Frequency Electronics Inc (FEIM) 2012 Q1 法說會逐字稿

Greetings, and welcome to the Frequency Electronics, Inc. second 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 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 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, Martin Bloch, President and CEO for Frequency Electronics. Thank you, Mr. Bloch, you may begin.

Good afternoon, everybody. General Joe Franklin, our Chairman, is on travel on the West Coast, so you are stuck with me and Alan Miller. I'd like, without any further ado, to introduce Alan Miller, and he is going to go through the financial presentation of this report. And then he will turn it over to me for comments, and then for questions and answers.

Alan?

Thank you, Martin, and good afternoon, everyone. For the first quarter of fiscal 2012, Frequency recorded revenues of $15.9 million, compared to $12.1 million in the year-ago quarter. This 31% year-over-year increase in revenues was generated primarily from the satellite payload programs that arose from the recent contract bookings in our FEI-New York segment. Revenues from commercial and US government satellite programs accounted for approximately 40% of consolidated revenues.

In the network infrastructure business area, our FEI-Zyfer segment generated increased sales that were partially offset by lower revenues in our Gillam-FEI segment. Network infrastructure revenues were less than 30% of consolidated revenues.

In the US government DOD non-satellite business area, year-over-year revenues were approximately the same each period, and accounted for 20% of revenues in the fiscal 2012 quarter. As we indicated previously, looking ahead, we expect the satellite payload business to be the dominant source of Frequency's revenues.

Cost of sales in the fiscal 2012 quarter were $9.8 million compared to $7.4 million last year; gross margin then was $6.1 million, compared to $4.7 million last year. In other words, the higher revenues yielded a 29% increase in gross margin. Gross margin rate for the fiscal 2012 quarter was 38.5%, compared to 39.1% a year ago. Gross margin rate for the first quarter of fiscal 2012 was limited by the product mix at our FEI-Zyfer segment. Interestingly, if Zyfer had achieved an additional $250,000 in gross margin, we would've recorded a consolidated gross margin rate of 40%. With future increased revenues from satellite payloads, we expect to achieve a higher gross margin rate of 40% or better.

As we noted on previous calls, increased revenues did not cause a comparable increase in operating costs. In the first quarter of fiscal 2012, SG&A and R&D spending combined increased by only 10% compared to the 31% increase in revenues. Fiscal 2012 SG&A was $3.2 million, and under 20% of revenues, compared to $2.8 million, or 23% of revenues in the year-ago period. R&D spending was approximately $1.2 million each quarter, but this represents less than 8% of fiscal 2012 revenues, compared to 10% in fiscal 2011.

As a result, we were able to more than double our operating profits to $1.8 million in the first quarter of fiscal 2012, from $789,000 in the same quarter last year. Our operating profit in 2012 was 11% of consolidated revenues compared to 6.5% in fiscal 2011. Other income, which consists of investment and equity income, and offset by interest and other miscellaneous expenses, netted to $200,000 of income compared to $68,000 a year ago.

This yield is pretax income of $1.98 million, compared to $857,000 last year. Now, during the fourth quarter of last year, we reduced the full valuation allowance on deferred tax assets. Before that, for the first 3 quarters of fiscal-year 2011, we recorded a tax provision at a much higher effective tax rate than historically because we could not reflect a tax benefit of certain timing differences.

In fiscal 2012, with the ability to recognize some tax benefit from deferred tax assets, our effective tax rate will revert to a more historical level, in the low 30% range. In the meantime, the valuation allowance remains at $4.6 million, and this may be reduced if and when circumstances dictate. Our net income then, for fiscal 2012 first quarter was $1.3 million, or $0.16 per share, compared to $507,000 last year, or $0.06 per diluted share.

For the quarter, we generated positive operating cash flow of $2.7 million, and cash and investments grew to $22.6 million. Our backlog at July 31 was $67 million, with about 60% of this realizable over the next 12 months.

I'll now turn the call over to Martin, and we look forward to your questions later.

Thanks. Thank you, Alan. I just want to emphasize what Alan has put in those numerics in a more mundane, Martin Bloch language. The first quarter of 2011, we did $12 million in revenue and $850,000 in pretax profit. This first quarter of 2012, we did $16 million, and $2 million of pretax profit, indicating that for a delta of $4 million in revenue, we generated an additional $1.2 million in profit. Indicating what we have been telling you over and over again, that increase in revenue has a very significant effect on our profitability, since many of our operating costs are constant on this.

What is more important, and because we expect that the largest growth of revenue will come out of satellite systems at FEI-New York for an increase of $3 million in revenue, we had an increase of $1 million in pretax profit.

When things are going very well, there isn't much to say, but I want to emphasize some of our policies. Our technology is at a niche that is at the proper time, and we see significant growth opportunities while the world is thinking that the government and others will cut down significantly in their purchases. Most of FEI's major programs need to be funded on a timely basis. And we see it happening, as we have seen in the press release, we have just gotten funding on the program for Satellite 7 and long-lead items for Satellite 8. And we see it happening on most of the programs that we have.

