 million or 16.4% of revenue in Q3 and $6 million or 15.2% of revenue in last year’s Q4; book-to-bill was 0.83. The result of some older push outs and administrative complications related to the U.S. government shutdown and overall defense budget delays.

The SSC segment is home to many of our flagship products including next generation microwave sub-system and modules. In Q4, we launched a new ultra-high frequency line of millimeter wave amplifiers shortly followed by the debut of a new broadband synthesizer and product line and this trend is continuing in Q1.

We are proud to hold design in the strategic supplier positions in more than 300 U.S. and international defense and commercial programs and platforms. The technical superiority and our successful heritage of our differentiated products continues to open new doors for us. As an example earlier this year we announced a major order for $3.9 million for a microwave sub-system in support of MBDAs Sea Ceptor program, if next generation all weather air defense system.

In response to increased demand for highly reliable mobile power sources we launched our technical power supply at the AUSA exposition in Q4 and already announced our first major $1.4 million order. Our power solution product line features a full line of intelligent power systems including power distribution units and protection systems for DC and AC applications. These products meet a grown need and it’s gratifying to see such a swift and positive customer response to a newly released product.

We also continue to see growing customer reduction in the commercial front, the result of a targeted engineering and sales effort to grow our non-defense customer footprint. As an example in FY 13 we booked nearly $2 million in new microwave design ends with a major wireless carrier for use on a cellular broadband network. Also the Q4 launch of commercial targeted offerings including new lines of current sensing and lightning protection product introduced to our differentiated highly a liability products had even broader audience.

Moving on to the SSIA segment. Our SSIA segment revenue rose from $3.7 million in Q3 to $5.6 million in Q4 due to strong shipment in UK and Canada. Adjusted EBITDA was $1.6 million or 28.4% in Q4, up from $0.6 million or 16.9% in Q3. Book-to-bill for SSIA was 1.1. SSIA continues to offer a strong growth potential especially in the areas of secured mobile communication and cyber security. API technologies have developed a portfolio of intellectual property in these areas and have channeled it into products to meet the existing and emerging customer requirement. In addition, we recently announced Federal information processing standards or FIPS justification for our common cryptographic module which opens up even more opportunities for new bookings and design wins.

Moving on to the EMS segment; for the EMS segment revenue for Q4 was $11 million compared to $13.3 in Q3. Revenue fell short of our expectation due to a slip to the right of a $5.5 million backlog order as we dealt with customer driven engineering design changes in associated delivery. We have been working closely with the customer to adjust key electrical and mechanical design issues and revenue from this program is expected to ship over the current fiscal year. This particular order is for a technically advanced electronic warfare system.

Our short-term investment in technology and processes and plans to successfully deliver on the project that has the potentiality of long-term gain in a very satisfied customer. Financially the adverse effect on Q4 gross profit due to reloc and shipping delays related to this program was at least $1.5 million. For EMS segment adjusted EBITDA for Q4 was a loss of $0.6 million or -5.5% of revenue compared to a $0.3 million or approximately 2% revenue in Q3, mainly driven by lower revenue in cost associated with the program that I just mentioned. Book-to-bill for the segment was 0.9.

Now let me provide some color on our end markets and trends. The following data represents our best estimate of end market breakout. Our U.S. defense end market revenue was $30 million or 50% of total Q4 revenue, compared to $33 million or 53% of total revenue in Q3. While we saw some short-term push out due to Q4 government closures, these had larger deal which has been largely addressed through the passing of the year’s budget. We continue to see solid demand across all program categories especially in C4ISR and electronic warfare.

Shifting to our government and security end markets; as a reminder, this end market includes U.S. non-DoD government agencies and foreign government. Q4 revenue was $7.4 million or 13% of total revenue compared to $7.7 million or 12% of total revenue in Q3.

Moving on to our medical, industrial and commercial aerospace end market, quarterly revenue was up in Q4 at $12.2 or 21% of total revenue versus $11.5 million or 18% of total revenue in Q3, mainly due to increased revenue from commercial aerospace customers.

Finally in our communications and consumer end markets; Q4 revenue was $9.7 million or 16% of total revenue versus Q3 revenue to $10.3 million or 17% of total revenue.

Now let me talk about our business highlights and operational accomplishments and goals. Our FY 13 book-to-bill was approximately one, despite defense industry headwinds. We are entering FY 14 on solid footing with a fully funded total backlog of $131 million combined with a growing sales funnel of $342 million and a reliable quarterly book and ship business.

Our focus on new product development continues to win us new customers everyday particularly on the non-defense commercial front where we have increased revenue for the past fourth consecutive quarters. We have a good foothold of high growth markets like mobile, wireless communications and commercial aerospace and expanding presence in the medical and oil and gas market. As

I previously shared over 25% of our quarterly revenue is from new products. And those products were designed today and it will become the revenue drivers in future quarters. As an example, in Q4 we won 15 new design wins with $40 million of potential program of life revenue. Year end FY13, we added $103 million through our sales from new design wins. It is a testament to our talented technology through our company-wide dedication to our customers and innovation that has positioned us well throughout FY13 as a market leader in high-end [indiscernible].

The total serviceable available market for our product is $5.5 billion annually which provide us ample opportunity for growth. Given our program region we’re proud that defense customers turn to us when they need to modernize and when new customers seek our proprietary technologies solutions, designing us into tomorrow’s enduring programs.

