Frequency Electronics Inc (FEIM) 2008 Q2 法說會逐字稿

Good day, and welcome to the Frequency Electronics second quarter fiscal year 2008 earnings conference call. At this time, I would like to inform you that this conference is being recorded, and that all participants are in a listen-only mode. At the request of the company, we will open the call up for questions and answers after the presentation.

Statements made 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 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 statements and other Securities and Exchange Commission filings.

At this time for opening comments and introductions, I would like to turn the call over to General Joseph Franklin, Chairman of the Board. Please go ahead, sir.

Thank you Katie. Welcome, everyone. Thank you for participating in our call this afternoon. We're very pleased to be able to report that our revenue right now is where we had had aimed it, and we expect this to continue for the rest of the year. As well, our operating income is up, and Alan Miller, who will follow me after this, our Chief Financial Officer, will have more to say about that.

I'm also joined by Mark Hechler, our Vice President for Operations and Chief Operating Officer, who will talk a bit more particularly about China and then our Chief Executive Officer, Martin Bloch who is offsite but is joining us by phone will also then be speaking on the rest of our projects. With that, let me turn that over to -- now over to Alan Miller, our Chief Financial Officer. Alan?

Thank you, Joe, and good afternoon, everyone. For the second quarter of fiscal year 2008, Frequency recognized revenues of $17.5 million. This is compared to $14.3 million in the year-ago quarter, and this represents a 22% increase in revenue year-over-year, as well as up 12% from the first quarter of fiscal 2008.

Revenues from our satellite payload program were up better than 50% from the rate of a year ago. Likewise, revenues from nonspace U.S. Government programs were up over 15% from year-ago levels. Our telecommunication structure revenues, are running 10% under last year's record rate. Cost of sales for the second quarter were $12 million, yielding a gross margin of $5.5 million compared to $5.3 million in the year-ago period. The gross margin rate for the second quarter was 31% as compared to 37% last year, but this represents a continued sequential improvement from 29% in the first quarter this year and 20% in the fourth quarter of last year. As indicated previously, the higher engineering costs on certain satellite programs, which are now being completed, have kept margins at this lower than targeted level. We expect to realize improved margins in the second half of fiscal 2008.

SG&A expenditures were $3.3 million compared to $2.7 million in the year-ago quarter. This is at 19% of revenues. Thus our SG&A expenses are in line with our target of being less than 20% of revenues. R&D spending for the quarter was $1.8 million compared to $2.6 million in the year-ago period. Over the preceding four quarters, our average research and development spending was in excess of $2.5 million a quarter. The higher rate of spending was especially focused on designing our satellite payload products to enable greater production throughput. As of the second quarter of this fiscal year, that initial effort has been largely achieved, such that our R&D spending can return to a more normal level of approximately 10% of revenues.

Our operating profit for the quarter was $376,000, compared to $19,000 in the year-ago period, and more importantly, this represents an almost $1.2 million swing from the $792,000 loss that we reported in the first quarter of this fiscal year. As we move on to more profitable programs, we expect to realize increased operating profits. Investment income and other expenses netted to $377,000 and were comparable to prior year. This leaves us with net income of $409,000 for the quarter, $0.05 per diluted share compared to $187,000 of net income in the year-ago period or $0.02 a share. Just a quick note, our effective tax rate year to date is at 40%. As we mentioned in our first quarter conference call, a $3 million gain that we realized on our Morion investment will more than offset the tax loss carry forwards that have been generated from last year. In the second quarter, we generated positive cash from operations of $1.8 million as we collected on certain contracting milestone billings. This is as contrasted to being down by $4.4 million in the first quarter of this fiscal year.

A quick comment on the balance sheet. We have cash and marketable securities of about $21 million. We have the very healthy current ratio of 5 to 1. You'll also see our receivables are at $17 million. A very important element of that especially relative to cash flow is is about half of those receivables are in the form of unbilled receivables where as -- whereby we have recognized revenues on certain long-term contracts but have not yet achieved the milestones to bill out. We do expect to collect on those in the next few months. Inventory is at $31.8 million, which is up about $600,000 from a year ago, but is down from where we were at the first quarter at the end of the first quarter, and we do expect that inventory will be drawn down further as we go into the rest of this fiscal year. Finally, just a quick note, our backlog at the end of October 31st was at just under $40 million. At this point I will turn the call over to Joe.

