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Axsys Technologies, Inc. Q2 2008 Earnings Call Transcript

August 22, 2008 | about: AXYS

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Axsys Technologies, Inc. (AXYS)

Q2 2008 Earnings Call Transcript

July 23, 2008 10:00 am ET

Executives

Stephen Bershad - Chairman and CEO

David Almeida - CFO

Scott Conner - President

Analysts

Stephen Levenson - Stifel Nicolaus

Michael French - Morgan Joseph

Michael Ciarmoli - Boenning & Scattergood

Presentation

Operator

Good day, everyone, and welcome to Axsys Technologies’ Second Quarter 2008 Financial Results Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. This conference call includes forward-looking information that Axsys does not undertake to update nor may not reflect actual results, changes and assumptions or changes and other factors affecting such forward-looking information.

Although, such statements reflect Axsys’ current reasonable judgment regarding the direction of the business, the actual results might differ materially from those in the forward-looking statements. Assumptions and other information that could cause actual results to differ materially from those set forth in the forward-looking statements can be found in Axsys’ filing with the Securities and Exchange Commission. Any non-GAAP financial information presented will be reconciled to GAAP financial statements on the Investor Relations section of the company’s website at www.axsys.com.

I would now like to turn the conference over to Mr. Stephen Bershad, Chief Executive Officer. Please proceed.

Stephen Bershad

Thank you, operator. Good morning, everyone, and thank you for joining us for Axsys Technologies’ second quarter 2008 conference call. Joining me today are David Almeida, our Chief Financial Officer and Scott Conner, our President.

Before I turn the call over to Scott and Dave to give you background behind our recent results, let me take a moment to give you some of the highlights from previous quarter. As you can see from our earnings release, Axsys continued to perform well in the second quarter. Sales grew 40% year-over-year to $60.3 million with record shipments in both segments of the business.

Even more impressive are our top-line growth from continuing operations grew by 75%. As expected, the faster growth of the high margin Surveillance Group business drove the increase in the company’s overall profitability. As a result of strong revenue growth and improved profitability, fully diluted earnings per share from continuing operations for the second quarter grew 69% year-over-year.

In addition to setting new quarterly shipment records, we also enjoyed record bookings of $76.3 million during the quarter, resulting in a record quarter end backlog of $174.1 million. Our strong performance in the first half of this year has left us very well positioned for the remainder of 2008.

Based on a combination of all of these factors, we feel confident in increasing our guidance for the year. We now expect 2008 sales to range from $237 million to $241 million, an increase of between 38% and 40% over fiscal 2007. In addition, we expect 2008 income from continuing operations to be in the range of $2.09 to $2.15 per diluted share. This will generate EPS growth of between 65% and 69% compared to the $1.27 per diluted share we delivered in 2007.

Our results, as impressive as they are, only tell part of the story. We are planning a significant increase in R&D spending to support our new product development, and we are also making significant investments in infrastructure, which Scott will expand on shortly. All of these efforts are designed to expand our market presence so that Axsys can continue to grow.

One last thing before I hand the call over to David and Scott. I just want to make a point of expressing my true appreciation to our management team, and all of the employments of Axsys for their extremely hard work during this period and their dedication to the growth of the company. During times like this, where we are growing at an extraordinary rate, it really calls on the efforts of everyone in the company to perform to their maximum and they have certainly continued to deliver in excess of our expectations.

Our recent successes are clearly a direct result of their ability and enthusiasm. I feel confident that this team has the potential to take Axsys to the next level in coming years and I look forward to reporting continued growth in the future.

At this point, I’d like to turn the call over to David for a review of the quarter’s financial results. David?

David Almeida

Thank you, Steve, and good morning, everyone. I will start today with a review of our consolidated financial results for the quarter and talk about the financial performance of our business segment and then touch on some balance sheet highlights.

Consolidated sales for the second quarter of 2008 were $60.3 million, up 40% from $43 million in 2007 due to growth in both reporting segments. Gross margin for the quarter improved to 34.4% versus 32.8% in the second quarter of 2007. As expected, the gross margin improvement was driven by faster growth rates for infrared lenses and the Surveillance Group, both of which carry relatively higher margins compared to the remainder of our business.

Operating income increased from $6 million or 13.9% of sales in the second quarter of 2007 to $9.8 million or 16.2% of sales in the second quarter of 2008. The favorable impact of higher gross margins combined with improved operating leverage drove the year-over-year operating margin improvement.

