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American Science and Engineering, Inc. (NASDAQ:ASEI)

Q1 2015 Earnings Conference Call

July 31, 2014 08:30 ET

Executives

Ken Galaznik - Chief Financial Officer and Treasurer

Chuck Dougherty - President and Chief Executive Officer

Mike Muscatello - Vice President and General Counsel

Analysts

Edward Marshall - Sidoti & Company

Josephine Millward – Benchmark Company

Operator

Good morning, ladies and gentlemen, and welcome to the American Science & Engineering’s First Quarter Fiscal Year 2015 Results Conference Call. My name is Bridget, and I will be your conference facilitator today. At this time, I would like to inform you that this conference call is being recorded, and all participants are in a listen-only mode. And we will be facilitating a question-and-answer session at the end of the presentation. (Operator Instructions)

Mr. Ken Galaznik, Chief Financial Officer and Treasurer, will now begin the conference. Please go ahead.

Ken Galaznik - Chief Financial Officer and Treasurer

Good morning and thank you for joining us for AS&E’s first quarter of fiscal year 2015 results conference call. I’m joined today by Chuck Dougherty, our President and CEO; and Mike Muscatello, our Vice President and General Counsel. I will begin with an overview of the financial results, and Chuck will then offer his comments, after which we will open the call to questions.

Before we begin, I’m obliged to inform you that during the course of this presentation, we may be making certain forward-looking statements based on our current expectations and beliefs. These statements are subject. These statements are subject to certain risks and uncertainties, and our actual results may differ materially. I encourage you to review the Safe Harbor Statement and the risk factors we have identified in our press release and our SEC filings, which can be found on our website at www.as-e.com. For those of you on the webcast, you can see we are incorporating a slide presentation in our call today, which we hope you will find helpful. Please note that you can download these slides from our website at your convenience.

Now, I’d like to discuss the results of the first quarter. When comparing results to the prior period, unless otherwise stated, I will be referring to the corresponding period of the prior year. Also, please note that what was previously referred to as custom products, we’ll now be refer to as other revenues and it will consist of custom products, spare parts, and other miscellaneous revenues. Net sales and contract revenues in the June quarter were $35.5 million or 18% below the prior period revenues of $43.1 million. This decrease in revenue is attributable to the $9.5 million decrease in service revenues due to the reduced activity and the revised contracting methodology in the war zone discussed previously, offset somewhat by an increase of $2 million in product sales generated by a $6.8 million increase in lower cargo offset a little by a $4.5 million decrease in cargo.

It should be noted that the current port revenues were negatively impacted by the violence currently occurring in various parts of Middle East. As you can see the breakout of revenues by product line for the quarter is as follows. Cargo was $9.1 million, mobile cargo was $11.6 million, parcel and personnel was $800,000, service revenue was $12.3 million and other revenue was $1.8 million. The gross profit of the quarter was $16.5 million, or 46.3% of revenue as compared to $19.1 million or 44% of revenue in the current quarter. The improvement in gross margin as a percent of sales is attributable to a 610 basis points improvement in product sales, which was primarily the result of the product mix as our higher margin mobile cargo systems comprised a larger percent of total sales, offset somewhat by a 290 basis points reduction in margin on service contracts due to increased labor cost as a percent of revenue required to service existing contracts.

Selling, general and administrative expenses were $8.2 million or 23% of revenue in the quarter as compared to $7.4 million or 17% of revenue in the prior quarter. The increase is primarily attributable to increases in marketing expenses primarily related to the rollout with the MINI Z and increases in incentive compensation expense offset somewhat by a reduction in legal expenses.

Company funded research and development expenditures for the current quarter were $6 million or 17% of revenue as compared to $4.4 million or 10% of revenue in the prior year, excuse me, as we continue to focus on the development on new products, while continuing to enhance existing offerings. It should be noted that the increase in R&D in the current quarter was primarily the result of additional material requirements in the current quarter. And in the prior year quarter, engineer resources were working on the completion of a significant custom-built revenue program at our international port.

The Company reported an income tax provision of $733,000 in the current quarter, as compared to $2.5 million provision in the prior year quarter. The decrease is due to the decrease of taxable income as the effective tax rate was 33.5% in both periods. Fully diluted earnings per share in the June quarter was $0.18 as compared to earnings per share in the prior period of $0.62 for fully diluted share. A review of our current balance sheet shows that the balance of cash was strictly cash and short-term investments at March 31st was $152.5 million or $13.2 million below the March 31st balance.

