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API Technologies Corp. (NASDAQ:ATNY)

Q2 2014 Results Conference Call

July 10, 2014 10:00 AM ET

Executives

Bel Lazar – President and CEO

Tara Condon – VP of Corporate Development & Marketing

Claudio Mannarino – SVP and CFO

Analysts

Mike Crawford – B. Riley & Co.

Operator

Good day, everyone, and welcome to the API Technologies' Fiscal Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please also note that today's event is being recorded.

At this time, I would like to turn the conference call over to Ms. Tara Condon, Vice President of Corporate Development and Marketing. Please go ahead.

Tara Condon

Thank you, Jamie. Good day, everyone, and thanks for joining us today. With us from management are Bel Lazar, President and CEO; and Claudio Mannarino, Senior Vice President and CFO.

A copy of the 2014 fiscal second-quarter earnings press release and Form 10-Q are available on the API Technologies' website under the Investor Relations section. The Company's website is located at apitech.com. On the site, you will also find information on how to access a recorded replay of this call and links to download the free API Technologies' Investor Relations app.

Before starting the call, I would 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, plan, projects, 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 risks about the Company's business in the section titled Risk Factors in Management Discussion and Analysis of Financial Conditions and Results of Operations in the fiscal year report on Form 10-K and the quarterly reports on Form 10-Q.

These reports are on file with the Securities and Exchange Commission, and should be reviewed with great care, because all forward-looking statements that management makes during this 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 Claudio Mannarino, who will discuss the Company's financial results. Bel Lazar will then discuss API's overall business and operations.

Please go ahead, Claudia.

Claudio Mannarino

Thank you, Tara, and hello, everyone. We'll start by reviewing our Q2 financial results. For the second quarter ended May 31, 2014, API Technologies reported revenue of $53.2 million compared to $58.9 million in Q1 and $64.2 million in last year's Q2. The sequential quarter decline was primarily due to Q1 booking softness and a push to the right of certain programs in our EMS segment. The Q2 2014 over Q2 2013 decline was primarily due to the defense industry headwinds and macroeconomic conditions that adversely affected our EMS and SSC segments.

Bookings for Q2 grew by 7.1% sequentially to $55.7 million, resulting in a book-to-bill ratio of greater than 1-to-1. GAAP gross margin for Q2 was 19.6% compared to 22.7% for Q1 and 22.8% for last year's Q2. Q2's non-GAAP gross margin was 22.2% versus 23.8% in Q1 and 23.7% in Q2 2013.

Non-GAAP gross margin percentages for our segments were as follows. Our SSC segment was 27.6% in Q2, up from 26.2% in Q1, primarily due to cost reductions and favorable product mix in Q2. Our SSIA segment was 24.8% in Q2, down from 32.3% in Q1, mainly due to an unfavorable product mix, as we had revenue with lower margin in Q2. The EMS segment non-GAAP gross margin was negative 3.4% in Q2 compared to 13.5% in Q1, primarily attributed to lower revenue in Q2.

Total restructuring costs in Q2 were approximately $1 million compared to $0.4 million in Q1 and $0.4 million in Q2 of fiscal 2013. We reported a GAAP operating loss of $1.9 million in Q2 compared to an operating income of $1.6 million in Q1, and operating income of $1.1 million in Q2 of 2013. Our non-GAAP operating income was $0.3 million in Q2 compared to $2.5 million in Q1 and $2.8 million in last year's Q2. Both the sequential and Q2 over Q2 increase in operating loss is primarily attributed to lower revenues in our EMS segment and the change in the product mix in the quarter, partially offset by a decrease in operating expenses.

For the second quarter of 2014, the Company's effective income tax rate was negative 4.3%, compared to a blended US federal and state statutory income tax rate of 38.5%. The difference between Q2 effective tax rate and the blended statutory tax rate is primarily related to the permanent differences between book and tax, the existence of valuation allowances for deferred tax assets, and income tax associated with foreign subsidiaries and state taxes.

For Q2 fiscal 2014, the Company recorded a net loss of $15 million compared to a net loss of $2.1 million in Q1, and a net loss from continuing operations of $4 million in last year's Q2. Both the sequential quarter and Q2 over Q2 increase in net loss are primarily due to a $10.2 million write-off of note discounts, deferred financing charges, and debt extinguishment; and in the EMS segment, to operating loss. Additionally, for Q2 over Q2, the increase in net loss is partially offset by lower interest expense resulting from lower debt levels.

As discussed during last quarter's earnings call, the Company redeemed all 26,000 shares of Series A preferred stock funded through a term loan adjustment and amended agreement with Guggenheim Corporate Funding as the agent. The share redemption resulted in no dilution to the Company's equity holders.

