Frequency Electronics Inc (FEIM) 2008 Q1 法說會逐字稿

Good day, everyone, and welcome to today's Frequency Electronics first-quarter fiscal 2008 conference call. Today's call is being recorded. Any statements made by the Company during this conference call regarding the future constitute forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements inherently involve uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences are included in the Company's press releases and are further detailed in the Company's periodic reporting filings with the Securities and Exchange Commission. By making these forward-looking statements, the Company undertakes no obligation to update these statements for revisions or changes after the date of this conference call. And now at this time, I would like to turn the conference over to Mr. Martin Bloch, President and CEO. Please go ahead, sir.

Good morning, ladies and gentlemen. You'll have to excuse our Chairman, General Joe Franklin, who couldn't be with us this morning. He had an urgent meeting in Washington so you're going to have to suffer with me. I would like to indicate a few remarks and then turn it over to Alan Miller to go through the financial status of this quarter.

I can tell you we are on track and we are very encouraged by the progress we are making in all business areas and we expect, as we predicted before, to have an increase in sales for fiscal 2008 as well as a significant increase in profitability. I will now turn over to Alan Miller to go through the details.

Good afternoon, everyone. Thank you, Martin. For the first quarter of fiscal 2008, revenues were $15.6 million compared to $14.3 million in the year ago period. This increased level of revenues has maintained that which was realized in the fourth quarter of fiscal 2007. Revenues in this quarter were led by a year-over-year increase of 60% in our satellite payload revenues and that particular segment of our business is up at a rate of over 60% from fiscal 2007 as a whole. Generally, revenues from our non space U.S. government programs, especially that from our FEI-Zyfer segment, were up over 60% from a year ago levels and at the rate at which they are realized is about 25% greater than the year of 2007 as a whole.

Only our Telecommunications Infrastructure revenues declined year-over-year. We've often experienced these quarterly revenue fluctuations in this market area in the past, but with our greater diversification in product offerings, our operating results are going to be far less impacted by these fluctuations.

Cost of sales were $11.1 million compared to $9.5 million in the year ago period, resulting in gross margin for the fiscal 2008 period of $4.5 million compared to $4.8 million in the year ago period. Now this resulted in a gross margin rate of 28.7% compared to 34% last year but it also represents a sequential improvement from the 20% realized in the fourth quarter of last year. As we highlighted in previous calls and press releases, our higher engineering costs on certain satellite programs, which substantially began in the second quarter of 2007, have kept margins at this lower than targeted level. We expect such costs to further decline as a percentage of total costs in fiscal 2008 and beyond and, therefore, to see improved margins in subsequent quarters of this fiscal year.

SG&A expending was $3.1 million compared to $2.8 million last year. And as a percentage of revenues both fiscal 2008 and 2007 were in line with our target, which was less than 20% of revenues. R&D spending in the quarter was $2.2 million compared to $1.4 million last year at the same time. Fiscal 2008 costs did increase by 50% from a year ago, but they are 20% lower than that was recorded in the fourth quarter of fiscal 2007. Again, this reflects a continuing commitment of resources to satellite payload projects to increase our production capacity on a cost-effective basis. We expect to realize the benefits of this investment in subsequent quarters of fiscal 2008 and into the future. We expect R&D spending during the balance of fiscal 2008 however to further decline from the current levels. This results in an operating loss for the quarter of $792,000 compared to a $691,000 profit last year, but this first quarter loss is substantially less than $2.7 million loss realized in the fourth quarter of last year on comparable revenues.

Other income was $3 million in fiscal 2008 compared to $547,000 last year. And as we previously announced, this includes a $3 million pretax gain from our reduction in our investment in MORION.

Just a note, we will no longer be recognizing equity income from our MORION investment since we are below the threshold. Our net income for the quarter was $1.4 million compared to $0.9 million in the previous quarter of 2007 or 16% compared to $0.10 -- I'm sorry, $0.16 per share versus $0.10 earnings per share.

Just a note for those of you who may be modeling us, the MORION gain will result in a higher effective tax rate in fiscal 2008 than we've recognized in prior years. I would estimate it someplace 37 to 38% rate. This is because of the different tax basis for -- tax purposes from the MORION investment than report purposes.

