Frequency Electronics Inc (FEIM) 2011 Q4 法說會逐字稿

Greetings and welcome to the Frequency Electronics year-end fiscal 2011 earnings conference call. 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 by the Company during this 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 would 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 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 very much, Jade. Good afternoon, everyone and thank you for joining us. Welcome to our year-end conference call for fiscal 2011. We are very pleased that our shareholders and employees could be on the line this afternoon with us after we issued our annual report this year for 2011.

As you can see, in fiscal 2011 we increased our revenues, we increased our operating income and we have reached a record high backlog. What that means is what I've said in our press release. We see a very strong revenue growth and increased profitability coming in fiscal 2012 and beyond, I'm reminded. We certainly do.

I'm joined by Alan Miller, our Chief Financial Officer; and Martin Bloch, as always, Chief Executive Officer. And I would like to turn it over right now to Alan for our financial report. He will be followed by Martin with our operations.

Thank you, Joe, and good afternoon, everyone. For fiscal year 2011, Frequency had revenues of $53.2 million as compared to $49.4 million last year. Revenues therefore increased by 8% year-over-year, led primarily by growth in all business areas that are served by our FEI-New York segment, that is, satellite payloads for both US government and commercial applications, US government DoD non-space product and for network infrastructure. Revenues at our Gillam-FEI segment were comparable to last year, but FEI-Zyfer revenues were lower by 6% as several US government programs were delayed.

Satellite payload revenues accounted for one third of consolidated revenues. Network infrastructure revenues were less than 30% of the total, and US government DoD non-space revenues were approximately 25% of consolidated revenues. Based on our recent contract awards, we anticipate that satellite payloads will be our dominant business area in the coming years.

Cost of sales were $33.3 million compared to $31.7 million last year, yielding a gross margin of $20 million in fiscal 2011 compared to $17.7 million last year. The gross margin rate for fiscal 2011 was 37.5%, an improvement from last year's 35.9%. Combined with higher sales, our total gross margin increased by 13% year-over-year.

With the new contract awards, we expect increased revenues in fiscal 2012, which will also yield a higher gross margin rate of 40% or better.

SG&A expenses for fiscal 2011 were $11.4 million compared to $10.6 million in fiscal 2010. This represents 21% of revenues, about the same in both years.

R&D spending was $5.1 million in fiscal 2011 compared to $5.4 million last year. In fiscal 2011, this represents less than 10% of revenues as compared to 11% of revenues in fiscal 2010. This is within our target range for internal R&D spending.

Thus, as we predicted, total operating expenses in fiscal 2011 increased by 4% as compared to the 8% increase in revenues. This enabled us to double our operating profits to $3.5 million in fiscal 2011 from $1.75 million last year. Operating income was 6.6% of consolidated revenue compared to 3.5% in fiscal 2010. It is significant to note, however, that operating profit in our New York segment, our fastest-growing business area, exceeded 10% of revenues for fiscal 2011.

With higher consolidated revenues in fiscal 2012 and costs in line with our targets, we anticipate achieving operating profits of 10% or better in future periods.

Other income, consisting of investments in equity income and offset by interest and other miscellaneous expenses, netted to $105,000 in fiscal 2011 compared to net expenses of $522,000 a year ago.

So this brings us to pre-tax income of $3.6 million in fiscal 2011 compared to $1.2 million pre-tax last year, and this brings us to taxes. Two years ago we established a 100% valuation allowance against all deferred tax assets. As we have discussed several times in previous calls, we expected to reverse this non-cash charge to earnings in some future period.

During this most recent fourth quarter of fiscal 2011 we did a reassessment of our tax position and we made a determination that it was appropriate to reverse a portion of this valuation allowance which exceeds $8 million. This decision was based on our profitable performance over the last two fiscal years as well as the recent significant increase in backlog, which gives us confidence that we will continue to perform profitably. Thus, during the fourth quarter we reversed $3.7 million of the valuation allowance, resulting in a net tax benefit of $2.4 million.

