Frequency Electronics Inc (FEIM) 2007 Q1 法說會逐字稿

Good day and welcome to the Frequency Electronics first quarter fiscal year 2007 earnings conference call. [OPERATOR INSTRUCTIONS].

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

At this time, for opening comments and introduction, I'd like to turn the call to Mr. Martin Bloch, Chief Executive Officer. Please go ahead, sir.

Good morning, everybody. You're going to have to put up today with Martin Bloch and Alan Miller, General Joe Franklin is on travel but we'll try to fill in for his absence. I'd like to turn over the financial presentation to Alan Miller, and then I will have remarks and then open the session for questions and answers. Alan?

Thank you, Martin. And good morning, everyone. For the quarter ended July 31st, 2006, first quarter fiscal 2007, our revenues were $14.3 million, compared to $11.1 million in the prior year. This represents a 30% improvement in year-over-year revenues, and they were led by primarily revenues from our commercial satellite programs. In addition, wireless revenues also increased almost 50% from the year-ago period.

Revenues from U.S. government sources and our Gillam-FEI and FEI-Zyfer segments were lower both from the year-ago period and sequentially but we expect revenues from all of these areas to increase over the balance of fiscal 2007. Our cost of sales were $9.5 million compared to $7 million last year, gross margin then was $4.9 million in fiscal 2007 period versus $4.1 million a year ago. The gross margin rate in the 2007 period is 34%, compared to 37% last year, but we're pleased that it is up from the 33% that was recorded in the fourth quarter of fiscal 2006.

High engineering costs on some of our larger programs as well as in support of major proposal efforts kept margins at this level. The SG&A was $2.8 million compared to $2.5 million a year ago. This represents in the current period less than 20% of revenues, which is in line with our targets as compared to 23% in the year-ago period on lower sales.

I would just like to note that in fiscal 2007 in this quarter, FEI began expensing stock-based compensation under FAS 123R for the first time. In this quarter, we reported $115,000 worth of cost, $53,000 of which was recorded in cost of sales and $62,000 in SG&A. For those of you who might be modeling Frequency, you should note that we expect that number to go up in the subsequent quarters, probably around 150 to $160,000 per quarter for the next few quarters. R&D spending was $1.4 million, about the same as last year at this time. Again, though, the greatest spending was less than 10% of revenues, which was in line with our target.

But we do expect to continue to invest in R&D at probably modestly higher levels in the balance of the year. Although the ratio is expected to remain about the same as within our targets. This yielded operating profit for the quarter of $700,000 compared to $100,000 in the year-ago period and up from $300,000 in the fourth quarter of fiscal 2004 and we were very pleased with the results as we contain the costs and continue to improve our margins and expect to see better results going forward through the balance of the year.

Net income for the year, for the quarter, excuse me, was $900,000 as compared to $1.1 million in the year-ago period. But in the year-ago period, that included a $1 million gain on the sale of certain securities. The earnings per share for the quarter was $0.10 compared to the $0.13 in the year-ago period. Again, that year-ago period had that $1 million gain.

For the quarter, we reported negative cash flow from operations of $1 million. However, this reflects the increase in receivables in inventory and the week following the closing of the quarter, the first week in August, we received almost $5 million from our accounts receivable. And this example illustrates why it's very difficult to analyze FEI on a quarterly basis. Our cash flow, our revenues, our backlogs and bookings are going to fluctuate periodically but long-term we expect everything to be quite healthy.

As far as the balance sheet is concerned, you will note that receivables did go up by $4.4 million over the year-end period and, as I indicated, that obviously came down quite quickly in the first quarter -- first week of August as a result of that collection. The inventory increased by $2 million from year end numbers. And this reflects higher work in process at Gillam and expectation to meet their sales commitments in the second and third quarters of this year, as well as the acquisition of materials to support some of the major programs that we have in house.

Our backlog as of July 31st is up from year-end period by $1 million to $37 million. And it's healthy and continues to -- bookings continue to be very good. Martin will elucidate on that a little bit more. I'll turn it over to Martin at this point and look forward to your questions a little later.