Net income was $6.1 million or $0.53 per diluted share in 2008, up from $3.8 million or $0.35 per diluted share in the comparable quarter last year. The prior year results included $0.03 of income per share from operations of our discontinued AST Bearings business as compared to a $0.01 loss per share in 2008. The current year loss is for expenses related to ongoing legal matter for AST.

During the second quarter of 2008, backlog increased to a record $174.1 million with approximately 90% of our backlog being shipped over the subsequent 12 months. Looking at our segments, the Surveillance Systems Group grew at 92% from $10.8 million in the second quarter of 2007 to $20.9 million in the second quarter of 2008. Increase in sales for the quarter was due to continued strong demand for stabilized camera systems for ground, marine and airborne platforms.

Gross margin increased from 38.9% in the second quarter of 2007 to 42.6% in the second quarter of 2008. The increase in gross margin was due to lower margins in 2007 and related to the acquisition of Cineflex and favorable product mix in 2008.

Operating income improved to $4.7 million or 22.7% of sales in 2008 from $1.6 million or 14.7% of sales in the comparable quarter of 2007. The higher operating margin was due to higher gross margins and increased leverage on operating expenses, even with the significant increase from selling expenses related to demos for our new MS2 gimbal.

For the Imaging segment, in the second quarter of 2008, sales for the group were $39.4 million, a 23% increase from sales of $32.1 million in the second quarter of the prior year. The growth is mainly due to strong demand for infrared lenses and precision motion control. Gross margin in this segment was 30% for the second quarter of 2008, down from 30.8% last year.

Operating margin for the quarter was 18.5% in 2008 compared to 19.1% in the prior year. The year-over-year decrease in gross and operating margins was due to a favorable end-of-product adjustment for a long-term contract that was accounted for under a percentage-of-completion method last year. As you may recall in the second quarter of 2007 we recognized $1 million of revenue without any corresponding costs within that quarter.

Concluding with the balance sheet highlights, we ended the second quarter of this year with $9.3 million of cash, down from $15.3 million at the end of last year. Our accounts receivables have increased $13.4 million during the first six months of the year. We ended 2007 with unusually low DSOs of 26 days. This, in conjunction with our increased sales volume, has really driven the growth in our accounts receivable.

The quality of our accounts receivable is excellent with less than 1% aged over 90 days. Our inventory has also increased by $6 million so far this year. While some of the increase has been driven by sales growth, we’ve made a strategic decision to increase our inventory levels.

This year we have seen delivery time become a more competitive dynamic, particularly in the Surveillance Group. We want to ensure that we can deliver for all of our customers. Overall, our balance sheet is strong and our cash flow results were in line with our expectations. We expect to generate approximately $8 million of free cash flow for the full year.

With that, I’ll turn the call over to Scott. Scott?

Scott Conner

Thanks, Dave, and hello, everyone. As Steve mentioned in his introductory comments, Axsys is experiencing positive momentum on many fronts. My comments today will focus on three areas that I expect will give you some sense of this momentum. The three areas are; strategically important contract awards; new product development efforts; and infrastructure investments.

As Steve mentioned in his comments, we booked $76.3 million of new orders during the quarter resulting in a quarter end backlog that was 24% higher than our backlog at the end of fiscal 2007. Several of these bookings were of particular strategic importance.

I’d like to start with a discussion of the Surveillance Systems segment which as a reminder is comprised of our infrared cameras and gyrostabilized gimbals businesses. In both of these areas contract awards met or exceeded our expectations for the quarter, but even more importantly, broad-based interest in our products continues to grow.

In the airborne gimbal area our new MS2 product continues to generate a great deal of excitement. A shift has started to occur in the composition of our orders and order pipeline, as interest in this next-generation military grade gimbal is starting to exceed the demands for our original V14 product.

Based on significant customer feedback, we’ve fully expect that this trend will continue in future quarters. The MS2 is clearly addressing an unmet need in the market, as is evidenced by the large turnout and enthusiastic response we experienced when we hosted a demonstration of this gimbal for government agencies.

This demonstration was attended by 175 people, representing virtually every U.S. government agency with airborne surveillance needs, in addition to three international military agencies. We fully expect that we will be supporting an increasing number of these agencies with their airborne surveillance needs in the future.

Demand also remains strong for land-based infrared cameras. The primary obligation areas for orders received during the quarter are border security and perimeter protection. During Q2 we booked sizable orders for border programs for customers in the Middle East and Asia and for the U.S. Border Patrol.

As an aside the U.S. border contracts were not in support of the SDI program, which as expected, continues to move forward very slowly. However, Axsys continues to supply camera systems to the Border Patrol to satisfy its existing surveillance requirements.

