Frequency Electronics Inc (FEIM) 2017 Q1 法說會逐字稿

Greetings and welcome to the Frequency Electronics first-quarter FY17 earnings release conference call.

(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.

With that, it's now my pleasure to introduce your host, Joel Girsky, Chairman of the Board of Frequency Electronics.

Thank you very much. Welcome, everyone. I appreciate your dialing in and talking to us. Sitting alongside me is Martin Bloch, CEO of Frequency Electronics, and Steve Bernstein, our CFO. I'd like to turn the meeting over right now to Martin, please -- or Steve. Why don't we go to Steve. Go ahead, Steve.

Thank you, Joel, and good afternoon. Satellite revenues represented approximately 50% of consolidated revenues in Q1 of FY17 compared to approximately 55% of consolidated revenues in the same period of FY16. In dollar terms, it was down $3.2 million. This was primarily due not to cancellation but delays in contract awards, many of which are sole sourced to Frequency Electronics.

Revenues from non-space US government DoD programs, including sales by FEI-Elcom and FEI-Zyfer, rose to approximately 25% of consolidated revenues in Q1 of FY17 compared to approximately 20% of consolidated revenues in FY16. Revenues from network infrastructure and other commercial products that are recorded in the FEI-New York, Gillam-FEI and FEI-Zyfer segments, were approximately 20% of consolidated revenues, about the same as in prior year.

Gross margin was $4.1 million, compared to $5.8 million last year, yielding a gross margin rate of 32% in Q1 of FY17 compared to 35% in the prior year. The decrease in gross margin percent was affected by decrease in sales resulting in an increase of unabsorbed overhead. Additionally, the product mix included a higher component cost relating to a multi-year low-margin contract expected to be completed this fiscal year.

SG&A expenses were $3.3 million as compared to prior year's $3.7 million, a reduction of $350,000. This percentage was over our target of 20% of revenue, but with cost saving measures put into place in FY16 that will be continued through all of FY17, lower levels of SG&A expenses will be maintained.

Internal R&D spending in Q1 of FY17 increased to $1.6 million or about 12% of revenues compared to last year's $1.1 million or 7% of revenues. The increased spending was focused particularly on affordable secure communication products.

Operating loss was approximately $800,000 compared to an operating profit of $900,000 last year. Operating profits were impacted by the decrease in revenue, as mentioned earlier. Other income, which generally consists of investment income offset by interest and other expenses, netted to income of $50,000 in Q1 of FY17, compared to a net income of $650,000 in the same period of FY16.

In FY16, there was a $400,000 insurance proceed and $175,000 gain on sale of securities which didn't occur in FY17. This yields pretax loss of $750,000 compared to a pretax income of $1.5 million for the same period last year.

In spite of our domestic loss, the provision for income tax is a benefit of $40,000 compared to an expense of $700,000 and 44% effective rate last year. Our effective rate is impacted by not receiving credit for any losses at foreign subsidiaries. Net loss for Q1 of FY17 is $700,000 or $0.08 per diluted share compared to $900,000 of income or $0.10 per diluted share for Q1 of FY16.

Our backlog at the end of the quarter was $36 million, up from $32 million at year end, and up from $22 million at January 31, 2016. During the first quarter we used cash from operations in the amount of $600,000 compared to $1.8 million in the same period last year. Frequency continues to maintain a very healthy balance sheet with a working capital position of over $75 million.

I will turn the call back to you, Martin, and we look forward to your questions later.

Welcome, everybody. I just want to take a moment. We usually have our conference call on the 15th and I'm sorry for the delay, but we had urgent business overseas and I just came in on Sunday. That's why we're scheduling today.

I'd like to address three aspects of Frequency business. Overall, revenue went down. We haven't lost any programs but many of the programs, both on government and on commercial space, moved to the right. These programs that we expected to book in October of 2015 we were not able to book until April of 2016.

This is programs that most of them are sole sourced to Frequency and they have great opportunity for the future. But that definitely impacted our revenue on satellites.

Another reason for the delay of the satellites program in the commercial arena is the redefinition that's taking place in the industry for very exciting future demands in bandwidth and high-definition video worldwide and internet service where enormous increase in bandwidth and high-definition resolution is required on those satellites. Satellites that had 20 transponders will have over 140 transponders. And this replanning delayed many of the programs which are expected to start breaking at the end of calendar year 2016. That's what our major customers are advising us and we see progress in that area.

