Frequency Electronics Inc (FEIM) 2012 Q2 法說會逐字稿

Greetings and welcome to the Frequency Electronics Inc second quarter fiscal 2012 earnings release. At this time all participants are in a listen-only mode. A 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 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, Martin Bloch, President and CEO for Frequency Electronics. Thank you, Mr Bloch, you may begin.

Thank you, Doug. Good afternoon, everyone. This is Martin Bloch. General Joe Franklin was kidnapped by the Army-Navy football game, so you are stuck with me. I would like to set the following format. I will turn it over to Alan Miller, who's going to go through the financial highlights, then I have some appropriate comments to make and then open to questions and answers. Without any further delay, Alan Miller.

Thank you, Martin, and good afternoon, everyone.

For the second quarter of our fiscal year 2012, which ended last October 31, our revenues were $15.1 million compared to $12.5 million in the year-ago quarter. The 20% year-over-year increase in revenues was again generated from satellite payload programs which accounted for more than 50% of second-quarter revenue. This satellite work occurs in our FEI-New York segment, which did a total of $11 million in revenue out of the $15 million in consolidated revenue this quarter. As a result of the increased satellite business, revenues from our other two major business areas, network infrastructure and US government DoD non-space, each accounted for approximately 20% of fiscal 2012 second-quarter revenues. Increased network infrastructure revenues at our FEI-Zyfer segment were offset by lower revenues in our Gillam-FEi segment. As we indicated previously, looking ahead we expect the satellite payload business to be the dominant sort of source of Frequency's revenues.

Cost of sales for the second quarter were $8.9 million compared to $7.7 million a year ago, yielding gross margin of $6.1 million compared to $4.8 million a year ago. The higher revenue enabled us to achieve a 27% increase in our gross margin. The gross margin rate for the fiscal 2012 second-quarter exceeded 40% compared to 38% a year ago. At this level of revenues and continuing favorable product mix, we expect to achieve a gross margin rate of 40% or better.

As we noted on our previous calls, increased revenues do not cause a comparable increase in operating costs. In the second quarter of fiscal 2012, SG&A and R&D spending combined increased by less than 10% compared to the 20% increase in revenues. Fiscal 2012 SG&A was $3.5 million and 23% of revenues, compared to $2.8 million, or 22% of revenues in the year-ago period. R&D spending was under $900,000 in the second quarter fiscal 2012, which is less than 6% of revenues, compared to $1.2 million or 10% of revenues in fiscal 2011. It is important to note however that many of our R&D resources are being applied to funded development under several contracts, and those costs are included in cost of sales.

Our operating income, then, as a result of improved gross margin and controlled costs, more than doubled to $1.8 million in the second quarter of fiscal 2012 from the $812,000 in the same quarter of last year. Our operating profit was 11.8% of consolidated revenue compared to 6.5% in fiscal 2011. Other income, which consists of investment income offset by interest and other expenses, netted to an expense of $369,000, compared to an expense of only $14,000 a year ago. Of the current year expense, $486,000 is attributable to our Elcom investment, including a $350,000 reduction in value of our interest in this privately held company. This yields a 76% increase in pre-tax income to $1.4 million compared to $798,000 last year.

Now, I will repeat something from what we said previously, but during the fourth quarter of last year, we reduced the full valuation allowance on deferred tax assets. Before that, for the first three quarters of fiscal year 2011, we recorded a tax provision of a much higher effective tax rate than historically because we could not reflect the tax benefit of certain timing differences. In fiscal 2012, with the remaining valuation allowance of $4.6 million on certain deferred tax elements, we are now able to recognize some tax benefit from deferred tax assets. However, we are not recognizing the deferred tax benefits from the Elcom impairment charge and losses at our overseas subsidiaries. Thus, our effective tax rate for the second quarter of 2012 rose to 45%. For the full fiscal year, we would expect our effective tax rate to be in the mid-30% range, subject to resolution and evaluation of other elements of our deferred tax assets.

