Frequency Electronics Inc (FEIM) 2011 Q3 法說會逐字稿

Greetings, and welcome to the Frequency Electronics, Inc. third-quarter fiscal 2011 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 those forward-looking statements.

Factors that would cause or contribute to those differences are included in the Company's press release 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 the date of this conference call.

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

Thank you, Shea, and welcome, everyone. Good afternoon. Thanks for joining us for our third-quarter results on this conference call.

I am here with our Chief Executive Officer, Martin Bloch, and Chief Financial Officer, Alan Miller, who will give you their reports, followed by a question-and-answer, as always.

You've received our press release, we assume, and as you can see we are very pleased with the results of the efforts that we have been engaged in to get our engineering and manufacturing updated and improved to looking at profitability.

That's what we will be talking about today, and I'm going to be followed right now by Alan Miller with our financial report. Martin Bloch will follow him, and as I said, questions and answers after that.

So go ahead, Alan.

Thank you, Joe, and welcome, everyone.

For the third quarter of fiscal 2011, revenues were $12.6 million compared to last year's $12.5 million. The composition of revenues in fiscal 2011 was comparable to last year. Satellites payload and network infrastructure revenues each accounted for approximately 30% of revenues, while revenues from US government DOD non-satellite programs were less than 25% of consolidated revenues.

During the quarter, in our network infrastructure area, we had an unexpected uptick in demand from wireless telecom OEMs and, with our enhanced manufacturing capability capabilities, were able to respond quickly.

However, satellite payload activity is still our leading market area and, given the recent contract awards, is expected to be our dominant market in the coming years.

Cost of sales for the third quarter was $7.8 million, yielding a gross margin of $4.8 million compared to last year's $4.4 million. The gross margin rate for the third quarter of fiscal 2011 was 38%, about the same as it has been throughout this year, and an improvement from last year's 35%.

As we have previously indicated, at current revenue levels, a high 30% gross margin rate is what we would expect to achieve. With the new contract awards we expect revenues to increase in future quarters, and we also expect the gross margin rate to exceed 40%.

SG&A in the third quarter was again $2.8 million, the same as the two previous quarters of the current fiscal year and up from last year's $2.6 million. The fiscal 2011 amount represents 22% of revenues compared to 21% of revenues a year ago.

R&D spending for the quarter was $1.2 million compared to last year's $1.5 million. R&D spending was 10% of revenues in fiscal 2011 compared to 12% of revenues in fiscal 2010. For the full year, R&D spending is again expected to be within our target range of less than 10% of revenues.

This results in operating income for the quarter of $796,000 compared to last year's $314,000. The third-quarter operating income is 6.3% of consolidated revenue compared to 2.5% last year. Significantly, in our FEI-New York segment where all of the satellite payload business takes place, operating income approached 11% of that segment's revenues.

Other income, which consists of investments in equity income and offset by interest and other miscellaneous expenses, netted to an income amount of $52,000 compared to net expenses of $235,000 a year ago. This results in pretax income of $848,000, compared to $79,000 last year.

The tax provision for the third quarter of this current fiscal year was $340,000, compared to a tax benefit last year of $1.97 million. As we've discussed previously, we have a 100% valuation allowance against all deferred tax assets. As long as that is in place, we cannot recognize the tax benefits for book purposes of deferred items.

The third-quarter provision brings the total nine-month provision to $1.16 million or an effective rate of 46%. In the year-ago quarter, due to a change in tax laws, we were able to recognize a $2 million tax benefit from the ability to fully utilize our tax net operating loss.

Net income then for the third quarter of 2011 was $508,000 or $0.06 per diluted share. That's compared to $2 million of net income or $0.25 per diluted share last year, and the 2010 results of course (inaudible - background noise) entirely to the $2 million tax benefit that we realized last year.

For the quarter, our cash position increased to $22 million, and year to date we have had positive operating cash flow of $2 million. We do expect to be cash flow positive for the full year.

Our reported backlog at January 31 was $41 million, but this amount excludes approximately $11 million of recent fixed-price contract awards that are being incrementally funded. Taken together, this is a new record high for Frequency.

At this time I will turn the call over to Martin and we will be entertaining your questions a little bit later.

Martin?

Thank you, Alan.