Probably the most second exciting thing that gives Frequency opportunity is the new demand on secure communication and command and control. And basically I'm sure that you've been exposed to some of the press articles on GPS, which was the mother of all lodes to provide precision time for every possible military as well as commercial use. And we find that this system, although it has the enormous precision, can be easily jammed, and, what's more, it can be spoofed so the user doesn't know he's not getting the right timing information, causing enormous problems in communication and command and control.

One of the cures for it is to increase the time accuracy in each of the users of this from, let's say, a minute to a day, which is ideal for FEI's product that we have developed this year and that have become actually probably the most outstanding source for this type of product, both for military and for non-military end use. So, the secure communication we have gotten some sole-sourced programs to get started.

But you know America's great. We solve every problem but we don't anticipate a solution. We have to have the problem face us, and then we come up with a solution.

Just to look back, when the earlier phone systems were rolled out, the wireless phones, every base station had an atomic clock because they needed autonomy of time and they couldn't rely at that time in year 2001 to 2008 on GPS. It was newer, nobody was certain how good it's going to be. So, that gave them about a day of operating in case GPS was not available.

As GPS became more comfortable that rubidium clock was replaced by very inexpensive quartz clock, from a $2,000 clock to a $5 clock. What was given up in that process is the autonomy from days to literally minutes. Now, many of the secure communication and command have to reverse the process and provide autonomy of time for a longer period of time.

That provides a great opportunity for our product, both for the military as well as homeland security, as well as many commercial applications there. We feel that will give us significant growth from our traditional business or building the ones and twosies and becoming the world's supplier of most precision time for space and space exploration to have applications in very large quantity for secure communication and control, and also the increase in opportunity in satellite business where we are going from 20 to 120 channels to supply the demand in that area.

Our staff has invested a lot of effort in being in a position to benefit from that opportunity. The quantity is so large that our emphasis and investment is being made on providing this type of capability which is affordable for the quantity that will be required. We look forward to significant growth in both of these areas in the future. And, as Steve has indicated, we have seen the beginning of it, and our increase in backlog from our lowest point -- what was it? -- $22 million on January 31 to about $38 million?

$36 million.

$36 million today in this area. I just want to emphasize again that most of this increase in backlog occurred in the late part of FY16 and beginning of 2017.

With this, I'd like to turn over to you guys. Ask any questions that you have in mind.

(Operator Instructions)

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

Good afternoon, Martin. I've got a lot of good questions for you, Martin, or for Steve. Steve mentioned that we have a low-margin contract that's going to end, I assume you mean in the fiscal year April 30, 2017. How much is left on the contract? How much was the contract? And what is the margin on this low-margin business?

Steve will answer the margin, but I can describe the contract. The contract we took very knowingly was for a very specific purpose. As part of being able to obtain a significant increase in business from our satellite customers, we had to demonstrate the ability of production space hardware on a large scale. And on this contract we had to produce 160 16-channel up-down converters and over 80 master timing systems. And it required a lot of automation and investment in automatic equipment to be able to put through. We are about 60% complete?

I would say 70%, 75% complete now.

On this contract. And the objective we have more than achieved. We're able to ship approximately 10 to 12 systems a month, a very complicated load. And we also resulted in the generation of automatic test sets, which can be used for this program, and then with slight modifications for the new anticipated programs on this.

But to demonstrate that we can produce the type of quantity was a big question of all our customers. They knew we can build the best of one or two of a kind, but this is the first time we were able to demonstrate, for space, large throughput contract.

So Steve, what is the balance on that contract?

I'd have to look at the exact numbers, but we're going to finish the shipments by April of 2017, going at that rate we're going now. We're on time with everything and that's when we expect sometime between February and April to finish the contract.

Was the initial contract $5 million, $2 million? In other words, I'm trying to understand, as a loss leader to get this business you had to show that you could produce. And presumably it's for all your clients or only one? Martin, could you give me more color on that?

I'll be happy to. This is Martin. This contract was for one earth-orbiting satellite program. I don't want to go into the exact customer because they get sensitive about being identified. But it's one customer and the contract was some place over $25 million.

Okay. So on $25 million, we're 70%, 75% complete. We took low margins.

That's correct.

Going forward, we expected, we've been discussing, getting maybe $40 million per satellite. When are we getting more contracts? How much are we getting per satellite? And when is it happening so that we can make profits and we can tell a good story? You say you have produced good results for this one satellite customer.

I can tell you what our customers tell us. They feel that most of the redefinition of satellite hardware will be complete before calendar year of 2016. And they expect some of the satellite contracts to be released sometime between now and December. At that time, we will have the opportunity to have more significant content.

