Frequency Electronics Inc (FEIM) 2010 Q4 法說會逐字稿

Greetings, and welcome to the Frequency Electronics, Inc. fourth-quarter fiscal 2010 earnings release. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

Any statements made by the Company during the 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 could cause or contribute to such differences are included in the Company's press releases and are further detailed in the Company's periodic report 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 that date of this conference call.

It is now my pleasure to introduce your host, General Joseph Franklin, Chairman of the Board of Frequency Electronics Inc. Thank you, General, you may begin.

Welcome to our conference call for the fourth quarter of fiscal 2010, and thank you for joining us. I am here together with Martin Bloch, our Chief Executive Officer, and Alan Miller, our Chief Financial Officer. And I want to offer a special thanks right here to all of our employees and the officers of Frequency Electronics in New York, in California, in Belgium and in China, for the outstanding performance that they achieved this year and that we have reported with our 2010 results.

In all of the turmoil of this last year's economic downturn, these are the people who have brought to FEI a profitable year and put us in position for further success in our government and our commercial markets upcoming. Our outlook is strong. All our parts are in good shape, and operating efficiently. And we expect our revenue to increase with greater profitability in the years ahead.

Let me turn it over now to Alan Miller, our Chief Financial Officer, for a financial report, and he will be followed by Martin Bloch, our Chief Executive Officer, with a report on the operations. Go ahead, Alan.

Thank you, Joe, and good afternoon, everyone. My comments today will focus primarily on the full-year results rather than on the fourth quarter since our performance during the quarter was fairly consistent with that of the full year. For example, fourth-quarter revenues were $13.1 million which is consistent with the revenue range that we have experienced over the last eight quarters. The composition of revenues for the fourth quarter from our three major business areas was within a few percentage points of the full-year ratios.

Our operating costs have been fairly consistent quarter to quarter. The only exception to this consistency is with respect to taxes which had a negative impact on fourth-quarter results, and I will address taxes later in my discussion.

So now turning to the full year, for fiscal year 2010, revenues were $49.4 million compared to last year's $52.7 million. Year-over-year telecommunication revenues declined by more than 20%, but the mix has changed. Revenue from wireless telecommunication equipment sales continued to decline, but sales of wireline synchronization equipment, including our US5G products, increased by more than 50% over last year's sales in the first full year of US5G being on the market.

Revenues from satellite payloads accounted for 32% of total revenues in both years, although revenue from US and government programs grew while revenues from commercial programs decreased from fiscal 2009. However, based on recent awards made to some of our customers, we do anticipate an improvement in both government and commercial satellite business during fiscal 2011.

Revenues from our US government non-space programs, which include our low g-sensitivity and ruggedized rubidium products, continues to show strength growing year-over-year. Sales from this business area have now reached a level of 27% of consolidated revenues.

Cost of sales at $31.7 million for the year compared to $42.6 million last year yielding a gross margin of $17.7 million or 36% in fiscal 2010 compared to the 19% gross margin rate last year. The fiscal 2010 gross margin of 36% is within the range of our expectation for this level of revenue.

In the last few years, we have struggled to achieve that level of performance due to the challenging satellite programs we completed last year. At the current revenue level and the present mix of programs, we expect the mid-30% gross margin rate to be a base number. As we increase revenues in future periods, we should be able to demonstrate our operational leverage and realize higher gross margins and operating profits.

SG&A expenses for 2010 were $10.6 million compared to $11.4 million last year. In fiscal year 2010, SG&A expenses were 21.5% of revenues compared to 21.7% last year and as compared to the Company's target of 20% or less of revenues. The $800,000 decrease in SG&A in fiscal 2010 reflects the Company's cost-cutting efforts during the year.

R&D spending was $5.4 million compared to $4.7 million last year. The fiscal year 2010 R&D spending is about $0.5 million higher than we anticipated at the beginning of the year because we added emphasis on the development of new space hardware during the course of the year. We expect internal R&D spending for fiscal 2011 to be within our target range to approximately 10% of revenue.