I'm very pleased with the progress the Company has made on all aspects of business opportunities, and the most exciting for this coming couple of years are going to be satellites, because we have been very successful in capturing many repeat programs on satellite systems that are successfully operating in orbit.

These satellite systems are crucial to the United States government, and they are very important areas of increasing revenue as well as profitability on this item.

We have had record bookings on satellites. And we expect that this will continue since the outstanding proposals in these areas are still close to the $100 million mark, and we are looking forward to additional bookings of both commercial and government satellite contracts in the very near future.

This coming year, the satellite business content of Frequency Electronics will increase significantly [on this side].

We've also made great progress in implementing our motion-sensitivity technology in many programs, and they make a great difference in performance and, again, it enhances the equipment that we supplied to DOD. And we are very proud of the fact and it's also good business for the Company.

We have been investing a lot of engineering effort in the past couple of years to improve the operation of the Company to be able to manufacture the very high-technology hardware with added machines, more design improvement and less what we call the magic of the great people that we have at Frequency. That enables us to produce more throughput with better margins.

We have been successful in implementing the initial ruggedized rubidium clocks for many military systems, and we have delivered the pilot production into the field and they are performing exceptionally well.

As a minor point of the business but of interest to us as we've been supporting the development of equipment for deep hole drilling for energy, and this equipment is performing well. It isn't a lot of business but it's something that will continue for many years. And this is a technology that we adopted from space experiments of sending clocks to Venus where the temperature is very high, and now adapted it for exploration in the deeper earth.

The people at Frequency have done an outstanding job in delivering on-time equipment to very critical programs. We have been recognized as the leader of reliable time and frequency equipment for satellite in the United States and worldwide.

Rather than me continuing, I want to thank the staff at Frequency and all the stockholders for sticking with us. We are looking forward to significant increase in the sales and profitability in fiscal 2012 and a profitable conclusion of the year of 2011.

I'd like to open at this time for questions and answers. So, go ahead.

Thank you. We'll now be conducting a question-and-answer session. (Operator Instructions). Michael [Emery] from Emery Company.

Great quarter. We are hoping that you will continue your road to initiate a dividend, even though I see that your cash has fell down this quarter.

No, no, Michael, the cash is up by $2 million.

It up by $2 million?

Yes, year over year, up by $2 million and up from last quarter's numbers.

Great, so that will go through the same [seasons] that we would have to bring to your attention. Please consider a small dividend, and the fact of the matter is that I don't know whether you mentioned your backlog, but it seems like you are having more and more orders coming in. What's your backlog compared to last year now?

The January 31 backlog is $41 million officially, and as we talked, about some of that -- does not include some of the not-yet-funded portion of some of the recent contract awards. And that compares -- I believe year ago we were probably in the low $30 million range.

Yes, historically $41 million has been a good backlog for you.

And that brings it up to approximately over $50 million, with the new contracts on the way. And I want to emphasize that it's one thing to have a backlog but the other, which is also very important, is backlog on repeat business for the engineering has been done, and now we can focus on getting the product on time with much better margin. And that's the mission for us for this coming year.

Thank you for supporting for our government and the US, and the whole capital system. Thank you for (multiple speakers).

Thank you. We are very proud to do it.

Sam Yake from BGB Securities.

Hello, thank you for taking my questions.

To whom are you addressing it?

I guess I address this to you, Mr. Bloch.

First of all, I'm just wondering, when should we expect your revenues to start to accelerate because lately they've been pretty flat each quarter. When do you think they are going to start to accelerate?

This coming fiscal year.

The coming fiscal year, so, for the next two quarters of this year we are not going to have too much?

Well, we don't -- this year is almost over, all right? The year ends on April 30.

Oh, okay.

Of this -- so all of the contracts that we have booked and a big portion of them must be accomplished in fiscal 2012, which starts May 1, 2011.

So maybe we have one more quarter where things are a little flat, and then it really picks up?

Yes. It's still positive in this quarter, but the significant bump will happen in next fiscal year.

Okay. And what kind of increase are you looking for in revenues, potentially, ballpark figure?

Well, that is something that after 40 years I have refrained from now predicting. All I can tell you is, it's going to be significant.

Significant?

Okay, and then could you remind us the approximate revenue level you can get to with your current facilities? And at what revenue level would you need to make significant capital additions to meet that?

