Frequency Electronics Inc (FEIM) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to the Frequency Electronics year-end earnings release conference call. Today's conference is being recorded. At the request of the Company, we will open the call 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 introductions, 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.

At this time for opening comments and introductions, I would like to turn the conference over to Mr. Martin Bloch, President and Chief Executive Officer. Please go ahead, sir.

Good morning, everybody. Today's conference will be attended from Frequency Electronics by myself, Martin Bloch and Alan Miller. General Joe Franklin, had a previous commitment to make a presentation and he wishes everybody the best of health and will not join us at this conference call. I would like to turn over the microphone to Alan Miller who will go through Frequency Electronics' financial presentation.

Thank you, Martin, and good afternoon, everyone. For FY 2008, revenues were $64.4 million, compared to $56.2 million last year. This is a 15% increase in year-over-year revenue, led by better than 40% increase in revenues from satellite payload programs. Revenues from telecommunications infrastructure softened, compared to the high revenue rate of fiscal 2007. While nonspace U.S. Government programs were also up over 40% from year ago levels.

Loss of sales for the year was $46.7 million compared to $39.1 million last year, yielding a gross margin of $17.7 million in fiscal 2008 compared to $17.1 million in the year ago. Now, this is a gross margin rate of 27% as compared to 30% a year ago. As we noted in the press release, cost of sales was especially impacted during the fourth quarter for higher than expected costs on three large satellite payload programs that were nearing completion. Since these programs are long-term percentage completion programs, these costs not only impacted cost of sales but also reduced the amount of revenue recognized, thus having a dual negative impact on margins.

SG&A for the year was $13.1 million, compared to $11.4 million last year. For the year that is -- SG&A was at 20.4% of revenue which is within range of our target of 20%. R&D spending was $7.1 million, down from $9.4 million last year.

Our R&D spending throughout fiscal 2008 trended down and approached our target of 10% of revenues. We expect this self-funded R&D trend to continue into fiscal 2009 as we expect to engage in more funded R&D efforts through the new development contracts we were recently awarded. Martin will explain some more on that issue.

This resulted in an operating loss for the FY 2008 of $2.6 million which is reduced from the year ago loss of $3.7 million. In other income, it was $4 million in 2008, compared to $1.9 million last year. Most of FY 2008 income was generated by the $3 million gain on the sale of a large portion of our investment in Morion during the first quarter of this fiscal year. As a consequence of this transaction, no longer account for Morion on the equity method as we did in fiscal 2007.

Our pretax income was $1.4 million, compared to a $1.8 million loss last year. Net income for fiscal 2008 was $887,000, or $0.10 per share as compared to a loss of $257,000 last year or $0.03 per share. Just a word on our effective tax rate; it came in at 39% for the full fiscal year. This is higher than our historical rate, typically in the low 30s to 30% range. This is mainly due to the higher tax gain on the Morion sale.

For fiscal 2008, we will report negative cash flow from operations of $1.9 million, but for the fourth quarter we did generate positive operating cash of $2 million. Included in our balance sheet in accounts receivable of $19.8 million, are unbilled accounts receivable of $9.6 million. As contract milestones are achieved and deliveries occurred in early fiscal 2009, we expect positive operating cash flow in the first half of fiscal 2008.

Other items on the balance sheet, cash and marketable securities are essentially the same as they were last year at this time at around $15.4 million. This was offset buy about $5 million in borrowings under a line of credit. Also, inventory is at $30.2 million, down from the year ago of $31.2 million; thus reversing the trend of rising inventories that we've experienced over the past two years.

Finally, a backlog at the end of fiscal 2008, ended April, is at $39 million as compared to $45 million at the end of fiscal 2007. Delays in bookings of new satellite contracts prevented growth in backlog last year. However to-date, including new GPS III program, the backlog is up to around the mid $40-million range. At this point, I will turn the conference over to Martin and we'll answer your questions a little later. Martin?

Again, good afternoon. I want to address four basic concepts. One is the profits we encountered in the three major programs -- satellite programs that are nearing completion in this quarter. This -- number two, what we are doing about it for the future. Number three, some color on the research and development contracts that we have gotten in the last quarter of '08 and the beginning of '09. And number four, the open business opportunities for Frequency Electronics.

We were in a very difficult situation. The good news is that over the past three years, we were able to increase our throughput of microwave frequency sources for satellite from ten in 2006, 50 in 2007, and 150 in 2008. The difficulty with this growth came a lot of extra work, because we had the units qualified with designs that were very difficult to manufacture in two aspects.

