There was a news release from a company on my watch list the other day. The wording was so direct that it took me aback, as I'm not used to seeing anything so direct.
The press release wording said.."The company's enviable balance sheet, growth prospects, and market presence, which make Axsys an attractive acquisition candidate, also position Axsys as an effective stand-alone company. As a consequence, while Axsys' board of directors feels that it is appropriate to evaluate offers for the company, it is under no obligation to accept an offer that it does not believe is in the best interest of its shareholders. There can be no assurance made that a transaction will be consummated, if at all, on terms acceptable to Axsys and its shareholders."
It was the part about the enviable balance sheet that caught my attention, and made me want to take a little look see.
The Business
Axsys Technologies, Inc. (Nasdaq: AXYS) was originally incorporated in the State of New York in 1959 and reincorporated in the State of Delaware in 1968. According to the company's latest SEC10-K filing for the fiscal year ending December 31, 2008, as filed with the SEC on February 17, 2009, the company is the leading designer and manufacturer of precision optical solutions for defense, aerospace, homeland security and high-performance commercial applications.
These sophisticated solutions are typically found in applications that demand the finest optical surfaces, highest accuracy and tightest motion control tolerances. Application examples include weapon systems, long-range surveillance cameras and highly precise imaging telescopes. The company typically sells their products to government institutions such as the U.S. Border Patrol, Army, Navy and Air Force, or to large defense contractors for integration into larger platforms.
Axsys Technologies, Inc. is organized into two business segments: the Surveillance Systems Group and the Imaging Systems Group.
Surveillance Systems Group
The Surveillance Systems Group designs, manufactures and sells highly precise camera systems for deployment on ground, marine and aerial vehicles. The products are typically used in surveillance, reconnaissance, tracking and targeting applications, anc can be grouped into two primary areas: non-stabilized camera systems and gyrostabilized camera systems.
Non-stabilized camera systems are often deployed as fixed mounts on poles or masts. Typical applications for non-stabilized camera systems include border surveillance, port threat detection and perimeter security.
Gyrostabilized camera systems are usually deployed on airborne vehicles such as helicopters, manned and unmanned aerial vehicles, and marine vehicles. Gyrostabilization is usually necessary in air-and sea-based applications in order to maintain a steady image while the vehicle is moving on several axes. Typical applications for gyrostabilized camera systems include search and rescue, drug interdiction, border surveillance, criminal pursuit and movie production.
The focus markets for the company's Surveillance Systems Group are defense, homeland security, law enforcement, electronic news gathering and film production, with products both as stand-alone products and as constituent parts of larger, integrated surveillance networks. Sales are achieved through a combination of direct sales and a worldwide distributor network.
The core engineering requirements necessary to design, develop and manufacture our products include visible and infrared optical engineering, precision mechanical engineering, electrical engineering and embedded and application software engineering. The company's engineering staff is particularly skilled at designing to military-grade specifications, which require a high degree of precision and must conform to extremely tight tolerance and reliability requirements.
The Surveillance Systems Group has design and manufacturing facilities in Nashua, New Hampshire and Grass Valley, California. and generated approximately 31%, ($75.6 million) of the company's 2008 revenues.
Imaging Systems Group
The Imaging Systems Group designs, manufactures and sells optical and motion control subsystems and components for deployment in larger, integrated systems. Products in the Imaging Systems Group include visible and infrared lenses, scanning systems, laser positioners, long-range telescopes, stabilized sensor positioning systems, precision motion-control components and imaging optics.
These products are often embedded in larger systems that depend on precise optical control for accurate operation of critical functions. Many of the applications with which we are involved are part of the continuing development of next-generation targeting, navigation and surveillance systems for advanced weaponry, armored vehicles, military aircraft and space-based surveillance.
The company supplies critical guidance and seeker components for platforms such as the Minuteman intercontinental ballistic missile and the AIM-9X Sidewinder missile.
The company is involved in many large-scale programs including the MRAP vehicle, Apache Helicopter, Stryker Vehicle, M1A2 Abrams Tank and Thermal Weapons Site, with many of the company' products included on many platforms within the U.S. National Missile Defense program ("NMD").