Thank you, Alan. Very fine report. Appreciate it very much. And, of course, when we finish with our talks to you, there will be a question-and-answer period. Mark Hechler is going to follow Alan, our Chief Operating Officer. Mark particularly I'd asked to talk a bit about China. With all the emphasis on space and the positive things that are happening this is something we feel is a very important addition to what's happening here at Frequency Electronics. Mark?

Thank you, Joe. Good afternoon, everyone. In this past fiscal quarter, FEI successfully completed the transfer to FEI Asia, a China facility, the manufacturing and test of all commercial production quantity quartz and rubidium oscillators. Our newly expanded facility has been qualified by two major telecom infrastructure manufacturers. The significant -- the benefits are obviously the reduction in cost and the ability to increase capacity. By December 2007, FEI Asia will have shipped 2,000 rubidium oscillators out of its new facilities. In addition to this, FEI Asia has set up a fully automated surface-mount assembly line currently producing printed circuit assemblies for FEI and its subsidiaries.

However, the major benefit of this transfer enabled FEI to increase its manufacturing and test capacity for producing space hardware in our facility on the East Coast. We're able to accomplish these tasks by, one, transferring trained personnel assembled specifically from our commercial group to our high-rel manufacturing group, and two, making additional space available to manufacture more of these space products. Right now, this facility is fully operational, and we're looking forward to a very good year with respect to producing commercial products. However, the major benefit as I recently indicated is giving us that capability to produce more hardware, space hardware in this facility.

Purely in New York.

In New York.

Thank you, Mark. Finally to wrap us up is Martin from his line off site. Are you there, Martin?

I hear you loud and clear.

It's your time. Go ahead.

Good afternoon, ladies and gentlemen. I'm very satisfied with the progress that we're making and the results of this quarter. We have been able to increase our throughput of microwave generators for space from, as I repeated many times before, from seven in 1996 per year, to approximately 14 per month in 1997. And our goal is to get to approximately 16 per month before the end of this calendar year. And that's a major achievement, and it gives us an opportunity to acquire additional space programs. We have a good backlog to continue, and to achieve the results we are projecting for this year. We are working on two major commercial programs, which we are going to be delivering the microwave generators and quartz oscillators. In addition, we are working on two VOD government programs, which are smaller portions of complexity but equally important, and have very bright futures.

We are baselined on four major satellite programs that are going to be released by government in the near future. We don't know exactly when, but they're targeted to be awarded, one in December and the other three before the end of our fiscal year. And, of course, after they are awarded to the prime, we are turned down fairly quickly because we are long lead items. Our proposal effort has been very hectic in space hardware, and we have over $60 million of open proposals, and we are working on additional proposals on a day to day basis. I would also like to indicate that we've gotten an additional classified program to continue development of the low G sensitivity for classified military pay loads, and the low G sensitivity has a very bright future for Frequency Electronics hardware. I want to express my sincere appreciation to the whole Frequency team for working very hard to achieve the results and putting us in a position to be able to book additional business and to grow as we must. I'd like to turn this over now to question and answers. Is that appropriate, General Franklin?

Yes. Katie, go right ahead. Thank you, Martin. We'll be all tuned into the questions, and we'll step up to the answers one by one, depending upon who you address. Please go ahead, Katie.

Thank you, sir. The question-and-answer session will begin at this time. (OPERATOR INSTRUCTIONS). Please stand by for your first question. And our first question will come from Robert Smith with Center For Performance.

Good afternoon.

Good afternoon.

Martin, where are you?

I'm off site on something very important.

Well, that's why I'm trying to track you down. Where are you?

Why?

Why doesn't he call you back, Robert, and you all can decide what you want to do about that. What is your question?

My question is what is the size of the China facility?

Mark, why don't you take it.

Approximately 20,000 square feet.

And how many people do you have there?

About 100 right now.