Our net income for the period was $776,000, or $0.09 per diluted share, compared to $328,000 last year, or $0.04 per diluted share. Year-to-date, we generated positive operating cash flow of $412,000, and cash and marketable securities are just under $20 million. And important to note, we also have zero long-term debt. During the second quarter, unbilled accounts receivable grew by $4 million, accounting for a slowing in our operating cash flow. Billings on our long-term contracts occur as milestones are met and we expect to have positive cash flow for the full fiscal year. Our backlog at October 31 was just under $66 million with about 60% of this realizable over the next 12 months. This backlog is roughly comparable to the backlog we reported at the end of our first quarter.

At this time I will turn the call over to Martin, and we will look forward to your questions later. Martin?

Good afternoon, everybody again. When things are good, my speech can be very short. So, I'll address the highlights the way I see them.

A year ago, or half a year ago, we were looking at Frequency as a $50 Million-plus company. With the progress we are now looking at a $60 million-plus company, which of course the largest portion of our growth resulting, as Alan had indicated, from an increase of 35% in both government and non-government satellite payloads, to almost 50% on this area. And that is the right direction because that's the area that we obtain the maximum gross margin since the fixed cost of operating a satellite, our [tied] facility, are pretty much independent on volume and we're looking forward to further improvement as we increase our revenues. With the backlog that we have, and the outstanding proposals and programs that are funded, we expect to be able, as we've indicated before, to produce positive revenue and profitability for fiscal 2012 and beyond, in fiscal 2013 on this.

The main reason for our success is that our precision time and low phase noise is a technology which is very applicable during this time of fiscal constraint. Since we are enabling existing platforms, such as existing design satellites, mobile military vehicles, airplanes, ships, to be able to achieve much higher performance without having to build a new platform. And of course, increasing capability of existing platforms is much more efficient sometimes as a ratio as much as 50 to one, compared to designing and improved platforms.

On this -- as a typical example of this is we are pursuing JCREW 3.2 and 3.3 systems, which you probably -- most of you know is a system to detect and interrupt road bombs, which have caused so many casualties. And the ability to be able to do it from a vehicle that is moving is faster, much safer for the vehicle, and this is an enabling technology, which FEI has. We are having a development contract and are looking forward to increase business in this area. So, the way I read the tea leaves, is we can see increased business in our satellite business, both commercial and military, increased business in DoD military hardware, and about flat on our telecom business.

Alan has not mentioned it, so I will mention it, we have a slight increase in inventory, and this is for a very good reason. We are pursuing to capture more and more of the US5G business from the telecom wireline opportunities, and they are -- the good part is they are very fast delivery cycle. A customer like AT&T wants to call up and get their hardware within less than 30 days, so we have to keep a good inventory in stock to be able to respond on this. We're making good inroads in penetrating that market area.

In addition to that, we are looking at another opportunity, and this is to improve our take on satellites from -- we started a long time ago with about half-a-million to 1 million per satellite. We are now experiencing 7 million and up per satellite on this item. The extension of our product line into higher frequency and still maintaining the accuracy of time and the low phase noise is another opportunity. And in order to do that, we can do it with internal growth, but it's a slow process, and we are very actively looking for the possibility of either partnering with somebody, an acquisition in that area, which will enable us to take the experience of another company having Ka experience but not being able to deploy it in space since they don't have LEGACY, or a possible -- merging with a company which enables FEI's opportunity and technology to multiply the resulting company.

Everything looks in order for us to make progress, and I want to express my appreciation to all of the FEI team that is working very hard to making our future bright and at the same time, to our customers and to our stockholders, who have been patient with us. We had recently our 50th-year anniversary of founding Frequency Electronics, and our mission statement is intact on this -- to take precision time and low phase noise technology from the laboratory into harsh environment in order to enable many systems that can operate outside of the laboratory. We have been called a United States treasure, and a key supplier of space for military and commercial hardware, and we are proud of that heritage. And I'm sure that the next 50 years will be just as progressive as the past. With this advertisement, I'd like to turn it over to questions and answers.