As you know, Frequency Electronics has streamlined its business objectives in three major market areas. Telecommunication infrastructure, which includes wireless and wirelines, and I'm happy to report that we are experiencing increasing market share and we see a good trend. We don't know to believe, how to believe it or how long it's going on, but the present view is a considerable increase in demand on -- especially on the wireless infrastructure. I'm also happy to report that we are intimately involved with a future rollup of WiMAX and our patent export is baselined for that technology and that is expected to march out starting in 2007 and everybody expects that it's going to be a good opportunity and a good opportunity for FEI.

With respect to our second segment, the U.S. Government/DOD programs, we are still heavily involved in prototyping many programs that we expect to go into production. Although our bookings has been a little bit down, we expect significant uptake after the beginning of the government new fiscal year, which is October/November. We have many programs that are partially funded and many are proposals outstanding which we expect to win.

Another major development for FEI is we have been awarded a key patent for the low-g sensitivity technology, which will give us quite a unique position in pursuing the upcoming business opportunities in that area. The third and probably at this time most exciting segment, because it's happening now, is our ability to increase the amount of business we can do per satellite from approximately $0.5 million to $1 million average to as much as 7 to $10 million, depending on the satellite. And this is by providing in addition to the timing to provide the frequency generators, microwave frequency generators, synthesizers and distribution subsystems. And this opportunity, we have booked a lot of business. And we expect significant increase in that area from both military and commercial satellite.

At the same time, we are pursuing additional business on the payload of satellites in the up/down converters, and we have qualified hardware flying, which gives us the legacy and we expect to be successful to capture business in that area, which will further increase dollars per payload. Our bookings are very much on track. And it's a very exciting year for frequency and I'm looking forward to a very good year, both in sales and profit. I would like at this time to turn over for question and answers. And you got it.

Thank you, sir. [OPERATOR INSTRUCTIONS].

And the first question comes from Morgan Frank with Manchester Management.

Hi, guys. One question on the inventory. So if we're building up work in progress on Gillam that would seem to imply that we think we're going to be doing more sale there is in the near term?

Yes.

If that finally is the US 5-G now finally through its qualification process and when do you expect to start to see material shipments of that product?

Okay. Morgan, this is Martin Bloch. In Europe, they have gotten the first pre-production orders on the U.S. 5GE and will will be shipping sometime in the next three to five months. In the U.S., we are in the final stages on this item and we have booked no business in the U.S. on the U.S. 5G. This is something that we anticipate to be a contributor in 2007 and on.

So when you say 2007, you mean fiscal 2007 or calendar 2007?

Calendar.

Okay. So we don't think that that's going to be a major contributor in this --

There might be some bookings, but there won't be any sales, because you know from booking to shipment, in that area is approximately a 90 to 120-day period. So if it is, if it is going to be a contributor, it's going to be minor.

Okay. And then --

Morgan to answer your question about Gillam and their build up and work in process, they do recognize revenue basically on a completed contract basis and their programs do tend to be a little bit lengthier and not quite necessarily as long as ours, but they do go up and down a bit. So they will probably realize the revenues in Q2 and Q3.

Okay. Let's see. What else? Anything new with Zyfer? It seems, it seems like since that acquisition, it's kind of gone nowhere for, you know --

No. Morgan, it has done more than what we expected in two areas. They have gone from a lowest generating to being a profit contributor. And in addition to that, they are heavily involved with FEI on pursuing many programs for both commercial and military application. And they've had a slight dip this last quarter, but from bookings, we expect that they'll be up, they'll be up for the year.

Okay.

And if you visualize when we bought FEI Zyfer, they were doing about $5 million and losing a bundle. And now they're up to $10 million and making a profit.

But if we look back a few quarters, they were doing 2.5, 2.8 million in a quarter and now we're back down to kind of 1.9.

Yeah, but that's a various that happens with a good portion of their sales, like 60-plus percent is government and it doesn't actually happen on a quarter to quarter basis. But I expect and we examine very carefully that the year will be, will be profitable in the sales will be as good as last year if not slightly better.

Okay. And then anything new on the deep well drilling side?