They required an enormous amount of high-skilled, individual tuning of each of these assemblies. Second, and equally difficult, is the surface-mounted manufacturing process was all manual and required a lot of labor in assembling the process and very difficult to make selective tests. We couldn't do anything, because of schedule constraints and qualifications. We had to really put all the necessary manpower and resources to get those units through to our customers, because they needed them for launch and that was very expensive to us.

Looking in the future, we have initiated the very active program to overcome most of those difficulties. Since the state-of-the-art designs are always going to be a certain amount of -- great deal of amount of skilled labor required in producing the devices. However, we can significantly make it easier by initiating certain procedures and processes.

Number one, we are looking at the design and packaging to make them easier to assemble and test. On this end, we have started it on all of the future programs and tried to phase them on the programs we have in-house. Second of all, is we have increased significantly our ATs, automatic test equipment, to do a lot of the testing automatically and at night, as well as daytime so we can have testing going on 24/7 with minimum amount of personnel. Thirdly, we have added a significant amount of new people to this process. With new people, there's comes a certain amount of training and disciplining that we need to impose in order to make sure that we get the best quality of the product and the most expeditious time.

A lot of training has been started and continuing in getting all of those people up to speed; and making EMS smart as the tribal knowledge that we had when we were making only ten units a year. Fourthly, the surface mounting assembly has turned out to be a bear. The small components which are basically 40 mill, that's 40 thousandths of an inch by 80 thousandths of an inches in size, manually mounted on PC boards, takes an awful lot of care and awful lot of time. What we are facing here is automatic surface assembly equipment which will significantly reduce pouch labor time and produce a more uniform product.

We expect to have all of this or the majority of it accomplished in fiscal 2009 and being able to produce this hardware at much higher profit. That's the commitment that management and all of the key employees are making for this year. It will -- most of the equipment has already been purchased. The investment in new equipment will be someplace around $2 million which is routinely what we budgeted for this year.

All of the major three programs and the shipments that were made in the fourth quarter of last year and the beginning of the quarter of this year had this type of complexity. The basic idea is that no compromising in quality because you are not -- you are forgiven if you lose money, you are forgiven if you are a little late, but you are not forgiven if you have any quality problem. And we have now one satellite with a majority of this microwave operating very satisfactorily in orbit. We are very happy because it establishes Frequency Electronics as a legitimate sources for this microwave sources.

Third, I want to address to two very exciting contracts we got. One is for an advanced clock and synthesizer for critical DOD program. And the second is the master clock and microwave sources for the GPS III program. This is very promising for added future business from this program. They are a direct result of investment in our technology that Frequency Electronics has done over the past couple of years. That's what got us to win those programs. The other good part about this program is it's built on a good portion of our R&D for future products, and that's a good thing.

Last, is to address the business opportunities. From the way we look with an opening proposal book of approximately $100 million, is that this will be a year for a record booking on satellite business. The previous high-to-date was 28 -- in the high 20s. I think $28 million. Right, Alan? Is that a good number?

Unfortunately in fiscal 2008, we only booked in the mid-teens, because many of the programs moved to the right. As an example, the GPS III program was supposed to have been awarded in October, November of 2008 -- 2007. And because of the delay by the government, we received the go-ahead in the mid of May. That cost us both time that we could have increased our shipments for 2008 and it moved into 2009.

And there was another -- about half a dozen programs that both are moved from late calendar of 2007 to the mid to late of calendar 2008. Programs such as many of you might have heard, [T-set] goes on this advanced EHF. We hope to be able to book some of them, if not most of them, this year.

In general, I can say that the success of Frequency Electronics has made a lot of progress in many areas. And because of our credibility of being able to produce this type of quantity space hardware, we expect record bookings on space hardware in fiscal 2009. I would like to turn it over at this time for answers and questions.

Thank you, sir. The question-and-answer session will begin at this time. (OPERATOR INSTRUCTIONS). Please stand by for our first question.

Can we ask the person asking the question to address it either to Alan Miller or Martin Bloch, please?

Certainly. The first question will come from Bart Blout of Sawtooth Capital.

This would be to you, Mr. Bloch. I missed the first part of the call, but I don't know that you went into this. My concern is when you have all these hope-for start and stops and are seeking to do a lot of business, the part that you want to call assembly or factory or anything like that, doesn't that hemorrhage red ink when you have downtime and nothing to put up? How much money does that cost you and what do you plan to do about it in the future?

