CentreInvest Inc. Initiates Coverage on Valpey Fisher Corporation

3/29/2005 08:00 - COMPANY BACKGROUND
Valpey Fisher Corporation (the “Company”) designs, manufactures, and markets a broad range of frequency control products. The Company offers a full line and complete range of standard and custom crystal and oscillator products for frequency control and timing. Quartz crystals and oscillators provide the precise timing signals needed in advanced technology communications like computer equipment, mobile phones, wireless computers, military, aerospace applications and others. Valpey’s unique expertise is in high performance crystal oscillators, Voltage Controlled Crystal Oscillators (VCXO) and Oven Controlled Crystal Oscillators (OCXO)/Major markets for the Company’s products include telecommunications, computer and computer peripheral equipment, scientific instrumentation, industrial and military markets. Valpey’s Ultrasound Division designs and manufactures ultrasonic sensors for non-destructive testing, medical and scientific markets.
HISTORY
Valpey Fisher was founded in 1931 by Ted Valpey, Sr. The Company’s original technology, “The Valpey Crystals,” was used in the 1933-1938 MacGregor Artic Expedition.
In 1999, the Company entered a strategic partnership with an engineering firm in Russia to develop its high precision crystal technology. This is a leading edge technology that extends the performance capability of the Company’s products, enabling tight frequency stability, wide pull-ability and low phase jitter.
In 2003, the Company acquired MF Electronics. MF Electronics had a 47 year history designing and manufacturing frequency control products for the military and large industrial and commercial customers.
Valpey Fisher is incorporated under Maryland law. The Company has 65 employees and a manufacturing facility based in Hopkinton, Massachussetts. Company shares trade on the American Stock Exchange under the symbol “VPF’.
PRODUCTS
Valpey Fisher offers a wide range of standard and custom crystal and oscillator products for frequency control and timing. More than ten years ago, the Company pioneered a new process to chemically etch quartz crystals that permit much higher frequencies than traditional techniques, while maintaining mechanical integrity. Quartz crystals and oscillators remain one of the most stable components to ensure accurate, controlled electronic frequencies and time.
Valpey’s products include standard devices like Crystal Oscillators (XO’s), which utilize a high precision quartz crystal and an integrated circuit to generate a clocking signal. High performance custom designs include Oven Controlled Crystal Oscillators, Temperature Compensated Crystal Oscillators, Voltage Controlled Crystal Oscillators, High-Reliability and Commercial Off-the-Shelf Oscillators.
Product categories follow:
Quartz Crystals
A quartz crystal is a piezoelectric device that provides a stable frequency reference.
Crystal Clock Oscillators (XO)
A crystal oscillator utilizes a quartz crystal and an integrated circuit to generate a stable frequency output or timing signal. XOs are designed to be very stable, reach high frequencies and are low cost.
Oven Controlled Crystal Oscillators (OCXO)
An OCXO is an XO with the ability to enhance stability by heating the crystal to a specified temperature. OCXOs are designed for high precision and stability.
Temperature Compensated Crystal Oscillators (TCXO)
A TCXO is an XO with the ability to enhance stability with temperature compensating circuitry. TCXOs are both standard and custom designed for high frequency range and low phase noise.
Voltage Controlled Crystal Oscillators (VCXO)
A VCXO is an XO with the capability to change frequency by changing input control voltage. VCXOs are typically used in phased locked loops (PLLs) for data acquisition or signal regeneration applications.
High Reliability Oscillators (Hi-Rel)
Hi-Reliability oscillators operate in extended temperature ranges from -55 degrees C to +200 degrees C.
Commercial Off the Shelf Oscillators (COTS)
These oscillators also operate in temperature extremes that range from -55 degrees C to +200 degrees C. They meet COTS qualifications for avionics and military applications.
Ultrasound Products
Valpey designs and manufactures ultrasonic transducers from 0.1MHz to 150MHz, which are used in nondestructive testing, flaw detection, thickness gauging, acoustic microscopy, particle sizing and medical diagnostics. This product line is very small, representing less than 10% of Company revenues.
