Frequency Electronics Inc (FEIM) 2005 Q2 法說會逐字稿

Good day and welcome to the Frequency Electronics Second Quarter Earnings Fiscal Year 2005 Conference Call. This conference is being recorded and all participants are in a listen only mode. At the request of the company, we will open the conference up for questions and answers after the presentation.

Statements in this release, which are not historical facts, are forward looking and involve risks and uncertainties, including but not limited to, the impact of competitive products and pricing, increased investment to support product introduction, market acceptance of products, product transitions by the company and its competitors, currency fluctuations, changes in product sales mix and other risks described in the Company’s registration statement and other Securities and Exchange Commission filings.

For opening comments and introduction, I would now like to turn the call over to General Joseph Franklin, Chairman of the Board. Please go ahead, General Franklin.

Thank you very much, Beth, and welcome everyone to our pre-Christmas Second Quarter Conference Call. It’s a particular pleasure for us today to welcome Dick Schwartz to our Board, as you all saw in our press release today.

Dick, who has had a--a long and illustrious career in industry, has agreed to be appointed to our Board and he’s listening in today as a matter of fact. For those of you interested in how things are going to work, Dick will also be a member of our audit committee.

We’re here today with Martin Bloch and Alan Miller. And what I’d like to do first to make sure everyone has seen the press release, is reiterate from that that our quarter, the second quarter, was right in line with our expectations. As we pointed out at the end of the last quarter, our major customers give us a year ahead forecast, and some of the key members of that customer group accelerated their demands from the yearly. So we would expect quarter to quarter that we’ll see some fluctuations in our revenues, but--through the end, at least of this calendar year, calendar 2004. But beginning with 2005, which is the fourth quarter of our year 2005, we expect to see those things pick up a bit again.

And as I said, this is going to be a year where, compared to 2004, our profits will--our profitability will increase, our revenues will increase, and we will see improved margins.

We’re very pleased with the progress to date and looking at a good year, 2005. Alan will give you a bit more detail on those financials and he’ll be followed by Martin, with our business report. So why don’t you go ahead, Alan.

All right. Thank you, Joe. Good afternoon everyone. As indicated in the press release, our revenues for the quarter were $14.4 million, which represents a 43% increase from a year ago, and a sequential decline of 19% from the first quarter of fiscal 2005.

Parcel sales for the quarter were $9.1 million, yielding a gross margin of $5.3 million. Now, that represents a rate of 36%--37%, a 4% improvement over what we experienced in the first quarter. And about half of that improvement was directly attributable to our FEI-Asia subsidiary, which we’re happy to report, reported their first positive gross margin, as well as the first profit in its history on increased revenues from that division.

SG&A for the quarter was $2.9 million. And this is roughly 20% of our revenue, which is within our target range.

Research and development was $1.6 million during the quarter, which is a $350,000 increase from Q1 based on some new opportunities. But this also was again, in line with our target which is approximately 10% of revenues.

Operating profit for the quarter was $775,000 which compares to a year ago loss of $700,000. And this continues the positive trend which started in the second half of fiscal year 2004.

Investment and other income was $411,000, yielding pre-tax income of $1.2 million and net income of $854,000 or $0.10 per earnings--earnings per share.

I want to back up to that investment income and other. Included in that number is about $70,000 representing our equity income from our increased investment in Morion, the Russian company in which we increased our ownership from just below 20% to 36% during this past quarter. And as indicated also in the press release, we have restated our prior period financial statements in accordance with GAAP, to reflect the earnings which we would have recognized on the equity vested, had we been on that method ever since we began investing in Morion. And this goes back a couple of years, and ever since our investment in Morion, they have been profitable. Consequently, this restatement will result in an increased earning, as--from--as those which had previously been reported.

For example, earnings for all of fiscal year 2004 will increase by $0.02 and the earnings that were reported in Q1 of this past fiscal year will go up from $0.11 to $0.12.