This decrease is attributable to the $8.2 million of cash used for operations, which was primarily driven by an inventory increase resulting from the production of units to meet the requirements of existing and anticipated orders, the payout of the fiscal year year-end bonus, fiscal year ‘14 year-end bonuses and income tax payments in addition to dividend payments of $4 million and CapEx expenditures of $396,000. Cash from operations less CAPEX, or free cash, in the current year was negative $8.6 million as compared to $10.9 billion in the prior period.

DSO at June 30th was 77 days as compared to 47 days at March 31st. The increase is due primarily to shipments occurring at the very end of the quarter. Year-to-date depreciation and amortization expense was $1.3 million. As to the stock repurchase program, there were no purchases made in the current quarter. Therefore, the total purchased and retired to-date remains at 2.5 million shares or $140 million at an average purchase price of $56.90 per share. The fifth $35 million amortization remains in place.

Net bookings in the quarter came in at $22.3 million, generating a book-to-bill ratio of 0.63. Our backlog at June 30 was $162.9 million, or 7% below the March 31, 2014, balance of $176.1 million, and down 6% from the prior year period. While not yet recorded in backlog, the company has $5 million of unfunded contracts which are expected to be recorded in backlog in the next 12 months. I’m pleased to inform you that at its recent meeting, the Board voted to approve a cash dividend of $0.50 per share. The dividend is payable on September 3 to holders of record at the close of business on August 20.

And I’ll now turn the call over to Chuck for his comments.

Chuck Dougherty - President and Chief Executive Officer

Thanks, Ken, and good afternoon, everyone. Let me first make some comments on the current environment – the current business environment that we’re seeing and then talk about some, I think, significant progress on our key long-term growth initiatives for the business. First half as Ken mentioned, escalating conflicts in the Middle East delayed both shipments and anticipated bookings in the quarter. Obviously, all you need to do is pick up a newspaper and you can get a sense of the volatility of what’s going on in some of our significant served markets at present.

We are still experiencing this quarter-to-quarter volatility and we expect there to be continued impact from the situations in the Middle East through the current quarter. Also, to discuss last quarter, we’re continuing to ramp-up our ZBV supply chain to meet increased ZBV demand. We expect this ZBV shipment ramp to commence in earnest in the second half of the fiscal year, as stated last quarter. Our pipeline, however, remains substantial for both mobile and cargo platforms and is continuing to steadily grow are most encouraged by a recent increase in our cargo pipeline in some of our key growth regions that we’re targeting specifically Africa and Asia.

We have our first significant cargo pipeline in Asia for the business that I think we probably – we may have ever seen. So, good progress on continuing to develop the targeted growth markets outside of our traditional served markets. And while we manage through this current volatility, we’re continuing to make significant progress on our long-term strategic growth initiatives. And let me touch on three key thrusts that we had during the quarter. As previously communicated, and as you may recall, our strategic growth pillars are focused around geographic expansion, portfolio expansion, the evaluation of our service business, and expanding our growth portfolio market reach through inorganic efforts.

Let me talk about portfolio expansion first. During the quarter, we had – what I consider very successful launch of our new MINI Z platform, which is the world’s first hand-held Z backscatter screening system. And this is more than just a new point product for the business. From my perspective, this expands the application of backscatter technology into potentially new market and it is also provides a low cost entry point for the use of backscatter technology, both for existing and new customers. So we’re expecting this to significantly expand the reach for our technologies beyond just the MINI Z platform as we move forward. This is also the first in and what we expected to be a family of portable backscatter products.

It leverages our leadership in backscatter technology. And it’s a small form factor platform that can produce real time image highlighting organic materials such as explosives, currency and drugs. This really is a portable on-the-go system. The market reaction and response to this has been just tremendous, both from our existing customer base as well as new customers. We see some of the potential applications for this and public safety for things such as unattended bag scanning, for customs and border applications, for scanning vehicles, interior of vehicles, portions of vehicles that were not easily accessed or may have required much larger fixed scanning systems, maritime security applications for scanning boat hulls and things of that nature, general aviation security. We see this having some significant applications for general aviation with the ability to scan aluminum wings and portions of general aviation platforms. So, we also see significant application outside of our traditional serviced market in industrial and commercial markets. And we’ve already had interest from very significant entities outside of our traditional served market for this platform.

So we’re very excited about the initial market reaction. We have not had large formal launches in international markets yet for this platform and we expect to do that over the next couple of quarters. We have received our first orders in-house for the platform. And we are currently starting to ramp our supply chain to begin volume shipments in earnest in the next quarter. In terms of geographic expansion, during the quarter we announced the launch of a North American public safety channel. And this channel is really put together and launched in concert with the launch of the MINI Z platform, which we think has a lot of relevance and applicability to state and local first responders in the public safety space.