The charts below demonstrate the wider frequency range, temperature stability and jitter control of several of Valpey’s high end products, versus key competitors:
ValpeyFisher Corporation
Competitive Product Comparisons
(Source: Company information)
High Frequency TCXO Comparison
Specification Condition VF Vectron Corning
Part ID VFT7H TC210 C2530
Product Type HF TCXO HF TCXO HF TCXO
Frequency Range 30 – 1,000 MHz 0.5 – 160 MHz 30 – 200 MHz
Temp stability, -40 to 85 ºC 1 ppm 1 ppm 1 ppm
Package size 22x25x7 mm3 29x25x10 mm3 22x25x7 mm3
Output type CMOS/Sine/PECL CMOS/Sine/PECL CMOS/Sine/PECL
Phase noise at 100 MHz
@ 10 Hz -80 dBc/Hz -70 dBc/Hz**
@ 100 Hz -110 dBc/Hz -95 dBc/Hz* -100 dBc/Hz**
@ 1 KHz -140 dBc/Hz -125 dBc/Hz* -120 dBc/Hz**
@ 10 KHz -150 dBc/Hz -130 dBc/Hz* -128 dBc/Hz**
@ 100 KHz -160 dBc/Hz -135 dBc/Hz* -135 dBc/Hz**
*Not specified, calculated from 10 MHz as 20 logN
**Not specified, data from 80MHz
Low Power OCXO Comparison
Specification Condition VF Vectron
Part ID VFT8S/14A EX380
Product Type Low Power OCXO Low Power OCXO
Frequency range 4.8 – 180 MHz 10 - 80 MHz
Temp stability, -30 + 70 ºC 2.00E-08 1.00E-07
Package size (inches) 0.6" x 0.6” 0.8" x 0.5"
Output type CMOS/Sine CMOS/Sine
Power consumption @ 25ºC 100 mW 330 mW
Warm-up time @ 25ºC to 1E-7 35 s 120 s
Phase noise at 100 MHz
@ 10 Hz -120 dBc/Hz -100 dBc/Hz
@100 Hz -145 dBc/Hz -130 dBc/Hz
@1 KHz -155 dBc/Hz -140 dBc/Hz
@10KHz -160 dBc/Hz -145 dBc/Hz
Ultra High Frequency VCXO / VCSO
Specification Condition VF Vectron
Part ID VFT5 VS-500
Product Type UHF VCXO UHF VCSO
Frequency range To 1,000 MHz To 850 MHz
Temp stability, -30 + 70 ºC 10 ppm 150 ppm
Package size 14x9 mm 14x9 mm
Output type PECL PECL
Phase Jitter 12 KHz to 80 MHz < 1ps (actual < 0.1 ps) 1.6 ps
100 Hz to 1 MHz < 1 ps > 10 ps*
Phase noise at 100 MHz
@100 Hz -85 dBc/Hz -50 dBc/Hz**
@1 KHz -125 dBc/Hz -80 dBc/Hz**
@10KHz -130 dBc/Hz -110 dBc/Hz**
@100K -135 dBc/Hz -128 dBc/Hz**
*Not specified, calculated to be >10 ps
**Not specified < 10 KHz, calculated there
BUSINESS STRATEGY
The Company seeks to capitalize on opportunities in the frequency control industry by developing state of the art products that are competitively priced and meet the quality specifications of customers. Valpey’s customer base includes original equipment manufacturers (OEMs), electronic manufacturing services (EMS) and distributors.
The Company’s growth strategy is driven by 1) new product design, 2) leveraging off core technologies into new markets, and 3) acquisitions. First, Valpey Fisher will make new investments in engineering in 2005 to support new product design. Second, the Company will leverage its core frequency control technologies by entering the Integrated Subsystems product segment. This involves adding new, higher value features to its products such as amplification, filtering, frequency synthesis, frequency translation, and others. Multiple functions are therefore provided in one integrated solution, which increases reliability. Integrated solutions are also more cost-effective for buyers. The Company believes competition in this niche market is limited to a few companies, namely M-tron, MTI Milliren and Wenzel. Limited competition derives from the fact that few companies have the broad range of technology and engineering skills required for a multi-function approach. Valpey estimates its own market potential in this segment could be $0.5 million in 2005 to $15 million by 2008. Moreover, Integrated Subsystem products for military applications generate an on-going, annuity-like revenue stream.
Finally, Valpey will consider accretive, synergistic acquisitions similar to their purchase of MF Electronics in 2003. The target size of a prospective acquisition is likely to be in the range of $2-10 million. According to Valpey, acquisition multiples for a pure oscillator business approximate 0.8X to 1.2X sales. Desirable acquisitions would involve a technology or product that can be sold through existing Valpey distribution channels, or production that can be moved to Valpey facilities, or engineering expertise can be utilized. The Company’s strong balance sheet reduces the risk of an acquisition strategy. Valpey’s cash balance was $6.4 million on December 2004, and the Company has no debt. A well-placed acquisition could nearly double the Company’s revenues with limited or no negative impact to the balance sheet.