Turning to the balance sheet, our cash is about $33 million, an increase of about a million and a half from year--year end of April 30th. Our receivables are $14.3 million, down modestly. And inventory is $21.3 million, again, down modestly from the year end numbers. And as of the end of the quarter, our backlog was $29 million, which is up nominally from the balance at the end of first quarter.

We’ll look forward to your questions about some more details on this as we go on and later on in the conference call. At this point I’ll turn it over to Martin.

Welcome, everybody. I’m happy to report that the--that in spite of all of the new starts which we have started this year, which is basically the new programs for the Department of Defense and for both secure communication, weapons delivery and--and satellite, the US5G, the high temperature clock for deep oil exploration and--and the low G sensitivity products. Both products have contributed negligible to their--to this year’s sales and profitability. And in spite of those, we’ll have an increase in sales and profitability and margin for this year.

This programs we--we expect significant increase in--in calendar of 2005, ’06 and ’07, and they will have an effect on--on the last quarter of--of--of our year. It is--they are--the products that we have developed on--on quartz have gotten great acceptance. The low G sensitivity has demonstrated an improvement of approximately 100 to 1 from the state of the art, and we are now developing equipment and systems for about a dozen DOD programs, using this technology, which gives them a--a significant improvement in navigational accuracy in--in--in radar and secure communication matters.

China as--as Alan has indicated, has for the first time indicated--has achieved sales and profitability, and we expect this coming fiscal year that 2006 for FEI, that they’ll be at approximately the $2.5 to $3.5 million in sales and--and profitable.

Morion, as--as Alan again has indicated, we now have 36%. They are being used as a source for manufacturing of the medium and low cost quartz clocks for systems. And--and they are--they have grown significantly since we got involved with them, from $4.5 million to $12 million anticipated this year. And they are a good source of products that we can incorporate in our system. The quality is great. The price is very competitive. And they have a large pool of skilled people that--that we can use.

With respect to our involvement in--in Gillam and in FEI-Zyfer, we are very satisfied with what they do. They’re operating and making a small profit. What is most significant is that they are contributing significantly to the development of new products for use in attacking the market. The US5G has gone through preliminary tests with very acceptable results. We now do testing, final qualification testing of--of the product for the Arbox [sp] manufacturer. And we also have one piece of equipment that’s being tested in the line of a major of Arbox [sp] service provider.

We--we expect no contributional sales from that product in--in fiscal this year, but we expect to book some orders before April 30th, and we’re looking forward to capturing a significant portion of that large market. And as you probably have seen, the market for the US5G type of equipment over the next three to five years is about $500 million U.S., and about additional $300 million worldwide. And they expect to capture our share of this--of this area.

With respect to the telecom customers, they--they are up and down as usual on this. They’ve had significant demands on increasing the products for the first six months, on this. And--and there are now some dips. But our conversation with them and their present view is that they are going to have about 15% to 25% increase in calendar 2005, which will help our fourth quarter, and of course our--our year--our fiscal year of 2006.

I think I’ve given you the highlights. I’m happy with the--with the--with the progress. Joe asked me silently to give you a quick indication of what were the commercial satellite businesses. Lots of them are failing in--in the skies. And replacement proposals are out. We expect a significant increase in--in businesses that we have--are embedded in. And also some new satellite starts. And that has significantly increased in 2005, and we expect significant business for 2006 and 2007.

Have I covered everything, Joe, that you wanted me to cover?

Right on the mark. Thank you, Martin.

Okay. I’ll send it over back to you, Joe.

So anything that you have questions on now, folks, we’re open to those. Fire away. Beth, you’ll be the moderator please.

(OPERATOR INSTRUCTIONS.)

Arden Vescia (ph), Deprince, Race & Zollo.

Martin, I was hoping to get some additional detail on--on two areas. One is as much as you can say about the opportunity you have, both for secure communications and other DOD type contracts, would be--would be helpful.

And then a little more granularity on commercial satellite opportunities would be helpful.

Okay. On--on the DOD starts with secure communication and it’s actually some of them also include the--the low G sensitivity. We have about a dozen starts for a variety of programs. And the projected needs of those for hardware over the next three to five years is someplace around half a million units.

