AML Communications Inc. (AMLJ.OB) is small high-tech stock focused on the defense sector. AMLJ is the leading designer of Micro-Electric Amplifers and Subsystems used in military defense programs.

It is a highly specialized market, and the company ends up being the sole source supplier on almost 70% of their contracts. Most programs are long lasting (2-20 years), ensuring repeat revenue.

The stock has turned in 13 straight profitable quarters, and annual revenues have increased from $4.5m in 2003 to $16.3m in 2010, an impressive 20% CAGR.

Despite strong competitive advantages and record setting financial performance, the stock is selling at extremely low multiples and a substantial discount to its peer group.

Company Overview

AMLJ is split in two operating segments, but the AML Communications group makes up 97% of revenue and is the main business driver.

AML produces solid state microwave power amplifiers across varying frequencies and output power ranges. In today’s world, many high-tech defense products are extremely complicated and require a large amount of customization.

AMLJ specializes in minor variations on their product lines to meet customer requirements while staying well within its core technological niche.

Company operations are vertically integrated, from inception -> program definition and design -> manufacturing and marketing.

For these large defense programs, the concept and design stage can take 1-5 years before an initial prototype is produced, so strong (long-term!) customer relationships are very important.

AMLJ has worked with many of the prime defense contractors including BAE Systems, Boeing, Lockheed Martin, Northrop Grumman, and others.

60% of revenues are generated from long-term defense programs. The other 40% is from the company’s catalog sales, a mail order business with a diverse range of small customers.

Existing Program Opportunities

AMLJ is already engaged in defense programs for aerial decoy drones, missle defense systems, UAV radar, aircraft electronic counter measures, and radar systems.

A few highlighted programs:

Northrop Grumman’s STARliteTM

“Small lightweight SAR/GMTI radar used for supporting tactical operations”

AMLJ is providing high quality amplifiers for the project that will be used by the U.S. Army for its Sky Warrior and Fire Scout programs.

Raytheon’s Miniature Air Launched Decoy (MALD)

“a low-cost, air-launched programmable craft that accurately duplicates the combat flight profiles and signatures of U.S. and allied aircraft.”

AMLJ has a five year contract for mission critical components related to the MALD program.

Financial Information

For the fiscal year ending in June 2010, the company reported overall revenue of $16.3m, a 23% increase from the prior year period.

Revenues were nicely split between the long term military programs and short term catalog sales. As these long-term contracts can be volatile from quarter to quarter, the small dollar / high volume catalog business helps smooth out earnings and cash flow.

Catalog customers are also a great source for new defense program opportunities, allowing the company to leverage existing relationships to go after the larger wins.

Gross margins made an impressive jump to 48% in 2010, up from 43% in the prior year, as the company benefited from initiatives to automate existing manufacturing processes.

Driven by increased revenue and higher margins, AMLJ reported net income of $1.5m or $0.14 per share, up from $959k or $0.09 per share in the prior period.

This momentum has continued into fiscal 2011 as the company prepares for a significant increase in production for the second half of the year.

Through the first two quarters of the year, sales were off 4% due to significant prepatory work for a ramp-up in production for a large contract. In addition, the company is also increasing its investments in engineering activity for a brand new $1m program.

Due to this preparation, gross margins fell to 45% during the latest quarter. However, on the conference call, management remains confident that margins will return to 50%+ for the remainder of the year.

The business continues to throw off cash, producing operating cash flow of $1.49m and 466k in owner earnings despite increased investments in property and equipment.

The company’s cash balance now sits at a healthy $3.3m, offset by only $3.0m in total liabilities, for a net cash balance of $300k.

Catalysts

Defense Program Growth

AMLJ received payment from Raytheon for a $2.2m and $3.7m order in 2009 and 2010 respectively.

As I mentioned above, management has been preparing for a significant increase in production going into 2011, with plans to reach annual revenues of $5.5m/yr for the next four years from the existing Raytheon agreement.

Management also announced a brand new program that will add another $1m starting next year.

Finally, AMLJ reported that they are in early stages of development on eight new defense contractor programs, worth up to $14m in incremental sales annually for 3-5 years.

At AMLJ’s size, even just one or two of these contracts per year will boost financial results significantly.

New Subsidiary

In September, management announced the creation of a new subsidiary company, Cal Mimix, focused on fabless development of RF and Microwave semiconductor products. While the semiconductor market has been hit hard lately, it makes good business sense for AMLJ as a logical extension of the core business.