More than 90% of revenues derive from the frequency control segment; less than 10% from the ultrasound business. Key customers include: Celestica, Solectron, Foxconn, and others. Sales to Solectron, an EMS company, accounted for 11% of sales in 2004. Customer concentrations, while high, have been significantly reduced over the past several years. Key customers are financially sound, Fortune 500 companies. In fact, during 2004 the Company credited a bad debt recovery of $20,000.
Long-term, there is an opportunity for market penetration by the Company in both the Traditional Oscillator market and the High-Reliability/Military Oscillator market. Market share gains are possible through technical leadership and greater exposure in venues such as trade shows. Valpey typically participates in three or four trade shows a year.
The Company employs a highly skilled engineering group. There are six engineers located in Massachusetts and additional engineering staff in Russia. These professionals typically have 15-20 years of experience in the field, with Ph.D. degrees in electronics and physics. Valpey can recruit skilled staff because of its interesting projects, which combine both disciplines of electronics and physics. The Company also employs a direct sales force for frequency control products and ultrasonic transducer devices, and independent manufacturers‘ representatives for additional products. Sales people have strong technical knowledge. Valpey’s engineers are on the road as much as possible too, keeping the Company close to customer needs.
INDUSTRY PROFILE
(Source: iSuppli research; Standard & Poor’s)
In 2003, the crystal and oscillator market showed signs of recovery, with worldwide sales up 17% to $2.7 billion, according to iSuppli Corporation. The upturn is attributed to increased demand for mobile handsets and recovery in the wired communications business. Through 2008, the crystal and oscillator market is anticipated to grow at a compound annual rate of 7% to $3.8 billion.
Crystals and oscillators are used in almost every electronics application. The PC market and wireless communications are major drivers of revenue. PCs have clock crystals and MHz crystals for the central processing unit, video interface and other uses. In wireless, cellular handsets require two crystal devices and high precision oscillators for clocking. Other applications such as consumer electronics, industrial and automotive equipment require a mix of standard crystals and XOs.
The telecommunications equipment sector, the biggest users of crystals and oscillators, has been one of the most troubled areas of the technology industry. About four years ago, sales growth fell off a cliff following a period of extensive network build-out in the 1990s. According to ABI Research, as the slumping telecom market struggles back to its feet, some renewed opportunities exist for quartz timing components. Silicon-based technology, however, is replacing quartz-based timing products in many applications. ABI sees some hope for quartz oscillators in niche market applications, including wireless base stations, GPS, Wi-Fi, military and space.
Moderate growth is expected to return to this market in 2005, as bandwidth demand grows and continued consolidation wrings some competition out of the telecom industry.
COMPETITION
(Sources: Yahoo Finance, iSuppli, Company management)
The crystal and oscillator market is very competitive. The top manufacturers of crystals and oscillators are Japanese companies, the top five of which enjoy a nearly 50% market share. According to iSuppli, the Traditional Oscillator Market reached $2.3 billion in 2002. Key market shares include:
Nihon Dempa Kogyo Corporation (NDK): 17% share
Seiko Epson Corporation (Epson): 10%
Daishinku Corporation (KDS): 8%
Kinseki, Ltd. (KSS): 7%
Toyo Communication Equipment Co. (Toyocom) 6%
Valpey ranks #23 in the world with approximately 0.3% of total market share.
Below are some financial statistics comparing the Company against select competitors. Some competitors are privately held or wholly-owned subsidiaries, and do not publish financials. In general, competitors enjoy greater financial resources and market share than Valpey, which is an investment consideration.
