Frequency Electronics Inc (FEIM) 2009 Q4 法說會逐字稿

Good day everyone and welcome to the Frequency Electronics Inc. fourth quarter fiscal 2009 earnings release conference call. Today's program is being recorded.

At the request of the company, we will open up the call for questions 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 remarks and comments, I would like to turn things over to Mr. Martin Bloch, President and CEO of Frequency Electronics. Please go ahead sir.

Good afternoon everybody. I'm sorry -- General Joe Franklin is not going to be able to join us. We expected to have this conference call about a week ago and Alan will describe the circumstances which caused our delay until today. So you are stuck with me.

I would like to turn over this presentation now to Alan Miller. And just to set up the scenario, I will make some remarks after that and then open to questions and answers. Alan, please proceed.

Thank you Martin. Good afternoon everyone. As Martin said, we do apologize first of all for the lateness with which we're having this conference call as well as the earnings release from this morning.

As you may recall, about six weeks ago we did make an announcement with respect to some write-offs that we were going to take against our telecommunications inventory and followed that with a board meeting and audit committee meeting and we felt that shortly thereafter we would be able to have this call and have the earnings release at that point in time. Literally a week and a half ago, a matter of a valuation allowance for our deferred tax assets was raised by our audit firm.

We were anticipating that we might have to post some valuation allowance but the idea of a 100% valuation allowance on deferred tax assets was not something that had occurred to us in previous workings with the auditors. Now because we have a new audit firm, we also engaged third-party tax accounting advisers as well as the prior year audit firm that was engaged last year.

There was considerable amount of effort to coordinate, to do the analysis, to look into all the issues and matters. And quite literally this morning, we were still going through some of the nits and little bits to make sure we had everything tidied up properly.

So that is the rationale for the timing of this release. As you might also imagine, we are also in a process of trying to file the 10-K yet this afternoon. So a lot of things going on.

And if you permit me, I just want to go on my soapbox here a little bit. Because I think that this situation is something that has come up recently with the Sarbanes-Oxley and awareness of asset values and things of that nature. It kind of adds up with a very perverse result.

I want to emphasize by way of not criticizing my accounting firm. The auditing firm, they did their job. This is in general relationship to the accounting profession entirely because what happens now is that we have made a poor year look a lot worse.

But as we turn profitable in future years, this valuation allowance could be reversed. And all of a sudden, you make a good year look spectacular and so initiated investors might possibly be confused by that issue. So it does give some rather skewed results. Anyhow, I'll get off my soapbox and get onto the numbers.

For fiscal year 2009, revenues were $52.7 million compared to $64.4 million in the prior year. As we discussed in the press release, in fiscal 2009 we saw a large increase in our government related satellite payload revenue but this was offset by a very sharp decline in commercial satellite business, reflecting somewhat the tougher economic climate that we are in.

Overall, satellite revenues were down approximately 25% year-over-year. Revenues on non-satellite US government and DOD business were modestly lower in 2009 although they were trending upward in the last half of the fiscal year.

Wireless telecommunication business continued to decline year-over-year and that decline accelerated in the second half of fiscal 2009. We are happy to indicate that we had important first-year sales of our new Wireline sync products in the United States but this revenue does not yet match the wireless revenue decline such that our overall telecommunications revenues were off by more than 20% from fiscal 2008.

Now because of the decline in the wireless telecommunications market and the future prospects for this arena, as we mentioned we increased our inventory reserves by $2.9 million in the fourth quarter and by $3.4 million for the full fiscal year. This reduced our gross margin rate in 2009 to 19%.

But as we highlighted in the press release on a non-GAAP basis excluding the write-down, the gross margin rate would have been 26% comparable to fiscal year 2008's 27%. And for the fourth quarter, the gross margin rate would be 30%, a substantial improvement from earlier in fiscal 2009.

We have made every effort to control our costs by personnel reductions and cutting other indirect costs and expenses and our annual expenses are now approximately $10 million lower than what we were experiencing in the first half of fiscal 2009. SG&A for the fiscal year were $11.4 million compared to $13.1 million last year, a decrease of 13% from fiscal 2008 and this is more than 21% of revenues but largely exceeds our targeted 20% for this expense line on a lower revenue base.

We will continue to look for ways to cut expenses in SG&A as well. R&D spending for fiscal 2009 was $4.7 million compared to $7.1 million last year. As we have indicated previously, many of our R&D resources are working on customer funded development activities especially the cost plus satellite programs that we've announced previously. Frequency will benefit from these programs by developing next-generation satellite timing systems for use in future programs and we expect internal R&D spending to remain at less than 10% of revenues in the coming year.

Now all of these items with respect to the inventory write-down and other expenses, generated a loss from operations of $5.9 million in this fiscal year compared to a $2.6 million loss in the year ago period. Other income and expense items amounted to $190,000 in fiscal 2009 as compared to $4 million last year.