The primary target markets for the Imaging Systems Group are defense, space and homeland security. However, they also serve high-performance commercial markets, such as thermographic camera systems and graphic arts capital equipment, with the company's products often designed to meet customer specifications. The company's products are sold as original equipment manufacturer ("OEM") solutions, which are integrated into a customers' products.
The core engineering requirements necessary to design, develop and manufacture the comapny's products include visible and infrared optical engineering, precision mechanical engineering, electrical engineering and embedded and application software engineering, with the company's engineering staff particularly skilled at designing to military-grade specifications, which require a high degree of precision and must conform to extremely tight tolerance and reliability requirements.
The Imaging Systems Group has design and manufacturing facilities in Nashua, New Hampshire, San Diego, California, Cullman, Alabama and Rochester Hills, Michigan and generated approximately 69% ($169.9 million) of the company's 2008 revenues.
Backlog and Orders
The company received new orders of $270.4 million in 2008, ending the year with a backlog of $165.1 million, of which 7.7% will be shipped beyond 12 months. The company's backlog increased by $24.9 million, or 17.8%, compared to their ending backlog of $140.2 million as of December 31, 2007.
Competition
The market for the company's products is competitive, with the company competing primarily on the basis of their ability to design and engineer products to meet performance specifications set by their customers. Some of the company's customers are OEMs that purchase component parts or subassemblies, which they incorporate into their end products. The company's thermal imaging cameras and gyrostabilized sensor systems are typically sold directly to equipment integrators, as well as government, military and commercial end users. Product pricing, quality, customer support, experience, reputation and financial stability are also important competitive factors.
There are a limited number of competitors in each of the markets for the various types of precision optical, infrared and motion control systems and components the company designs, manufactures, and sells. Competitors are often well entrenched, particularly in the aerospace and defense markets. Some of these competitors have substantially greater resources than the company does. The company believes that the quality of their technologies and product offerings provides them with a competitive advantage over certain manufacturers that supply only discrete components or who are not vertically integrated with enabling technologies.
The company expects their competitors to continue to improve the design and performance of their products, and cannot assure investors that their competitors will not develop enhancements to, or future generations of, competitive products that will offer superior price or performance features, or that new technology or processes will not emerge that render the company's products less competitive or obsolete.
Increased competitive pressure could lead to lower prices for the company's products, thereby adversely affecting their business, financial condition and results of operations.
Customers
The company's customers include end users, equipment integrators and OEMs that demand high-precision, high-performance products or subsystems. The company sells their products primarily to customers in the aerospace and defense, space, homeland security and high-performance commercial markets.
BAE Systems, an aerospace and defense systems supplier, represented 23.2% of total 2008 sales, 15.8% of total 2007 sales, and 14.6% of total 2006 sales. The company participates with BAE Systems on multiple programs, with the majority of their sales to BAE Systems relating to two armored vehicle programs and a thermal weapons sight program. Both programs are ultimately dependent on U.S. Department of Defense spending and could be canceled. However, night vision systems are a high priority for the U.S. military and, therefore, the company does not foresee any weakening of demand for these products in the short term.
The company's infrared lens products, which are used in BAE Systems' remote operated weapon station programs, represented 13% of total sales during 2008. No single product or class of similar products, represented 10% or more of total company sales in 2007 or 2006.
Raytheon Company, an aerospace and defense systems supplier, while not a material customer in 2008 or 2006, represented 10.9% of total sales during 2007.
The company had aggregate sales, both military and non-military, directly to the U.S. government, including its agencies and departments, of approximately $7.0 million in 2008, $6.2 million in 2007 and $4.8 million in 2006.
These sales accounted for approximately 2.8% of sales in 2008 and 3.6% of total sales in each of 2007 and 2006. Approximately 70.7% of total sales in 2008, 66.4% of total sales in 2007 and 68.9% of total sales in 2006 were derived from subcontracts with U.S. government contractors.