VPF NDK Epson KSS*
Current Price 3.30 Y 2,260 N/A Y14. 6 mil
Market Cap 13.9 mil N/A N/A N/A
Revenues 11.5 mil Y 30.9 mil 13.4 bil N/A
Net Earnings (165) thou Y 1.6 mil N/A (1.3) mil
Free Cflow 1.24mil Y(1.8) mil N/A N/A
CTS Dover (Vectron) Corning KDS
Current Price 13.89 39.25 11.61 Y 445
Market Cap 509 mil 8.00 bil 15.9 bil Y1.98 bil
Revenues 531 mil 5.49 bil 3.85 bil Y30.2 mil
Net Earnings 19.9 mil 409 mil (2.19) bil Y 1.6 mil
Free Cflow 6.3 mil 630 mil 152 mil Y 3.4 mil
*FYE 2002 available only
Competitor Descriptions
(Source: Yahoo!Finance and company websites)
Nihon Dempa Kogyo Co., Ltd. (“NDK”): the largest crystal device supplier in the world, NDK develops, manufactures and sells quartz crystal electronic components that are used in diverse applications including mobile communications, fixed radio communications, office automation, audio-visual and automotive electronics equipment. NDK competes against Valpey in the Traditional Oscillator market, with an estimated 17% share. The Company trades on the Toyko Stock Exchange.
Epson: the company designs and manufactures information equipment (printers, scanners, etc) semiconductors, liquid crystal displays, quartz devices, visual instruments and precision watches.
Kyocera Kinseki (KSS): the company is a diversified crystal and oscillator supplier. It offers products required in applications such as cellular telephones, pagers, VCRs, digital cameras, CTVs, standard clocks for microprocessors, analog and digital data transmissions, automobile engine controls, keyless entries, etc
Daishinku Corporation (KDS): Founded in 1995, KDS designs and develops quartz related products and is a leading provider of affordable, high-quality monitors and computer related peripherals geared toward corporate, government, education and consumer users.
CTS: a vertically-integrated global manufacturer of components, CTS manufactures a broad portfolio of state-of-the-art components for wireless communications, automotive and computer applications.
Wenzel: Wenzel Associates is a leading manufacturer of precision crystal oscillators and related radio frequency devices for the communications, navigation, military and test equipment markets. In addition to components, Wenzel Associates manufactures a variety of high performance instruments and subsystems.
Dover (Vectron): Vectron International is a division of Dover Technologies and a world leader in the design, manufacture, and marketing of frequency generation and control products. Vectron uses techniques in both bulk acoustic wave (BAW) and surface acoustic wave (SAW) based designs from DC to microwave frequencies. Products include crystals and crystal oscillators; frequency translators; clock and data recovery products and SAW filters and components used in telecommunications, data communications, frequency synthesizers, timing, navigation, military and instrumentation systems.
Corning: Corning Incorporated is a diversified technology company with products aimed at the telecommunications, flat panel display, environmental, life sciences and semiconductor industries.
M-Tron: M-Tron Industries, Inc. is a wholly-owned subsidiary of Lynch Corporation. M-Tron is a manufacturer of Frequency Control devices such as oscillators, crystals, Voltage Controlled Crystal Oscillators (VCXO), and Temperature Compensated Crystal Oscillators (TCXO). M-tron offers a full line of products specifically designed and developed for the telecommunications, wireless, Datacom, LAN/WAN and PBX industries. M-tron can provide crystals ranging from standard specifications for microprocessors to tight specifications, high frequency fundamental crystals for telecommunications applications. Crystal oscillators are available in TTL, CMOS, HCMOS, ACMOS, ECL, and sinewave logic output.
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COMPETITIVE STRENGTHS
Valpey Fisher’s competitive strengths are based on the following:
74 years of industry experience : since 1931, Valpey Fisher has proven its can adapt and innovate its products to fit the needs of the electronics industry, whether for traditional or leading-edge solutions.
Broad line of products: the Company is a full line crystal & oscillator manufacturer. Customers benefit from Valpey Fisher’s wide spectrum of standard crystals and oscillators, and its ability to customize designs for specific needs.
Innovative technology: the Company’s innovative technology provides low phase jitter, low phase noise, small sized components, lower power consumption, lower supply voltage, improved stability, higher frequency, faster warm-up time, higher reliability and superior service compared to the peer group.
Ability to leverage technical expertise: Valpey is leveraging its technical expertise in the timing area to create new integrated modules. The Integrated Subsystems market has substantial potential for the Company, estimated to reach $15 million in 2008. We feel that Valpey’s ability to find new markets and new uses for its technology speaks to its strong experience and competitive advantage.
Excellent balance sheet: Valpey has a strong balance sheet, with no debt. The Company successfully de-leveraged during the telecom downturn, reducing debt by $1.3 million. Good cash flow and undervalued real estate assets also provide financial flexibility.