Also, I should note that border programs are the kind of application that fits right into our technological sweet spot, since it requires large high-performance infrared lenses to see long distances. Equally important, this market continues to show strength.

The largest land-based camera orders that we received during the quarter came from two U.S. military promoter perimeter security programs, IBDSS and CRAM. The former, IBDSS, is an Air Force-based defense program that uses long-range infrared cameras to protect air bases in the U.S. and abroad. We’ve been protecting soldiers in critical Air Force assets as part of this program for several years now and our products have a strong reputation among the user community. IBDSS is a critical program for the Air Force for which we expect to receive additional significant orders in coming quarters.

A somewhat similar but new program for Axsys is called CRAM, or Counter Rocket Artillery Mortar. This is a U.S. Army program which uses long-range cameras, not simply to identify threats, rather our cameras are used as part of the system that identifies and intercepts incoming ballistic threats and targets the enemy’s launch site.

During the second quarter, we received a $4 million order in support of this program and we have already received another $2.8 million order in Q3. For this program, the Army is using a mix of Axsys camera types to satisfy CRAM’s program requirements.

Now I would like to turn to the Imaging Systems segment which had yet another very impressive bookings quarter. We have previously announced the two largest contract awards from the quarter for CROWS and TWS II programs, but because of the magnitude of these orders I’d like to spend just a minute or so to explain them.

The $16.9 million CROWS order that we announced in May is a follow-on order, infrared lens order, for the Kongsberg remote weapons station. This weapons station was selected by the U.S. Army to be mounted onto the existing [hung] deeply. And as I now understand, it is being deployed on MRAPs the new Mine Resistant Ambush Protected vehicle.

Our initial order for this program could amount to $87 million over five years if contract options are exercised in their entirety, which by the way, looks likely. More importantly, this weapons station market is still in its infancy and therefore represents longer-term opportunities for our products.

The second previously announced large contract award was the $13.5 million order for the Thermal Weapons Site II Bridge program. As you know we have been supplying TWS lenses for BAE for several years, but this contract was not a follow-on order from BAE. Rather this was an initial award from one of the TWS program’s second sources who unfortunately I am not at liberty to name. With this new TWS order, Axsys has solidified its position as the premier lens supplier for one of the U.S. military’s most important infrared programs.

During the quarter, we also booked $3.2 million of new orders for DRS’s Mass Mounted Sites program. The Mass Mounted Site is essentially a high-performance targeting gimbal that sits atop the Kiowa Warrior Attack helicopter and is used to scan the battlefield to acquire, identify and engage targets with minimal exposure to threats, minimum exposure to threat.

Axsys supplies high-performance optical housing and precision motion control components for this system. The Kiowa’s success in Iraq has led to the extension of the aircraft service life to 2017. Therefore we expect the Mass Mounted Sites program to continue to be significant for Axsys.

Also strategically important, Axsys booked approximately $2.6 million of orders for two classified satellite programs. While we obviously can’t give any specific details of the program, the order represents Axsys’ continued strength in technically challenging space-based applications.

While we are very pleased with our strong bookings performance in the first half of this year, we are equally excited by the new products we have in the development pipeline. In addition to the investments we continually make in the evolution and enhancement of existing products, we are increasing investment in new product development.

For example, in the second quarter we completed the development of a new uncooled, short-range camera for economical, relatively short-range surveillance. This new camera can recognize a human at about three kilometers. This is part of the market that we’ve not traditionally targeted. But with the decline in cost of infrared detectors, our competitive position in this lower end market is constantly improving.

In support of this initiative, we also introduced a new economical two access positioning system called the APS-15 in the second quarter. This positioning system will also ultimately be sold independently from our own camera system, but its initial purpose is in support of the needs of the internal camera requirements. As with all of our positioning systems, this product is top of the line in terms of technical performance.

Another new product we are actively developing in the second quarter is a small 98 gyrostabilized camera system for small lower flying vehicles. This product is targeted at application and customers that are sensitive to the weight, size, and price of the gimbal system and do not require the long optical reach of the MS2.

We’ve made significant progress on this product during the quarter and expect that technical qualifications will be completed by the fourth quarter of this year. Once again, we believe that this product will satisfy economic requirements while setting a new standard for technical performance.

As we discussed last quarter, the growth in our business has highlighted a need for additional infrastructure. And we are continuing to invest in the necessary people and capital to keep our growth on track. As I was just discussing, we are increasing our investment in engineering to broaden our product line. We are also increasing our sales and marketing resources to continue to build brand awareness.