And we expect to significantly benefit from that type of business. And to name a couple of programs that we can is--is the Clauster [ph] program, which is the secure communication, the low G sensitivity application for helicopters and jet planes, small weapon delivery and remote pilotless vehicles is--is another area. And areas where navigational accuracy needs to be increased. So our objective is to capture a good portion of this large quantity market that’s there.

With respect to commercial satellites on this, we have at this time about a dozen proposals outstanding right now. And--and we expect significant bookings, sometimes this fiscal year. Of course which the--the typical delivery cycle on a satellite system is someplace in the area of nine to 15 months. So they’ll have minimal contribution to this year’s sales, but will be a--a good base for--for fiscal 2006 and 2007.

The view of these timeline for all this product is that--the phases that we are in now is called low rate production. That means you--you build a couple of hundred systems and--and validate them in the field and see how they play, and see if they perform all the functionality that was intended. And then you start up the [indiscernible] and the present projection of our customers it that--that significant quantities are going to be in--starting towards the end of calendar 2006 and 2007.

But in the meantime, there will be limited production quantities, which means in--in the thousands in the earlier period of time, until it gets to the very large volume.

Okay. I guess a follow-up on--on the low rate production. Is--is what we see kind of in your current results, reflective of--of what we might expect in the--in the government segment during this--this low production period?

Well, like I mentioned, they--they made it--they made a negligible contribution to this year’s sales and they were really in [indiscernible]. They--the first contribution that I expect from that low rate will be in--in fiscal--in calendar 2005, which will fall into FEI’s fiscal 2006. And this--at this moment you--you know, we have been supplying between 50 and 100 units in this low rate. We have finished the development phase, which is of course, the--the difficult one. And--and our qualification phase. Now, the major manufacturers of the systems have to go through their qualification phase before the government will turn on the spigot.

Okay. Who are some of your--your partners I guess in the defense industry for--for these products?

I’m saying the Fortune 500 on this.

Okay.

To be specific would--it would--would not be a good idea.

Okay. Fair enough. I’ll--well, I’ll get back in line and see if there are any other questions.

(OPERATOR INSTRUCTIONS.)

Buddy Howard with TM Capital.

Let me just sort of follow up with the last question. Martin, in the DOD area you mentioned 500,000 units. Can you give some--some flavor for the--the size dollar-wise, what that would represent?

Yes. I can give you some flavor. The variation of the clocks are going to be from--from around $500 to around $10,000, depending on the complexity and their mission. So that’s a mix. With a large quantity being at around the $500 unit price.

All right. And is--is that--is that still a situation where you guys would be the sole supplier for that particular component?

For--for all of the programs that we have now on start, we are at this time, the sole source. And this obviously, as time goes on, it’s going to be the government pressure to try to find additional sources of supply. But at this time, we are the sole source.

Could you envision anything providing much of a threat to you in terms of securing that business, from a competitive standpoint?

Well, I’m--I’m confident that we’ll capture a good portion of that business. And this--this catch-up is usually quite expensive and lengthy and I don’t see any major breakthrough in technology that will enable somebody to come up with some magic lower cost.

Okay. Sure. Can you also give maybe the same kind of information on some of these deep drilling applications that you’ve got in terms of the dollar-size of the market over the next three to five years? And I know that’s sort of an emerging area, so it may not be possible to give a--a real specific number. But if you have any kind of conservative estimate of what that might represent--.

--Yeah--.

--I’d--I’d love to hear that as well.

Okay. I can tell you what our customers are telling us at this point. They expect that eventually they’re going to use up approximately between 500 and 1,000 systems a year. And that’s--that goes into the hole. And the system costs us about $50K.

All right.

And--and the basic idea is--that’s very cheap, as you realize, because if this can save them one day of drilling on land, that costs them $100,000. And one drilling day on the water is $1 million dollars. And this more precise timing should significantly help them reduce their drill time.