An experienced, conservative management team: the Company is run by a team of individuals who are highly skilled in the industry and take a conservative, long-term view to managing the business. In an industry that tends to be volatile, cyclical and ever-changing, it is reassuring to know Valpey’s management team is steady and conservative, with a clear vision for the future.
MANAGEMENT AND DIRECTORS
The Company’s management team has more than 150 years combined experience and includes the following:
Michael J. Ferrantino – President and Chief Executive Officer since September 2002. From January 2002 until September 2002, Mr. Ferrantino was President of the Micro Networks Division, which manufactures high performance frequency and filter components and subsystems, for Integrated Circuit Systems, Inc. From 1999 to 2002, Mr. Ferrantino was President and Chief Executive Officer of Micro Networks Corporation. From April 2000 to January 2002, he was Chairman of the Board of Micro Networks Corporation. Mr. Ferrantino holds a BS degree in Industrial Technology from Northeastern University.
Michael J. Kroll – Chief Financial Officer since May 2002. Mr. Kroll also served as Vice President and Treasurer of the company since 1982. Mr. Kroll is a licensed CPA in the state of Massachusetts. Mr. Kroll holds a BS in Accounting and an MS in Taxation from Bentley College.
Roman Boroditsky – Chief Technology Officer since September 2004 and Vice President of Engineering since 1992. Previously Mr. Boroditsky worked for NEL Frequency Control as Sr. Design Engineer. Mr. Boroditsky holds 2 patents and has published greater than 20 papers in the frequency control area. Mr. Boroditsky holds a BS and MS in electrical engineering from the Minsk RF Engineering Institute.
Michael Ferrantino, Jr. – Vice President of Control Components Group since November 2004 and Vice President of Sales and Marketing since January 2003. Mr. Ferrantino previously worked for Performax as Vice President of Marketing and Eaton Corporation’s Semiconductor Equipment Operations as Product Marketing Manager. Mr. Ferrantino holds a BS in material engineering from Rensselaer Polytechnic Institute and an MBA from Loyola College.
Joe Pavao – Vice President of Operations since February 2001. Mr Pavao’s 20 years experience in the quartz crystal industry includes 5 years at CTS Corporation, as Director of Operations for the Illinois and Singapore facilities, and 11 years at Microsonics, a division of Signal Technology, as President. Mr Pavao has worked at Raytheon’s Submarine Signal Division, Keltec Florida, and Power Systems in various management positions. Mr Pavao holds a BS degree in electrical engineering from the University of Massachusetts and a MS degree in electrical engineering from Northeastern University.
Bob Dandaraw – Director of New Business Development since April 2003. Mr. Dandaraw previously worked for General Dynamics and W.L. Gore & Associates in engineering, new product development, and marketing. Mr. Dandaraw holds a BS in mechanical engineering from Rensselaer Polytechnic Institute and an MBA from Babson College.
Dan Nehring – Vice President of Engineering since May 2003. Mr. Nehring previously worked for MF Electronics (acquired by Valpey Fisher in 2003), Corning Frequency Control and CTS Corporation in engineering, product line management and marketing roles. Mr. Nehring holds BS and MS degrees in Electrical Engineering Technology from Northern Illinois University.
Ted Valpey, Jr. – Chairman of the Company since before 1999, Chief Executive Officer and President of the Company prior to 1999 to September 2002. Mr. Valpey is an Investor.
INVESTMENT CONSIDERATIONS
Valpey has a competitive core business in frequency control devices. The potential for new customers and new product roll-outs is favorable. The technology can be applied to many uses in many industries, including telecommunications, computer and computer peripheral equipment, scientific instrumentation, industrial and aerospace.
The price and quality proposition for the Company’s products include high precision, highly reliable and sophisticated applications at a rational price point. Valpey’s technology is characterized by low phase noise, low phase jitter, small size, lower power and voltage usage, improved stability, higher frequency, faster warm-up time, reliability and service and support.
Valpey has identified a potentially profitable, under-tapped market to support organic revenue growth. The Integrated Subsystems product segment involves leveraging existing technology by adding new, higher value features such as amplification, filtering, frequency synthesis, frequency translation, and others. According to the Company, competition in this niche is limited to a few companies, namely M-tron, MTI Milliren and Wenzel. The Company estimates its own market potential in this segment could be $0.5 million in 2005 to $15 million by 2008.