The majority of these contracts are subject to termination at the convenience of the U.S. government, and certain contracts are also subject to renegotiation. Currently, the company is not aware of any proposed termination or renegotiation of such contracts that would have a material adverse effect on their business.
Because a substantial part of the company's business is derived directly from contracts with the U.S. government, U.S. government agencies or departments, or indirectly through subcontracts with U.S. government contractors, the company's operational results could be materially affected by changes in U.S. government expenditures for projects or programs using the company's products.
However, company management believes that the broad number and diversity of the programs with which the company is involved, and the breadth of the company's product applications, may lessen company exposure to such risk.
About BAE Systems
BAE Systems plc (LSE: BA.L) is a premier global defense, security and aerospace company delivering a full range of products and services for air, land and naval forces, as well as advanced electronics, security, information technology solutions and customer support services. The company has approximately 105,000 employees worldwide, with 2008 sales exceeding £18.5 billion (US $34.4 billion).
Headquartered in Rockville, Maryland, BAE Systems, Inc., a subsidiary of BAE Systems plc, employs some 45,000 employees in the US, UK, Sweden, Israel and South Africa generating annual sales in excess of $10 billion. BAE Systems Inc. consists of three operating groups that provide support and service solutions for current and future defense, intelligence, and civilian systems; design, develop and manufacture a wide range of electronic systems and subsystems for both military and commercial applications; and design, develop, produce, and provide service support of armored combat vehicles, artillery systems and intelligent munitions.
Raw Materials Suppliers
The raw materials and components the company purchases are generally available from multiple suppliers. However, Brush Wellman, Inc., a subsidiary of Brush Engineered Materials, Inc. is the only U.S. source for beryllium, which is a material used extensively by the company. Historically, the company has had an excellent relationship with Brush Wellman and we have not encountered problems in obtaining our supply requirements.
While there is an alternative source in Kazakhstan, most of the company's military contracts preclude the use of non-U.S. material. Management believes that a partial or complete loss of Brush Wellman as a supplier of beryllium, or production shortfalls or interruptions that otherwise impair the supply of beryllium, would have a materially adverse effect on the company's business, financial condition and results of operations.
About Brush Engineered Materials, Inc.
Brush Engineered Materials, Inc. (NYSE: BW) through its wholly owned subsidiaries, is a leading international producer and supplier of high-performance engineered materials. Brush Wellman Inc. (BWI) is the only fully-integrated producer of beryllium, beryllium-containing alloys, and beryllia ceramic in the world. Engineered Material Systems are produced through Technical Materials, Inc. (TMI) , and precious metal and specialty alloy products through Williams Advanced Materials Inc. (WAM). International markets are served through Brush International (BI).
Brush’s materials continue to find new applications in a widening array of markets where superior performance and reliability are essential. Brush Engineered Materials’ four primary business segments, Advanced Material Technologies and Services, Specialty Engineered Alloys, Beryllium and Beryllium Composites, Engineered Materials Systems, provide the products to meet these growing demands.
Patents and Trademarks
Axsys Technologies is not dependent upon any single patent or trademark. They have a combination of patents, trademarks and trade secrets, non-disclosure agreements and other forms of intellectual property protection covering their proprietary technology. Although they believe that their patents and trademarks may have value, management believes that the company's future success will depend primarily on the innovation, technical expertise, manufacturing and marketing abilities of company personnel.
Competitors in the United States and foreign countries, many of which have substantially greater resources, may have applied for or obtained, or may in the future apply for and obtain, patents that will prevent, limit or interfere with the company's ability to make and sell some of the compan's products.
Environmental Regulation
At this time, the company believes that it is currently in compliance, in all material respects, with federal, state and local laws and regulations governing the use and discharge of hazardous substances and other pollutants into the environment or otherwise relating to the protection of the environment and that any non-compliance with such laws will not have a material adverse effect upon the company's business, financial condition, results of operations, capital expenditures, earnings or competitive position.
The company has incurred, and may incur in the future, costs and liabilities under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") or similar state laws for the investigation and cleanup of hazardous waste or contamination at third-party waste disposal sites or at current or former facilities, related in part to historical practices or waste disposed of prior to the purchase of facilities by the company.