One of the company’s suppliers discontinued a key component, so management decided to step in and leverage its existing technological know-how to source and manufacture the product on their own.

According Mr. Inbar, the company’s CEO, “There are clear opportunities for new products evolving from our long term relationships with our customers and for devices that replace products no longer available.”

While revenue projections have not yet been disclosed, initial devices will be launching before the end of the year.

Acquisitions

In July 2010, the company announced the hiring of C.K. Cooper and Company to identify strategic acquisition opportunities to expand the business horizontally.

On the latest conference call, the CEO announced that they had identified and signed two Letter of Intents (LOIs) with prospective acquisition targets, a basic framework on how a possible deal could be structured.

He also made it clear that he wants to fund the acquisition from the company’s existing cash balance, with common stock being a last resort – a solid indicator that management believes that the stock is undervalued.

Hopefully the team has identified highly accretive acquisitions that can be smartly integrated into existing operations.

Valuation

Despite achieving record levels of sales and profits, the stock is only 9% above its 52-wk low.

FCF for the year should come in significantly higher due to the second half ramp up in production – AMLJ had owner earnings of approx $2.2m last year so these numbers are conservative.

EV/EBITDA is only 3.39x and the company is selling for less than tangible book value. Despite having the highest gross margins among its peer group, the stock is near the bottom on a EV/EBITDA basis:

Source: AMLJ Investor Presentation, Nov 2010

Applying a more reasonable EV/EBITDA ratio of 6x would almost double the current stock price.

Conclusion

An investment in AMLJ is not without risks.

Defense programs can be notoriously fickle and depend heavily on funding from the U.S. government.

A sharp cutback in defense spending could have a significant impact on AMLJ’s business (although I think high-tech electronic components for unmanned vehicles would be pretty far down the cut list).

In addition, one of the company’s directors has been steadily selling shares throughout the past year, although it has been confined to just this one insider.

All told, insiders hold approximately 34% of shares outstanding, solidly aligning their interests with common shareholders.

I’m adding AMLJ.OB to the Value Uncovered portfolio at the 12/01 closing price of $1.27.

Disclosure

Long AMLJ.OB

Imagine my surprise this morning when I checked my charts:

Right off the open, China Agri-Business (CHBU.OB) shot up almost 400% after closing the day before at less than $1.

Although the stock rose and fell in about an hour, it managed to close above $2 for a 102% gain in one day! Almost 1m shares traded hands, compared to an average of 17.5k.

I first covered CHBU back in June when the stock was trading at a significant discount to its net cash balance. It enjoyed a nice run-up to over $1 in the recent weeks, and I sold CHBU on November 24.

What a difference one day makes! Although I can’t help but be disappointed that I missed out on a 100% gain (or even more!), I still feel my reasons for selling were valid.

The business has really taken off in the past six months and the stock had risen high above my conservative asset floor. With all of the recent scandals and fraud surrounding Chinese micro-caps, I felt it best to take my gains once CHBU turned into a growth/earnings play rather than a discount to NNWC.

Congratulations to anyone who was still long. I scoured the internet but cannot find any news or explanation for the sudden jump.

Please comment if you have any links or additional info on CHBU’s sudden rise, as I’m dying to know!

Disclosure

No positions (unfortunately!)

Techprecision Corp (TPCS.OB) reported fiscal 2011 second quarter results last week, continuing a trend of rising backlog and consistent profits.

The new CEO seems extremely confident in the future prospects for the company but the stock remains undervalued despite a recent run-up in price.

Financial Highlights

Second quarter revenues were $8.4m, compared to $15.1m in the prior year quarter. However, the 2009 quarter was affected by a non-recurring inventory transfer to the company’s largest customer, GT Solar.

I’ve written about TPCS’s dependence on GT Solar before – TPCS receives much lower margins on raw inventory transfers versus shipping finished goods.

Adjusting for this one-time cost, sales increased 25% over last year’s results, along with a sequential increase from the first quarter.

Although gross margins were around 30%, operating expenses increased $500k to 13% of total sales compared to only 4% of sales last year.

The increase is partially due to the hiring of new sales personnel to cover the mid-Atlantic market. The expense increase was also impacted by the CEO search (recently completed in July with the hiring of James Molinaro).

Net income was $855k or $0.04 per share fully diluted compared to $0.06 per share last year – YoY comparables are difficult due to the materials transfer last year.

Through the first six months of fiscal 2011, the company has generated a net profit of $1.6m, up 40% from the same time last year.