Therefore, we had net income for the year of $6 million or $0.72 per share diluted, compared to $2.7 million of net income or $0.33 per share last year. For the year, we generated positive operating cash flow of $1.9 million. And as Joe alluded to, our backlog at April 30 was about $71 million, a record high for Frequency. Given the long-term nature of some of our recent contract wins, approximately 60% of this backlog is realizable in fiscal year 2012.

I will be responding to your questions a little later. At this point I will turn it over to Martin.

Good afternoon, everybody. As Joe Franklin and Alan have said, we are very pleased with the performance of fiscal 2011, both an increase of revenue and profitability and, most important, with our ability to have booked a significant amount of business, bringing our backlog in excess of $70 million.

What is also very important is that backlog is based on investment in programs that we have previously done. Over $30 million of his backlog is repeat business, and that has the significance of requiring less engineering effort and less risk and therefore higher confidence of profitability in 2012 and beyond.

What is also very important is during those lean times we have a backlog that will fuel our furnaces in 2012, and we expect, of course, significant additional bookings in 2012 and beyond on this item. Some of the programs that were very significant is the military and commercial space programs. Most of them were based on hardware that we have previously developed and launched into space with great performance.

I would also like to address one of the significant wins in the commercial program on April 15 of this year. That's the Iridium NEXT. We have gotten two pieces of equipment on that spacecraft, a master timing system and an L-Band Up/Down converter. The master timing system is, of course, a legacy product that we have built for many systems in the past. The L-Band converter is an added new equipment to our product offering and will give us other opportunities.

The Iridium program also gives us another capability. We will be in continuous production of this hardware for a period of three years after the development phase of this, which will enable us to use this capability to reduce cost on future satellite programs and improve our margins on this.

What is also gratifying to me personally is that to meet the schedule on existing programs and on this Iridium follow-on, we will be able to utilize some of our inventory product that we have bought before year 2000. Not only are the products helping in the schedule, but they are a significant help in the cost models because the replacement of this product in 2011 are significantly higher.

I want to express my great appreciation and thanks to the employees of Frequency Electronics for working hard and getting FEI's products accepted on this, our customers that have faith in us and our shareholders that are standing by. We have made some major technical breakthroughs, and that resulted in our ability to improve our backlog during this time.

Our challenge in this coming year is to continue the improvement of our products to reduce size, weight and cost because the future, especially in the space programs, is to launch more transponders per spacecraft. And obviously, you can't build them much larger than we are building them now. So the only way to do that is to reduce size, weight and power consumption. And our continuous development of the advanced product for precise timing in atomic and quartz senders, which are key for satellite business and for many critical to the programs on this.

Our cost plus contracts have also been of great fit to Frequency Electronics and in developing new product and, at the same time, in minimizing the amount of in-house IR&D we have to spend. We are very proud to support many programs that saves American lives, such as JCREW and other programs which are classified and cannot be discussed in detail.

I think the best thing for me to do at this time is to open up for questions, if you have.

(Operator instructions) Sam Yake, BGB Securities.

Yes, hello, congratulations on a -- you are doing a great job!

Thanks, Sam.

I'm just wondering, with all the pickup in business, are there any capacity concerns at all? Are you still on schedule? You can meet all this demand?

We are in good shape on this because, like I said, a good portion of our business is repeat. So the risk in engineering development is mitigated enormously. We are also doing a significant amount of automation in test and assembly technique, which adds capacity to our present workforce. We will, of course, add some personnel, but a fairly modest amount because we have increased the capacity with the present workforce.

The other thing is that we are achieving probably 95% of our milestones on or ahead of schedule, which, of course, is good for the bottom line as well as appreciation by our customers, or faith in giving us additional business.

Fantastic! And then I'm wondering; how much of your current backlog is cost plus contracts?

Not that much; it's a fairly small percentage. I'm guessing here (multiple speakers) --

I'm just going to add it up (multiple speakers) well, 1.5, 3 -- less than $10 million.

Less than $10 million? Is it fair to say, in general, you prefer fixed price contracts over cost plus contracts?

Yes, but they both have their important place. Obviously, on our fairly advanced scientific development, our cost plus contracts enable us to develop the product with a minimal investment of FEI's money. So that's the good part. Obviously, the profit margins on cost plus contracts are a lot less than fixed cost contracts, so the ideal situation is to have a mix.