So far, we have zero downtime on this. It just took in a lot more hours to produce the hardware that we have to deliver on this item At this moment, we actually are looking to still expense our capacity to be able to handle future record business that we expect. We didn't have any downtime on this.

I wish we had a little bit of downtime on this. By putting in this automatic equipment and this automatic assembly time, it will allow to us grow without increasing personnel but just increasing revenue and bottom line.

But you still have to amortize that over so many units or some product.

Well, as I think you missed the beginning. We bought most of the test equipment last year. We only have to add approximately $2 million of additional equipment on this. Therefore basically, we'll increase our throughput without having to increase enormous number of people to do it manually. Obviously, machines are much more profitable than people.

Then the other thing is for -- could you reference what you think would be a good or hopefully, you've got a good pursuit in being able to interest people in your company, because it's as I was mentioning to some others, it's like a private company where you hear a peep every now. There's no interest in the Company and a big holder can affect it on the sales side. There's not enough interest or following for people to buy it. And it becomes a very frustrating stock to deal with. I don't know if you have contemplated putting updates on your website or whatever, but it isn't working. I think you would agree.

I would welcome any type of recommendations from you guys on how to do it better. I'm a technologist and my mission is to generate wealth. How to get outside people to appreciate it, I would welcome any type of input on how we can do a better job there.

We have of course gone to some conferences in the past year. We've just been at the Needham conference for example, back in January and went to the AEA this spring. It's just a question of how much more we should be doing, but we have made some attempts at this.

I know. I understand that. But one conference and then no follow up and no pursuit, and no nothing when they have this crisis that we've had in the market just isn't working.

I understand. You make a very good point. We will give it some thought and action. I would encourage any of you that have ideas, please don't hesitates to send an e-mail to me and Alan Miller.

We welcome your thoughts. This is your areas of expertise. We would like to here from you and take it in as good as we can. In the meantime, we will focus our energies on generating revenue and profit.

Thank you.

(OPERATOR INSTRUCTIONS). Next question, Michael [Amari] of Americo.

Hello, guys.

Hello, Michael.

How are you guys?

I'm glad to here you're in good health.

Thank you. Congratulations on meeting milestones in terms of record volume.

Thank you.

And directing the Company towards growth. You are asking a reasonable question about recommendation about how to get the stock capitalized or going up. And the simple way to consider will be what we talked about last time, the reinstated -- the dividend partially or fully.

Even at the cost of excluding your own holdings from the dividend, because there are a lot of institutions that need that dividend to justify owning the stock. That was the cement that was holding the stock at a double-digits. Now, we are suffering at a lowly five, because of the misdirection of removing the dividend which was a real -- your own great achievement over the years, having a good balance sheet and managing to pay the dividend.

Well, Michael, we will take it up at the next Board meeting and depending on business development and cash flow, and how we can best use the money, it will be on the table, I promise you that.

Even at $0.02, instead of the $0.10 that you're used to paying, would have been better than removing it. (multiple speakers).

We're taking your suggestions.

You understand the situation here. We are losing the sponsorship, because of that very faulty position to make that a small savings at a cost of about $30 million in capitalization is a real foolish step. But that's up to you guys.

We hear you, Michael. As we said, our normal time period for evaluating this for the Board is in our spring meeting and our fall meeting. The fall meeting, we will definitely take up that issue once again.

Thank you.

Your next question will come from Jeffrey Myers of Wachovia Capital.

Two questions, first one is the wireless business. Is there any difference between LTE and Wi-Max insofar as you having safe devices out there? Is one better than the other for you?

Wi-Max is much better for us for a couple of reasons. First of all, we are all designed in and for many of the manufacturers, we are sole source. We have a very economical solution for that. We are cheering for Wi-Max.

Okay. And then the second question is on the wireline side, just if you can give a little update on the upgrade cycle in the U.S. and how you guys are doing versus your big competitor out there.

Well, nobody is doing very well, because the upgrade is moving very slowly. The good part is that we have gotten the first orders from American users. We are now integrating the equipment online. The predictions are very exciting, but I'm from Missouri, I've got to see it before it happens on this. Obviously, it needs to happen, but when it's going to happen is anybody's guess.

All right. Okay. Last question for you just on -- back in the satellite side, I guess there are a couple contract announcements that you guys are waiting for. Do you have any sense on the timing on those? Or it could be any -- ?