And have you--have you indicated when you think the revenues on that business will start to--to filter in?

Well, we will definitely have, starting in--at--in calendar 2005.

All right. Good. Also, Alan, this is probably I guess question for--for you. The tax rate I noticed, dropped down in the most recent quarter. It would--in terms of just going forward, would you think that you’re about the same level as you were in the--in this quarter or--?

Well, it’s kind of hard to--to estimate that. But what happens Buddy, is there’s some--there are--some other entities, notably China, where they don’t pay taxes at this point because of losses from prior years. So there’s no provision for there. So I--I--I’m just going through the nuts and bolts of this thing. If you have $1.2 million pre-tax right now, take off about $200,000 from various other sources, the Morion equity income, for example, is not taxable. So you take those numbers off and you get about a 35% rate after deducting those.

But to take a blanket percentage is kind of difficult to do you because you don’t know what kind of profit you’re going to realize in those other entities.

Yeah. I guess since--since Morion and--and China are--are--you know, that’s not likely to change, those situations aren’t likely to change drastically, it--is it unreasonable to sort of assume pretty close to the same rate going forward as what you were in this quarter?

I--I would hope that that would be maintained.

Okay. The R&D, now that presumably US5G is--is starting to ramp down a little bit in terms of just the development side, should R&D moderate a little bit going forward?

This is Martin Bloch. Okay. Hello?

I can--I can [inaudible] fine, yeah.

Okay. This--the--the answer is--is--is yes. The bumps that we had this quarter was to really finish off the final software improvement that our Arbox customers felt was important to make their life easier and installation. And we can--we--we see that it’s going to be--it’s not going to increase and there is a good possibility that there will be a significant decrease.

Even in the third quarter?

Alan, I don’t know how much in that third quarter. We have to take a look on this. The third quarter will--it will probably be flat.

Okay.

With a--with a decrease in the fourth quarter.

Okay. And then just the--the final question. Capacity-wise, can you talk a little bit about where you are and you know, are--will you be prepared to handle the kind of growth that is implied by some of these new markets, and--and how will you address those issues if you do have capacity issues?

It’s funny that you should ask. I just had to--to make--to prepare this answer to a major telecom customer. And what we have done at this moment is that we have established that we’re going to manufacture the quartz product in three facilities, FEI-New York, a major portion in FEI-Asia in Tainjin, and also at the Morion in Russia. And--and on the rubidium center for the telecom will--the basic technology will be maintained in the U.S. because that’s the requirement of--of--of Department of Space.

However, the integration and assembly and tests will be done in our FEI-China facility. So at this moment we feel that we--that we have everything in place to pick up with the--with the capacity that our customers are expecting. And also the ability to take bursts [indiscernible] industry comes up with.

Great. Well, it’s--it’s a good quarter, and--and keep up the good work.

(OPERATOR INSTRUCTIONS).

Morgan Frank with Manchester Explorer Fund.

Just a--just a bookkeeping question for you. When I go through your press release and I add up all your segment revenues, I’m getting a number significantly different from the revenue number you recorded. Was--was there an unusually large amount of inter-company business this quarter or--

--One--$1.5 million.

Okay. And that--that’s an unusually large number for you guys? Was--was there something--?

--Well, it--a large amount--.

--specific going on that caused that?

--I’m sorry to talk over you. Say--say the question again.

Well, I mean that’s--that’s an unusually large number of you know, a large amount of inter-company business for you guys. What--what was going on?

It may be a number that may be becoming larger as we do more between the two entities, particularly with Asia. It probably was a little bit higher than we might have anticipated or envisioned going into the quarter. But there was some other work that our Asia facility was doing, not only for us here in the United Stats, but also for our facility in--in--in Belgium. So it’s been a real synergistic opportunity for us with this Asia facility.