In the first quarter of fiscal 2008, we will report negative cash from operations of $4.4 million. This is a result of the operating loss and phenomenal increase in our inventory and almost a $2 million increase in our receivables.

Just a note on that, major impact on our cash flow is the effect of unbilled accounts receivable. During this last quarter, at the end of last quarter, we will have $7.5 million of unbilled accounts receivable out of the $17.5 million that we have on books of total receivables. This is representative of the major large contracts that we have in-house that has grown substantially over prior years. And the timing of the billings is based upon the achievement of certain milestones, so it doesn't always track the revenues that you recognize. As an example, we expect to bill and collect about $5 million worth of unbilled receivables in this current quarter and that will have a major impact -- positive impact, obviously, on cash flows going forward.

At the end of the quarter, we would have a backlog at July 31st of $43 million. This is important to note that we were able to maintain this backlog at approximately the same level as at year end while keeping revenues at the same higher rate as the fourth quarter of 2007, and this is after a debooking of about $2 million related to telecom infrastructure at quarters, which does occur from time to time in our experience.

I will be turning the call over now to Martin and we will be ready to take your questions at the end of the call.

Okay. Let me address the highlights for this quarter and going forward.

First of all, with respect to backlog, on this -- in spite of the debooking that happened because of the commercial telecom, which happens periodically, and we keep it current, and the increase in revenue, we were able to keep the backlog about flat. I expect significant bump in the backlog because there are three major satellite programs in which we are heavily involved, and they will all be awarded to our customers before the end of the year, or are expected to be awarded. And we are confident that we will be awarded at least one of them because of the very critical schedule that satellite is on. As a matter of fact, in order to protect the schedule, we have gotten early approximately $1 million worth of funding to mitigate the risk of scheduled slippage by purchasing long lead items and doing some of this IR&D, which is -- this is customer funded, so it's actually customer funded research and development, to make sure that the schedule can be maintained.

With respect to the telecom industry, although they are a little bit on a bump down, they still project significant growth over this calendar and our fiscal year on this. And of course the big variable is when China will break loose. The latest date we get it sometime around January of this year, which is going to make it enormous pressure boiler plate to get the infrastructure in place.

With respect to WiMAX, we have been given long lead contracts to build up a significant amount of inventory for the rolloff of a WiMAX in the first three cities. And just to give you some numerics, our participation is over $1000 for base station. And what we hear from the street is the base stations are going to be between 10 and $15,000 a base station. And as you probably know, the numbers of base stations on WiMAX estimates are going to be anticipated of being north of $0.5 million if that program develops the way it's expected.

With respect to the US5G, we have made significant progress in Europe. We have sold over 30 US5G's and installed them for European customers, including the Orange Telephone Company in England, and in addition, about additional 30 versions of the US5G. In the U.S., the motion has been slower. However, I'm happy to report that we do have a US5G on line with one of the major RBOCs companies.

With respect to China, and MORION, we have gone through a significant milestone this year. Both our major customers have qualified the facility to be able to ship complete products directly from that facility to the field. In the past, they were qualified for doing subassemblies and we had to do the integration and test [on] FEI. We consider this to be a major milestone.

With respect to the low-g technology, we are under contract now for about 12 programs in the prototype phase and I'm also happy to report that we've gotten the first contract for pilot production, which is a rubidium low-g sensitivity timing system for the UAVs, they're unmanned airborne vehicles. And the prospect for this low-g technology for telecommunication, intelligence, interoperability of secure communications and delivery of smart weapons is very promising.

Proposal activity on the satellites is very high and the numerics are still the same for the next 10 years; the projection on the Street is they are going to build between 400 and 440 satellites. On this -- we are basing our estimates on a much more conservative number. We figure there's going to be 20 plus a year and our objective is to capture between three and five of those programs at a minimum in the near future. This -- at this time, just again, there are 11 satellite proposals outstanding that we have, of which three or four of them should be funded to our customers before the end of this calendar year. I believe that these are the main highlights of frequency with one final numerics that is important to keep score.