Right, right, okay thank you so much, and continued good luck.

Nick Halen, Sidoti & Company.

The first question I had is, what caused the hiccup in gross margins in the fourth quarter of this year? Overall in the year they were strong, but I was just wondering kind of held them back a little bit this quarter.

It's really just a matter of product mix more than anything else, Nick. As we talked about some of these cost plus programs, there's a lower margin there. So they were probably a little bit higher percentage than what we anticipate going forward. Also, our overseas subsidiary historically -- they had a pretty good quarter revenue wise, but their cost structure was different. They had some inventory write-offs, I believe, which pulled their gross margin down. So it's in the mix there.

Okay. And now also I know it was mentioned on the call that one of the challenges you guys have in the coming year is continuing improvement of your products and especially regarding the weight and things like that. I was wondering if we could expect any significant increase in R&D as a result of that.

No; we will just be fortunate we'll be able to choose the engineering staff that we have with very modest addition to accomplish that task because of the many repeat programs that reduce the engineering content on this. So -- and on some of the programs, of the cost plus programs and advanced development programs we have from the government which are fueling the same type of demand. So we expect IR&D to be less than 10% of revenue.

Okay. And then I don't know; I know you were talking about the Iridium NEXT project. I don't know if I may have missed it, but are you guys expecting to start seeing any revenue generated in the next quarter from that?

Absolutely.

Well, on a day-to-day basis. I mean we are in full development phase of the two equipments. And so -- and we have progress -- well, it's not actually milestone payments on this job, so the answer is yes.

Yes, we recognize revenue on a percentage of completion basis. So as we work it, for every dollar you spend you get some portion of that back in revenue. It may not all translate into cash because those are contractually written into milestones that would allow us to bill at certain time intervals.

Just to elaborate on this Iridium program, the first 15 months is a significant portion of the effort which is to develop and polish the equipment for manufacturability and to develop the automatic test equipment because, in the following couple of years, we have to put through a lot of product, and we want to do it with minimal amount of touch labor and as much automation as we can. So it will significantly contribute to revenues in fiscal 2011, '12 and beyond.

Great, thanks for that. And just one more kind of a housekeeping question -- do you have a year-end CapEx number for fiscal 2011?

It was just under $2 million.

Just under $2 million, okay, great, thanks, guys, congrats.

Hardin Bethea, HSB Capital Corporation.

Alan, you had indicated the 12-month backlog, or the 2012, I guess, backlog was about 60%, 6-0% of the year-end backlog of $71 million?

Yes. That's how much we expect to recognize in revenue in fiscal 2012, about 60% of the $71 million.

So can you tell me what -- can you remind me what the backlog was at the end of the January quarter?

It was about $40 million funded. I think we had about $50 million that was funding yet to come. So we are up about $20 million in total quarter to quarter.

Okay, so -- and is there a funded portion that you can tell me for the $71 million?

Yes. There's a little bit that is not funded yet on this, and I think $3 million or $4 million. So technically speaking, apples to apples, we would say maybe $75 million compared to $51 million, when all the funding becomes available.

Okay.

That is all, of course, compared to last year, when we were in the low 30s, the $30 million range.

Yes, I remember, okay. And how -- we've talked -- Martin has talked about the satellite business, which is significant with regard to the entire Company at this stage. How are the other segments performing, in particular, non-satellite, government versus -- and the network infrastructure?

Obviously, the biggest growth that happened and we foresee in the future is in the satellite business, and what I can also add to the satellite business is the government portion of the satellite business, what I would define as critical programs. And they have the best opportunity to continue funding in many years in the future for these areas. Like, for example, you have a constellation that you need six in orbit in order to be able to have global coverage. Three are launched on this. We're working on the fourth one. If you don't launch the other two, you really have not accomplished anything. So we are very confident of continuous adding business on this.

The other is the low-G sensitivity is getting traction in many applications, and we have lots of prototype and early production phases of those programs and we see growth in those areas as well because many of them are, again, critical and determine the safety and the efficiency of our own services. Did I answer you?