Yes, they are drilling. And they are characterizing the equipment in the earth and I can tell you that our equipment is functioning very well. On this and it's up to the people that are building the equipment to start really merchandising and characterizing it. It's a long process, but it's very exciting.

Obviously, there have been some pretty significant deep finds recently.

Yes, the whole idea of that equipment is to be able to find deep finds at the significant improvement in the cost model.

Right. So I mean, when might this finally become a revenue-generating business? When would, when might this start to have noticeable impact?

If I take their projections on this, it should happen in the next 6 to 9 months. And they have purchased some more additional clocks for characterization I think someplace around 8 clocks and some 5 to 8 clocks and ground timing equipment. But they have not been able to roll out the equipment and I'm happy to say, Morgan, it isn't because FEI was late with the clock development. We developed that and it's performing outstandingly. The rest of the equipment, they have to do some more improvements. They've run into some, some trouble with the rest of the sensors on the drill bit, which they are working to resolve.

Okay. And then the last question, just sort of simple modeling stuff, you have this kind of $4.2 million operating expense, run rate, SG&A and R&D, is that a good number to use going forward through the year? Might that trend up? Might that trend down? What do you guys expect to see?

The absolute dollars, Morgan, will probably trend up a little bit, again as a result of rising revenues. Some factors are going to be tied to that. But we expect that the ratios of expenses to revenues will be about what we have recorded in this quarter, about 20% SG&A, and 10% R&D.

Okay, great. Thanks very much, guys.

Thank you, Morgan.

We go next to Hardin Bethea with DePrince Race and Zollo

Good morning.

Good morning.

The question on the telecom market, can you, relative Martin to your wireless infrastructure comments that demand trend is good, what is it that's driving that currently? And is there anything at this point for India or China?

If you want to believe what they are saying, this is that they are booked significant business for improving the infrastructure in the United States and they expect significant bookings of business to meet the infrastructure necessity for China and India on this. And they are projecting very great numbers. About you we have become very skeptical to believe them. And the Chinese as you probably have read, is that, is that they'll start rolling it out sometime in the middle of next year. To meet that 2008 Olympic deadline.

They'll start rolling it out by the middle of next year?

Start awarding the major contracts. They are going to spend about $25 billion on the infrastructure. That's U.S. dollars. But that has been hanging on now, they were going to release it any moment, any day. The latest information is that they're going to release it approximately in April or May of 2007.

Okay. And --

The WiMAX, you know, is just starting its infancy, but it's very exciting new technology, and there's a, a great possibility that it will be a major winner.

And how can you describe to me how frequency --

Frequency is baselined with its patented timing and that's the technology that requires very good timing but can't afford the power and the cost of atomic sensors, so our patented quartz and the four, five series is baselined at this moment for the initial rollout of the WiMAX equipment.

Okay.

And as you probably know, when it starts moving, they're going to need lots and lots of base stations, much more than the wireless infrastructure. Because they'll be covering a smaller area with a much wider bandwidth.

Okay. And when I look at the projections of market opportunity which you all disclosed in the presentations, is WiMAX included in that commercial opportunity?

No. We, we have not taken WiMAX into our projection because we cannot define at this time the quantity. We're waiting for, it looks like it's going to be gigantic, but we're waiting for more data from the basic equipment manufacturer, especially Motorola.

That bigger or smaller than $400 million, five-year market opportunities for the wireless?

It's bigger. Considerably bigger. But like I said, we need some more teeth into that before we can define it.

Okay. And then, I'd actually was on a little bit late, so Alan, forgive me if I missed what you said about subsequent to the end of the quarter, the, their receipt of was it $5 million?

Yes. Yes. $5 million came in the first week in August.

All right. And that was the -- what you had expected to happen? Is that --

Say again?

It's not a windfall. Is that expected? We expected it to actually get it in mid-July and this are just regular receivables. And the major the major people need to be monitored and pushed in order to get them in on time.

Okay.

So, yeah, we would have had positive cash flow in the quarter of $4 million had we collected that just one week earlier.

Great. What was, was that the reason for the short-term credit?

Yes.

Okay. Is there any reason why cash and equivalents went up and marketable securities went down in the quarter sequentially?