Also, as we discussed in last quarter’s call, we are moving forward to procure additional operational space. The plan is to relocate our infrared camera business from our current national facility into this new building, and also establish this new location as our manufacturing center for full rate gimbal production.

New gimbal development, as well as low rate production of customized gimbals, will continue to be performed in Grass Valley, California. This move, which we expect to take place in the fourth quarter of this year, will give our thermal camera business, our airborne gimbal business and our infrared lens business the space that they each need to grow. It will also allow us to maximize the obvious synergies between these organizations since this new 67,000 square foot facility is less than half a mile away from our existing building.

With that summary of the quarter’s operational events, I would now like to open the call for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question will be from the line of Stephen Levenson of Stifel Nicolaus.

Stephen Levenson - Stifel Nicolaus

Thanks. Good morning, everybody.

Stephen Bershad

Good morning, Steve.

Scott Conner

How are you?

Stephen Levenson - Stifel Nicolaus

Good, thanks. I hope you all are well. (inaudible). A question on the orders that you booked. If I am correct, you have participation in the program that supplies the observation surveillance masks for the MRAPs. And I’m wondering if there were any orders in the quarter related to that program?

Scott Conner

There was. I had rather not talk about magnitude, but there was a booking in the quarter for that program and we also had some shipments for that program as well. That’s the VOSS program. I think you mentioned in one of your notes, vehicle operating surveillance system which is a mass-mounted surveillance program that’s been deployed on all of the variance of the MRAP, but not every – it’s in reference to some percentage. And the expectation is roughly 20% of the MRAPs will have this surveillance application integrated.

Stephen Levenson - Stifel Nicolaus

And is the initial order for the whole thing or probably more to come?

Scott Conner

We’ve been actually -- we’ve been shipping for this program for certainly over a year. Maybe more like a year and a half and we –

Stephen Levenson - Stifel Nicolaus

No. I mean since it was re-competed?

Scott Conner

No, this is still the original.

Stephen Levenson - Stifel Nicolaus

It’s a new contract.

Scott Conner

This is we are still shipping and the new order was – what I’m not totally sure whether it was from the re-competed part or whether it was part of the original order. I’m not certain.

Stephen Levenson - Stifel Nicolaus

Okay.

Scott Conner

We are a supplier to that, of course. We are a little bit delayed.

Stephen Levenson - Stifel Nicolaus

Okay. Thanks. Then there appears to be some concern about the armed – the new armed reconnaissance helicopter program and one of your competitors, I believe, is on that one. Do you see an opportunity in the future?

Scott Conner

Yes. That’s going to be a little while from now. In fact we are benefiting from that delay, however, because I had mentioned in my notes about the mass mounted site. That actually is benefiting. The longer life of the Kiowa is directly related to the delay on the armed reconnaissance helicopter. Now that’s going to be several some time out before that happens, but of course that presents an opportunity for us down the road.

Stephen Levenson - Stifel Nicolaus

Okay, thanks. In terms of the order pipeline, I know you say your orders can be lumpy and they were pretty strong last quarter and again this quarter. Has anything changed there? Do you see things actually improving?

Scott Conner

It’s a good question, because it does seem like a trend. As a general statement, I don’t want to be read into this particular quarter. I don’t want that lumpiness to say or to suggest that this particular quarter is high when I say that. It’s a general warning that bookings come in big numbers. For example, just to give you an example that CROWS order that we booked this quarter, $16.9 million that will ship over many quarters. And so, I don’t want anyone to take a very large order and assume that that is all going to ship very, very quickly because it doesn’t. The shipments are much more measured in their delivery than the bookings are.

Stephen Levenson - Stifel Nicolaus

Thank you. And in terms of your beryllium source and availability, is that what some of that inventory is you are stocking up on the material or are you seeing –

Scott Conner

No, not really.

Stephen Levenson - Stifel Nicolaus

That’s pretty much available?

Scott Conner

No, that inventory growth is for two reasons. And you know, you chime in, Dave, if you have additional comments. But the first is when you are ramping quickly, of course, that leads to increase inventory. That just is -- it’s just the map. The second thing as Dave alluded to, in the camera and gimbals world in particular, there is the competitive dynamic is changing somewhat where delivery time is becoming an important competitive determinant. And so, in order to play the game we need to invest a little bit more in advance to have cameras, at least one of the lead items in inventory so that we can compete on delivery time.