What about network you did, with regard to --

Network is -- we have seen a bump the network, but it's very difficult to predict what they are going to do on this. We know that many of the -- basically users want to extend the life of their stations, and they also want to increase capacity. So we have seen a bump, but (multiple speakers) (inaudible) on the wireless. On the wireline on this item, we have seen a 25% improvement in our business capture. And this is because they have to upgrade the wireline because the old equipment are dying. So we are very encouraged by the US 5G acceptance and the increase in business in that area.

As a curiosity on this, although it's not a significant point of business but it's very gratifying to me personally, is that about six years ago we started the development of equipment for deep hole drilling and horizontal drilling for oil and gas. And we are seeing some early preproduction business on that area as well. And the use of this equipment is getting wider spread over the United States and other territories.

Okay. And just one more question with regard to cash flow -- can you tell us what cash flow was in the quarter?

I have to look at the quarter. It was $1.9 million, as you heard, for the year. Right?

Right, okay, so I can figure it out.

It was almost breakeven for the quarter.

Okay.

We are trying to collect some of our receivables; that's one of the major challenges we have.

I think that's what we have seen during this slightly tightening time is that, although most of our customers are Fortune 25 and government, you've got to keep after them to get paid on time.

We had a sizeable chunk of money come in, in June.

Got it, okay, good, keep up the good work.

(Operator instructions) Sam Rebotsky, SER Asset Management.

Congratulations, Martin, Joe and Alan and the rest of the team there -- wonderful! Tell me, did I hear you say that the tax valuation allowance is $2 million that you haven't booked? And when would you be booking that?

The remaining valuation allowance is roughly $4.5 million, $4.6 million, something like that. We have to do a full reassessment of these things on a quarterly/annual basis. We talk about it, obviously, with our tax advisors. There's a full esoteric process that you have to go through in order to release some of that valuation allowance. So it's something we will be looking at on a quarterly basis.

So I don't anticipate at this point in time that we will see a big chunk like this come in. It's possible that we could in the future. I won't discount that entirely, but we would hope that we would be somewhat on a more steady basis. In fact, I think some people might ask the question about what we might anticipate for our effective tax rate going forward. And I have usually used something in the low 30% range as an appropriate effective tax rate for this Company without these valuation allowance issues.

Okay, that's good. Now, tell me -- the backlog, the $70 million, are we bidding on the same number of projects? Are there more projects to bid on, compared to the previous quarters? And do we expect any problems because of the -- talking about cutbacks from the government, etc.?

We are bidding on a similar number of projects, and our proposal efforts is very high. And I'm sure that we are going to feel some pain due to the stretch-out of programs, especially at FEI-Zyfer, on this area. The good part is the programs that we are involved, as I defined previously, is what I would label critical programs. And we expect that they will be -- hit the lease.

So we have a good pipeline because most of these programs and many of our programs that we are bidding on are repeats. And repeat programs need to go into orbit, and so we are in good shape on that.

And the $30 million of your backlog which is repeat business -- are you also doing better off compared to your competition in winning business that you might have been taking away from competition? How do you see that?

Well, most of this program that we have gotten on, we are really sole sourced because of our unique technology on this item. And yes; and we have been successful in taking away business from competitors due to our better performance, not because of costs. We have one programs that are at higher cost levels because of our unique ability to meet the requirements, meet schedules and the reliability of our hardware in orbit.

Okay. Now, one thing further relative to the stock -- do we plan to get more exposure to investors in both -- and the -- we always ask about the dividend going forward. Could you address those two areas?

As far as exposure is concerned, yes. In fact, we do have some scheduled road shows, non-deal road shows that we have set up for some time in August. And we do expect to participate in certain other activities. One of which we have gone to in the past was the one out on the West Coast the American Electronics Association sponsors, [ones from Microcapsule]. We'd hope to participate in that. And if we get other invitations, we will be open to doing those as well.

With respect to dividends, which always comes up and we always bring it up at every Board meeting on this. I always abstain because I'm one of the big benefactors of this. However, I must say that the cash that we have, we are looking forward to looking for partners and acquisition and also for expanding our product line. And the Board of Directors unanimously, with my abstention, voted not to issue a dividend on the Board meeting that we had today. But it will be on the agenda for our next Board meeting in October 11.