Our operating income for fiscal 2010 was $1.8 million as compared to an almost $6 million loss a year ago. The fiscal 2010 operating profit was offset by $522,000 of other expenses, principally reflecting non-cash charges related to our investment in Elcom Technologies, which we have discussed in previous quarters.

Our net income for fiscal 2010 was $2.7 million or $0.33 a share as compared to the $11 million loss or $1.33 a share that we incurred last year. In both years these bottom-line results were significantly impacted by taxes.

As we noted during the third quarter, we recorded a $2 million tax benefit due to a change in tax law regarding net operating loss carry backs. As a result, we were able to fully realize the tax benefit of the loss incurred in fiscal year 2009. Going forward, we must accrue for current taxes since the NOL has now been fully utilized.

Under ordinary circumstances deferred income tax benefits might offset the current provision resulting in our typical tax rate on book income of approximately 30%. However, under US GAAP accounting, last year we established a 100% valuation allowance against deferred tax assets. That 100% valuation allowance remains today such that any deferred tax benefit is completely offset by an increase in the devaluation allowance. This skews the effective tax rate.

At some point, perhaps by the end of fiscal year 2011, after we have demonstrated consistent pretax profits, Frequency will be able to -- will be enabled -- excuse me -- to reverse some or all of deferred tax valuation allowance, and we will recognize a large tax benefit. In the meantime, it is difficult to predict the effective tax rate for any given period.

Over the long term, it is reasonable to expect our effective rate to approximate the 30% of pretax book income.

For the year we recorded positive operating cash flow of $8.7 million compared to $7.2 million last year. Our cash and marketable securities at April 30 increased to $20.4 million from last year's $13.8 million. The $13.8 million from last year also included a $1 million -- was net of $1 million in borrowings under our credit line.

Stockholders equity increased from $59 million to $62 million. And as of April 30, our backlog was just under $30 million. Today after recent bookings, our backlog is now in the low $30 million range.

I will now turn the call over to Martin, and we will look forward to your questions a little later.

Good morning, everyone. This year 2001 was plagued by delays in programs and business moving to the right, so Frequency Electronics set to some very important objective to achieve during the year. One was to increase our productivity. Two was to generate profit and cash flow. Three, to develop new products that will be necessary to supply the new challenging markets and environments that are available to us. Four, is to emphasize significant amount of our effort on proposals for satellites and DOD business.

And I'm happy to say that we have achieved all of these objectives during the year, and we now have outstanding and a large number of proposals and opportunities to harvest in fiscal 2010 -- 2011.

I am also happy to say that we see significant payback and traction in our investment in low g-sensitivity and ruggedized rubidium clock. As you have seen by their latest press release that we have gotten production quantities on that technology, and we are unique in this field where we can produce a clock for critical secure communication on the sensor accuracy radar and position and that can operate in mobile platforms, and it's a combination of a low g-sensitivity [quartz] clock and a ruggedized rubidium clock which provides the long-term accuracy and no interruption in time accuracy during severe environments.

We have taken the same type of formula and set our objective for fiscal 2011. One on our list is to increase revenue. Two is to make sure that the increased revenue is accompanied by increase in profitability. Three is to turn the outstanding proposals and business opportunities into firm contracts. And as we mentioned in our report, as typical on this -- many of the proposal and contracts that FEI is sole source moved from our objective of getting them in April and May of 2009 to the end of 2010. And some of the commercials moved because of financing issues; many of the military moved because of reassessment and the importance and the criticality of these programs. And I'm happy to say that many of these military programs are now funded.

We will of course continue the research and development. So we stay at the avant-garde of our technology, and continue to contribute to the space and military hardware.

I am happy to say that FEI's low g-sensitivity and ruggedized rubidium technology is contributing right now significantly to secure communication, accuracy of sensors, the improvement accuracy of radar and position, and we are very proud of this effect.