Thank you. Ladies and gentlemen, at this time I will be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Nick Halen from Sidoti and Company. Please proceed with your question.

Nick, can you address it either to Alan or me?

Yes, absolutely. I guess first off, for you, Alan, just can you give us a little color on that impairment charge that you guys took? What exactly caused that and is that kind of a one-time thing you guys are expecting?

We would hope it would be a one-time thing at this point. We have taken impairment charges, about a year and a half ago I think, against Elcom, but they had a very tough quarter. We took about $136,000 charge just for our equity piece, and because of the poor performance we went through the process of doing evaluation of market comparabilities and felt that another $350,000 was warranted to the charge against them, so that's the two pieces of it.

This is Martin Bloch. I'd like to add some color to that, as our investment in Elcom has nothing to do with making money on Elcom. We needed their technology for certain space applications, which we have very successfully employed to date. We have deployed their technology, which they developed for military and ground, on satellite programs, and it's the beginning of continuing that technology.

Okay. Great. Thanks for clearing that up. And also I guess for you, Martin, just kind of a broad question, on the DoD side of the business, are you guys expecting any of the funding cuts that we keep hearing about from the Department of Defense? Are you guys expecting that to have a material impact on you guys at all in the near future? Or do you guys feel like you're somewhat insulated from that?

A very minor effect for the reason that I stated that we are a technology that, at this time, is saving money rather than increasing expenditures. By example I can tell you, to increase the capability on existing -- on an existing satellite that will be launched on this is about one-tenth to one-fiftieth of the cost of designing a new satellite. And the way to increase the performance is to improve the timing and reduce the phase noise. So, we are enabling existing platforms to improve their performance and that is the wave of the future for DoD. There might be some minor effects but we have analyzed the programs that were involved, and we looked fairly solid. This is one reason.

The other reason, which also helps us significantly, is some of the DoD satellite programs that we are involved, the same financial restraints as is on the United States is on the rest of the free world. And then in other countries are partnering with the US and contributing money to those satellite programs so they can have access to bandwidth without having to launch their own, which, again, solidifies those programs. So, we look in very good shape.

Okay. Great. And then also just lastly real quick for you, Alan, do you have a CapEx number for the quarter?

Start with 45%.

Just a second. For the quarter, it was $300,000, not that much, but it's about $855,000 for the year-to-date.

Great. Thanks, guys, congrats.

I will add, we do expect to incur more probably in the second half of the year.

Okay. Thank you.

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

I guess this question is for Alan Miller. I'm wondering, when I look at your assets, your property plant and equipment is carried on your books for about $7 million because it's heavily depreciated? I'm guessing that it's carried on the books for an amount that's far below your replacement costs?

Of course.

Would that be fair to say?

Absolutely.

Significantly.

Significantly, okay. Would you hazard a guess at what the replacement cost may be?

I would say it's three to four times that value.

Okay. And I guess that kind of leads into my second question, even without carrying the PP&E at the current amount, your stock is still trading below your tangible book value. I'm wondering, sitting on all your cash -- I completely understand there has been a lot of debate about paying a cash dividend. I understand you don't want to pay a cash dividend because you get locked into -- people expect it quarter after quarter and you want the flexibility. I don't understand why you're not out there buying back your stock when it's trading at the current valuation. So, could you comment on that?

Yes. This is Martin Bloch. I can comment on that. As I mentioned, at this moment our main objective is to see if we can capture significant amount of additional payload on satellites. And at this moment, we are really working very hard to see if we can find a partner or an acquisition to accelerate this process. We can do it from within, but it's slow because our engineers are deployed on meeting current demand and the resource programs that are funded by government on the future developments.

So, the Board of Directors looks at both of these options to buy back stock, or to declare a dividend on every board meeting, and we, at that time, look on what would be the best use for that cash and the decision to date. That doesn't mean we won't bring it up again in March when they have the next Board meeting, is to look for that acquisition, which will enable us to significantly increase our revenue because increase in revenue means significant improvement in the gross margin. On a satellite operated company, the fixed cost, such as equipment and facility and personnel associated with quality control and all of the accelerated functions, are pretty much fixed independent of the volume of business we do. So, if we can increase significantly the volume of business, we will significantly increase the gross margin. And that's our present view.