TPCS generated $1.1m in free cash flow despite a significant increase in capex costs associated with the purchase of a new gantry mill to upgrade and modernize the company’s manufacturing equipment. The mill’s total cost is $2.3m and will be spread out over the remaining quarters of 2011.

The balance sheet remains solid with a cash balance of $9.24m compared to total liabilities of $8.1m. The stock’s current ratio is 6.1.

Future Growth Opportunities

Total order backlog increased from $21.5m at March 31, 2010 to $26.4m as of the September 30, 2010 filing. It further increased to $31m as of November 1, 2010.

The sales efforts for the company have paid off with several large orders from existing customers:

• Sept 8 – $2.9 Purchase Order from Existing Tier-1 Clean Technology Customer
• Sept 29 – $3.9m Purchase Order from Solar Customer
• Oct 13 – $6.7m Purchase Order from Solar Customer

Even better, TPCS announced an exciting expansion opportunity in the fast growing Chinese market by creating a company subsidiary to meet the growing demand for local manufacturing and machining from its customers.

This new local arrangement resulted in a $2.9m purchase order, and the company expects a significant increase in business with multiple customers as a result of this arrangement.

According to Mr. Molinaro, TPCS’s CEO,

“Demand for solar, nuclear and industrial components is growing globally, but this demand is increasing most in Asia and especially China…Already, 80% of poly silicon panels and many nuclear reactors are scheduled to be built in China, and our customers indicated interest in expanding business with TechPrecision if we could support them locally in Asia”

Reverse Stock Split

The latest proxy statement shows a new amendment giving the Board of Directors the power to affect a 1-for-2 reverse stock split. According to the filing,

“The Board believes that the Reverse Stock Split is an effective means of increasing the per share market price of our Common Stock in order to achieve the minimum per share stock price necessary to qualify for listing on well-recognized stock exchanges, such as the American Stock Exchange or the Nasdaq Capital Market. “

Currently trading on the OTCBB, the uplift of TPCS to a major exchange will significantly increase its exposure to individual and institutional investors, likely resulting in a big boost to the stock price.

The shareholder meeting for this proposal was on November 22, and the amendment was subsequently approved.

Conference Call

Management held its second quarter conference call, and seemed extremely bullish on the company’s prospects going forward.

A few notes from the call:

• Management’s goal is 4 new Tier-1 customers before the end of fiscal 2011
• First Tier-1 gas generation client will have prototype done in mid-2011 with full production in 2012; expect a significant increase in business from this market
• Stillwater is finishing up the medical beam prototype and expects to complete clinical trials in mid-2011. The university has hired a prominent specialist to head up the new unit, showing a commitment to the proton beam therapy
• New China operation will provide slightly higher margins and some tax advantages. Will also better serve the solar market in China (GT Solar has more orders than capacity through at least 2012!)
• China operation will also give them access to the nuclear market. U.S. has 104 old reactors but China is building rapidly with 10 new nuclear plants planned

Valuation

Trailing TTM diluted EPS is $0.12, giving the stock a current P/E ratio of 10.42. Based on management’s bullish prospects and the increasing order backlog, 2011 fiscal results should come in higher.

Assigning a more reasonable multiple of 12 to conservatively estimated 2011 EPS of $0.16 would equal a share price of $1.92.

An even better valuation metric is EV/EBITDA. TPCS’s EV/EBITDA ratio is only 3.77, very cheap for a growing, profitable company riding the clean energy wave.

Risks

An investment in TPCS does have risks around customer concentration and common stockholder dilution.

Although the company has focused hard on expanding its operations outside of the solar market, 54% of quarterly revenues were from GT Solar. The loss of this customer, or even a pullback in demand similar to 2009, would have significant consequences.

In addition, the share count has been increasing each year through a combination of stock warrants, options, and convertible shares. The company has seen some turnover in its executive ranks, which leads to the corresponding options grants.

Hiring a new CEO is expensive for a small company from an ownership perspective. However, the new CEO has a great deal of experience in the solar space, and seemed extremely confident on the conference call on the future direction of TPCS.

Conclusion

Despite the solid report, a company insider has sold a significant chunk of stock in the past month, a possible warning sign.

I’ll be keeping a close eye on TPCS and evaluating my exposure, but I like the direction the company is headed.

The downside is limited due to the strong balance sheet so the investment thesis depends on management’s ability to capitalize on the company’s growth opportunities.

Disclosure

Long TPCS