Maybe in the future, they will give you a dividend.

You never know.

All right, good luck, everybody.

[Michael Esner], private investor.

Great job, guys! A question -- you doubled your backlog in the next six months. I know you can't expect that type of increase, but where do you see the backlog going?

Say that again, the question on this?

Basically, you doubled your backlog in the last 6 to 9 months. Where do you see the future with that?

We see the backlog to staying at about the same level on this item with slight increases during the next year. Of course, a lot depends on what DoD spendings are going to be like. The commercial spendings look very promising. DoD is a little bit unknown, so we will have to watch it. We don't see any significant dip, but it should be only modest increases.

And how are your outstanding proposals at this time?

That is the part of the day-to-day bread and butter on this. I would say that we are making two or three proposals a week.

I know you told me -- last time you mentioned you were like $100 million in proposals.

We have at least that amount outstanding now.

And final question -- you mentioned you had some old parts from like 2000?

Yes.

What is the value of that?

The greatest value -- the greatest value to be able to meet schedule and performance on this program. The monetary value I'll let Alan, when we have identified the part that we will be able to use on this, to calculate. But the most significant part is our ability to meet the very demanding schedule on our programs.

And just that emphasize that many of our parts in our inventory have great value both in their performance and their ability whenever demand comes up.

All right, so it's more significant to the timing than the value of the part itself?

Well, there is significant value. I just don't have a number, Mike.

That's fine, excellent job.

Robert Smith, Center for Performance Investing.

Congratulations, and especially on the foreseeable future. I hope it materializes. So my question, first question, is with the increased volume, can you not move the gross margin yardstick more than a couple of percentage points?

I'll let Alan answer that.

It's still dependent on the mix, the product mix who have the sales or where they are being generated. We do anticipate, as Martin has referenced before, the profit margins that we expect on some of these repeat businesses, the contracts that we've been recently awarded, should generate good profit margins. Cost plus programs, if we get a large number of those, will dampen it a bit. So it's difficult to project that.

We do anticipate, as we've indicated, though, that our New York segment is going to be one of the leaders in the revenue growth. And that's where we are already experiencing some good increases. So it's to the extent that our overseas subsidiaries, for example, become less as a percentage of sales and less of a gross profit, then we should not see as much of an impact on the drag, so to speak, that results from their sales.

I don't know if you heard Alan, although our overall profitability was approximately 6%, the New York segment, which we expect to launch as a growth portion in the future, was in excess of 10%. So yes; we do expect improvement in the margins. And the exact definition is -- we will keep you updated as we go in the future. But it's very promising.

So just circling back to the defense portion -- so you say you're mission-critical on many programs. How vulnerable do you feel you would be to defense cutbacks in those areas?

Again, my view on the programs that we have in New York, very little vulnerability. There could be some stretch-out on programs for FEI-Zyfer because they are programs a little bit more sensitive to the idiosyncrasies of DoD, and their timing sometimes slips on this. We are being prompted to have great confidence because the government is realizing that making block buys saves a lot of money overall. And many of the programs that we have -- in the past couple of years the government ordered one satellite at a time. And there's a lot of pressure in Congress to make block buys because that was initiated and stated by the major contractors, DoD contractors that that could produce more for less. And it could produce overall as much as a 20% savings on some of the satellite programs.

For us it would be like manna from heaven to be able to work three satellites at a time instead of working one. And we see quite a few programs that fall into this category that are right now being discussed. And from the way I read the tea leaves is that, in spite of the economizing we have to do, they will be funded.

Guys, what are you looking for in acquisitions, so to speak? And how far do you think you might leverage the Company in seeking a partner?

Well, first, and what are we looking for? We want something -- a partner or an acquisition that falls in our technology and our expertise on this item, and one of our next phase developments is to advance our equipment to the KA band, which is the next expansion in satellite technology. So that's the type of partner or acquisition we're looking for.

So how many companies exist in that space, so to speak?

Probably a dozen.

And size-wise?