We have capacity over there to increase the space very easily and increase the number of people. That's one of the easy things that China makes feasible. They have lots of trained people, and that's very easy to do.

I didn't have my notes from the last call. What was the backlog three months ago? That's the time of the last call.

$43 million.

So it's actually slipped a little.

Yes.

Martin has said to keep your eye on the backlog as the determiner of the future of the company, so could you just give me some color on that?

Absolutely. We have achieved record sales, and some of the programs that are ours that we are baselined have moved slightly to the right, and nobody can predict when the government will place those programs. All I can tell you is that all of the programs have been approved by Congress, and they are funded. So it's a matter of red tape on when they are going to release them. Backlog doesn't come in linearly. It comes in lump sums. Any time a program comes in, it's a $10 million chunk. So we expect, like I say, these four satellites and some of the commercials to materialize over the next three to six months.

Okay. And finally, for this round, the Galileo program in Europe, if this goes forward is this a plus, a negative, or no --

It's neutral. No effect, and who knows if it's going to go and when. It has no effect on FEI or the GPS program which is the net navigational system now in existence.

Thank you. I'll step back in the queue.

We'll go next to Robert Lambert with RLR Capital.

Hi, good afternoon. Nice quarter.

Thank you, Robert.

Could you address a little bit about the uniqueness of Frequency now as far as competition and as far as what we've achieved in this transition and the way I see it, how we've sort of -- I guess would you say now we're more in a growth company mode. Can you address that a little bit, about how unique we are?

I'll take that, Bob. This is Martin. We have quite unique technologies. Let's take the satellites first. Our main competition is in-house. Actual satellite manufacturers. And we have an advantage of being able to build better performance, which is very important, lower noise, which gives better bandwidth and better throughput. Smaller size, lower power, and what's more important, our cycle time is considerably less than the large companies.

So there's a major move to outsource this type of assemblies to a reliable source. Now we have the capacity to produce, and we have the long legacy of reliable hardware in space. So we are in a great opportunity to benefit from that development. In addition, our proprietary technology on the lower G sensitivity is becoming very important for all military radar, secure communications, intra-agency operability, and other sensitive electronic missions. Everyone is wanting to listen with higher resolution and more security, and we have quite a few development programs on that area, and it has a very bright future for Frequency to obtain this.

At the same time, we have gotten the first order for the U.S. 5-G, which is basically in competition to obtain the large market that is available for synchronization for the telephone companies, and our equipment is operating very well in the field, and we're looking forward to booking significant sales in next fiscal year. Very little this fiscal year but we're over the -- basically the baptism of fire of getting the equipment underway.

All right. Thank you, and the only other comment I would make is I hope that over the next several months that you will be able to get to some conferences and to actually show off a little bit.

I believe, Alan, are we scheduled to appear at the Needham conference in January?

I don't think we've made any official commitment just yet.

Okay. Well, we'll advise you and our aim is to do that.

All right, thank you.

okay.

Thank you very much, Robert.

Thank you. (OPERATOR INSTRUCTIONS). We'll go next to Larry Litton with Second Line Capital.

Good afternoon. Thanks.

Good afternoon, Larry.

First question, obviously we've increased capacities significantly. Can you give us an update? I know it's by product line. As best you can describe it what's the volume capacity at this point to the dollar volume?

On which product line?

Well, either in aggregate or by product line.

Well, basically, we have the same capacity for the wireless communication, because this is the quantity is about constant per year, but the major achievement that we've done is we've moved this capacity to our China facility for two reasons. One is to reduce costs and improve margins, and the second and equally important is to release qualified people at FEI to be able to be transferred to the aerospace and DoD projects. On the space projects, in 1996 we shipped, I think, six or seven Frequency generators the whole year, and we're now shipping at approximately 14 a month, and our goal is to go up to 16 a month by the end of this year. So those are the two main areas. On the lower G sensitivity this is still in the development phase. It's only the prototype and pilot production on this because it's a new technology and a very exciting and revolutionary, and it will take a little bit of time before it goes into launch production.

What is the market potential of low G if the were to mature on a annual basis, do you think?