Okay. I completely understand that. I guess my one comment would be that I can't imagine there's many acquisitions out there that would be attractive right now as your own stock. So, you know your own company the best, you know what you have and I see all too often public companies go out and buy -- they buy other companies at inflated valuations when they can buy their own stock back at terrific valuations and I never understand that, so that would just be my one comment.

Okay. Understood. We take it in good faith, and thank you very much for that input.

Okay. Thank you and best of luck.

Thank you.

Our next question comes from the line of Sam Rebotsky from SER Asset Management.

Yes, congratulations, Martin, Alan, the rest of the team. Good quarter. The first part is for Alan. I'm not sure -- I was off the line for a little bit. But the cost and estimated earnings in excess of billings, which is significantly higher than the previous quarter, does that mean that the next quarter will be significantly higher -- items to be billed that you didn't bill this quarter? Or --

Yes, it's probably that's going to be the case because we did do quite a bit of billing already in November and expect to do some more in December. Whether we collect all of that before the end of the next quarter, that's the issue, but we should be doing substantially better than we did in the second quarter in that regard.

Okay. Yes. And as far as talking about mergers, talking about partners, are you using outside services, or do you care to talk who you may be using to facilitate some type of transactions? Is there some kind of thing that we expect soon, or what is the nature of that?

We get input from outside sources on this end, we look at them very carefully. And we also have our own in-house search engines going, and the key is, as mentioned before, not to overpay for somebody on this item. But more than overpaying, we want a match that will enable us, in culture and technology, to take advantage in the short order of time. And that is -- so maybe we're being a little bit overcautious, but opportunity is knocking on our door, and we need to do it soon.

Martin, I am a pack rat and I seem to go through my files when you went public, and the different offerings that have taken place. And the stock was trading so much higher, relative to the earnings today and relative to the value of everything else. Do you get inquiries of people that may want to take you over? Because no doubt it would appear that you should be worth more. Your stock had traded much higher at these other times, and besides showing the earnings, besides looking for a merger partner, are you thinking more to tell your story to blow your horn, whatever?

Well, blowing the horn for me is a short-term gain because all I can do at Frequency is to increase our value by increased revenues and profitability. I have very little control of the value of the stock. You guys control that. That's not my level of expertise on this item. However, what we are looking for is to see any of those three opportunities and to answer you, we get periodic fishing on our availability and our answer, at the right price. I have to bring it to the Board of Directors. And I'm giving you the same answer.

This is good, even though the people outside, unfortunately, with the ETFs and all these other things and because of the small market capitalization, there are limited people that even know you exist, where if you do let people know that you do exist, because a lot of people don't know you exist, my guess is that you would trade at higher valuations, and it's a whole new world out there. Unfortunately, it's not like it used to be. And clearly, I would say, this is my judgment, that you could be acquired for twice the price you're trading at in a heartbeat if people knew about you. So --

I think you're making good suggestions, and we'll take it. Why only twice?

I don't know why twice. Got to get a bigger horn.

Okay. We will do that.

And we are trying to participate in similar investor conferences. Coming up, we will be at the Needham conference in January for example and others like that. So, we are trying to get out there a little bit more.

Presuming you will be at Sidoti also, I guess?

Yes.

Well, good luck in these types of results should develop more of a following.

Thank you.

Our next question comes from the line of David Starkey from Smith Barney. Please proceed with your question.

Hello, David. I thought you were not going to ask a question since General Franklin is not here.

I thought I would throw my two cents in. How are you?

Fine, David.

This is for Alan. I was noticing the accounts receivable jumped up quite a bit a quarter. Is that something that's been taken care of since the end of the quarter, or what happened there on that?