From $10 million to $2 billion.

Okay. And I assume that you would not want to dilute your bottom line, or would you?

Of this, I -- on a short-term basis, I don't think it's an issue. On a long-term basis, you are absolutely right.

Okay. I just want to go on record as favoring the dividend. I think that, despite the promising future, we all live in an uncertain world, so to speak, and many investors understand that the total return on an investment is a critical part of the equation. And especially in these days of very minor return on your savings rates, I'm sure that you understand that, any little bit helps. And also, there are institutions around who will not make an initial investment in the Company unless they offer some kind of a return. So you might want to weigh and consider that.

We definitely will. Thank you for your recommendation.

And good luck going forward,

(Operator instructions) Hardin Bethea, HSB Capital Corporation.

I just wanted to clarify what, Alan, something you said. I wasn't clear if the operating profit comment you made with regard to future periods being greater than 10% specifically related to New York, or was that total Company?

Well, the point we were trying to make is that New York -- we do anticipate to see the largest revenue growth and profit growth in the New York segment. So as it becomes more dominant, that should result in consolidated profitability when we get above that double-digit number as well.

Was that specific for 2012 on an annual basis (multiple speakers)?

We anticipate we could get that point. We try not to be real predictive on these things with precision. But, yes, we'd anticipate that in the future we will be -- in some future periods, we should be able to get above that for the consolidation.

Okay. And then that would imply, again, if gross margins are in that 40% plus range, that the balance of operating expenses (multiple speakers) 30. But R&D -- you are leveraging R&D, it seems like. So what would be driving selling and administrative increases, or would they grow less quickly, I guess?

Oh, absolutely, less quickly, definitely, just like we saw in this time period. We don't anticipate that we need an awful lot more administrative assistants there that would cause that number to go anywhere near the same growth rate as revenues.

Okay. In terms of the cash and marketable securities, can you describe how current cash is held? Is it all in cash, or are there some investments as well?

Well, the cash is somewhat in money market accounts, which, you know, is paying virtually nothing. We're trying to identify other opportunities for us to put the money to work. So we have increased, somewhat, the marketable securities, still some government securities as well as some other ventures and things of that nature.

Okay. Are there any equity investments in that?

Yes.

Are they in private or public?

Small amounts, but some of them are in ETFs.

Okay.

AFTs.

And then, the long-term obligations -- is there debt outstanding currently?

Only a cap lease, it's a very small piece.

Okay, that's on the New York facility?

Yes.

Okay, great guys, thanks.

Dr. Robert Lambert, RLR Capital.

Hi, everybody, great report card. It's so nice to hear. As you know, I have been on so many of your conference calls.

Martin, I don't understand why we can't pay a small dividend and do an acquisition. I think we could do both because the dividend, I'm thinking, is fairly small. And I don't know why there's a problem with doing both. Could you explain that to me?

I'm not saying there's a problem about this. As I said before, I abstain from that discussion on the Board because of my personal beneficiary position on this. The Board looks at it on every quarter, and I abide by the Board's decision. And I promise you, Bob, that it will be brought up again on October 11, where we are going to have the next Board meeting and probably the same stockholders meeting on the same day. So we will give it a close look.

Okay, well, thanks for considering that. And again, congratulations, great quarter, great year.

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

Thank you very much today, and thank all of you for tuning in. It's always our pleasure to talk to you. We will look forward to the shareholders meeting in October.

And let me say sincerely, the thanks that we have, the leadership of this Company, to our officers and all of our employees for the really great work that they're doing to produce these results. We are very appreciative of it, as I know you are as our shareholders. And we look forward to seeing you now on October 11. We will be announcing that soon for our shareholders meeting.

Let me add one other thing. Martin doesn't know I'm going to say this, and so he will probably chastise me. We will soon celebrate 50 years since Martin Bloch founded Frequency Electronics. How many companies in the history of our country can say that? We will be doing more with the 50th anniversary and let you all know about it. But a little applause for Martin. Thanks to you all for turning in, thank you, Shea. We will see you at our shareholders meeting on October 11.

I was in diapers when I organized the Company.

Thanks again.

So long, everybody.

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