Frequency Electronics Inc (FEIM) 2012 Q3 法說會逐字稿

Greetings, and welcome to the Frequency Electronics, Inc. third-quarter fiscal 2012 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 reports filed 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.

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 begin.

Thank you very much, Kevin. And welcome, folks, to our third-quarter fiscal-year 2012 report. I want to make a special welcome, of course, to our shareholders, and the rest of you who are listening in. And especially thank our 400-plus good folks, our employees who work together around the world to make Frequency Electronics successful. We appreciate your efforts and your time that you're spending with us. And I'm going to be joined today, as usual, by Alan Miller, who will give our financial report; and by Martin Bloch, our Chief Executive Officer and Founder, who will talk about our operations and the outlook we have coming up.

As I said in the press release, that all of you should have in hand, our revenues and profits are showing solid growth. And I want to add a special welcome to the folks from Elcom who have joined the Frequency team. And Martin is going to talk a bit more about having Elcom onboard with us. Welcome, folks. We'll have a Q&A to follow -- a question-and-answer. So everybody will have a chance to join in.

I'll turn it over to Alan now for our financial report. Go ahead, Alan.

Thank you, Joe, and good afternoon, everyone. For the third quarter of Frequency's fiscal 2012, we recorded revenues of $15.4 million compared to $12.6 million last year. This 22% year-over-year increase in revenues was again generated from satellite payload programs, which accounted for more than 50% of third-quarter revenue. Satellite work occurs in our FEI-New York segment, which recorded a 40% increase in revenues compared to last year. Revenues from our other two major business areas, network infrastructure and US government DOD non-space, each accounted for approximately 20% of third-quarter revenues. Revenues of both FEI-Zyfer and Gillam-FEI were off less than 10% from revenues recorded in last year's third quarter.

As we indicated previously, looking ahead we expect the satellite payload business to be the dominant source of Frequency's revenues. We also anticipate that revenue from non-satellite government and DOD business will experience significant future long-term growth that will be enhanced by the recent addition of Elcom Technologies to the Frequency family. The higher revenue enabled us to achieve a 28% increase in gross margin to $6.2 million from $4.8 million last year. The gross margin rate for the fiscal 2012 third 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 previous calls, increased revenues did not cause a comparable increase in operating costs. In the third quarter of fiscal 2012, SG&A and R&D spending combined increased by 5% compared to the 22% increase in revenues. Fiscal-2012 SG&A was $3.4 million compared to $2.8 million in the year-ago period. And both amounts are about 22% of revenues.

R&D spending was under $900,000 in the fiscal-2012 quarter, and less than 6% of fiscal-2012 revenue, compared to $1.2 million or 10% of revenues in fiscal 2011. This does not mean we are spending less on development, as many of our R&D resources are being applied to funded development under several contracts. And those costs are included in cost of sales. However, any new products or technologies that may result from such development remain Frequency's proprietary property. As a result of the improved gross margin and controlled costs, we were able to more than double operating profits to $1.9 million in the third quarter of 2012, from $796,000 in the same quarter last year. Operating profit was 12.6% of consolidated revenue compared to 6.3% 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 income of $52,000 a year ago. Of the current year net expense, $335,000 is attributable to our previous equity interest in Elcom, as well as certain acquisition transaction costs. Since the transaction was completed in the fourth quarter, it will be reflected in our financial statements at year-end this April. We do expect our Elcom transaction to be accretive in the next fiscal year. This yields an 86% increase in pre-tax income, to $1.6 million compared to $848,000 last year.

Our third-quarter tax provision is $500,000, or a rate of about 32%. For the nine months of fiscal 2012, our effective rate is under 36%, and is impacted by non-tax losses at our foreign subsidiaries. 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, including our ownership change in Elcom, and consideration of the remaining valuation allowance of $4.6 million on certain deferred tax elements that we have discussed previously.

Net income for the third quarter was $1.074 million or $0.13 per diluted share, compared to last year's $508,000 or $0.06 per diluted share. Year-to-date, we generated positive operating cash flow of $1.3 million. And our cash and marketable securities balance is $22.6 million. And this is after borrowing $2.3 million under our credit line at very favorable rates rather than liquidate a portion of our investment portfolio which has a higher yield.