The company is in the process of remediating two formerly owned sites in Bedford, Ohio and St. Petersburg, Florida and is participating as a potentially responsible party ("PRP") at a third-party waste disposal site in Norwalk, Connecticut. Although liability under CERCLA is joint and several, meaning that liability can exceed a PRP's pro rata share of cleanup costs, management believes, based on currently available information, that it is remote that costs associated with these sites will have a material adverse effect on the company's business and financial condition.
As of December 31, 2008, the company had an accrual of $0.8 million for future costs related to the Ohio, Florida and Connecticut sites. These estimates have been developed in consultation with outside environmental and legal consultants handling these matters and are based upon an analysis of the anticipated remediation plans. Management does not anticipate these matters will have a material adverse effect on our consolidated financial position.
The company uses or generates certain hazardous substances in their manufacturing and engineering facilities. Mangement believes that the company's handling of these substances is in compliance with, and exceeds what is required by, applicable local, state and federal environmental, safety and health regulations at each operating location.
The company invests in protective equipment, process controls and specialized training to minimize risks to employees, surrounding communities and the environment due to the presence and handling of these hazardous substances, and regularly conducts employee physical examinations and workplace air monitoring related to these substances. When potential or actual exposure problems have been indicated, the company implemented corrective actions.
In general, re-occurrence has been minimal or non-existent, and te company does not carry environmental impairment insurance. Accordingly, any failure by the company to properly manage exposure to hazardous substances could have a materially adverse effect on the company's business, financial condition and operations.
Employees
As of December 31, 2008, the company employed 991 persons, including 728 in manufacturing, 60 in sales, 121 in engineering and 82 in administration. Currently, none of the company's employees are represented by unions and managment considers their relationship with their employees to be satisfactory. There has been no significant interruption of operations due to labor disputes.
Legal Proceedings
The company is a defendant in various lawsuits, none of which are expected to have a material adverse effect on the company's business or financial position.
Acquisitions
On April 13, 2007, the company acquired Cineflex, a privately held manufacturer of high-precision gyrostabilized aerial camera systems, for $26.7 million in cash. Additional incremental cash payments of up to $42.5 million are possible if certain revenue targets are exceeded as part of a three-year earn-out agreement.
In addition, a second contingent payment of up to 10% of all revenues to be recognized from multi-year orders in backlog at the end of the earn-out period is possible if revenues in the fourth year from the acquisition date exceed $40 million.
During 2007, an earn-out of $3 million was earned, which increased the purchase price to $30 million. This $3 million earn-out was paid in the first quarter of 2008. Additionally during 2008, an earn-out of $0.8 million was earned which increased the purchase price to $30.8 million.
In connection with the acquisition, the company incurred $0.4 million of legal, audit and other acquisition-related costs. Cineflex is a technology leader in the design and manufacture of highly stable, multi-sensor, multi-axis surveillance platforms serving customers in federal and local government and in the motion picture and electronic news gathering industries.
Liquidity and Capital Resources
The company's strategy to enhance stockholder value is dependent on its ability to take advantage of both internal and external business opportunities as they arise. Maximizing the utilization of the company's cash resources is crucial to the successful execution of that strategy. The company's secured revolving credit facility permits borrowings of up to $40.0 million, of which $3.0 million may be utilized to issue letters of credit. The company had no borrowings outstanding under our revolving credit facility at December 31, 2008; however, $2.5 million of the company's revolving credit facility was utilized for outstanding letters of credit.
The company's revolving credit facility remains available through May 2012, subject to optional prepayment in accordance with its terms. The company may elect to have any borrowing under the revolving credit facility bear interest either at the bank's prime rate or the LIBOR rate plus a margin of 100 to 200 basis points, depending on the company's consolidated funded debt-to-consolidated EBITDA ratio. The company has the option of selecting the 1-month, 2-month, 3-month or 6-month LIBOR rate.