I am also [of a] curiosity want to mention that I don't know if you have seen our release on the accuracy and longevity of clocks which had the Voyager 1 and Voyager 2 clocks operate for 33 years continuously in space with outstanding performance. And prior to that, they operated for three years on the ground, which is the longest continuous operating clocks in space built by anybody in the world. And they are performing now better than they initially were launched. They really aged in to perfection.

This is just a few examples of the longevity and performance of FEI's technology in space for both military space exploration and commercial satellites.

I am looking forward to a good profitable year, and I would like now to open to answers and questions.

(Operator Instructions). [Dr. Robert Lempert], RLR Capital Partners.

Congratulations. I guess this might be directed to Alan Miller. For every $5 million of extra revenue over our base, let's assume $50 million, what would you expect as far as coming down to the bottom line? So in other words, if we do $50 million and now this year we get lucky and we increase our revenues let's say to $60 million, without knowing the makeup of that extra $10 million, what would it be a guesstimate of profitability for the Company?

I think we would expect to see our gross profit margin especially improve by roughly 10%. That would translate probably down to probably about a 10% delta in the operating profit.

Okay, and this is for Martin. Where, as far as R&D, where do you think we need to spend the most time without giving out any information that you shouldn't? But I mean where do you see our Company headed as far as research and development?

Very specifically on this, and some of it is founded by internal R&D and some are founded by our customers. So let's go through the shopping list of it is [involved]. For advanced space, we are [counted] by our customers to develop more accurate clocks that can improve significantly the accuracy and security of military satellites and some deep space exploration by NASA.

FEI's investment for space is to meet the challenge of more hardware is going on the spacecraft that is instead of 10 to 20 channels the objectives of the future is to put on 50 to 80 channels. So that produces an enormous pressure on reducing size, weight and power consumption. So for that our emphasis is to invest in the development to achieve those objectives.

For DOD, on the low g-sensitivity rugged rubidium are doing an outstanding job, and the objective over there are twofold. One is to reduce size because, again, they want to be deployed into more mobile platforms where size is at a premium. And the second is they want to be deployed in less-expensive systems where affordability becomes an issue. So those are the two areas that we are investing in our resources.

The third objective that I forgot to mention, which falls into the same line is we are now getting to have the cash affordability to be able to acquire additional resources which we need in order to take advantage of this new development, developing markets.

All right. That sounds like we have a lot on our plate.

We have a good plate.

Thank you. And again, congratulations.

[Michael Omari], [Maurizio Inc.]

You know my [old man tries] that if we just referred to the cash that we have and recently we have accumulated a real nice size cash and I was wondering whether you would again look forward to see stock at $8 again by putting a penny a share dividend on a quarterly basis. This way some mutual funds that like to have dividend in this price stock would accumulate the stock again. So could you please consider this seriously? I think it will be a benefit for everybody.

As usual, per your request, I will put it on the agenda for our next Board meeting without fail. That is a promise.

Okay, thank you, and thank you for great work.

Thank you.

You have had a very good (inaudible) quarter.

Thank you very much.

Michael, Joe Franklin, you should know that at every Board meeting, every Board meeting, we discuss that point that you brought up. So you can be assured, as Martin has told you, it will be up at our next meeting in October.

[Frank Boreze], Stifel Nicolaus.

On the profitability question the first gentleman asked, when you said -- he gave the example of a $10 million increase in revenue. Did you mean like the incremental profit on that with -- when you said 10% would be like an additional $1 million in profitability, or I wasn't exactly sure what you meant.

What we were trying to indicate is that we definitely think that our gross margin rate will be much improved from even the mid-30% range. So we were given a roughly a 10% improvement, that could easily translate into -- will translate into higher operating profits obviously, but difficult to determine specifically where we will end up.