That's just a flip flop between two of those.

Okay Can you talk about any activities this Company to utilize that cash?

One of our major initiatives that we have at Frequency Electronics now is to increase capacity, especially for, of course, satellite opportunities. And we're looking very diligently to establish partnership or acquisitions in this area to get a quantum increase in the capacity for satellite, payload building because opportunities are there and it's up to us to make sure we have the capacity to take advantage of it.

What are the latest industry figures for satellite I guess build rates and then your own proposal activities --

Well, their projection industry over the next five years are going to build 174 satellites on this. Our model is based on actually more conservative number of 17, 14 to 17 satellites per year. And that's very conservative, because this year already, the number is higher than expected.

How many, I guess, I don't know how you want to look at it, but in the last 12 months, how many contracts have you received?

Did FEI get on satellites?

Yes.

Give me a second. I'm counting on my fingers. Seven.

And is there a dollar amount for those contracts that you can share?

Well, two of them were $15.5 million, combined and I would have to add it up, but it's significant dollar value. And some of them, like the government portions are partially funded, waiting for additional funding after October, November release out the new government fiscal year. So, I don't have a hard number, but it's in excess of 20. $20 million.

Greater than 20. And that's all in the backlog?

Some of its in backlog, some of it is in revenue because one of them, one of the missions in our opportunities, there are two reasons for our opportunity, three reasons for opportunity that we have. One is legacy that we have product, proven in space and this is a must in getting the business.

Second, is that lead time is very critical so the turnaround is very fast. It's not the old 36 to 42 months programs on this. Most of the programs are typically a year to 14 months. And that third is because we have parts and inventory which helps to schedule helps our cost model so they're quite competitive against our main competition. Which is in house such as the major satellite manufacturers.

Okay. So those seven contracts would stretch through sometime in fiscal '08 or would they go actually further?

No. As a matter of fact, six out of the -- five out of those seven must be delivered in this fiscal year. And the other two have to be delivered in calendar of 2007.

Okay. All right. And how would you characterize proposals outstanding and, you know, current proposal activity?

Hectic.

Okay.

I mean, I have utilized quite a lot of engineering resources to meet the proposal demand and to give you an example, right now, I'm -- and the team are reviewing four major proposals that will be submitted next week.

Okay. All right. If in the last, let's call it in the last year, more than 17 satellite contracts have been awarded --

This, in calendar 2006, I believe that the quantity will end up to be like 22.

Okay. So 22 in 2006. You've gotten 7.

No, in calendar 2002 -- 2007, we see opportunities for about 17-plus satellites as well.

Right, but no, what I was saying was so you've been, you've received contracts for 7 of 22 --

Yeah. And we have gotten contracts on 7 and we have outstanding proposals on quite a few more. From the time, the contract is awarded on the satellite until the payload is defined and the RQs go out a certain a lag time, typically 6 months. So -- yeah. And they are, they are all varying amount of how much we propose per satellite.

Okay. Okay. I'll let others ask questions. Thanks.

[OPERATOR INSTRUCTIONS]. We go next to Chris McDonald from Kennedy Capital.

Good morning.

Good morning, Chris.

Just a question on the low-g sensitivity technology. Now that you have a patent, I'm wondering if you could characterize the magnitude and perhaps the timing of that opportunity.

Well, we are very heavily involved in prototyping both new platforms and upgrades in existing platforms. And the low-g sensitivity systems in production will be from someplace around 3 to 5,000 to as high as 50,000 per clock. And it's difficult to, maybe too sensitive to put quantities numbers out. But if you take a look at the upgrades of existing platforms such as the F-15, F-16 on this, some of the other things the C-130 that are flying and the new platforms that are involved in like the remote pilotless vehicles that will give you an idea of the opportunities.

It's very exciting. I think the only thing that is difficult again is when it's going, when the government is going to decide which one to fund and to release. So we had the exciting and a difficult job to prototype most of them. Since it's very difficult to determine at this time which one will be funded for production.

Is it possible that you see production orders as early as this coming fiscal year?

There is no question they are going to start, they're going to start in this fiscal year. We have proposals outstanding for that right now.