Well, minor capital additions we do continuously, to keep up with technology and to implement automation on this.

In this facility, we can probably reach, with our present facilities worldwide, $100 million-plus, without having to change anything. And then we also have, obviously, the option of going to more than one shift. So we are in good shape.

So you're in good -- that's terrific.

And then one final thing -- could you address, it seems to me like the outlook for the satellite business -- it's not like these contracts you are getting are one-time things and then they're going to go away. You expect the satellite business to be strong for many years to come. Am I correct on that?

Absolutely. On this -- as a matter of fact, many of the satellite contracts that we've gotten amount to yearly might, for example, on this -- we'll get a contract for six satellite systems and funding the first one, and then be incrementally funded as they are launched on this item. So all of this -- the majority of the satellite contracts that we have now have legs in the future, where there are going to be additional requirements in the following years.

That's very gratifying to me, because we put so much effort in the development. It's nice to have legs.

Okay, very good. Thanks so much, best of luck and thank you for taking my questions.

My pleasure.

[Bob Lambert, RLR].

-- everyone; wonderful quarter, and nice to see progress. I have two questions.

Martin, what's on your wish list as far as directing some either accretive or new business to the Company? What would you wish for?

And two, my question goes back to the dividend. Everything you're saying today makes a great case for starting a dividend that can grow the dividend. We don't want just the dividend, we want a dividend that actually can grow which, as you know, is in vogue on Wall Street now.

Well, I will -- as usual, we take the recommendation from our stockholders and we will bring it up to the next Board of Directors meeting for review. There's no question on that one. The Board meeting goes by where we don't address it, but our main objective is to generate growth. And at this moment that's where we are focusing the Company. And we have the backlog, we have the opportunity. We are bidding on some significant additional satellite programs that can make a significant impact on the Company. And we'll -- of course we'll always review the idea of dividends.

And then my first part of my question, about your wish list and, for example, I'll just make a wish. Would it make sense for you, example, to do business with a company out of Israel or out of South Korea? Or I mean, do you see anything that looks interesting as far as making our Company even more valuable?

We are looking to get affiliated and do business with high-technology companies that will move our product line to the next level. We are on the avant-garde of the technology in frequency control and generation and timekeeping. And the next level is to incorporate additional technologies to make our products smaller, like NASA -- [in other words], smaller/cheaper/faster.

So we are looking very much to establish affiliation with high-tech companies that can help us on this path. And if they happen to be in Israel or South Korea, or Japan, that would be a second choice. The primary choice would be in the United States, because a good portion of our business is government, and it is much easier to handle technology in the United States with all the (inaudible) restrictions that exist, Bob.

Well, thanks and great, great job.

Sam Rebotsky. SER Asset Management.

Good afternoon, gentlemen. Congratulations, Martin, Alan and Joseph.

When I look at the 10-Q at October 31, we listed a backlog of $31 million, and we stayed that $5.5 million was included in that, but it wasn't funded yet or a firm commitment.

Then, when you talk of $41 million and, so would you say that the October 31 to be comparable to the $41 million, would be $25.5 million, plus the $11 million that you say is not committed yet?

This is a little complicated discussion, but the $41 million also includes roughly another $5 million of cost-plus programs.

Okay.

-- that have not yet been funded. We treat them differently than the fixed-price programs.

Okay.

All right. The fixed-price programs, we can't recognize revenue until the program has been funded. And that's why we make reference to the $11 million, but it's not in the backlog, the $41 million backlog.

So the $41 million and the $31 million are pretty comparable. (multiple speakers) in terms of what's been funded and not funded.

Okay. Would it be fair to say that, of the $51 million -- assuming the $11 million gets funded --

Right.

-- you expect that to be completed 75% next year? In other words, plus whatever new business you get for the year, or --?

Yes, that's usually a pretty good rule of thumb to go by; our backlog usually has that kind of a life to it.

Okay, and what would you say about the pipeline on what you are bidding, compared to -- what's the size of what you're bidding on compared to what it was then? Is it $50 million you are bidding, $100 million? What kind of pipeline would you be bidding on?

This is Martin, on this.