According to a research report by iSuppli Corporation, the crystal and oscillator market broke out of its slump in 2003 with worldwide sales rising to $2.7 billion, up 17 percent from $2.3 billion in 2002. Through 2008, the market is expected to grow at a compound rate of seven percent, to $3.8 billion. We believe Valpey is well-positioned to benefit from this upturn.
Management has more than 150 years combined industry experience.
Valpey has a strong balance sheet, characterized by no debt. Moreover, certain real estate assets are undervalued on the balance sheet, suggesting hidden value exists. The Company successfully de-leveraged during the telecom downturn, reducing debt by $1.3 million. Good cash flow also provides significant financial flexibility.
Valpey has a track record of skillful management of operations during difficult times. Valpey’s largest market, the telecommunications sector, has been one of the most troubled areas of the technology industry. About four years ago, sales growth fell off a cliff following a period of extensive network build-out in the 1990s. During this challenging period, Valpey skillfully and conservatively managed its operating costs and working capital to minimize losses. The Company also maintained its top customers and added new ones. Additionally, Valpey effected a strategic acquisition with MF Electronics, better positioning the Company to profit from a recovery of its major markets.
Valpey’s shares are attractively valued when compared to peers and the overall market. (see chart provided at end of this report).
RISKS
The Company’s revenue is concentrated among a few companies. In 2004, the five largest customers accounted for 32.8% of net sales. One customer, Solectron Corporation, accounted for 11% of net sales. Financial problems surrounding these few customers can have a direct and material impact on Valpey’s bottom line.
Valpey operates in a very competitive industry. Competitive pricing can erode margins and profitability. Nevertheless, the Company has proven its staying power and ability to compete over many business, economic, and technological cycles.
The promise of growth from new customers and new product roll-outs may be limited in the short-run by continued uncertainties for the telecom industry in 2005.
Valpey buys raw materials from foreign suppliers, in U.S. dollars. The Company does not hedge its foreign currency risk. Consequently, as exchange rates fluctuate, raw materials can become more costly than for competitors who do hedge this exposure. If the value of the dollar continues to sink, Valpey’s gross margin may come under pressure.
In 1998, Valpey sold the assets of its subsidiary, Bergen Cable Technologies, Inc. As a result, the Company was required to perform environmental remediation that has cost more than $1 million. The Company appears to be in the final stage of this process; however, additional expenses related to this remediation could negatively impact Valpey’s future earnings.
Currently, liquidity for Valpey shares is limited. Approximately 45%-48% of shares are held by insiders.
FINANCIAL PERFORMANCE
Fiscal year 2003 was better than 2002 but still weak, reflecting a slowdown in equipment purchases by telecommunications providers. Net sales increased 16% to $1.2 million in 2003. The Company incurred a net loss for the year of ($1.4 million), or ($0.33) per share. This was narrower than 2002’s net loss of ($2.8 million) or ($0.67) per share. 2002’s results included sales cancellations from two customers, highlighting the operational risk of Valpey’s exposure to customer concentrations.
Capital spending in the telecom market, Valpey’s largest market, declined until the fourth quarter of 2003, when signs became evident that the crystal and oscillator market had broken out of its slump. Valpey’s book-to-bill ratio for 2003 improved overall to 1.05 from .95 the year before. The book-to-bill ratio gives a snapshot of supply and demand. When the ratio is above 1.0, it means demand exceeds supply.
In May 2003, Valpey purchased MF Electronics, a private company, for $798,762 in cash. MF Electronic designed and manufactured a wide range of frequency control products. The acquisition provided Valpey with new customers and a broader range of products aimed at military, large industrial and commercial customers. MF Electronics has proven to be a conservative and well-integrated investment, which gives us confidence in management’s strategic intent for future acquisitions.
During 2003, gross margin was 11.6% compared to a gross loss a year earlier. This increase was due to gross margin contributions from the MF Electronics acquisition, as well as a reduction in provisions for excess/obsolete inventory, lower overhead and personnel costs. Raw materials also decreased 6%, thanks to a change in product mix. Total selling, advertising, general and administrative costs also fell by nearly 6% in 2003 compared to 2002. This was due to largely to reductions in advertising and bad debt expense. Valpey’s ability to conservatively manage operational costs during weak business and economic cycles is strongly positive and speaks to the Company’s long staying power in a tough industry.