Sure. I mean, well -- I mean, to -- incrementally would you -- when you said -- I think you said 50% gross margin -- would that mean you meant on the incremental $5 million of gross profit you would think on $10 million more revenue? Or I mean, I know we don't know, but --

Right. No, we are at about a mid-30% range in gross margin. And if we were to get to a 60% -- $60 million in revenues, we would anticipate that we would get into the mid-40% rage for gross margins. That should translate into a large portion of that going right into operating profits. We don't anticipate, for example, R&D spending to be impacted by the level of revenues per se. And G&A would go up not in lockstep with the growth in revenues, but it would go up a little bit. But not the same ratio.

Okay, okay. And I mean like you don't have a target of revenues grow 20% will increase R&D by 20%?

No, no. We don't have a formula for that that goes in that basis.

We have always had the objective to keep our R&D to less than 10% of sales, and we are entering in a very beneficial phase where much of the R&D that we planned are being sponsored by our customers.

So we are -- and that is becoming more and more because of the need by DOD and some of the military space programs to really push forward with performance, which is significantly better than what now exists.

Okay. And you mentioned, Martin, a third area you had in mind was the two like I guess make acquisitions or investments. You were talking about to make things lighter and smaller. Was that specifically for the low g products you were referring to when you just --?

Two effects. Make it lighter, smaller and less powerful the satellites because they just want to put more hardware on the same satellite, more channels. The trend is to increase enormously the number of transponders going for spacecraft for both commercial and military.

So if you have the same amount of space and you want to put more channels, the only way you can do it is by reducing the size of each channel. So it's very compelling in this area.

For the low g-sensitivity, the driving forces are twofold. First of all, is they want to put this technology on smaller and smaller moving platforms even to the extent of some missiles. (inaudible) space is at are a premium and also to try to incorporate them on lower asset type of electronics where affordability becomes an issue. So for that we are going to reduce size and improve the manufacturability so they can be more affordable.

Very good. And then on the wireline/wireless business, the wireline -- is that -- have you ever like or do you give a breakdown of how much of your telecom business is wireline now? Is it still a small percentage, or --?

All we can tell you is that it is growing significantly from previous years. But to break it out would just give our competitors more information than we would like them to have. But it has significant growth since we introduced the US5G, and we see further opportunities in that area.

Okay and obviously 50% is a pretty big jump. But you expect substantial growth in the wireline this year as well?

We expect growth. That's very -- you know, you can predict just as good as I how much will AT&T and the rest of the service providers have capital to upgrade their network on this. When they update it, only they know.

Right. And so all this wide brand, it is mostly I guess a lot of it is Internet related, this wireline where they have to upgrade.

They need to upgrade the wireline to service the Internet as well because most of those systems are interrelated. They don't stand alone. They have a lot of conductivity between the wireless, wireline as we go into next generation of data and video transmissions.

And if I could ask just one more question on the satellite business. You expect both the commercial and military to grow this year. This new product initiative you have where you are offering a lot more of more components, I can't remember what you call it but where you are adding -- you are doing a lot more than you've done in the past, those new (multiple speakers)

Right. We are adding more wraparound electronics to our basic clock.

And will that increase -- I may in terms of the potential market, how much does that increase the market you can serve a lot?

A lot.

So quite -- and when do you expect to start to see -- when would these efforts become revenue? (multiple speakers)

I think we are going to be able to see the beginning of this effect in fiscal 2011. We have lots of proposals outstanding, which includes the basic electronics and the wraparound, the basic clocks which we are the world's experts and the wraparound electronics which increases the dollar value per satellite.

Okay and does it double the dollar value per satellite?

More like 10 times.

Gee. I hope you get some.

My mother would say from your mouth into God's ears.

Okay, well thanks a lot. Good job.

[Larry Litton], Second Line Capital.

Could you speak up please? We are losing you.

This is Larry Litton with Second Line Capital.

Before you speak, can you raise the volume somebody?