This channel is comprised of six well-established public safety channel partners and it covers the entire North America – the entire U.S. marketplace and I just want to be make that clear. The entire – it covers the entire U.S. marketplace. We also look at this channel and the reach to state and local entities as something that we want to replicate internationally. I see the localization of our technology as a key growth opportunity for the business and as most of you are aware, we primarily sell to federal agencies in all of our served market and we are seeing a growing need and growing use of this type of technology at the state and local level in a number of markets, not just United States.

So, this channel is something that we’re looking to replicate overtime and some of our key international markets to afford us broader reach and broader penetration in those certain markets. The next I wanted to highlight is around our services evolution. And there were three main thrusts behind our – the kind of the recreation, I’ll say, of the – of our services business, the multi-vendor service offering meaning serving – servicing third-party content with our own organization capabilities, systems integration and managed services.

During the quarter, we made significant progress, standing up our multi-vendor service offering. We have our first contracts in-house to service both competitive gear as well as what I consider complimentary gear like radiation detection platforms with our own service organization. And this really leverages our broad demand expertise and the reputation of our service offering with our customer base, which I think the reputation of our service offering is best-in-class in the industry and this leverages that to grow beyond just servicing our own content. So we made significant progress on that during the quarter. Those are some of the highlights on the key growth initiatives for the quarter.

At this point, I’d like to turn it back over to the operator and open up for questions. Thank you.

Question-and-Answer Session

Operator

Thank you, Mr. Dougherty. The question-and-answer session will begin at this time. (Operator Instructions) Our first question comes from Edward Marshall with Sidoti & Company. Your line is open.

Edward Marshall - Sidoti & Company

Good morning, guys.

Chuck Dougherty

Good morning, Ed.

Edward Marshall – Sidoti & Company

So I’m curious if you can maybe elaborate on the MINI Z, the marketing efforts are surrounding that business. How product acceptance is going so far I guess you you’ve been marketing this for – what – a little less than the quarter now.

Chuck Dougherty

Yes, we’ve launched it, I think last week in June, Ed.

Edward Marshall – Sidoti & Company

The last week in June. Okay. So you’ve had about a month. And then – and I saw you kind of talked about the supply chain. So you kind of had that building out.

Chuck Dougherty

Right.

Edward Marshall – Sidoti & Company

How should we think about the timing surrounding this product and customer acceptance, etcetera?

Chuck Dougherty

I’d say – I would look at – for the next quarter, we’re kind of in a demo mode to get units out there in customer hands to really prove out the concept with the capabilities, the platform, and we are at doing that just as an example, in concert with our product safety count partners. We’ve demonstrated this already to a number of state police, bomb squads, counter terrorism units, department – state level department of Homeland Security personnel. We’ve demonstrated this to most of our federal customer base. And a number of – we’re getting it into their hands to use in real applications over the next quarter and we’ve had as I mentioned interest from our non-traditional customer base, which to me probably the most exciting aspect to this for – what I call broader industrial applications. So, we are kind of at the stage of seeding the market, getting a decent quantity of units out in the key stakeholders’ hands, while we also put in place our plans to do formal international market launches of the platform.

Edward Marshall – Sidoti & Company

Okay. Now, I noticed – and you said you that brought it up in June, so maybe this is why. But I noticed that you obviously have a manufacturing line in place or what you need. There is also, I guess, a selling component as you market this item as well.

Chuck Dougherty

Yes.

Edward Marshall – Sidoti & Company

What – you mentioned that there was a drag on SG&A. And I can understand why in the June quarter. First, can you quantify that? And secondly, should we see a step down in both, I guess, gross margin and maybe a step up in SG&A for 2Q as we kind of think about the marketing efforts surrounding this or is it small enough where it kind of will be muted over all?

Chuck Dougherty

I’ll let Ken to comment.

Ken Galaznik

It’s – they’re looking specifically at the MINI Z now I would not think so. There is other things that could impact what you’re referring to there. But the MINI Z, I don’t expect it to have the impact you’re referring to.

Edward Marshall – Sidoti & Company

Okay. Then why do we call it out in Q1 as far as a hindrance to SG&A? Is it just because of the presentation of that product and the marketing efforts for that?

Ken Galaznik

If you look at SG&A sequentially, it’s down. If I look at compared to prior year quarter, which we’re required to do, it’s up. That’s one of the reasons it was up.

Edward Marshall – Sidoti & Company

Right. But as a percent of revenue, is there a fixed element to this – to this number that I should be thinking about with SG&A?