But as you may recall, that $4 million included a $3 million gain on our reduction in our investment in Morion. As we indicated, our tax provision for this year is a provision, not a benefit, because it includes a $7.6 million valuation allowance that we referred to previously and that yielded a loss for the year of $11 million or $1.33 per share compared to $887,000 of income and $0.10 per share last year.

For the fiscal year, we did report positive operating cash flow of $7.2 million. And on our balance sheet, our net cash which consists of cash, marketable securities and less any borrowings under our credit line which is secured by the marketable securities was $13.8 million which is an improvement from the net cash of $10.4 million from a year ago and this is after we used $3 million to acquire frequency stock under our repurchase authorization.

Finally, our backlog at the end of fiscal 2009 was $36 million as compared to $39 million at the end of fiscal 2008. At this point, I'll turn it over to Martin and will be available for your questions later.

Thank you Alan. This year was a tough year but when the going gets tough, we instituted all the necessary steps in order to reduce cost and maintain our throughput. Our cost reduction came by improved design, improved automatic testing and a significant reduction in G&A overhead and direct personnel to match our present needs.

FEI is very fortunate to have one significant cost plus contract to enable us to develop the next-generation clocks for both military and satellite programs. This includes atomic and quartz clocks that will significantly enhance performance of our future satellites and will put FEI in a unique position to benefit from both developments.

In addition to that our in-house R&D and our challenge for the this year is to invest in improving our product offering to our commercial and military satellites, by incorporating the DC/DC Converters, the clock and the microwave frequency generators into opt down converters, beacon transmitters and telemetry transmitters and thus we will be offering a more significant payload dollar value for each satellite.

With the opportunity of submitting new satellites over the next 10 years, approximately 100 per year, we feel that this is a unique opportunity for FEI to significantly increase its dollar value per satellite. Although the satellites have almost doubled over the next 10 years, there are challenges and the challenge is the satellites will have more capacity and cost pressure is quite high. For that reason, size, cost and cycle time are challenges for FEI in their new product line development.

Our plan is to have all of this completed during fiscal 2010 and again to emphasize what Alan Miller said and we will stay well within 10% R&D budget that we've established for the year. And basically the challenge that we have is to make it more manufacturable friendly our whole product line and we have done this challenge very successfully with the rubidium manufacturing about eight years ago and we're confident that we will be able to accomplish it this year with all of the satellite products and products for DOD in providing clocks and [low phase] noise sources for challenging environment on low-g sensitivity.

Those programs are very exciting and we have quite a few of them in the prototype in the preproduction stage and we have to really improve their manufacturability in order to make them affordable for the mass production that will be required in this product line. We have a unique capability and we have -- our technological breakthroughs makes us unique in that discipline.

I would like to take this opportunity to thank the enormous efforts of FEI employees that have worked diligently during this challenging time, our stockholders for sticking with us; and most of all, our loyal customers that continue doing their best, providing us with a lifetime which makes everything go wrong. I would like to take this time to turn it over to answer some questions. So go ahead.

(Operator Instructions)

Kelly, could you ask people to announce their names and affiliation as they are asking the question please?

(Operator Instructions) Sam Yake, BGB Securities.

I was wondering on the clocks, can you use the technology that you gained in the government research that they're helping fund? Can you use that technology in your commercial business or are there any restrictions on that?

There are no restrictions in using it in our commercial satellites as long as we abide by IFA regulations and that's the same no matter where the development. The whole concept of FEI development with government is we don't give up our proprietary right. We're doing the development and customizing for their application but FEI maintains all the proprietary rights on the clocks.

Your clock business for the satellite is a terrific business. What kind of annual run rate do you think you can achieve on revenues on that?

Well, I think we can get specifics on this. Typical clock for a satellite is -- for a commercial satellite or a military simple communication satellite -- is about $1 million per satellite. When you enter more esoteric satellites, that can be two or three times that (inaudible) in the clocks and the opportunity is to grab as many of these 100 satellites by [years] that will be -- that are coming into being over the next 10 years.

Thank you very much and good luck.

Larry Litton, Second Line Capital.

Alan, looking at the operating expenses for like the fourth quarter or for the full year, is that kind of run rate going forward, around $4 million per quarter?

Are you talking about SG&A now?

SG&A and R&D combined, yes.

Combined, it should be similar in that ballpark, yes. Like I said, we will continue to see if we can pair costs in certain areas. But it's -- like I said, our target roughly is around 20% G&A and under 10% for our R&D spending.

And what are you thinking is the breakeven level now that -- revenues per quarter to break even?

Well, we think around where we are now, we had some special charges in this quarter. We haven't got all the costs out. But at the $12 million level, we think we can break even.

So the implication is what, that the 30% plus gross margin going forward?

Yes, we definitely expect to see an improvement in our gross margin rates. As we said, we got rid of some of those satellite programs, we completed those. Now we are on -- the [cost plus] is the dominant factor here as well as some of the new programs that we are doing well on.