Okay, excellent. And then you obviously have a lot of confidence in growth and revenue and earnings going forward. I'm just wondering, want to make sure that really the key element is Frequency's ability to continue to win greater content on satellites. That's really the near-term driver for the business, correct?

Absolutely correct. You hit the nail right on the head. And at this time, I will look in great position and, remember, that the majority of our competition now in house and, therefore, we are quite cost effective and we're also have a better response time in schedules. We have two good opportunities to capture more of the business.

Okay. Thanks, guys. Appreciate it.

And we'll go next to Robert Lampert, private investor.

Hi, good morning. A couple things. I came in late and you might have already discussed this. But we've, I had a question for you. Do you do any sharing of information with a company that's right next, right near you called Interdigital Communications? They're one of the leaders in TD-SCDMA in China.

No.

Okay. And my second question is, have you made comments about China in general? I didn't hear if you did. I can listen the the replay.

I made some, but I can elaborate on it. In China, we are pursuing multiple opportunities. One is to support the present infrastructure builders such as Lucent and Motorola that are bidding for a big portion of their business, as well as we have prototyped quite a few of the in-house, by in-house I mean infrastructures builders in china that are pushing very hard to roll out the TD-SCDMA.

Correct.

And at this moment, we don't know which one is going to be awarded what magnitude. My present guess is with the time pressure that is outstanding to get the infrastructure up by 2008, there will be more of the existing technology that will be built out rather than the TD-SCDMA because again that technology hasn't been fully broken in.

I see.

It's higher risk for the Chinese to really commit their whole or major portion of their wireless infrastructure to that new technology. But we could not take a chance so we had to cover all the bases.

All right. Okay. Well, thank you very much. If you can just make a suggestion, you might find it very informative to maybe get in to Interdigital. They're quite bright in that whole area of intellectual property and they're working with China and they're your neighbor.

Thank you. We will explore it.

We'll go back to Hardin Bethea with DePrince Race and Zollo.

Just a maybe this is for Alan, clarification, question.

Can you speak up, please, a little?

Sure. This is just a clarification question, maybe, for Alan. I think in your 10-Q you're talking about margin expectations, gross margins, improving or exceeding 40% as revenues increase. Can you again kind of go, I know you might have done this in the past much but just making sure nothing's changed in terms of your expectations for margins as revenues grow.

Yeah. It's pretty consistent story with what we've said in the past. And that is that we do anticipate that our revenues increase from the current levels that we should be able to realize greater gross margins and then as we talked about the ratio of sales and R&D being at 20 and 10% respectively that we would anticipate that our operating profit would come down to being around 10% plus. There's always, it's also going to be lumpy from time to time as you've seen in this particular period when costs are a little bit higher than maybe one previous quarter based on the type of activities that is involved.

Okay.

But that's our target.

Okay.

Looking, this is Martin Bloch, but looking on an annualized basis, your assessment is in line with what we have as our objective to achieve.

Okay. And again, those objectives would be achieved on what level of revenue run rate?

Well, Alan, do you have a number on that from the model? We'll have to take a look at it on this. But a modest increase in levels.

Okay. And yeah, because it looks like sequentially revenues were down $700,000 or so. But gross margin was actually up more than 100 basis points.

Yes. It's mix related as well. So you can't always pin it down to one particular revenue level.

Okay. Great. Alan, can you tell me specifically where the option expense was on the income statement?

Well, like I said, $62,000 is included in selling general administrative expenses and $53,000 is recorded in the cost of sales.

Okay, great. Sorry, I missed that earlier. Thanks.

And at this time we have no further questions. I'd like to turn the call back to Mr. Bloch for any additional or closing comments.

Again, I want to thank everybody for listening in to Frequency Electronics first quarter results. On this, I'm very gratified and I want to thank the team at Frequency Electronics for doing a great job in pursuing the opportunities. And we are, we are continuously making a commitment to improve our gross margin, or margin above 40% and I believe it's within our reach very quickly. Again, on behalf of Joe Franklin, I want to bless all our armed services who are in harm's way and wish everybody of you a good day. Thank you and good-bye.

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