Well, in number of units, I'll give you some wild numbers that were given to us. For secure communications, about half a million radios that need to be updated with that type of clock. For existing and aircraft in their design, there are a couple of thousand of very sophisticated systems that are required. So remote pilot-less vehicles, it's a large number but the number is classified. And then the application on the low G is becoming important for every moving platform. So it's very difficult to quantify this except it's a very exciting, large number.

What's the unit value to us?

Well, that is something I would not like to do it but I can tell that you some of the units -- I'll give you a range of $3,000 to $30,000 per unit.

And what's the competitive landscape right now? Who else has the ability?

At this moment, to the best of my knowledge, we are the only ones that can meet this very stringent requirements. I'm sure that other people are trying to catch up. But we have a very basic patent on that technology so we are very comfortable. And just in terms of the statement about expecting good growth for the year, obviously we've had good growth year-over-year in the first half and we expect that to continue but is the second half volume going to be a nice step-up revenue wise from the first half or more or less similar to the first half volume?

I believe it will be a step up. I'll have to do some more analysis. Alan, I believe it will be -- what did we do the first six months?

$33 million.

I expect --

$33 million? We will match or exceed in that the second half.

In terms of gross margin improvement, is gross margin improvement in the second half strictly tied to revenue increases or even if the revenues were flat.

It's tied to a couple of factors on this area. We were able to manufacture the wireless product and wireline product at lower cost in our China facility. We have more productivity with those people for the military and space product. So both of the sectors will hopefully add to our margins meaningfully.

Going forward the China transition is still going to be increasing the margins that's not done yet?

It's a work in process.

Maybe lastly, can you just talk a little generally about WiMAX and Sprint and the demise of that venture? Do we not talk about WiMAX any more?

No, we talk about WiMAX. With any new technology, it sometimes hits a bump on the road, but from my discussion with the people in Motorola, they feel it's a very exciting technology. They are not reducing their pursuit of this implementation, and, as a matter of fact, I believe that they just booked a system for Taiwan using the WiMAX approach.

In terms of any real revenue opportunities for us is that in the next twelve months, the next two to three years?

If I knew that I would know which stocks to buy but I have no idea how the expansion is going to be.

All right. Thanks a lot.

Thank you very much, Larry.

And we'll go next to Hardin Bethea with Idea Group.

Hey, guys.

I didn't know you had changed your name.

We have multiple names.

Good to hear from you.

Good to hear from you. Just curious, Alan, improving the gross margin is consistent with what you said last -- I think last quarter. It's a magnitude of improvement. Was that also as expected?

Yes, we definitely expect to see improvements across the board, particularly as some of these lower margin programs are completed. So that's why we're pretty confident going into third quarter and fourth quarter that we should see continued improvement in gross margin in addition to what Mark just talked about with the lower manufacturing costs to China.

Okay. Is -- in terms of the wireline order, the U.S. 5-G order, Martin, that you discussed, is that a production order?

No, this is just a feasibility -- just a token order to show that we have gone through the difficult transition period of getting the equipment qualified and accepted to be used by [RBOX] manufacturers. The importance is not the dollar value. It's the idea that they are serious about our equipment. It's a very difficult battle to go through until you're accepted on this took us two-and-a-half years of testing before they accepted the equipment. So we're very happy that we're through that difficult process, and they have accepted and bought a piece of equipment, because usually they want it for free. So when they buy it, it means they are serious that they'll start implementing it in the field.

Okay. Does -- the other question is related to the wireless, terrestrial wireless business. How would you describe current conditions? What are your customers saying?

Bumpy is what they're -- well, they are saying that everything is rosy but what we are seeing is a very bumpy road ahead. Very difficult to foresee what's going to happen and who's going to win out, and how it's going to develop on this. In the meantime, we have reasonably good backlog of orders both for our new quartz, which has been baselined on many base stations, as well as our rubidium existing older products. I was going to ask you what do you see about the wireless?

It's not clear to me, either. I was just curious. Different markets.

I tried to get calibrated from our customers with great difficulty.

And there's no significant increase in order activity in China?