Ken Galaznik

I don’t think so, yet.

Edward Marshall – Sidoti & Company

Okay. And then if I could look at – maybe just talk about how the orders flow through. I looked at – there was a couple of orders in, I guess, early April. Maybe that’s why they actually hit the prior quarter, but one of which was $33 million – or 33 ZBV vans. So I guess it equates to about $25 million, which is more than the bookings that you had in the quarter so, I’m just kind of (indiscernible) did you have – I guess did you have any cancellations that hit in the prior quarter and then that’s just optically off or just want to…

Ken Galaznik

That was reported in the last quarter, Ed.

Edward Marshall – Sidoti & Company

Okay. So how many actual orders for manufacturing devices did you have in Q1?

Ken Galaznik

Numbers of orders I couldn’t tell you off the top of my head.

Edward Marshall – Sidoti & Company

Okay, I mean, is the bulk of that $22.3 million field service related?

Ken Galaznik

A significant part of it is. Yes.

Edward Marshall – Sidoti & Company

Okay, thanks guys.

Ken Galaznik

Thank you.

Chuck Dougherty

Thanks, Ed.

Operator

Thank you. And our next question is from Josephine Millward with the Benchmark Company. Your line is open.

Josephine Millward – Benchmark Company

Hi, guys.

Chuck Dougherty

Hi, Josephine.

Josephine Millward – Benchmark Company

I dialed in a few minutes late. Can you give me the revenue breakdown again?

Chuck Dougherty

Absolutely.

Josephine Millward – Benchmark Company

I know it’s your favorite question, Ken.

Chuck Dougherty

Where you go, you go. He’s very good at it.

Ken Galaznik

I try so hard to enunciate on this one. Cargo $9.1 million, mobile cargo $11.6 million, parcel $800,000, service revenue $12.3 million, other is $1.8 million.

Josephine Millward – Benchmark Company

Perfect, thanks. And, Chuck, congratulations on the MINI Z deal – the MINI Z launch. Can you talk about how that’s different from the current hand-held offering, talk to us about the pros and cons of MINI Z, and how does it compare to others in terms of pricing?

Chuck Dougherty

Sure. One, it competes with a number of different platforms. One, as you know, it is unique and it is a backscatter platform and has both short-term detectors contained in one unit. So, there is no need to have a detection ability on the other side of what you’re scanning. So it competes with standalone transmissions based systems today, which requires that type of a setup to place detectors on the other side of the object which we’re scanning so, there are operationally more cumbersome to deal with. It also competes with trace detection systems when you’re looking at the category of product as an example and we’ve add – we could take it through this probably more that, but we’ve laid out the different types of categories of product and we feel price it and positioned it right with these competing technologies and solutions. So, we feel that the price point from a marketing perspective is kind of in a sweet spot for the technology. And this is new. So we think the user friendliness of this and the simplicity of this – the ease of which you can go and just scan a standalone package or bag as an example with no setup, really is creating a new category for the industry. And so, we’re going to watch the market very closely in terms of pricing as you can imagine we’re looking a lot of different models relative to pricing elasticity, the applications for the product as it evolves and I mean, this sincerely – every customer we go into – there is some new application for the product that we may not have envisioned. So, we’re – and it’s exciting for us as we’re learning a little bit as we roll this out with our existing customers and we’ve had just through the press, very sizable commercial entities reach out to us, interested in using the technology. And these are entities that we don’t typically call on or target, but the tied in the public safety channel we put in place, they do call on these unique entities. They don’t just call on police and fire. They call on transit authorities, they call on prisons. They call on a number of agencies that we do not deal with. And they also have a commercial account base of Fortune 500 types of clients. So, putting those two things together to me is a big part of it from now.

Josephine Millward – Benchmark Company

That’s great. I know it’s early. Do you think we can see some revenue contributions from MINI Z in ’15 and how do you see a ramp in fiscal year ‘16?

Chuck Dougherty

I think we’ll see – you will see some revenues in the second half of fiscal ’15 and ’16 to your point is I think the bigger year and we haven’t laid out specifics relative to revenue expectations and our unit expectations. At this stage, but as we move forward, we’ll continue to get some commentary, Josephine around it.

Josephine Millward – Benchmark Company

Thank you very much.

Chuck Dougherty

Okay.

Operator

Thank you. There are no further questions. Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1 (855) 859-2056 for U.S. callers and 1 (404) 537-3406 for international callers with the conference identification number 76073890. An audio replay and a copy of the presentation slides will also be available on the AS&E website at ir.as-e.com. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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