Net sales in fiscal 2004 (ended December 31) surged 36% year over year, to $11.5 million. Net loss from continuing operations narrowed to ($55,000) or ($0.01) per share versus a loss of ($1,400,000) or ($0.33 per share) in 2003. Improved results reflect higher sales to existing customers, the addition of new customers, and strong factory efficiency. The Company’s book-to-bill ratio was maintained at 1.0.
Gross margin increased to 28% of net sales compared to just 12% in 2003. Actions taken to achieve this included lowering overhead costs and adding customers who bought higher margin products. Going forward, we look for gross margins to be sustained in the 28%-30% range. Our assumptions are somewhat more conservative than management guidance; consequently, there may be potential for upside to our earnings estimates here. Beyond 2005, we believe Valpey can achieve gross margin in the 32%-38% range; net margins may reach 5% to 10%.
LIQUIDITY AND CAPITAL RESOURCES
The Company has no debt, which provides substantial financial flexibility.
With the current $6.4 million cash balance, the Company may make a strategic acquisition along the lines of MF Electronics. We expect future acquisitions to be funded with cash; however, Valpey has ample ability to borrow if needed.
PROJECTIONS
We expect fiscal year 2005 earnings to reach $200,000 or $0.05 per share, versus a net loss of ($55,000) or ($0.01) per share in 2004. Improved profitability should result from better market conditions leading to organic revenue growth, and the benefits of continued discipline on costs. Should Valpey make a material acquisition during 2005, our estimates could prove too low.
We anticipate that growth will accelerate in subsequent years. One important risk to our recommendation, earnings estimates, and target price is customer concentration risk. If one of Valpey’s customers suffers a serious financial set-back, our estimates could prove wide of the mark. Our estimates would also be negatively affected by higher raw material costs and worse currency fluctuations than currently forecasted.
VALUATION AND CONCLUSION
Due to net losses incurred by the Company in recent years, traditional valuation methods such as P/E ratios or discounted earnings per share are not applicable. Therefore, we applied the Price/Sales valuation method in an effort to arrive at an accurate target price.
Based on this, we arrived at our Speculative Buy recommendation and (12-18 months) Price Target of $4.00.
Valpey trades below peer valuations and the overall market. (See chart, below) We believe the Company’s shares are attractively valued.
Source: Reuters
Valuation Ratios
RATIO COMPARISON
Valuation Ratios Valpey Industry Sector S&P 500
P/E Ratio (TTM) NM* 26.99 28.50 21.62
P/E High - Last 5 Yrs. NA 43.49 59.78 42.14
P/E Low - Last 5 Yrs. NA 13.18 18.84 15.74
Beta 1.61 1.72 1.89 1.00
Price to Sales (TTM) 1.46* 1.97 4.79 2.97
Price to Book (MRQ) 1.44 3.32 5.40 4.01
Price to Tangible Book (MRQ) 1.44 8.86 7.21 7.12
Price to Cash Flow (TTM) 25.18 19.45 23.37 15.25
Price to Free Cash Flow (TTM) 12.25 29.93 26.03 25.39
% Owned Institutions 3.74 44.86 46.49 65.39
Income Statement Model for the Years Ending December 31
($ thousands)
2003A 2004A 2005E
Net Sales 8,496 11,545 12,775
COGS 7,507 8,285 8,991
Gross profit 989 3,260 3,784
Selling & advertising 1,406 1,409 1,549
General & admin 2,043 1,955 2,078
Operating Income (Loss) (2,460) (104) 156
Interest Income 49 36 34
Interest Expense 12 0 0
Gains on sales of assets 0 13 10
Dividend income 0 0 0
Income (Loss) Before Tax (2,423) (55) 200
Income Tax Benefit (expense) 1,023 0 0
Income (Loss) Continuing Ops (1,400) (55) 200
(Loss) Discont‘d Ops 0 (110) 0
Net Income (loss) (1,400) (165) 200
Basic earnings (loss) per share
Continuing Operations ($0.33) ($0.01) $0.05
Discontinued Operations $0.00 ($0.03) $0.00
Consolidated Balance Sheets for the Years Ending December 31
($ thousands)
2003 A 2004A 2005 E
Assets
Cash & Equivalents 4,209 6,455 5,110
Accounts Receivable 2,467 1,137 2,299
Inventories 1,571 1,501 1,550
Deferred Taxes 675 629 630
Total Current Assets 8,922 9,722 9,589
Property & Equipment 10,752 10,807 12,142
less accum depreciation 7,064 7,808 8,742
Net PP &E 3,688 2,999 3,400
Other 134 143 138
Total Assets 12,744 12,864 13,127
Liabilities & Stockholders Equity
Current Liabilities 1,440 1,655 1,684
Deferred income taxes 646 578 612
Stockholder‘s Equity 10,658 10,631 10,831
Tot. Liabilities & Stockholders Equity 12,744 12,864 13,127
Cash Flow Highlights for the Years Ended December 31
($thousands)
2003 A 2004 A 2005 E
Net Income (1,400) (165) 200
Depreciation & Amortization 833 819 800
CAPEX -154 -140 -204
Working Capital 7,482 8,067 7,905
Free Cash Flow 6,761 8,581 8,701
Weighted Shares Out 4194 4212 4238
FCF/Share 1.61 2.04 2.05
Price 3.09 3.30 4.00
Price/FCF 1.92 1.62 1.95
EQUITY RESEARCH
DMITRY UGOLKOV
Director
SALES & TRADING
BILL HERLYN
Vice President
CentreInvest Inc.