China is a dilemma on this. Supposedly it will break loose any day, but I've been hearing it now for two years. So, so far, nothing has moved out in China, to speak of. I don't know how they're going to manage and what they're going to do for their summer Olympics, but nothing has broken loose.

Okay. And then finally, the company's involvement in external initiatives to broaden the investor base and the awareness of investors regarding the company, could you kind of describe the efforts that are underway to, you know, as we sit kind of at the precipice of what looks like a significant market opportunity as the company seek to communicate that opportunity more efficiently or maybe more meaningfully to investors than the -- and the investing public?

This we have to solidify, Hardin, on this, but we realize the necessity to do it now, and to participate in more of this financial conferences, and try to give more time of me and some of the senior management to travel and talk about the company. We'll solidify this program before the mid-January and we will advise you.

Okay. Thanks.

And we'll go back to Robert Smith with Center For Performance.

Hi. So how much is left of the low-margin stuff? Are we going to see this end in the third quarter?

I believe most of the low margin stuff will be accounted for in this coming quarter.

When you say most, still going to drag into the fourth?

I don't believe so. I'd have to take, with Alan, a closer look. I believe that all of it is behind us.

Okay. And circling back to the low G, you added that you had a strong patent position. So could you go into some depth on this as to what you're speaking about? I mean, as far as the competitive landscape.

Basically we've gotten a basic patent which allows us to achieve this type of performance that has never been achieved before in industry, and that's a patent we're using on all of our devices, and I believe that competition will have a rough time beating that patent, or work around it. How much lead time do you think you have? Well, I would say until somebody comes up with a different hook that bypasses this patent, five years.

But you've got further work that's necessary in this before it becomes commercial?

Say that again.

You have further work to do before it becomes commercial?

It's never going to become commercial. This application is primarily for military end use.

Well, I meant from a business enterprise.

From a business enterprise, a lot of prototyping due because systems have to be updated with this new capability and introduced into new systems which are now being developed, but I forgot to say there is some commercial application because commercial carriers, communication that they carry on board through satellite will also benefit through this lower G sensitivity clock. We're building some for customer already.

But you don't have to tweak this any further, it's there now?

It's going to be tweaked because we want to get another 20 to 30db improvement and we he want to make this unit manufacturable. At this moment it's only being made in prototype quantities. So there's going to be continuous development, and we've gotten a lot of support from government to do it. We have one contract which is to develop, and we're proposing two or three other contracts to improve the producibility of the device and improve its performance. The more you improve, the better it is. Very significantly for radar and secure communications.

So what time line are you looking at, like one to three years?

That's a good line.

Okay. All right, good luck and happy holidays.

Thank you, to everybody.

And we'll go next to Robert Lambert with RLR Capital.

It wasn't clear. Are we allowed to do satellite work that's out of the United States? In other words, foreign government or putting a commercial satellite? Do we get that work, can we get that work?

Yes we can. It's a little bit more difficult because the Europeans do not like to buy American products. So they buy only American products that they cannot make at all. But we are allowed to do it. We need State Department approval for every satellite, but we are allowed to satellites that don't go into harm's way for the United States.

Okay. Thank you.

You're welcome.

If there are no further questions I will turn the conference back over to Joseph Franklin.

Thank you very much, Katie. Thank you all for tuning in today. We appreciate your interest, and also your support. Of course, we're part of a much wider corporate audience that's looking to the future, not only with the kinds of things that Sarbanes-Oxley is proposing but world affairs today, and the finances of our own country. With all that said we are looking forward to the increased pace of that business we've been able to generate and moving ahead with that along with building our profitability. The outlook for Frequency Electronics is very, very good. And with that said, I'd like to wish all of you a very pleasant holiday season. I hope your celebrations are all good and that your families and friends are with you. God bless our soldiers and their families, and thank you very much for joining in.

Happy holidays to everybody.

Happy holidays. Thank you, Martin. Thank you, Alan, thank you, mark.

Joe, call me back on my line, please.

Got you. Okay.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 1-888-203-1112, or 1-719-457-0820, with a passcode of 1114761. This concludes our conference call for today. Thank you all for participating, and have a nice day.