We are supporting the C4ISR markets. And the timing, the ruggedized timing system, the low phase noise, and our ability to supply frequency and timing sources from DC to 42-gigahertz is of primary importance on there.

The marching orders that we are getting from our customers, and from government, is we have to do more with less. That sounds like a difficult task. But it offers enormous opportunity for Frequency Electronics because robot and key costs of new platforms, which are very expensive and long in duration, there is a need to improve performance on existing platforms by making them more effective with respect to all of their capability. And that means upgrading them with better timing and better phase noise equipment for secure communication, for all of the applications that Frequency's expertise is.

So, our time has come, where our technologies has found the proper place. I'm very happy to report that we see this trend continuing for the near and long future.

I'd like to open, right now, for any answers and questions. And I would appreciate if you would address the question either to Alan or myself, so we can be more responsive.

Thank you. Ladies and gentlemen, at this time we will be conducting a question and answer session. (Operator Instructions)

Our first question comes from the line of Sam Yake with BGB Securities. Please proceed with your question.

Yes, thanks for taking my question. I don't know who this question is for, I guess it's just in general, whoever wants to answer it. I'm wondering, as good as the first quarter results were, do you expect the first quarter results to be the weakest of the year? And things are going to get better as the year goes on?

We expect it to be approximately constant over the year.

Approximately constant? Okay, thank you. And what's the backlog, the most recent backlog number?

As at July 31, the number was $67 million.

$67 million? Okay. And then, 1 final thing. I wanted to thank you for telling the story of Frequency at the Morgan Keegan conference. I thought it was a very good presentation.

But there was 1 thing you mentioned in passing there, you mentioned at the conference that you were potentially open to selling the Company if you found the right fit. Could you -- did I hear that correctly? And could you elaborate on that a little bit?

I don't remember ever saying it, so you weren't hearing it correctly. However, as you very well know, if somebody offers a fabulous price, it's my legal obligation to bring it to the Board of Directors.

Okay, thanks so much, and continued good luck.

Thanks.

Our next question comes from the line of Michael Amari with Amari Co. Please proceed with your question.

Hello, guys, how are you?

Hi, Michael.

Congratulations on a great quarter.

Thank you.

I'm just a bit concerned about all this talk about government cuts and stuff like that. And I wonder, how -- what's the priorities here? Could you please explain to me -- how are you skewed in terms of these contracts with the government?

Okay. As I mentioned before, most of our equipment are on programs that are critical, rather than discretionary. And that puts us in a very good position to really not only not be affected but, in some respect, to benefit from those needs, as I mentioned.

The marching orders are to do more with less, which means to improve existing platforms with more capability rather than spending money on new platforms. And that gives our technology a great opportunity during this very tight budget time. And that is why we see continued ability to book business during this difficult time.

Again, congratulations on the quarter, and I hope you continue the good work.

Thank you, we will.

Our next question comes from the line of Nick Halen with Sidoti and Company. Please proceed with your question.

Good Afternoon, guys.

Hi, Nick.

Hi.

First question I had -- Martin, you could probably answer this one. Given the pretty significant sales growth we've seen, I was wondering if you can give us an update, and talk a little bit about where you guys are in terms of capacity right now?

We have to increase the capacity, but very modestly, because all of the infrastructure is in place. So, we will be adding modestly to our test and engineering staff. If you want numerics, probably over the next 12 months, someplace around 20 bodies, and that would more than enable us to continue on the slope that we are presently have.

Okay. And then, this is probably 1 more for Alan. I know you mentioned you're expecting gross margins around 40%, hopefully a little over 40%. That's what it would have came in at the quarter just given the shift in the product mix a little bit in the quarter. But I was wondering, in terms of operating margins, if you think this 11%, what we saw in the quarter, if that is sustainable as well?

Oh, yes, definitely. Especially if we get the gross margin up above the 40% range, definitely would continue to see that double-digit result.

Okay. And then, just lastly, I was wondering, in terms of the 12 orders that you are doing currently with the government, I was wondering if you can give us a little bit of an update on that and what exactly you guys are doing at this moment on those contracts?

Well, on the satellite contracts, we are involved primarily in secure communication and surveillance. We are at that low phase noise on precision timing is key. On the government programs, we are prototyping about a dozen programs with ruggedized low-G sensitivity clocks. And that's again, taking existing platforms and significantly increasing their capability as a typical program.

Although we don't know what the future production scale is going to be, it's like J. Crew, and we are the low-G sensitivity producers of significant advantage to being able to communicate, detect, destroy, pinpoint, save lives, while the vehicle is moving rather than in the past, in order to be able to get this type of accuracy, the vehicle had to stop. And that made our moving vehicles very vulnerable. So, the low-G sensitivity ruggedized clocks are being implemented on many existing platforms.

Okay, great. Thanks, guys.

You're welcome.

(Operator Instructions)

Our next question comes from the line of Sam Rebotsky from SER Asset Management. Please proceed with your question.