As we mentioned in the previous years, we shipped approximately seven microwave generators per year and I'm happy to report that in this test quarter and the next quarter, we will be shipping in excess of 60, so we are averaging approximately better than 10 a month and that's a major breakthrough in our capability of supplying this for this, our very aggressive market. And the opportunities for us in that market are very, very bright.

With those, I would like to turn over to any questions and answers that you guys might have.

(OPERATOR INSTRUCTIONS). Robert Lambert, R. L. R. Capital.

Good morning. I just wanted to know -- I know we get a figure for satellites over the next 10 years, but this unmanned planes drones if you will, what do you think that represents to frequency over the next five years?

Well, again, the projections that that's going to be a major vehicle that will be built in the thousands and that should be a significant portion of our DoD business. Nobody in the unclassified world has a firm number except that it's going to be a very large number.

And would that also be a -- could we sell out of the country? In other words, would there be -- would we be allowed to sell to, for example, Israel or other countries?

We are allowed to sell to anybody that meets the ITAR requirements and that means we can sell to any -- to Israel or to any European country that has an end use statement. And there are certain very strict rules of the ITAR, which allows us and our decision is simple. We get a request, we send it to the State Department and they either bless it or reject it. But the answer is yes; we are allowed to sell it to other countries.

Thank you.

(OPERATOR INSTRUCTIONS). Larry Litton, Second Line Capital.

First a follow-up on the last question. What's the value we have per drone?

Well, it's -- 20K would be an approximate number.

And how many other companies have the same capability to compete with us for that product?

To the best of my knowledge, at this time, with the performance that we achieved, we are quite unique.

Okay. And same question with the WiMAX market. I realize there's a big question about when and if and how big it will be, but the numbers that you threw out mathematically get to be about a $500 million market. Presuming that were the case, how many serious competitors to us would there be for that market?

Obviously, as time goes on, they are going to be other people that will be competing. At this moment, we are sole-sourced to one of the providers and we have provided it to two other companies. But that market, if it goes, will have 0.5 million major stations and probably 10 to 100 million small substations. You know, the plans are so elaborate that you're going to be able to buy one of those small spaces for your home and be wireless connected for the last mile. So it's really too wild at this time to estimate.

Do we participate on the substations, the 10 million to 100 million substations?

No. We don't play in those. Those are going to be something you are going to buy like probably through a Radio Shack or some of the other distributor and it's going to -- the estimated price of those will be like $150 this microstation.

But on the base stations, you would expect two or three other competitors at least to be competing against us?

Eventually, yes.

Okay. Thank you.

[Michael Amari], [Americo] Inc.

How are you? Let me just --

Can I wish you a happy new year before you start?

Thank you. Same to you, sir.

(multiple speakers)

Let me ask you -- we had one time a buyback program. In the last couple of weeks, I have seen the stock dip down all the way down to $9 level. I was wondering whether you give Alan Miller the liberty to get in and buy the stock around the $9 level in case it gets down there because the market is ridiculous recently as you know. So what is your status on the buyback program?

We look at it all the time and the Board will decide at this moment we have a much better use for the money for expanding our market share and looking at the opportunities of partnership and acquisitions because I'm very happy that the investment that we have made in MORION, which paid off for us in two ways -- first in a big return of cash and establishing a lifelong partner that supports our business in this area. And we have made another investment in L-com, which is a small microwave company, to add to our technology. So obviously we will look at any time at buying back the stock, but our primary objective is to grow Frequency Electronics revenue.

But you do have an authorization from the Board?

Yes, we do.

Well, thank you and good luck to you guys.

Buddy Howard, Equity Research.

Hi, Buddy.

Hi, how are you doing, Martin?

I'm sorry I didn't return your call.

That's okay. Good to hear from you. I just had a couple of quick questions. Relative to year ago numbers, the gross margin erosion that you've had, how much of that really reflects compression on the margin across the board versus how much of that reflects the increasing percentage of your revenues comprised of the satellite business?

Well, the majority of the erosion in the gross margin is due to IR&D and that additional engineering expenses and developing the new product line and taking it from a boutique status to be able to produce production quantities. And our goal is, like I say, we started with 70 here. We are now operating at approximately 100 plus a year. And to take advantage of the market that we see, we want to have to build up our capacity to approximately 200 of these microwave frequency generators per year.