In FY13, our revenue was $244.3 million with adjusted EBITDA of 207.1; through our divestiture activities we were able to streamline our product offerings while paying down approximately $93.2 million in term debt in FY13. Additionally in Q4 we initiated two consolidations and successfully completed approximately $1.2 million of net annualized cost reduction part of our $4.7 million in net annualized cost reduction completed in FY13. Overall, we’re consistently EBITDA profitable, we’re shedding debt, we’re eliminating unnecessary cost and we’re improving efficiencies.

In Q4 as well as throughout FY13 we continued to cement our position as we go to supplier in high barriers entry business. And our differentiated product portfolio gives us access to the technologically advanced defense community and a growing audience of commercial customers worldwide. Overall, I am pleased with our performance and looking forward to FY14. With that we’ll turn the call over to questions. Please go ahead operator.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-session. (Operator Instructions).Our first question is from Mike Crawford with B. Riley Company. Go ahead please.

Mike Crawford - B. Riley & Company

Your 10-K talks about a lack of seasonality in the first quarter, it does say maybe some slowness or some strengthen in the May quarter for SSIA. But is that accurate statement, I think in the past there were some concerns that Q1 is usually a seasonally slow quarter?

Bel Lazar

Q1 was seasonally low quarter during the Spectrum days and if you look at the Spectrum filing, historical filing that was true as we have done more acquisitions and added more products that seasonality has shifted. The May quarter seasonality is associated with depending on is actually related to the UK and Canadian government fiscal years. For SSIA and sometimes we get orders before the end of this fiscal year which is end of March and sometimes you get it at the beginning of the fiscal year. So there is some seasonality with SSIA related to UK and Canadian fiscal years.

Mike Crawford - B. Riley & Company

So with the book-to-bill of close to 1 one the year the growing sales funnel the 14 million in new design wins last quarter. Is it fair to state that we shouldn’t expect a drop in revenue in the next quarter versus the quarter just finished?

Bel Lazar

As you know we don’t give guidance but it’s safe to assume that FY -- I mean in general right now the outlook for FY14 is better than FY13. So there could be some ups and downs related to operational execution, timing of certain bookings. But in general what we have been looking on the last couple of years is the lining of the cost coming up with new products which has significantly increased our sales funnel. And when we started tracking, the sales funnel was about couple of hundred million dollars now we’re closing 350 and it’s mainly due to our new product design, and actually time to market a lot of times.

Mike Crawford - B. Riley & Company

And in the past you talked about a target of achieving a 20% EBITDA margin for the business given a certain mix and approximately 72 million of quarterly revenues has the thinking changed on the target or probable operating profitability of the business?

Bel Lazar

No it’s still the same, we’re at 72 million and with the right mix about 20% revenue from EMS, we will be able to hit the 20% EBITDA.

Mike Crawford - B. Riley & Company

The SSIA business had some nice wins in the year and we’ve seen a uptick in revenue and activity there. Is that something you see as sustainable or what is your outlook for that business?

Bel Lazar

As you know it’s a small business, if you look at FY12 we actually did about $22 million in revenue in that segment and in FY13 actual revenue was down slightly but it’s within the fluctuation of this business. So this business is approximately say about 20 million today and with our cost, with our operational efficiencies and our ability to reduce our materials cost, this business runs about 22% to 23% EBITDA. Last quarter we had a good EBITDA quarter but in general its north of 22%, 23%, and it’s sustainable. And probably we can improve it slightly and obviously if the revenue grows over 25 million than the EBITDA percentage would grow as our overheads would be -- is fully absorbed. SSIA actually we operate in three countries UK, Canada and U.S.

Mike Crawford - B. Riley & Company

And the EMS business continues to struggle with although the backlog isn’t down that much. What’s down from 37 million and 25 million year-over-year? But is this a business that you expect to write itself this year? I mean you talked about this electronic warfare system, where there is some changing customer requirements, which sounds like ironing themselves out and could give you some boost next year. How would you characterize your expectations for that EMS business?

Bel Lazar

We are disappointed in terms of that large, we were happy to receive that large order and we were disappointed that the order was still undergoing engineering effort, we put to satisfy that very important customer we had to put in extra ordinary amount of effort to make sure we deliver the product, some of the products at least to meet their requirements. And so very difficult quarter for EMS in terms of execution on that order. But if you in general as far as this business if you look at 2012, we ended up with about 59 million of revenue and we had a loss of about 500k. And by the way all these numbers include corporate allocation and other services. So we’re just -- all the numbers I am saying includes corporate allocation.

In FY13 we did 55 million and it was a positive 400k, now if we had shipped that order we would have done another 1.5 million. So you are looking at a business in FY13, its 59 million of revenue. And if you add back that alternate order shifted to the right, you would get close to 2 million EBITDA. So we believe we have fixed streamline the operation, the efficiencies are there, head count is correct. We don’t expect significant revenue increase in that business, so it’s about $60 million business with improved EBITDA outlook for FY14.

Mike Crawford - B. Riley & Company

Thank you and last question relates to strategic alternatives. So you had two very successful sales of asset and business line in 2013. I believe the process, is ongoing I am not sure if I heard you comment on it. Is there -- how would you couch that probability of seeing other pieces distributed in the coming year?

Bel Lazar

Mike this is a Board process and as we said before the company is continuing to explore number of strategic alternatives. We do not intend to disclose any development unless the Board has approved a specific course of action.

Operator

There are no further questions in the queue. This will now conclude our question-and-session. I would like to turn the conference back over to management for any closing remarks.

Bel Lazar

We appreciate your time today and thank you for joining us on today's call. Thank you very much.

Operator

The conference is now concluded. Thank you for attending today’s presentation. Please disconnect your lines.

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