The only sense that we have is what the government projects on this. Basically and I can tell you out of the eight programs that we are looking at, the only time line that so far has been announced is that TSAT and advanced advanced EHF is going to be funded this calendar year.

Got you.

The rest of them is in limbo. As a matter of fact, there are two more classified programs that are going to be funded this year. About four or five of these programs are going to be funded this year. We have good expectation that this will allow us to get our record bookings for fiscal 2009 in the satellite business.

Got you. Okay. Great. Thanks, guys.

(OPERATOR INSTRUCTIONS). Our next question comes from Larry Litton of Second Line Capital.

Thank you. Martin, first of all in terms of the three problem programs, what stage they are versus completion. When will they be completed? What's the risk of additional charges being taken in the first fiscal quarter?

Okay. On the three program, one has been shipped and complete and the other two are about 70% complete. We still have 30% to go through on this and we are trying to run them as efficiently as possible. Obviously, most of the blood letting has been done.

Of the ones that are 70% complete, when are you slated to be 100% complete?

Our target is to complete the other two programs before the end of August.

And are they being booked currently at a zero profit margin?

Alan?

It will be close. There should be some profit margin in there at this point. I'm not sure how big.

Once you get past those programs, where do you think the gross margins would normalize?

Once we get past these programs?

Yes.

We would probably start seeing them get into the more of the mid 30-range.

You're hopeful that by the second half of the year, we would be at 35% gross margin?

Somewhere in that area.

You are talking about record revenues for fiscal '09. I assume you are looking at revenue growth?

No, no, no. We are saying record bookings.

I'm sorry, record bookings. Could you speak to what type of revenue growth you might get in '09? Some range?

That, we have no idea. We don't know the timing on how these programs are going to come in. And it's been traditionally not our policy to project revenues.

And the record bookings, you are talking about just the satellite division?

Yes. The satellites is the ones we see on -- by the way, the military work that we are doing is also very encouraging, because many of the programs that we have done with the low-G technology that we have been in the prototype phase for a long time. We now have a couple of programs of what is called the preproduction phase and we see that business also growing.

The wireless is hard to predict, because it's a wildcard. If you listen to the Motorolas and the Lucents and the Nortels, it's going to be great business. But I've heard that over and over again. Until we receive the orders, we are not going to do it.

I thought Telecom was still pretty much still on its back, though, so it shouldn't get worse, should it?

I cannot predict. I can tell you that with the record bookings that we see in the satellite and the military, that we have a hard data on, we can see that this is a year going to be a record bookings and very profitable.

And a final question for Alan. What's the total debt, short-term and long-term today?

Just a little over $5 million. I'm sorry, you want short and long, about $6 million.

$6 million. Okay.

Really that includes a capital lease of $900,000 long-term.

Okay. Thank you.

And David Starkey of Smith Barney has our next question.

Hello, David?

How are you doing?

Okay.

Good, good. Just a couple questions for you.

For me or for Alan?

Alan would be the primary one here. (multiple speakers). Alan, on the balance sheet, what's the cash level look like right now when you include your various investments? And how are those performing?

$15.4 million.

Are those invested primarily in treasuries now or -- ?

Agency paper, primarily. (multiple speakers). Now, the actual balance of marketable securities is quite low in comparison to prior years. It's only about $4 million. A lot of it's right now in money market funds, because we had a lot of redemptions during this past fiscal year. There's a lot of cash in money market funds.

Great. And then, the other question related to going forward on your contracts. Are most of your new bids going to be cost plus now?

I hope not. We have two large contracts that the customer insisted on making them cost plus, because of the changes that they anticipate and that is easier for them to manage. But we've got now about $20 million of cost plus, so that's probably the largest amount we've ever had on cost plus contracts. Most of the other contracts that we are pursuing, we are pursuing at fixed price.

Which you anticipate being more profitable?

It gives us a flexibility and a lot more profitable, because cost plus margins are very tightly controlled by the government.

It doesn't, don't you get or run the risk of a lot of cost overruns, though, like you have in a lot of these other contracts when you get that situation?

If you want to have risk good profit, you always have to have risk of possible over expenses on this. But we prefer to learn as we move on. We've learned every year. This was a big lesson to swallow by going from ten to 150 space assemblies per year which we've learned a lot and we've put a lot of lessons learned into work. Now, we want to reach the -- get the benefits of better margins.

Now, the current two contracts that you got a bit left to go will be this first first quarter numbers?