Our funded backlog at January 31 was about $58 million. But this does not include over $7 million related to a DOD satellite program that was awarded in January, but not fully funded until just after quarter-end. About 60% of the backlog is realizable in the next 12 months.

At this point, I'll turn the call over to Martin, and we'll look forward to your questions a little later.

Good afternoon, everybody. As Alan has indicated, the future growth that we see, the majority will take place in FEI-New York due to the very good product lines that we have for satellite and DOD and commercial applications on this. We are very fortunate to be at the right time at the right place, with the technology that enables to get accomplished more with less. That means more capability on existing platforms. And that has given us traction on the programs that we have, and the programs we expect to get on this area.

Alan has indicated that double [GS] program -- on this we got now fully funded the first week in February. And we expect continuation on this and the other DOD and commercial programs that we have on our build. It's very fortunate that because of our unique technology, we're able to get significant sponsorship of research and development, and yet with the ability to contain the IP for Frequency Electronics. That's a major accomplishment, which gives us capability for the future, as well as less expenditure of IR&D that we have to do.

I want to address the Elcom acquisition on this. As you probably know, we have been a minor participant with Elcom over the past five to six years on this. And I see this as a double win. They had great difficulties in proceeding on their own with their products line, and we are going to make a significant contribution. First, FEI technology and customer base will enable them to more fully explore their product line. And also offering products that have the low G sensitivity and low phase noise to military and other critical customers worldwide. So, that should result in them operating on this profitable for the next fiscal year. As Alan has mentioned, our present view is they will be accretive and with an increase of sales from the previous year.

Equally, secondary, and most important, is the conversion of their technology for space use. And with their technical personnel and the adopting of their technology for space, especially extending it to the Ka line. It will facilitate FEI to achieve what we're now doing around less than $10 million per satellite with the opportunity to pursue payloads that will enable us to get $25 million to $30 million per satellite. And that effort has already started with a vengeance, and we want to accelerate it as fast as possible on this.

I want to welcome FEI personnel to the FEI family on this. And I want to express my sincere appreciation to the Frequency team for doing a great job in this difficult times. And we are looking forward to increase sales and profitability for this coming quarter and for the next fiscal, which starts on May 1, 2012.

Good news doesn't require much words, so at this moment, I'd like to open for questions and answers. I would very much appreciate if you address the question either to Alan Miller or Martin Bloch or Joe Franklin, so we can respond clearly to you. Thank you for listening, and go on with your questions.

(Operator Instructions) Nick Halen from Sidoti & Company.

The first question I had was just in terms of the acquisition pipeline; this is more for Martin. I know in the last call you said that you saw a lot of opportunities out there in terms of acquisitions. And I was just wondering if you can give us an update on what the pipeline looks like? And also if the acquisition of Elcom has affected your interest in making future acquisitions.

If anything, it has whetted my appetite on this. So, we are keeping an open mind. And obviously, we will be able to digest Elcom very quickly since we are very familiar with their personnel. And as you might or might not know, I was really Chairman for Elcom for a few years, so I'm very familiar on being able to integrate them very quickly. And we'll be looking for other opportunities to be able to enhance our technology with what's available.

And now, just in terms of size, what would be ideal for what you'd be looking to add on to Frequency?

I don't think size is an issue. I think the key is technology and marketplace where we can put two and two together, and get seven. So, size would be a secondary consideration.

And then just one more question, for Alan. I know you've been able to keep some of the proprietary rights to the R&D spend that you guys have been seeing, and it's obviously running significantly lower than last year. I was wondering if this is a short-term thing, or if going forward we can continue to see R&D spend trend lower?

Let me take this. You mentioned some IP rights. I want to correct you on this. We have been able to maintain all our IP rights. And that has been the philosophy since I founded the Company on this. We've never given away the Frequency Electronics proprietary rights.

The second part, and I'm intimately involved on this, is because of our unique technology, we anticipate to get additional sponsorship as we go along, because our technology is very adapted to this time for the United States, especially for DOD and the military. So, I expect that we are going to get continuous sponsorship done to adopt our product to the present needs. And that will help us reduce our own internal IR&D.