Stephen Levenson - Stifel Nicolaus

Okay, thanks. And Steve, you mentioned moving to the next level. What is the next level? Does it include acquisitions or just further expansion with new products?

Stephen Bershad

Well, the next level really is increased penetration of the current markets that we are competing in for camera systems and some of the products that Scott has mentioned that we are developing internally. That is the smaller gimbal that addresses the unmanned vehicle market, some of the larger, more sophisticated military grade products. But also we are looking at a number of other sensors, other capabilities that go in these systems; designators, laser designators, laser range finders, other types of sensors include radar sensors, that type of thing.

So, there’s still, I think, a lot of opportunity out there not the least of which is penetrating the existing markets we are competing in. You know we have a significant competitor out there who we really welcome the opportunity to take more share from.

Stephen Levenson - Stifel Nicolaus

Great. Continued success. Thanks a lot.

Scott Conner

Thanks.

Operator

Your next question will be from the line of Michael French of Morgan Joseph.

Michael French - Morgan Joseph

Good morning gentlemen.

Stephen Bershad

Hey Mike.

Scott Conner

Good morning Mike. How are you doing?

Michael French - Morgan Joseph

Congratulations on an excellent quarter.

Stephen Bershad

Thank you.

Michael French - Morgan Joseph

Scott, if you could walk us through the new products that you are developing here, particularly if you could discuss what the market opportunity is and what the timing of your entry would be? What we should look for there?

Scott Conner

Sure. So, I mentioned a few things. We are working on several fronts, but I’m going to just discuss the three that I mentioned on the conference call now. One is an uncooled, kind of a next generation uncooled camera and to distinguish what I mean by that is uncooled cameras as opposed to cooled cameras are shorter range. And they typically have a smaller lens on them. As we’ve discussed in the past, we tend to focus on those markets that require very long camera, long lenses, because that means that the sensor is a smaller percentage of the camera, and the lens is a larger percentage of the cost of the camera, gives us an advantage both on the cost and chemical capability, I should add.

But as those sensor prices are dropping, the lens is becoming a bigger part of the cost of even shorter range cameras. And so, we basically have come out with a new shorter range, and again, I mentioned three kilometers. That is short range. I am not talking about fire – handheld fire cameras and that kind of thing. But this we are moving basically down into that kind of market. That’s not to suggest we are not moving up as well into longer range cameras, but it is basically a tangential market for shorter range parameter surveillance. This particular one is also military grade, but also, in fact, we had some commercial sales during the quarter for oilfields. In fact, we are selling to Exxon for their perimeters and this product is being used for that.

We also sold along in conjunction with that new camera is the new positioning system which was developed by one of our other organizations inside the company and very high precision, but low, but economical positioning systems to move sensors around. Of course it was designed with our short-ranged camera in mind, but the application is broader. You can use that smaller positioning system for a variety of sensor systems.

And the other one that I mentioned was a smaller gimbal. You know, our MS2 and even the V14 is for higher altitudes, very long-range surveillance, to see up very close from great distances.

But there is another market for lower range – they don’t – customers don’t want to, they don’t require that long-range, and don’t want to pay for it. And they also are weight – concerned about weight. And this can be in lower flying helicopter applications or, as Steve mentioned, in certain new AV applications. That is another market that, of course, is appealing to us that we are not addressing at all today with our current products.

Michael French - Morgan Joseph

What do you anticipate the margins to be like in these markets where there is more price sensitivity and –?

Scott Conner

I’m not expecting a dramatic reduction, because it’s not that these lower end markets don’t necessarily carry more competition, because they are still technically challenging products. But the price sensitivity correlates to how we designed the product below our cost. Does that make sense?

Michael French - Morgan Joseph

Yes, I understand. And I guess switching subjects take another stab at the pipeline for this quarter in terms of bookings. Sounds like you didn’t really think you would be able keep up this same pace, but maybe I am misreading that.

Scott Conner

Yes. I did not say that. I did not say that. In fact I want to make sure that I don’t give that impression. We are not suggesting that our bookings rate will decline, but it’s just a general statement that bookings come in big lumps. But that does not in any way imply that our bookings rate cannot be maintained.

Michael French - Morgan Joseph

Are there any particular programs where you are expecting a decision during the period?

Scott Conner

There are – we have lots of irons in the fire. Let me put it that way.

Michael French - Morgan Joseph

Okay. Well, I will stay tuned. Thanks and good luck.

Scott Conner

Okay.

Operator

(Operator Instructions). You next question comes will be from the line of Michael Ciarmoli of Boenning & Scattergood. Please proceed.