The company's credit facility requires that the company maintain compliance with certain covenants, including covenants regarding minimum EBITDA, a minimum fixed charge coverage ratio and a maximum leverage ratio. As of December 31, 2008, the company was in compliance with all the covenant requirements of their credit facility. The credit facility is secured by a lien on all our assets and the assets of thec omapny's subsidiaries, including a pledge on the stock of their subsidiaries.
The company continues to invest in new growth opportunities and increase spending on research and development and capital equipment that is critical to increased production capacity. With the company's existing cash balance, anticipated cash flows from operations and available borrowings under our revolving credit facility, management believes that the company has sufficient liquidity to finance their operations, capital expenditures and working capital requirements for the foreseeable future, including at least the next twelve months.
Off-Balance Sheet Arrangements
As part of the company's ongoing business, they do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2008, the company was not involved in any special-purpose entities.
Critical Accounting Policies
Revenue Recognition
The company manufactures products that are sold to end users, equipment integrators and OEMs. Some of thier contracts are subject to customer acceptance and generally the customer will inspect and accept the product at the company's facility prior to shipment. Generally, legal title passes to the customer upon shipment. The company's policy is to recognize revenues when a product is either shipped to, or received by, the customer based on the terms of the specific sale. However, occasionally a product is shipped FOB destination. When the product is shipped FOB destination, revenues are not recognized until the customer receives the product.
Certain long-term contracts are accounted for under the percentage-of-completion method. Revenues and estimated gross profit are recognized as work is performed based on the percentage that incurred costs bear to estimated total costs. Cost estimates include direct and indirect costs such as labor, materials and overhead. These contracts require judgment relative to assessing risks, estimating, and making assumptions for schedule and technical issues. Contract changes are included when the costs can be reasonably estimated. Te company may receive progress payments that exceed costs incurred on these long-term contracts. Such advances are recognized as billings in excess of costs and are included in accrued expenses and other current liabilities on the company's consolidated balance sheets.
Deferred income results from advance payments from the company's customers on both military and commercial contracts as well as advance billings to the company's customers for the cost of beryllium, known as material only billings. These advance payments and material only billings are deferred and subsequently recognized as revenue only when the associated finished product is shipped.
The company monitors their contracts periodically to determine if actual costs are comparable to cost estimates used at the time of order acceptance. If the company determines that their actual costs are exceeding ehir original estimates, the company will adjust their margins accordingly and record a loss contract reserve if costs are expected to exceed contract revenues.
A Wax Ink Opinion
I have this stock on my watchlist with a Reasonable Value Estimate of $52, a Buy Target of $26, a First Sell Target of $50, and Close Target of $55. This means that for the stock to hit my Buy Target, based on a recent close of $40.46, the price of the stock would need to fall $14.46 before I would consider adding it to my portfolio.
But adding the stock to my portfolio wasn't really why I took a look at the company. It was the words from a recent press release, "...The company's enviable balance sheet, growth prospects, and market presence...", that made me want to take a look.
So based on my criteria for evaluating management, as well as my criteria for evaluating a balance sheet, I have reduced my buy target for the company from $26 to $12, as to me, the company's balance sheet is simply not that strong.
Free Cash Flow for fiscal 2008 was ($1.52) while the Free Cash Flow to Sales margin was (7.13%). The company's Acid Test ratio (Cash, Marketable Securites and Accounts Receivable divided by Current Liabilities) was 1.16, a number that leaves little room for the unforseen.
The company's Cash Conversion Cycle, the number of days it takes to turn Inventory into Sales is about 143 days, not very impressuive, at least to me. One thing I did like, was that while it took the company on average 40 days to collect its receivables, it took the company on average, 40 days to pay its payables.
One additional very very bright spot was that the company ended fiscal 2008 with $0 debt, which is a good thing since Goodwill and Intangibles make up almost 40% of Total Assets.
Is the company's balance sheet enviable? It may be to some, but it certainly isn't to me, and I don't think it will be for a prospective buyer.
As an investor, I personally would prefer the company's balance sheet contain the two things it is missing, a little bit of debt and a helluva lot of free cash flow.
Accordingly, I have no investment interest at this time, and rate the stock, a sell.
Axsys Technologies1208.pdf