With the follow-on of the existing contracts that we now have on the books -- and they are follow-on, like there are six in a configuration and we are now building four, and of course you know that in order for the satellite configurations to work they need to put five and six. Plus some new programs that were [in stock] we have, and activities that were looking right now of $100 million-plus.

And would you attribute your success to the quality delivery of products compared to the competitors? Are you winning against your competitors in new business as far as increasing of your backlog?

Absolutely on this. On-time, quality delivery is important. Of course, the advanced technology that we have gives us the tools to do it, but we've made enormous strides and we've gotten accommodations from our customers for being on time and meeting all of the requirements, and this helps enormously in booking new business and pushing out competition.

Or, even more important, the decision of, do they build the wraparound electronics in house or do they give it to us? So it's been of enormous help in pursuing a larger magnitude of business opportunities.

And is it the appropriate time where you expect improved gross profit margin, improved sales going forward, to tell your story to the Street so that you get a better following?

Yes.

Okay. Does that mean you're going to start doing it?

Yes. (laughter)

Okay. All right, wonderful. Good luck.

Michael Wasserman from Moors & Cabot Investments.

Congratulations, gentlemen, on the improving results.

Martin, I was wondering if you could comment, please; this relates a little bit to the last question, I guess, but what are you experiencing now in terms of competitive conditions in your various businesses versus what you have previously experienced in the last three to five years?

I would say that in the business that we are pursuing, we see less competition for our primary technologies, and that's because of the performance that we've demonstrated (inaudible - background noise). So we are, we are really gaining a lot because of the on-time, high-quality delivery of products that are performing exceptionally in the field or in space, and that is helping -- you know, nobody wants to jeopardize $1 billion satellite in orbit based on somebody being 10% or 20% less expensive. To go with legacy and proven reliability, and that's helping us to really shine above our competition.

Thank you.

(Operator Instructions) Michael Esner, who is a private investor.

Hi, Michael.

How are you? I missed the first couple of minutes; I'm not in the country. But I have a couple of questions.

Mike, we can't hear you; speak up.

I'm sorry, I'm on a cell phone.

What was the margins?

Gross margin was $4.8 million for the quarter, or 38%.

38%? All right. Is that up or down?

That's pretty much the same for what it was all this past fiscal year, up from last year; but we've been running about 38% as you may recall, from Q1, 2, 3.

Thank you. Any word -- and I guess this is for Martin -- any word on another director?

Just, we are considering at this time on this, all right, and we are looking. Obviously we've not made a decision on to add one and when. But it's one of the topics that has been discussed for the Board meeting and will be discussed on the next Board meeting.

Okay, and I think two phone calls ago, someone mentioned going to the Street to let people know about FEIM. I couldn't hear all that.

Just, the question was asked and answered. We are going to do a better job of trying to tell our story, Michael.

Excellent. I couldn't hear everything. Thank you, and did you hire more people?

All right, we're going to be -- there's going to be some delta increments, but fortunately on this, for the present contract there's going to be very minor increases in personnel, like half a dozen, to meet the new demand for this year. However, with new opportunities that we are bidding on, that might add incrementally again some additional people.

But I want to emphasize one big emphasis is, as we have indicated over and over again -- our fixed cost is pretty much constant. Any delta business that we get on this additional personnel that we hire, are small compared to our base costs. So our margins improve significantly with increased in volume.

That's excellent. And did you mention anything about acquisitions?

We are looking at partnering an acquisition every day, and I spend a good amount of my personal time devoted to that action.

And, final question -- sorry, I have a couple of questions -- that $52 million, that incl -- last big major contract as you called it?

Say that again; I didn't understand the question.

The $52 million total backlog, or $51 million -- did that include that last, the last contract that you received? You couldn't (technical difficulty) how you want it.

Yes.

Yes.

Would you say it was a major contract?

Yes.

(multiple speakers). But as I indicated before, Michael, we are imminently bidding and expecting additional contracts on both commercial and military satellites.

Excellent. Thank you.

A follow-up from Bob Lambert from RLR.

Hi again. You know, I forgot to ask -- are we doing anything with the drones? Is any of our clocks necessary? I know they are smaller and they are certainly not like big satellites. But is there any area there that we are working with?

Yes, we are a major supplier of ruggedized timing systems for the drone industry.

And is that company --? I know they just had wonderful earnings at AVAV -- Aero-Environmental. Do you do anything with them? (multiple speakers) out on the West Coast?