Yes, it is related to the unbilled receivable I made comments on. We do expect that that will turn around, at least -- I don't know if it will come down to where we were at the end of April, but I would expect to see lower level of that unbilled receivable because we will have met many of the milestones just because of timing, for the most part, we didn't achieve before the end of October.

Right. Okay. And your backlog is stable. Do you anticipate that continuing going forward? It's sort of been the $60 million company size now, at this point. I get the impression from Martin that that is sort of the way it's going to continue for a little while just based on the comments?

Yes. It should probably stabilize in this arena. As you know, we sometimes tend to get a little lumpy. We will see some big program come in and then bleed it off a little bit, but we've been holding pretty much in the $60 million plus range, $65 million range thereabouts.

Right. And I know that, Martin, you've addressed dividend a bit. I know in the past there's been talk about -- or we were kind of hoping the shareholders to get that $0.05 a share per quarter dividend put back on. I know you would benefit most from that, but you've been there a long time, you've been working hard, you might do that at this point, so that's my two cents worth there.

Thank you, David. I promise to put it on the agenda for the next Board meeting without fail.

All right. Good job, and look forward to the next quarter. Thank you.

Our next question comes from the line of Robert Lambert from RLR Capital. Please proceed with your question.

Hi, congratulations. It's nice to see us in this position. With Europe being in such disarray, of course mostly in banking and financial, do you have a vision of any company there that could be synergistic with us? Is it worth you exploring something in Europe now? What I'm saying, is there a bargain there that might be appealing?

There are bargains, and we have looked at a couple of opportunities in Europe. Our first choice would be at the US because of many of the programs that we have a certain amount of -- especially for the DoD space, that have a sensitivity. So, it would be easier for us to integrate a property that's in the United States, but we're not closing our eyes to European opportunities.

Could you give us an example of your vision of what you would think would be utopia for us to buy? In other words, what would be great for Frequency to buy? What would you be looking at or what would get you excited?

I'll tell you. If I could see a company that's doing anywhere from $8 million to $20 million in sales in the Ka band frequency domain for military, for military applications, and we could easily adopt that technology and convert it to space, that would be an ideal candidate.

I see. Well, let's hope that you can locate a company like that and really start to get value in our stock price, because everybody on the call was saying the same thing. And that is we think the Company is extremely undervalued.

We agree.

Well, congratulations again.

Thank you very much.

I will be looking forward to the next call.

Thank you, Robert.

(Operator Instructions) Our next question comes from the line of [Michael Eisner], a private investor.

Hi, great job with the margins. I know this was the major goal of yours to go over 40% --

Speak up, Michael, I can hardly hear you.

I'm sorry. Great job with the margins.

Thank you very much.

I know you were going to try to go over 40% for a while. What's your outstanding proposals right now?

Probably in that same vicinity. They vary at any one time between $50 million and $100 million.

All right. And did you say what your cash was?

Our cash position right now?

Yes.

Our cash and marketable securities is just under $20 million, $19.95 million.

All right. And final question, if you made an acquisition, would that be for stock, or cash and stock, or how would you do that?

We're flexible.

We're flexible, but mostly cash, since everybody over here agrees, including me, that our stock is grossly undervalued. On this, cash is fixed, giving away equity is a little bit more expensive.

And what's the ratio of revenues times sales or sales times -- would you have to pay? Is it one to one, or what's the ratio?

Well, that depends on what the company has. I don't think that's the important part. The important part is what will they enable Frequency to move? If they have a very great compatible technology, then we'll have to make the measurement on what added value they bring to us.

All right. Excellent. Thank you.

Thank you, Michael.

There are no further questions in the queue. I'd like to turn the call back over to Management for closing comments.

Thank you, everybody, for participating. We are very proud in the technology that we have brought to this country. We are the leader in precision time and low noise for all of the critical programs, and we will continue to maintain this leadership for as long as is humanly possible, if not forever. I want to thank everybody again and all of our employees, customers, and of course stockholders. Thank you, and have a happy holiday season.

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.