And the gross margins, did they improve over the course of the year or you hope to be a fairly steady state for the four quarters?

You are talking about revenues or margins?

Gross margins.

We think that they will probably be improved. It all depends on the mix. Once again, we keep referring to that. It depends on how the contracts come in.

And I missed the very beginning of the call. But so for revenues for the new year, are you expecting revenues to be up or can you give us any kind of a range?

Similar to this year.

Okay, I'll get back in line if anyone else has questions. Thanks.

Robert Smith, Center for Performance Investment.

So in wireless and speaking about the network, your comment about moving to less sophisticated products. Is this something that surprised you or is it -- can you give me some color on that?

I think it surprised the whole industry, not just us. Basically outside of some of the developments, advanced products such as WiMAX, the rest of the networks are really moving to lower performance without the holdover that was kind of a basic holy temple that was predominant until recent times. They are all being driven by trying to make the equipment as inexpensive as possible and giving up on some of the sophisticated performance that was part of the nature.

What do you think is behind that? What is the rationale behind that? Cost?

Cost. Cost, cost and cost. You have base stations that have gone from $200,000 a base station to as little as $10,000 a base station and that's what is the driving parameter.

So excuse me for saying this in a way, but the story here has always been manana and manana kind of never comes, so when is manana?

Well, I will tell you, manana is now. The basic idea is that this was a very tough year for the whole industry and we did a great job.

We didn't produce the bottom line, but we were able to significantly reduce the cost and maintain our throughput and won some very significant contracts for future development and have outlined a plan on how to incorporate these [microwave] areas in higher-level products to address this upcoming opportunity. And the basic idea is the flexibility that our unique technology has is that when one segment goes down the drain, we don't fall apart. We are able to apply this technology to new opportunities.

Yes; but, Martin, we are looking for growth. So when you say the current fiscal year is going to approximate on a revenue basis this past year, where is manana in the current fiscal year?

Well manana in the fiscal year is focused on three very challenging objectives which I'm confident we can achieve. One is to make a profit.

Second of all is to complete the development of the products to take the opportunity for the new satellites that are coming online. And third is to make our product manufacturable for the large production and DOD business that we know is eminent and being moved to the right and we will do the best we can to get there.

So based on your internal long-term plan, where do you expect to be in say three to five years? What kind of a plan do you have? Do you have a five-year plan, a three-year plan?

We have a three-year plan and we want to be at least more than double our size.

With what kind of consummate gross margins?

Well the basic idea is that the delta gross margin for FEI are very encouraging since we have quite a fundamental cost independent of volume. So any [doubt of] volume have significant benefits to the gross margins. If we double our sales, our gross margin will be in excess of 50%.

Well good luck. That's what we were expecting kind of this year several years back. So we didn't arrive and I hope we can get there.

We will do our best. Thank you.

Larry Litton.

Martin, the microsatellites, is that an opportunity for us? If it is, what is the opportunity?

We are looking at that. At this moment we did very little with the microsatellites because they are basically short lived and short missions on this.

But it's funny you should ask because I have been asked by a couple of our customers to take a hard look at what we can do to reduce the size of our products in order to be able to support that industry. So we are looking in at the opportunity and how we can support it.

They need the performance that we have but they cannot [purport] the size primarily from early and the second is the cost (inaudible). So we are seriously taking a look on a couple of specific programs to see what we can do to reduce the size of our equipment to be able to support that industry. Of course you know there are thousands of those microsatellites that are now on the [planning board].

Lastly for me, kind of two-part question. Obviously the company is known for high quality, high performance. I think a weakness over the years in part has been manufacturing efficiency although we've tried to address it.

So I'm wondering, is there any thought to bringing in the chief operating officer, a president from really outside the company who really has a handle on supply chain and manufacturing efficiency? And as a second part to that, I'm not trying to push you out and I recognize you're importance, but is there any kind of succession plan that you're thinking about here?

Well it's always on my mind and basically to answer your question is that we did add some significant technologies to our base in order to move forward in manufacturing and engineering. And the whole concept is to really -- it's not the mass production type of business.

So the idea of how do you do a custom business economically and being able to manufacture effectively. So it takes some very unique type of talent and I believe we have added the talent to the company to be able to accomplish it.

And we have made significant strides in testing time and assembly in the HI-REL. We have reduced assembly time by better than 50% and reduced our test time by more than 70% in this year. So we've made significant strides in that area.

And the second part of the question would be what is the board doing at this point, what are you doing at this point in terms of thinking about a succession at some point?

Well, it's being reviewed at every board meeting. It's being addressed.

Gentlemen, there appear to be no further questions.

Is that it? Well thank you everybody for listening and for sticking with the company. We will not let you down.

We will do our best to produce a profitable year. And we all thank you for attending this meeting. And on behalf of General Franklin, who is not here, God bless our armed services. Thank you all and have a good week.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 888-203-1112 or 719-457-0820 using passcode 381-8084. That concludes our conference for today. Thank you all for participating and have a great day.