I am going to tell you, Bob, the work that we do in that area is sensitive and we are not at liberty to discuss the equipment that we build and for whom we build it, or the quantity. But we are heavily involved in that technology.

All right, thank you.

(Operator Instructions). Paul Edmonds from Edmonds White Partners.

Hello, gentlemen. Could you speak for a minute about (multiple speakers) --?

We can't hear you.

Oh, I'm sorry. Hello, gentlemen.

Could you speak for a minute about what your incremental margins are?

Alan?

Well, we hesitate to quantify them with any specificity, here, because they are going to be somewhat program-specific and dependent. But as we have been indicating, we do know that we have very level fixed costs. Martin has talked about the fact that the new programs that we have are not going to be demanding a lot of new personnel to be able to accomplish. So we're looking right now at, as we said, at the $50 million annual run rate of high 30%. We believe that we can easily get into the 40% range with another $10 million worth of incremental revenue.

If we get into the $100 million range, we are looking probably north of 50%. But that's sort of a general form.

Okay, thank you. And can you speak for a minute about the seasonality of your core business?

Most of our core business is not subject to different seasonality. I mean, there could be some issues with respect to timing of new contract awards, based on the government budgeting process and timing. We have experienced a little bit of seasonality at some of our telecom business, again relative to the budgeting process. But in general, we don't see an awful lot of variability, just based on the time of the year.

Okay, thank you very much.

I just want to add to this, with respect to the DOD business, there is typically some lumping that happens. The budget gets approved, sometimes in October on rare occasions and many of the programs get finalized and really funded in December-January-February. So those are usually slightly bumper months, and then the commercial programs really pop up independent; they have no seasonality associated with it.

So on the whole, there is a few bumps due to government programs and when they are kicked off and when they are fully funded.

Okay, and your new satellite business which you recently won, that would grow sequentially through the year or would it be lock-step? How does that work?

Could you repeat that again, please?

The new satellite business that you've just won, would that grow sequentially through your fiscal year?

Yes.

Okay, thank you.

A follow-up from Sam Rebotsky SER Asset Management.

Yes, the one follow-up on the taxes. Is there any different tax asset in the balance sheet? Or is there any reserves? Have you received all the taxes that you are supposed to receive, and you only have state taxes, that's not reflected?

Well, we have deferred taxes of -- in excess of $8 million. But we also have a full $8 million valuation allowance against them. So on the balance sheet right now it is zero. (multiple speakers).

This has nothing to do with cash per se. These are all future tax benefits, to be recognized -- or benefits that can be taken into the P&L at some point in time, if the valuation allowance is reduced.

So, what kind of earnings do you have to achieve in the current year ending April 30 for you to reflect in the balance sheet this $8 million potential of tax benefits, so to say?

Well, we have been in discussion with our auditors on that score, and there's a whole lot of rules related to that. The rule of thumb that they use is looking at your three years of cumulative operating profits or loss. And we had a very large write-off two years ago in fiscal 2009, which is playing havoc on our results as far as deferred tax assets are concerned.

So when we overcome that, they say that at that point we can start to take down the valuation allowance. So it may not happen in our fourth quarter.

We're looking for confidently that it will be something that will take place in fiscal 2012 at the minimum.

So you would look at it on a quarter-to-quarter basis?

Yes.

And if you could justify the earnings going forward, you could piecemeal the whole thing, depending on what your projections, what the calculation is to reflect that?

That is correct.

Okay, thanks, that's all I have.

Thank you. At this time, we have no further questions. I'd like to turn the call back over to the speakers for any closing comments.

Thank you very much, Shea, and thank you all for tuning in to us. We're very pleased that our outlook today is exceptionally positive, and I think that's reflected in the comments and in your questions.

Any time that we can speak with you on that, we'd be happy to do it, and we'll be looking forward to speaking with you in July. We will put the date and the details out and give you our year-end and fourth-quarter report for our fiscal 2011.

Again, reflecting what Martin said earlier -- our employees, our directors and our executives at Frequency Electronics are the ones that have really made this happen. And I know some of them are tuning in, so we want to thank all of them and we will be doing that every time we get together with you.

See you all in July.

Thanks, everybody. Good night.

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