But you might anticipate that the 6% of revenues level is probably at the low end of the range. But our target has always been 10%, or around that region. So, we could see it uptick a little bit, but we're probably at the low end of the range right now.

Okay, great. That's very helpful. Thanks, guys.

Michael Eisner, a Private Investor.

Great job, guys. Martin, the first question is for you. The Elcom acquisition, does that meet all your Ka-Band needs? You talked about Ka-Band for the last year.

Say that again, I'm sorry. I didn't catch it.

The Elcom acquisition, does that meet all your Ka-Band needs?

No, it is a good step in the right direction.

So you need more?

Either more by acquisition or more from in-house development in order to obtain our goals.

All right, excellent. And Mr. Miller, one quick question. What was the total cost of the 75% of Elcom that you didn't own?

In the 8-K, you'll see it represented that we valued the Company at about $7.5 million, and we paid $5 million, $5 million-plus.

All right, thank you very much. Great job.

(Operator Instructions) Frank Barresi from Ameriprise Financial.

Just a few simple things. This is simple anyway. If you could refresh my memory on what -- I think you said the backlog is now $58 million, and you had another $7 million contract that wasn't in there. But what the backlog was last quarter.

And then you mentioned, Martin, on the Elcom acquisition, that it would help you on low G and on Ka Band. Could you elaborate how this will help in the future?

Let's separate the two. Alan?

Let me answer the backlog question first. If I include the $7 million that came in just after quarter-end, we've been running our backlog roughly around the mid-$60s million, about $65 million, from the last three consecutive quarters. At year-end it was a little higher, but that was because of a spike from a recent order at that point in time. But mid-$60s million is where we're at now.

And second of all, let's separate. Our low G sensitivity and low-phase technology is going to help their product line because they will be able to penetrate DOD customers, both in the US and the friendly countries that they are selling. Because it will enhance their product capability on this side. Their technology, we will adopt the high speed synthesizers and their Ka-Band capability to expand our lines. We at this time are provided lots of hardware from L-Band to Ku-Band. And the world is moving into Ka-Band, and that's our objective. And their technology, plus their personnel, will help to accelerate us getting there.

Okay. And how much was their revenue -- Elcom's?

The last fiscal year, which they are on calendar year, was about $8.5 million.

Okay, so about $8.5 million. And one other thing. You are all real strong in satellite. Does any of this technology relate to drones, or is that something totally different?

No, it's directly applicable to drones. And we both are participating in providing building blocks for drones. FEI, by their ruggedized low G sensitivity clocks, which is a major building block, and it's our standard product line, and they provided synthesizer modules for the drones. And the game in the future is to see if we can combine this and get a larger piece of the action by using the key technologies and wrap-around additional electronics to increase our share on drones, as well as aircraft.

Okay. Have you been designed into drones?

Yes, we are a major supplier for ruggedized low G sensitivity timing for US drones, yes.

Okay, great. Thanks a lot.

Sam Rebotsky from SER Asset Management.

Congratulation on the acquisition. But when we look at the numbers, April 30 had $2.2 million of equity, and you took a $500,000 writedown. So, it would appear that there would be some goodwill that you will record on this transaction. What kind of goodwill do you expect to record?

That's a little bit up in the air, Sam. We are having experts go in right now to look at the assets and the value of Elcom for the purpose of allocating the purchase price. We believe that there will be a substantial amount of intellectual property that we can assign it to, as well as some hard assets. And the remainder would go to goodwill, if any. So, we really don't have a firm number at this point in time.

But we'll have it before the next quarter.

Yes, definitely.

Okay. Martin, you indicated that you could go from $10 million, to $25 million to $30 million per satellite. How many satellites are you putting $10 million on? And how soon can you get to the $25 million to $30 million per satellite?

That's a very good question on this. Let me tell you, we have probably a half a dozen satellites that we have on a significant payload right now. And those same satellites are migrating to Ka-Band, which will increase our ability to supply on the payload. Since we have the legacy in space, and we have already supplied some isolated cases in Ka-Band, I expect that we'll be able to add and to increase it within a year.

So, you think you could get five satellites increase?