Adjusted EBITDA for Q2 2014 was $4.3 million compared to $6.5 million in Q1 and $7.3 million in last year's Q2. The sequential quarter decline was primarily due to an adverse swing of $1.8 million in adjusted EBITDA in the EMS segment, and a $0.5 million decrease in the SSIA segment, offset by slight growth in our SSC segment by $0.1 million during the same period. The Q2 over Q2 decline was primarily affected by the completion of the sensors business transitional services agreement, and also affected by lower revenues in the Company's EMS and SSC segments, and a product mix in our SSIA segment.

Moving on to the balance sheet, as of May 31, 2014, the Company had $10.6 million of cash and $131.7 million in total debt obligations. For Q2, cash flow from operating activities was flat, primarily driven by the EMS segment operating loss and offset by positive working capital. DSO was 64 days in Q2 compared to 61 days in Q1. Inventory was $52.7 million at the end of Q2, flat with Q1. Days of inventory were 113 in Q2 versus 104 in Q1.

And with that, I'll turn the call over to Bel. Bel?

Bel Lazar

Thank you, Claudio, and congratulations on your promotion.

Q2 was a disappointing quarter for us from a revenue and EBITDA standpoint. The main contributor was our EMS business, which delivered weak revenue and profitability in Q2, due to Q1 weak bookings associated with timing of certain programs and defense programs; while SSIA and SSC segment revenues were flattish. In Q2, we delivered companywide book-to-bill greater than one, driven by strong booking activity in our SSC segment, specifically for our RF microwave differentiated products. I will provide more detail on bookings activities later on during the call.

Let me start by discussing our segment results and end markets. Our SSC segment includes RF microwave products, electromagnetic integrated solutions, and power products. SSC segment revenue was $39.3 million, flattish with Q1's $39.7 million. Book-to-bill for the segment was higher than 1.1.

In Q2, we released many new products, including state-of-the-art integrated microwave assemblies, GPS low-noise amplifiers and advanced filter product solutions to address new requirements in defense, air traffic control, broadcast and wireless communications, and satellites. Featured Q2 bookings included a $3.1 million order for transponders for a UK defense program, a $1.6 million order for microwave and switch filters on a major US EW platform, and a key gallium nitride power amplifier design win on a multimillion-dollar US DoD program.

At June's International Microwave Symposium, new products included an expanded line of GaN-based power amplifier solutions and radiation-hardened power management products. In the past two years, we have evolved the API Technologies product offerings and, in the process, enhanced our ability to favorably compete against Tier 2 and Tier 1 suppliers in the AESA radar technologies, power amplifiers and power solutions.

Moving on to our SSIA segment. SSIA segment revenue in Q2 was $5.1 million, flattish with last quarter's $5.4 million. Book-to-bill for the SSIA segment was 0.7. This segment exhibits lumpiness due to timing of UK and Canadian government fiscal year spending trends.

Moving on to the EMS segment. Q2 EMS segment revenue was $8.8 million compared to $13.9 million in Q1. Q2 EMS book-to-bill was 0.8. The weakness in EMS was mainly due to timing of certain key defense programs, and pushed to the right of certain opportunities due to customers' new product execution.

Because our EMS business tends to be driven – mainly driven by large program bookings, quarterly profitability results could vary due to timing of program funding. To better balance the business, we continue to judiciously reduce costs to align with demand without impacting capabilities in future growth. Moreover, we continue to diversify beyond US DoD applications, and pursue more opportunities in the commercial realm, such as a recent $1.7 million win with a leading wireless products company.

Now, let me provide some color on our end markets. The following data represents our best estimate of end-market percentage breakouts. Our US defense end market revenue for Q2 was $30.3 million or 57% of total revenue versus $35.8 million or 61% of total revenue in Q1. Strong revenue drivers in Q2 were military communications, military aircraft, and weapons programs.

Moving on to our government and security end markets. Q2 revenue was $3.5 million or 7% of total revenue versus $4.9 million or 8% of total revenue in Q1. The main shift here was due to delivery timing of an EMS US classified program, with delivery now expected during Q3.

For medical, industrial, and commercial aerospace end markets, Q2 revenue increased to $13 million or 24% compared to $11.4 million or 19% in Q1. This end market growth was mainly due to successful design-ins for RF microwave and EIS products in prior quarters. Finally, in our communications and consumer end markets, Q2 revenue was flattish at $6.4 million or 12% compared to $6.8 million or 12% of total revenue in Q1.

Now let me talk about our business highlights and operational accomplishments. We have added many new standard and customizable solutions to our product portfolio. Even as recently as two years ago, over 90% of our product offering was custom products, which limited our ability to sell our product in a proactive manner. The release of more standard products has enabled us to overcome these hurdles, and tap into broader base of both defense and commercial customers.

On other fronts, we continue to simplify our balance sheet between debt paydown and a Q2 Series A preferred stock redemption. We are pleased to have a solid lending partner, Guggenheim Corporate.