It isn't only us. If you take a look at the large satellite manufacturers, such as Boeing, Lockheed Martin, Northrup Grumman, they all got delayed because the satellites are being reconfigured on there. We can only tell you what they tell us. They expected to start breaking loose in calendar 2016. And some of the satellites that we have proposals outstanding go from 20 transponders to 140 transponders. That will give us an opportunity to capture more per satellite.

So, as far as we're concerned, they're happy with the backlog that we have, the $36 million. What percentage is at a higher rate, at a normal rate?

The $36 million that we have are primarily --

[60%] is space.

About 60%-plus is space. And they vary from the ones and twosies for very unique programs to fairly reasonable, like $10 million per satellite.

Okay. Now, I'm going to give you a compliment, Martin, after giving you a hard time.

Thank you. I can use it after traveling for 19 hours yesterday to come here.

All right. This is the first time in a long time that you've put on the Board two gentlemen who have a lot of stock, and two gentlemen who work in the industry, and their companies have made significant acquisitions. These people are a little younger, generally speaking, on the balance. But it would be nice that you could look at -- if you can't get a reasonable backlog where you can make good profits and your stock could appreciate, you should, with their help, put the Company up for sale and achieve a higher price.

But they should help you look for acquisitions that you could add on because the two companies that the gentlemen that are in industry have made substantial acquisitions. They know how to make acquisitions. They could help you do this.

And you need people also to tell your story so that it's not a secret. Evidently Frequency has been a secret for a long time. Everybody has been in and out and nothing happens. So let's see what happens.

Are we going to look for acquisitions? Are we going to look to sell the Company? What is the story, Martin?

We are on the same page. As Charles Girsky has addressed, we are on the same page with additional Board members and opportunities, and we're looking at all aspects of acquisition, merger or partnering in order to take advantage of the business.

And I want to call your attention that you're looking at the satellite opportunity and you're overlooking an opportunity which is probably even larger than the satellite -- the secure communication. There are literally hundreds of thousands of applications where our timing is going to become very critical. And that is an opportunity which probably is large or larger than our satellite business.

And it's becoming not a luxury, it's becoming a necessity because we cannot continue where our communication and control systems are continuously compromised or jammed So, we have both opportunities. And with the help of the additional members on the Board, we hope to move it along faster.

Martin, that's wonderful. And I think you need more sales help to get business sooner than later. It doesn't make a difference whether it's satellite or whatever it is, we need money to the bottom line so you can give the stockholders a dividend, so the stock could go up. And the other members of the Board that don't own much stock should buy some stock.

Okay. I'll tell them that.

All right. Thank you. I'll jump back later on. Thank you.

Our next question comes from the line of Richard Johns, Private Investor. Please proceed with your question.

I have a question about the up-down converters and the hundreds of low earth-orbiting satellites that seem to be coming. Does every satellite use an up-down converter? Does every satellite have a clock in it?

The answer to both is yes. The only differentiator is how good the clock is and how many transponders per satellite. Typically in the test there have been, on a military satellite, between 5 and a dozen type of transponders, and on a commercial satellite between 10 and 30 transponders.

The new demand for bandwidth and high video resolution and internet requires the quantity to go up from the 20s to the 120s. And this is applicable both to the GEOs, the LEOs, and the in between.

And the transponders are different. On the LEOs, you get more transponders but you also get a lot more satellite. So, each satellite from a network, let's say, of 10 satellites, if you go to people like OneWeb they're looking for 900 satellites to provide this. And on the GEO-synchronous, you just provide this higher resolution and more bandwidth by having a lot more transponders. Each transponder provides a service to a given set of customers.

Okay. And with respect to the previous questioner, I just want to say that I'm excited by your story. I believe your story. I've been patient as an investor and I sure hope you won't be acquired before you're able to come into your glory.

As my mother would say, from your mouth into God's ears.

Okay.

Gentlemen, there are no further questions at this time. I'll turn it back over to management for any closing remarks.

Okay. Before I turn it over to our new Chairman, I want to express my great appreciation to our previous Chairman, General Joe Franklin, who served the Company for over 25 years and did a great job. I personally want to thank him very much for all his efforts. And also to the employees of Frequency Electronics and stockholders that are standing by us and letting us the opportunity to expand to our potential. Joel?

Thank you, gentlemen, once again -- and ladies, if there happens to be any -- for attending our conference call. We will be having our annual meeting sometime in early November. We look forward to seeing you in person or getting to talk to you again. With that, have a good day, gentlemen. We appreciate you calling. Good-bye.

Ladies and gentlemen, this does conclude our teleconference for today. We thank you for your time and participation and you may disconnect your lines at this time. Have a wonderful rest of the day.