Good afternoon, Martin and Alan, and even though Joe is not on the line, I guess he deserves compliments to participate in the great results you've accomplished.

We will tell him so.

Okay. I'm trying to understand the profitability, when I look at the 10K and I look at FEI-New York, compared to the sales with Gillam-FEI, and FEI-Zyfer, and the operating profit. Are we continuing the same proportions in profitability in the current quarter as for the year for these representative entities? And if we are, what are we doing to improve the profitability of these less profitable pieces?

On a quarterly basis, there is definitely going to be some fluctuations within these -- any one of these segments here. Certainly the FEI-New York segment has always been the dominant segment here. And with the growth in the satellite business, we expect to see that to become even more so.

We did have a loss in the Gillam facility this past quarter; they were profitable for the year. We expect them to be profitable for the full fiscal year. That's primarily a matter of their sales and the timing of it. Summertime, for them, is typically one of their slow times as it is in a lot of parts of Europe.

Zyfer held its own in the quarter, made an operating profit as well, and we expect them to maintain profitability. But those things will be up and down on a quarterly basis. On an annual basis, we would expect them to all contribute to profitability.

No, what I'm driving at is there -- we are at the year end, you showed operating profit of $3.536 million for FEI-New York and $270,000 for the other 2 entities when you compare $33 million in sales to $23 million, do you expect to proportionately have a greater proportion improvement going forward? Or is there -- what can you do to have a greater profitability? Are they helping anything else contributing --?

You hit the number -- the hammer right on the nail. They do support -- Gillam is the engineering resource for the US 5G that we are trying to penetrate the market, and we're making great inroads in this area. And we are continuously examining their operation to see how we can streamline and improve their profitability.

FEI-Zyfer has the marching orders to pursue larger programs because they have been basically a hand-to-mouth operation on this supplying very short order programs, and that is very difficult to make margin with a lot of custom building. So, they are now pursuing programs that are larger in dollar value and larger in quantity and have longer durations. And I'm paying a lot of personal attention to make sure that they can achieve better results in the future. I have every expectation.

Well, that sounds very good, Martin, because it seems you have -- if any significant improvement in profitability would come down to the bottom line. And hopefully, which would lead into the next question, is the -- with the $4.6 million valuation allowance, it would appear, based on this first quarter, it would appear you should be able to pull more into that. And you would get a much higher earnings per share because this first quarter, you're paying taxes, where at the end of last year, to get to $0.72 you contributed a significant amount of the tax benefit. So, Alan, maybe you could address what, based on where you are today, what is your judgment relative to picking up more of this valuation allowance?

Well, it all depends on certain circumstances occurring. There may be some windfalls, for example, that could occur that might change it dramatically. But I don't anticipate, at this point in time, that we would see a substantial change in that number.

It might come down, small pieces at a time; it's all dependent on the timing of the reversals of some of these deferred tax assets. That's the measurement point. But there could be some surprises, but nothing that I see on the table at this moment.

You mean positive surprises?

Positive.

Which leads me to dividends.

As usual, we'll bring it up at every Board meeting. And we'll do that this time. And our next Board meeting, with the stockholders meeting, is on October 11, on this point. But at this time, we are pursuing avidly the idea of partnering and doing joint programs in order to generate growth.

And I think that will be a lot more beneficial to the stockholders than an immediate dividend. But as usual, I abstain from voting because if there's a dividend, I'm the largest single beneficiary. So, I make the proposal, but I do not vote on -- at the Board with respect to dividends. But I assure you that it will be on the agenda.

So, with your significant amount of cash, you're looking at joint ventures? Are you looking at acquisitions? What are you looking at? And with the dividend consideration, if the tax rate increases on dividends, it would make sense to give a significant dividend at the year-end; is that a possibility?

I will bring it up to the Board. This -- that's all I can promise you.

Yes, and are you looking at joint ventures to use this cash? Or acquisitions?

We're looking at joint ventures and joint programs where we can utilize and produce significant bottom-line results with cash. So, the cash -- poor rich, it's good to have cash, it gives us a great deal of security for these opportunities. It also has another effect, which might be difficult to see right away, but I assure you that it's a significant factor. When we are talking to our customers, and trying to chop off a larger portion of a satellite or larger portion of a program, which is the area that has generated the growth, having the cash gives us a lot of negotiating power. And it eliminates the fear that the large contractors have with small companies of how are they going to go into trouble and not to be able to deliver. So, it gives us a lot of advantages in pursuing larger portions of systems.

Well, good luck. It really sounds good, it looks good, and with a book value of close to $9, it seems very good. Okay, good luck.

Thank you very much.

There are no further questions in the queue; I would like to hand the call back over to management for closing comments.

Okay, I want to take this opportunity to express my thanks to all of the employees at Frequency Electronics, the whole family, for the effort that they are putting in to make us successful. And to the stockholders that have had faith in us. And I want to wish everybody a healthy year. Thank you, and goodbye.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.