In addition to that, we want to add the synthesizer portion and the Up-Down Converters, which will further enable us to increase a larger share of the satellite market.

And I don't know if I was clear, but I want to make it clear right now, we have 11 major proposals for satellite outstanding right now, and it's only the beginning -- almost the beginning of our year, so that's the area where the money went to.

Sure. How long do you see this kind of heavier investment in IR&D as it relates to the synthesizer and some of the other components taking? Is that like a six month, nine-month period?

It has significantly decreased from last quarter to this quarter and I expect it will decrease significantly in the next three quarters. Both our IR&D and engineering investments are decreasing significantly from quarter to quarter. And that will enable us to improve the margin significantly from the 28% that we are now.

Is 40% a possible goal for you guys to hit latter part of 2008 or would that be too aggressive?

I would be disappointed if we don't achieve it. And there's one other clarification I just want to tell you. The margin erosion was primarily due to satellites, not to any of the other product lines.

Okay, that's good. Thank you.

(OPERATOR INSTRUCTIONS). Robert Smith, The Center for Performance Investing.

Good afternoon. So Martin, in the past you've told me to keep my eye on the backlog as an indicator of where we are all going. So with a flat backlog over the last quarter, what are the prospects of building this backlog significantly in the next six, nine months?

Very significantly. We have 11 proposals on major satellites outstanding. Three of those are expected to be fully funded before the end of this calendar year, which is basically October, November.

And how would the three programs translate if you won them?

If we won all three, you will be very happy. If we win one, I'll be happy.

Okay. So one would translate to what build in the backlog?

Significant.

Okay.

Ten plus mill jump in the backlog and I just want to tell you we are very encouraged because we've gotten early funding from our prospective customer to mitigate schedule risk.

Okay. So and then there's this comment from Alan. He says as a result, gross margins increased from 20 to 28% and the operating loss is substantially reduced. As exceptional expenditures [obeyed] and higher revenues are realized, we can expect more meaningful improvements in gross margins, profitability, and cash flow to follow this fiscal year. But what about this fiscal year?

Well, I think it's implied that we were talking about the current fiscal year that we will expect to see engineering costs a little bit -- will be reduced. Therefore, our gross margins should start to increase. We have already seen a growth in our gross margins from quarter to quarter sequentially. And so we expect that Q3 -- Q2, Q3, Q4 that the gross margins will improve and as Martin has indicated, the R&D spending will probably also be (multiple speakers).

Okay. So that was a little unclear to me and I thank you for that clarification. So good luck.

Thank you, guys. We are very happy. We are on track and business looks very brisk.

Rick Hicks, Hicks & Hicks.

July 12, General Franklin stated that revenues turned up sharply in the fourth quarter and we see this higher rate continuing through the first quarter of fiscal 2008. Shortly before that statement, and shortly afterwards, there was insider selling by five of your executives. Only one insider bought. That was Charles Stone. That was an exercise of an option on July 24th, which he then immediately sold the stock. In view of the performance, which has not been up to expectations, and the insider selling by executives, how do you justify making stock grants to executives?

Well, let me start saying that -- this is Martin Bloch. I have not sold a share [of this]. And I obviously, you know, when you have a diverse population, that frequency and they are free to do with their options what they want as long as they abide by the law. And I don't think it had anything to do with the Company's performance. I am -- I haven't been involved in any of the details, but I am sure that they've done it to satisfy some personal needs. That's -- people have expenses and needs. And we don't overpay our executives, so if they need some extra money for special occasions, that's a case where they get it from. But I -- I can tell you that my holdings and my estate holdings have not sold.

How about the stock grants?

You know that in a small company, getting a stock option is a very powerful thing especially to our technologies. It makes them feel that they are part and that they are sharing in its future. And I found it a very powerful tool to attract people that are working their bones off to make this transition from the small, medium-sized company to the next size, and that takes an enormous amount of effort. And I recommended those stock options to the compensation committee and they agreed with me.

Thank you.

Larry Litton, Second Line Capital.