140 Broadway
46th Floor
New York, NY 10005
Phone: (212) 809-8707
Fax: (212) 809-8726
www.cigresearch.com
info@cigresearch.com
© 2004 by CentreInvest Group. All rights reserved.
Research Disclosure
Any recommendation contained in this report may not be suitable for all investors. This document is solely intended for informational purposes. Any unauthorized use or disclosure is prohibited. Neither the information nor any opinion expressed herein constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivates related to such securities. While the information and opinions contained herein are based on materials believed to be reliable, we make no representation as to the accuracy or completeness of such information and opinions. CentreInvest Group and its affiliates accept no liability in relation to the use of this information. Investors should obtain individual financial advice and perform their own due diligence before making investment decisions. Some investments may not be readily realizable and valuing the investment and identifying the risk to which customers are exposed may be difficult to quantify. Past performance is not necessarily a guide to future performance. Some investments may be subject to sudden and large falls in value and on realization customers may receive back less than they invested or may be required to pay more. CentreInvest and its affiliates, their officers and directors, stockholders, and employees (excluding the US broker-dealer unless specifically disclosed), or clients may have or have had interests or long or short positions in any of the securities or other financial instruments mentioned herein at any time and may make a purchase and/or sale, or offer to make a purchase and/or sale, of any such securities or other financial instruments from time to time in the open market or otherwise. As of the date of this report, we, our affiliates, any officer, director or stockholder do not have a position in the stock of the company mentioned in this report. The Company paid a retainer of $5,000. Upon distribution of the initial report, the Company will pay to CentreInvest, Inc. $1,500 per month for the creation and dissemination of research reports. CentreInvest, Inc. is not a market maker and does not currently have an Investment Banking relationship with the company mentioned in this report and was not a manager or co-manager of any offering for the company with in the last three years. Analysts’ compensation is determined based upon activities and services intended to benefit the investor clients of CentreInvest, Inc. and its affiliates. Analyst compensation is based on the analyst’s productivity and the quality of the analyst’s research and the analyst’s contribution to the growth and development of our overall research effort. Further information on the securities referred to herein may be obtained from CentreInvest, Inc. upon request.
Investment Ratings
BUY. We estimate a stock is undervalued relative to its market and is expected to outperform the market on a total return, risk-adjusted basis.
SPECULATIVE BUY. We believe a stock is undervalued relative to its market and is expected to outperform the market on a total return, risk-adjusted basis. The risk is higher compared to our BUY recommendation.
PERFORM/HOLD. A stock is estimated to perform in line with the market.
SELL. A stock is expected to underperform the market on a total return, risk-adjusted basis.
Distribution of Investment Ratings
The current ratings distribution in the CentreInvest universe is as follows: Buy - 58%, Speculative Buy - 13%, Hold - 19%, and Sell - 10%.
Price Target Risks
Investment risks associated with the achievement of the price target include, but are not limited to, the company’s failure to achieve our earnings and revenue estimates, unforeseen macroeconomic and/or industry events that adversely impact demand for the company’s products or services, product obsolescence, changes in investor sentiment regarding the specific company or industry, intense and rapidly changing competitive pressures, the continuing development of industry standards, the company’s ability to recruit and retain competent personnel, and adverse market conditions.
Analyst Certification
The research analyst(s) certifies that the views expressed in this research report and/or financial model accurately reflect such senior analyst’s personal views about the subject securities or issuers and that no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report. This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.