Can you hear me? Alan, first for you and not to beat you up, but in terms of what you are talking about in terms of a gross margin increment, if you were able to go from $50 million to $60 million and take the gross margin to 45%, you'd probably wouldn't be talking about a 15% operating margin and a very high overall contributory margin. I don't know if that is what you mean to say but that seems rather aggressive.

You have the advantage of having a calculator handy, I take it.

Okay, yes. So maybe more realistically though, on a $10 million increment maybe $4 million or something like that or $4 million or $5 million could flow through to the bottom line do you think?

That's a reasonable number, I would think.

Yes.

Okay. Just some housekeeping numbers. Depreciation and capital spending in fiscal year 2010, what were they?

Just short of $2 million.

Short of $2 million for both?

Yes.

And 2011, do they look comparable?

Yes, it is around the $2 million range.

Cash flow and depreciation (multiple speakers)

Oh, I'm sorry. Yes, depreciation was about $2 million. Capital and equipment was less than $1 million.

Okay. And Martin, can you run through whatever legs of the revenue stool you want to call them satellite, government, commercial, government non-satellite, telecom and rank them in terms of growth prospects you think for 2011 and to whatever extent you can give any more detail in terms of what the range of growth possibilities are.

Well, the largest opportunity for FEI New York we expect in 2011 that approximately 50% of our business is going to be between commercial and military satellites. And a good portion, the next major contributor is going to be the DOD low g-sensitivity technology is going to be number two. From a corporate point of view, the third one will be the wireless and wireline with primarily increases in the US5G sales.

And do you expect all product lines to actually be growing in fiscal 2011 or some of them could be declining?

These three that I mentioned I see them all as growing.

And if you wrap it all together obviously given all the pressures on the commercial and government side, realistically should we be looking at mid to low single-digit growth, or do you think double-digit revenue growth is a realistic possibility?

It is a realistic possibility.

Okay. So hopefully something in the 10% to 20% growth we could actually execute on?

That is realistic.

Okay. Thanks a lot.

(Operator Instructions) David Starkey, Smith Barney.

Hey guys, how you doing?

Hi, David. Great.

Dave, how are you -- in Florida?

It is nice and warm and sunny down here today. Hopefully it is up there, too. A couple of questions for you guys. First of all, the makeup of the inventory you got on hand is about $26 million. Can you tell me is that a work in progress, is it all just waiting to go out the door? It seems like a relatively large number at this point.

It is certainly consistent year-over-year, as you know, Dave. Some portion of it is finished product or near finished product that was going to be shipped out in the first quarter. So the timing of our US5G sales in particular, some of this is to have a heavier emphasis in the first quarter and the last quarter of the year. So the mix is roughly about the same as what it was in prior year.

And is the obsoletion at all of all these new products coming? Do you expect just anything more than the normal amount?

Nothing out of the ordinary, no. As you may recall, last year we did a fairly substantial write down of inventory primarily related to wireless telecom. We don't anticipate anything out of the ordinary. There is always some you write off a little bit here and there, but no big hits.

I feel we are very safely reserved for our obsolescence and inventory.

And Alan, you mentioned the fourth quarter was impacted by higher taxes. Can you tell us what approximately that number was?

Well, the tax provision if you saw the press release, is $450,000 compared to $600,000 pretax income. So that is the impact. As I said, if we were doing things normally there would be a deferred tax benefit offsetting that. We would end up with maybe a tax of around $200,000. So the impact of this deferred tax allowance is probably around $200,000, $300,000 in the fourth quarter.

Okay, so that was in the neighbor of what $0.10 a share or something like that?

No, more like $0.03 or $0.04 a share.

$0.03 or $0.04 right, okay. Because I am trying to get a profitability number based on our $13 million run right here for you.

Yes. More of a normalized run rate, yes.

Now your backlog is in the low 30s now and it had been running in the upper 30s the last few quarters. It seems a little optimistic based on the current backlog levels to be able to show a double-digit increase in revenues for 2011. You still are comfortable with that potentially?