Martin, you know -- you talk about the IRAD and engineering development and the financial measures or bookkeeping measures. I guess in the past you talked about how you had a handful of scientists who could build these high-tech things, but what you wanted to do was to change it so that --

Ordinary people could --

Ordinary people could build it. So when you talk about IRAD and engineering development coming down, does that mean we are at the point where ordinary people can do what they need to do? What's happening on the ground in terms of mass producing with ordinary people?

Okay. The mass production is a misnomer when you are producing from 10 to 100, you are still actually the small production scale, but we have made significant achievements. Obviously, you know, to go from seven a year to 10 a month, is a quantum leap and we did improve the engineering development. We invested and built automatic test equipment so the data and testing can be done by a machine. So to transfer the smarts of those few scientists to machines in taking the data, they take it accurately and they don't take coffee breaks and they work 24/7, so that's a lot of the investment that we have made and it's behind us. And what we have done is we optimized the procedures that are -- I would say more than ordinary, but skilled people can align and test this equipment and this is how we've been able to increase the throughput to date. And the majority of this work is behind us.

And are their reject rates still too high or how does that look?

Well, reject rate in satellite is an unacceptable -- unacceptable name because in the 6000 assemblies that we have in the past 40 plus years in space, we have three failures.

No, but you have components coming through your line being built --

Yes, those are -- that of course is a problem that we track very carefully. It takes a lot of energy to keep the component reliability up because there are problems in incoming parts, but we have it under control.

I would also like to say that we have significantly, in addition to incorporating the procedures, increased our staff significantly in this alignment and test of these very complex microwave frequency generators.

So is there another surge in spending or another new challenge in terms of productivity? Or you're basically just working the same issue and when it's done, there's nothing immediately on the horizon that you have to focus on in this regard?

Right. We expect that the IR&D and engineering effort will significantly go down in the next three quarters because a lot of the problems have been put behind us and we have the procedure on how to manufacture it. And the IR&D we will be investing now is in the development of new products and trying to obtain a larger share in the satellites, where at this time, providing the timing system and the frequency generation and we are starting to get contracts for the synthesizer portions of the satellite. We still are after in capturing the synthesizers and the Up-Down Converters, which will enable us to significantly increase the value that we get for a satellite. So that's where the investment is going in this year.

And where are you in terms of physical capacity if these orders actually came in and how you could deal with that?

Well right now, we can -- we can ship 100 plus frequency generators a year and my goal before the end of this year is to be at someplace around 150 and then by the end of this, our fiscal year of April 30th, to be at a capacity rate of being able to ship 200 of these microwave or microwave equivalent generators out of Frequency Electronics.

Okay, so no immediate plant or labor shortages right now?

Well, it's always a challenge to find the right people but we have been successful and we also invested a lot in upgrading our people inside by training them and cross training them inside the Company and that's a continuous challenge. I'm always looking for a few more good men, not quantity.

What is the head count today and to get to that 200 rate, what would the head count be?

I think at this moment, we are about --

300 here in New York.

In New York, which is about 300, and we plan to increase by about another 15 to 20 people between now and the end of our fiscal year.

Okay. Thanks a lot.

Chris McDonald, Kennedy Capital.

What's the average revenue per frequency generator, Martin?

About 200 plus K.

Great. And then just a quick question on the telecom infrastructure biz. Alan mentioned that you had to debook a couple million bucks of orders. Is there any inventory risk associated with that business in general?

They [are for small inventories] but we are very fortunate that we have made it clear to our customers that they have to take the inventory risk if they want us to have the ability to basically take care of their crazy surges, which happens without any notice. So we have a good portion of our inventory guaranteed by our customers.

Okay, thank you.

And gentlemen, we have no further questions at this time. Mr. Bloch, I will turn the call back over to you for any additional or closing remarks.

Okay. Again, on behalf of myself and the senior management, I want to thank the employees of Frequency Electronics that are working very hard to increase our productivity and to make Frequency a successful player in the three major markets that we are in. I also want to thank all our stockholders for their patience. And as we have stated before, I want to reiterate again, we are looking forward to an increase in sales from fiscal 2007 and a significant increase in the gross margins.

I want to wish people of the Jewish faith a happy new year. And if General Joe Franklin would be here, he would wish our armed services to be safe and out of harm's way. Thank you and have a good day.

That does conclude today's conference call. Thank you for your participation. You may disconnect at this time.