No, I'm not pinning down the number of satellites. I'm saying on this, what I'm looking for is to be able to increase our payload take from the low $10 million to around the $25 million to $30 million. How many satellites we're going to win in a year, I cannot predict at this time. We'll do the best to win as many as we can.

Okay, good. Now I've got a question for Alan. We recorded in excess of $1 million of profit, but the stockholders' equity went up only $564,000. Is there some foreign currency adjustment or what is it?

Yes, typically there's foreign currency. You may note that the euro dropped quite a bit in the last quarter. I think we got below $1.30 per [dollar]. So, the euro's activity is what caused most of that decrease.

Okay. Your presentation at Needham was very good. Do you expect to do more of those?

Yes.

Do you have anything that's lined up right now?

We don't have anything definitive. We've been talking to a couple people who want to take us on a road show. And there are other opportunities that will probably present themselves, possibly out in the West Coast, as well as here on the East.

But we'll keep you advised.

Okay. I want to address the large audience that you're getting. I would like to see you achieve the market valuation you had in 1981. Which, as I indicated, you sold 340,000 shares at $40, which had 2.6 million shares outstanding with over $100 million market valuation. You had much less of a stockholders' equity. I think you have to get out on the road and tell people your story, and convince them that you should be where it's more than you are trading at.

You're right on the money. And we're so busy building wealth that we are not telling our story. And we'll take it to heart, and we'll do better.

Okay, good luck, Martin.

(Operator Instructions) Robert Lambert from RLR Capital.

I have a question, of course, about frequency. But I wanted to share with you -- which has nothing to do with frequency -- but if anybody can get a hold of the book -- Prevent and Reverse Heart Disease by Dr. Esselstyn, do so because it's fantastic and you'll really help your health.

Now, on to my question. Overseas, in Europe, a lot of companies are anxious for trying to work out maybe a sale or maybe a partnership. Do we have any feelers or are you doing anything in Europe?

We have feelers, and we are looking at opportunities in Europe, as well.

That's great. And is there any restrictions on what we can do with satellites with foreign countries?

Of course, on this. This is the big question that ITAR is very possessive on this, and we have to be very careful to make sure that no technology transfer takes place to any country without written authorization and permission from the State Department. And we are following it to the T.

Okay, thanks again, and congratulations. This is what all shareholders want to see. And one of these days, the stock will reflect this.

[Michael Amari from Americo].

It has been quite a while, but congratulations on a great quarter. And I'm still thinking that it would be great to bring FEI back to its glory by adding a small dividend on a semi-annual basis of some kind. I hope you will consider this. I know you are using the money very prudently. But I think that would be prudent also to consider the limitation of some funds that would like to invest in the stock but need that little dividend.

Hi, Michael. This is Joe, the Chairman. This is on my agenda at every Board meeting. I assure you, your Board addresses the question of a dividend and how best to use the Company's money every time we meet. And sometimes we'll talk about it in between. Since we declared a dividend years ago when we had the cash and it was right to do, we did that. Now we see other uses for the money. But do not ever forget, your interest in the dividend is on our table at every Board meeting. And I appreciate you keeping us advised.

All right, thank you very much, and good luck.

(Operator Instructions) John Evans from Edmunds White Partners.

You talk about, in your statement, that the acquisition's going to be accretive. Can you give us any more definitive of how accretive you think it will be to the numbers next year?

No, we really are not predictive, even in respect to our own financial statements, though we are less so with the Elcom transaction. We do believe it will add to both profits and to revenues obviously, but we do not get into specifics.

So, when you look at Elcom in general, on a yearly basis then, how much were they doing in revenues?

Their last fiscal year ended in December, they did $8.5 million worth of revenues. They lost some money because of some stretch-outs and programs. But we expect that to turn around, and we'll see some of those programs come into, this coming fiscal year.

And do you think you can get it to your 10% that you've been targeting and that you achieved this quarter pre-tax?

For corporate?

No, for margins. You did about 10%.

That's to be determined just yet. We have to get a few things straightened out first. But ultimately that will be our goal, of course. How quickly, we don't know.

Okay. And then just the last question, operating income was greater than 10% your target. Are you guys thinking about revising your target on operating income to moving it up as you're continuing to grow?