As I mentioned, there is -- just to give you a typical example, programs that we are sole sourced and has got delayed between DOD and commercial by $50 million for the past year to year and a half, we know that all of those three major programs are now funded and actually our prime contractors has the contract. We expect that they will break loose this year and we expected them originally to break loose in April of 2009. So we had the opportunity.

The amount of revenue is we had the capacity to do it (multiple speakers) and the question is how quick those contracts will materialize and contract to us.

So basically those $50 million in potential value bids are out there and awarded but not -- and they are funded but they are not technically -- they haven't given you the okay yet to go ahead with them, right?

Our prime contractors have the contract which is a very giant step. Okay? Now it is then to go through their due diligence and [did allow] the money to the subcontractors.

Are you just one of those? I mean, there are other -- there are still competition for these contracts that you are facing?

Well this $50 million that we mentioned, we are for the majority of it we are sole source.

Okay. So it is just a question of time in that respect. Okay, and I am assuming you will make some announcements at that point, right?

Any significant thing, you will be the second one to know.

Okay, and I would also like to kind of reiterate on this dividend policy you got your cash flow of up to past $20 million now, a $0.20 dividend. I think that is what we used to be at just a reinstatement of that is about a $1.6 million a year. You're not making but a pittance in interest on that money at this point. So it would be -- I have to justify, too, the quite a few clients that I have in the stock right now why we keep holding this stock, and letting them earn a little bit of a rate of return on their stock just from the income while we wait is certainly a prudent thing to me. And not going to take away from your cash level a whole lot. So please take that to the Board and --.

I will do that, as I promised Michael Omari, it will be on the agenda for the next Board meeting without fail.

Do you have to wait until the next Board meeting? That is a long way away.

No, no, we don't have too, but that's the most opportune. But we will look at it to see if there are compelling things. As I mentioned on this, we now have got to a point of getting there. We will have enough cash to do some very needed acquisition and engineering capability. So this is number one of the agenda and dividend is going to be number two.

Right. Okay. All right, well, hopefully we will hear something hopefully before October on that. Good quarter and good luck going forward here.

Larry Litton, Second Line Capital.

Martin, just on the $50 million of programs that might actually be released, over what time frame would that $50 million be realized?

Well, the typical cycle for a satellite program is about 18 months for the commercial and about 26 to 30 months for the military.

Okay, so over two to three years fairly linear or something like that?

Well, actually typically between 1.5 and 2 years.

Okay. And Alan, apropos of the cash, you've got $20 million of cash today. Given all the moving parts and holding aside the possibility of a dividend or holding aside the possibility of acquisitions, what kind of cash do you hope to generate over the next 12 months?

I would see something comparable to what we experienced in this past couple years, so in that range, $7 million to $8 million would be realistic.

And how much of that comes from net income, and how much comes from working capital? And how much comes from capital spending under depreciation? Not much from the depreciation, not much from the depreciation capital spending account, it seems not much from working capital and you're not going to get that much from net income. So is a lot of it coming from tax benefits? I'm not clear.

In this last year there were some tax benefit, there was a $2.8 million tax refund helped out the $8.7 million. But no, we would anticipate that this is going to be mostly driven from profits.

That would be impressive. You would be talking about $1 per share of earnings. (multiple speakers) Okay. That's it for me.

There are no further questions in queue. At this time, I would like to turn the call back over for management for closing comments.

All right. Thank you very much, and thanks to all of you for our investors particularly for listening into this conference call, for your participation and your support. We here at Frequency will continue to earn that support. I want to thank you again and congratulate our employees and our officers for their efforts and their results. Martin?

This is Martin Bloch again. I want to express my thanks to all of the employees at Frequency Electronics that are working very hard during these difficult times and to our loyal stockholders. And we are working hard to achieve growth and profitability. Thank you all.

We look forward to seeing you all in early October at our shareholders meeting. We will be announcing the date shortly.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.