All right. Morgan, this is Martin Bloch. I expect that that number is going to go significantly higher as--as we progress in the next phase, since both Gillam-FEI and FEI-Zyfer are learning more effectively on how to deal with each other and--and how to manufacture the product at the place where we can get the best quality at the lowest cost. So--so-- so that’s--Gillam, to give you an example, for Gillam FEI-Asia made about $1 million worth of product this year, and we can see it’s increased and they will continue making significant products for FEI integration tests in both quartz and the rubidium assemblies.

Got it. And then was--was Gillam profitable as an operating unit this quarter?

Yes.

Well--.

--Well--well, without the R&D, they would have been. They were going to break even.

Yeah.

But they had a substantial amount of R&D, as we talked about, so, [indiscernible]. Yes.

Right. Okay. Well, so but--so when you--when you look at them as a unit, the way--the way you would attribute cost, they were not profitable?

That’s correct. From--from you might say a GAAP point of view, you would--you would show a loss. But the R&D is a major--major contributor to that.

Right. I mean is that creating tax deficiency for you?

Yes and no. I mean we have to look at that as we get closer to year end, there may be some transfers that we might be able to make to--to make it more tax efficient than what we have right now.

Okay. And then you said at the beginning of the call that about half the gross margin gain was from China. What was the other half?

Well, it’s just the--the efficiencies. About 2%. I think we had different entities, just because of a mix, had slight improvements. We saw better margins at Gillam and at Zyfer, for example. So just a combination of those more efficiencies there.

And is that a--so is this a number that--that could continue to increase going forward as--?

--Well--.

--Time continues to ramp up or--?

--We--we believe that our--our margins--gross margin rate will probably be in the this upper $30 range. That’s what we believe is a reasonable target for us to achieve at this point.

Got it. Okay. That takes care of me. Thanks, guys.

And we’ll hear again now from Arden Vescia. Please go ahead.

I guess the--I just want to make sure I’m as clear as I can be on the timing of some of the products you’re developing. On the commercial side, US5G I think, Martin, you said orders expected hopefully in fiscal year ’05, but no revenue until--until fiscal year ’06. Is that--is that right?

That’s correct.

Okay. On the side--I’m sorry. On the geothermal clock, the--the deep hole clock, starting in calendar year ’05, is that in fiscal year ’05 as well, or is it in fiscal year ’06?

Well, it’s going to fall into fiscal year ’06 on this--.

--Okay--.

--Because they--they are--we have just finished the qualification and our customer has to finish their deep hole qualification in the field. And they are working around the clock to do it. So I would expect that we should probably get some orders in our fiscal year ’05 for shipments in--in--in the later of calendar 2005.

Okay. Great. So actually by the--by the end of your--your fiscal year, you might actually be showing orders for US5G for geothermal clock, and potentially some impact, albeit marginal, from some of their government starts?

No question about that.

Okay. That’s good news. Thanks.

And it appears that there are no further questions at this time. I would like to turn the conference back over to General Franklin for any additional or closing remarks.

Thank you, Beth. And thank you all for listening in. We welcome your comments and your questions, and look forward to this calendar--this fiscal year 2005, which will end on the third of April, being a good year. As we said, our revenues will increase from the previous fiscal year, as will our profitability. And as you questioned Alan, and heard more about it, the efficiencies that we’ve--we’ve been able to implant to give our gross margins a better view on what we think we’re going to be able to maintain will go on this year.

And certainly, as you glean from Martin’s comments, beyond fiscal 2005 and into those years, we have some very interesting projects that are in development and looking to revenues to grow even further at that time.

This is our holiday season and we want to wish to you and all your loved ones, the best of times for the holidays, getting together. And I’d ask all of you in each of your way to ask that our soldiers be looked after where they are. God bless them and God bless all your families. Merry Christmas and Happy New Year folks, and we’ll talk to you next year.

And Happy Hanukkah.

And Happy Hanukkah.

Have a happy holiday.

All the best from all of us. Thank you, Beth.

Thank you. And ladies and gentlemen, if you wish to access the replay for this call you may do so by dialing 1-888-203-1112 or 719-457-0820, with the passcode of 9-0-9-5-5-5. This concludes our conference call for today. Thank you all for participating and have a nice day.