As revenues increase, yes, we would expect to be able to move those targets up. As I indicated, at the current revenue levels, 40% gross margin, 10%-plus at the operating is appropriate. But if we continue to expand the revenues as we anticipate, yes, we'll have to come back with some new targets for you.

Got it. And then just one last question relative to that. Can you give us a sense of the incremental margins? In other words, you talk about at these revenue levels, but if you put in $1 extra, what's the incremental margin? Is it basically the gross margin? Or do you have to add incremental expenses below the gross margin line?

Some expenses would be natural, but not to the same extent, of course, as we saw just in this most recent couple of quarters. That the increased gross margin does not equate to the same thing at the SG&A level. And $1 of additional revenue could create the 50% better end results, again, dependent on product mix.

And this is Martin Bloch. As we have maintained all along, being in the technology business as we are, for satellites and for DOD, there's a base of cost that's immaterial of the volume that we do. And as we get increase in volume, we expect our gross margins to be affected positively significantly as we go in the future.

I'm sorry, one last question. Can you give us any insight into what type of top line growth you potentially would be looking for, for next fiscal year? So far you've grown a little bit more than 24% the top line. Do you think that's repeatable, or are you trying for double digits? What do you see? Can you give us any kind of insight?

As we have maintained for the past 50 years on this, we only give a trend. And the trend is that we see the next fiscal year on this to have increase in revenue and profitability, but we do not feel comfortable quantifying it.

Okay. But what you are saying is we should see an increase in revenue next fiscal year and profitability next year, right?

Yes. Our present view is that we see an increase in revenue and in profitability.

Great. Thank you.

Frank Barresi from Ameriprise Financial.

I keep thinking about questions on this Elcom. Because you were talking on the low G, because I don't know if you would say you pioneered low G, but you guys are like the leaders, or you developed it. How much incremental revenue potential is there on this low G for Elcom -- your Elcom group?

This is Martin Bloch. That's one of the missions to explore on this. And to answer you, yes, we pioneered the low G technology, and we own one of the basic patents on that technology. And we see a lot of traction on there. And the application is very simple. Everything that we were able to do in the past by standing still, we now have to accomplish on mobile platforms. What the low G sensitivity enables is to be able to accomplish on mobile platforms such as tanks, Humvees, airplanes, drones, ships on this, in motion with about 100-to-1 improvement in accuracy. So, we see this as a continuous expanding business in all areas of electronics.

But these are products they have that you'll be able to work together more closely with them to integrate it?

That's correct. This is products that we are now unique in supplying it to DOD and even on certain satellite applications. And this is products both big paybacks as the low G and low-phase noise. That's the name of the game because those are two technologies that enable to accomplish more with less money. That means upgrading existing platforms to improve the accuracy, to improve the secure communication, to improve the ability to isolate explosives. All are facets of electronics while you're in motion instead of having to stand still, which is not practical.

Okay. And then, you were talking that within a year, you expect to have the products on, or at least some of this Ku-Band. And you're moving from Ka.

Ka-Band. To have the products in the Ka-Band, this is the next frequency band, which is being explored to be able to increase bandwidth and to get a lot more throughput in the same space.

So, the Ku -- I misspoke on those letters, sorry about that -- so the Ku and I don't remember the other band that you have a lot of products in, this is like in addition in satellites, where they will still use the Ku and whatever the other-- ?

Yes, they will still use the old bands because there's enormous amount of equipment worldwide out on the existing bands. And the Ka-Band is just to increase throughput and bandwidth, and these are the ones that are being implemented.

Okay. And then, you are still developing more, on your own Ka-Band to fill out capability of the system?

Absolutely. But the technical step, as well as the technology at Elcom, will help us accelerate the process.

Okay, great. Thanks a lot.

(Operator Instructions) It appears there are no further questions at this time. I'd like to turn the floor back over to management for any closing or further comments.

Thank you very much, Kevin. And thanks to all of you for tuning in. We really appreciate your interest. We're looking ahead to really good things happening at Frequency Electronics. And a great help to us just to hear your questions, so we can see that future focus and where we need to go. Again, all the best to all our investors; all of the best to all our shareholders. God bless our soldiers and Go Army.

And our employees.

And our employees. We said that. All our gang. Okay, thank you.

Thank you, everybody.

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