Yes. They are scheduled, as I mentioned before, they are scheduled at this time to be completed by the 26 of August.

Given your learning curve, you feel pretty confident that you are going to get a much stronger second half of the year? We've heard this before, but you feel more confident this time about it?

Yes.

Okay.

Well, the confidence is one. And lesson learned and getting the productivity behind us and is more positive. A lot more positive.

And you anticipate announcing -- there's at least a couple potential large contracts that could be relatively soon, right?

Yes, and we will announce them as we get them.

Great. Good luck, you guys.

Thank you.

Our next question comes from Robert Lambert of RLR Capital.

Hi. You did partially answer this, but if you could expand a little bit. These unmanned aircraft that we are working with, I guess that's what you were referring to in the military programs. Do you see that expanding?

From the military point of view and if you read on this, that's the major investment that our military is making and making more of this remote up (inaudible) around. If I tell you any more details, I'll have to shoot you.

All right. And can you expand a little bit more that we are completing done as far as expansion -- as far as expanding in our new technology or wherever -- assembly line? I know you've had a tremendous learning curve. Could you now -- for example, I know one of your slides spoke about payloads as much as possibly $20 million, $25 million per satellite.

Yes. The whole game plan that we put in place for this year is to build increased capacity and more hardware on the satellite without significantly increasing personnel by putting this better designs, automatic testing and automatic assembly equipment online. And we are still pursuing in getting larger portions of the per space craft and are working very hard to get that part.

And the other question I had, if there was something that you had in your mind that would be excellent for frequency to buy? In other words, some small private company that would just make our efforts so much easier, is there something that you have in minds? I don't need to know the company, but is there something that you had in mind that we might need to purchase?

We are looking at it all the time for opportunity to increase our partnering or increase acquisition that will help us in the growth process and in our ability to produce more profitable hardware. It's always on the horizon, Bob.

Well, thank you.

You're very welcome.

We have a follow-up question from Larry Litton.

Alan, one question for you and one question for Martin. In terms of working capital, Alan, either holding revenues flat or given some type of growth, is the working capital a source of funds or is it use of cash?

Working capital would be a source for us, I think at this point.

If revenues were flat, what could you get out of working capital?

As I mentioned, the critical thing is in our balance sheet is a lot of unbilled revenue that results from these long-term contracts. We recognize revenue prior to actually sending invoices out on a percentage completion basis. As Martin alluded to, we are going to be seeing these programs completed in the next couple of months and we will get the billings out, substantial dollars in those. We will probably collect those by, let's say, end of September or thereabouts. We will have a very good source of capital right there.

I'm sorry, those are receivables?

They are in the receivable, but they are called unbilled receivables.

Anything come out of inventories or are inventories pretty normal at this level?

We expect our inventory is probably at a higher point right now. We will probably take that down over this coming year as well.

You might get a couple million out of inventory and $5 million out of receivables?

Yes,.

Okay. Martin, last question for you. You talk about all the lessons you've learned and every year, you are learning lessons. That's fine, but a lot of companies have learned these lessons before and in some ways, you are learning them the hard way. Have you given any serious consideration to bringing in either a strong, independent president with experience in terms of manufacturing and volume and ramping? Or bringing in a CEO and you becoming a chief technical officer and chief sales officer in a sense?

Everything is on the table.

Well, on the table or is given serious consideration are a little bit different.

We are giving serious consideration to getting expertise. The problem that we face is in this type of technology it's very difficult to find individuals on this. We've been looking for a senior manufacturing person just now for about a year and a half. And you really are right that there might be outside people that can do it at a better pace than what we have done by ourselves, and we are not ignoring that.

And Martin, I know you have a nice thing going there and you have a friendly Board, but you might consider getting some new blood under that Board because I don't think that Board is adding a lot of value in terms of bringing something forward.

I've been thinking about it very seriously.

All right. Appreciate it.

There are no further questions. I will turn the conference back over to Mr. Bloch.

That's it? No more questions? Well, thank you everybody for attending. We are doing -- everybody is working hard at Frequency to grow and to produce profit for all of us and especially, the stockholders. I want to wish everybody good health and if Joe were here, let's not forget to get our best wishes for our armed men in harm's way. Thank you very much for listening. If anyone -- I want to emphasize again, if you have any suggestions on this, please take a moment, send us an e-mail. We would welcome your input and we'll give them serious consideration. Thanks again. I'm signing off.

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 2017004. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.