In Q2, we had our challenges, particularly in our EMS segment, but topline growth remains a clear goal for us. Over the past several quarters, we have introduced new and innovative solutions, optimized our product development and go-to-market processes to embrace standard products, and in doing so, expanded our available market and opened up new sales territories and opportunities.

The past two years have been witness to adverse macroeconomic conditions and a tumultuous defense industry environment. Despite that, in the past seven quarters, we have shunned acquisitions, and instead, focused on our efforts on developing and introducing new and innovative products. Today, the new design-ins we secure are based on the strength of our product portfolio. Booking growth, particularly for products in our SSC segment, demonstrates positive customer response to what we have to offer, and positions API Technologies well for future growth.

We enter Q3 with a fully funded $123.7 million backlog, SSC bookings momentum, and a growing catalog of technically advanced products that address critical communications, performance, and power needs in the global place.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mike Crawford from B. Riley & Co. Please go ahead with your question.

Mike Crawford – B. Riley & Co.

Bel, the SenDEC business in particular has been a disappointment for several years now. Previously, it was driven by some of this IED jamming-related business. And what is it now that is causing so much problems in EMS?

Bel Lazar

You are absolutely correct. That was – that's the history of SenDEC. We have had – in the last couple of quarters, we've worked with another customer that was – that had some startup issues in their new products development. And in doing that, we were trying to support them through their new product introduction. And so we had significant inefficiencies in our old SenDEC, or now we refer to as EMS Rochester plant, that is now behind us. And we have taken costs out and aligned it to the current revenue levels. So we should get back to breakeven and some profitability in future quarters.

Mike Crawford – B. Riley & Co.

Okay. And you also have some EMS business at Windber from Kuchera, I believe. And taken together, if – let's say you get EMS to breakeven in the current third quarter, in the past, you've talked about that business, the EMS business itself, approaching a 10% EBITDA margin. Is that level something that still appears attainable, say, next year? Or is that further out goal now?

Bel Lazar

I think it's FY15. And if you look, Mike, what we did in – like a Q1 of this fiscal year. We had $13.9 million in revenues and we generated about $1 million in EBITDA or 7.4%. Keep in mind that includes all corporate allocations. So from – which would be higher from a business unit contribution. So at revenue levels of roughly about $15 million, $16 million, we would get close to that 10%. And Q1 is a good benchmark, if you want to look at 13.9% and 7.4% EBITDA.

Mike Crawford – B. Riley & Co.

Okay, thank you. Now with the bookings relatively strong at $55.7 million in the quarter, are you able to characterize how you are running so far in the August quarter versus the May quarter?

Bel Lazar

Yes, actually, we've got about – we're about $4 million to $5 million better visibility compared to last quarter same time. I also want to point your attention to the bookings in the SSC segment. In the May quarter, we booked almost $45 million. And in the February quarter, we booked $42.4 million. And we've been shipping, historically, at the rate of approximately $40 million.

So, eventually, the bookings – the strength in booking in SSC would translate in revenues. So that's good news for us.

From an EMS, we've struggled in the last couple of quarters in terms of book-to-bill. SSIA, it's more steady-Eddie with slight growth. It's lumpiness; one quarter, we would – we could book $7 million – $6 million, $7 million and the other quarter we could book like $2 million or $3 million. So you're got to look at it more on a two-quarter or three-quarter run rate. But the good news for us is the SSC bookings momentum.

Mike Crawford – B. Riley & Co.

Well, a couple of years ago, the Company received unsolicited interest for all or part of the business. Over the next year and a half, your Company did in selling off a product line and a business line. Is it safe to say that that initial thrust is now finished?

Bel Lazar

This is actually part of the strategic alternatives process of the Board. This is really a Board process. And we don't really intend to discuss this [closed] [ph] development with respect to the Board's process until the Board has approved a specific course of action.

Mike Crawford – B. Riley & Co.

Okay. Thank you. And then last question relates to next year. So, I mean, it sounds like this quarter, you're looking for at least a $4 million jump sequentially in revenue from May – I imagine November is not too different – but from August. Next year, do you think it's still possible to get to mid-teen EBITDA margins and somewhere with continued growth, given the bookings that you've achieved so far through six months this year in your current pipeline?

Bel Lazar

That's reasonable, Mike. We – that's reasonable to achieve. Absolutely.

Mike Crawford – B. Riley & Co.

And did you give – did you quantify that bidding proposal pipeline? You have in the past.

Bel Lazar

I'm sorry?

Mike Crawford – B. Riley & Co.

In the past, I think you've quantified your sales funnel, that there was a $342 million at the end of 2013.

Bel Lazar

Yes, actually, we didn't point it out in our script. But right now, it's $354 million with growth in the SSC. The EMS went down a bit. But it's right now – it stands right now $354 million.

Mike Crawford – B. Riley & Co.

Great. Thank you very much.

Bel Lazar

Sure.

Operator

And ladies and gentlemen, I'm showing no additional questions. I would like to turn the conference call 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

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.

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