Frequency Electronics, Inc. (FEIM) Q3 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics, Inc. Third Quarter Fiscal 2012 Earnings Release. [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 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. It is now my pleasure to introduce your host, Gen. Joseph Franklin, Chairman of the Board for Frequency Electronics. Thank you, Gen. 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, and 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's going to talk a bit more about having Elcom onboard with us. Welcome these folks. We're going to have a Q&A to follow, 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 fiscal -- FEI-NY segment, which recorded a 40% increase in revenues compared to last year. Revenues from our other 2 major business areas, network infrastructure and U.S. 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 cost. 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% to 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 cost, 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 increase -- to an expense, excuse me, 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 pretax 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 9 months of fiscal 2012, our effective rate is under 36% and is impacted by nontax losses at our foreign subsidiaries. For the full fiscal year, we'd 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 $1,074,000 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 50% 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 of it will take place in FEI-NY due to the very good product line that we have for satellite, 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 us [ph] to get accomplished more with less. That means more capability on the 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 WGS, a 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 are 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 5 to 6 years on this, and I see this as a double win. They had great difficulties in proceeding on their own with their product 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 offer income products that have the low g sensitivity and low phase noise to military and other critical customers worldwide on this. So that should result in them operating on this profitable for them 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 adopting of their technology for space, especially extending into the Ka line. It will facilitate FEI to achieve what we are 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 fiscal -- 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] Our first question is coming from Nick Halen from Sidoti & Company.

So the first question I had was just in terms of the acquisition pipeline. I guess 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. And 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 I guess just in terms of size, I mean 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 that the key is a technology and marketplace where we can put 2 and 2 together and get 7. So size would be a secondary consideration.

Okay. And then just one more question, I guess, for Alan. I know you've been getting -- 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 kind of a short-term thing or, going forward, we can continue to see R&D spend churn lower?

Let me take this. You mentioned some IP rise. I want to correct you on this. We've been able to maintain all our IP rights, and that has been the philosophy since I founded the company on this. We have never given away the Frequency Electronics proprietary rights. Second part, and I am intimately involved on this, is because of our unique technology, we will -- we anticipate to get additional sponsorship as we go along because our technology is very adaptive to this time and for the United States especially for DoD and the military. So we -- I expect that we are going to get continuous sponsorship 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.

Our next question is coming from Michael Eisner, a private investor.

Martin, first question is for you. The Elcom acquisition, does that meet all your Ka-band needs? Are you talking about Ka-bands for 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.

Oh, so you need more?

Well, 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 for the 75% of Elcom?

Say again?

What was the cost of the 75% of Elcom that you didn't own?

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

[Operator Instructions] Our next question is coming from Frank Barresi from Ameriprise Financial.

All right. Hey, if you could -- just a few simple things. If you could -- well, 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 then 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 kind of elaborate how this hedge [ph] will help in the future?

Okay. Let's separate the 2. 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. It should be about $65 million from last 3 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 is where we are right now.

Okay. And second of all, let's separate. Our low g-sensitivity and low phase technology is going to help pay our product line because they'll be able to penetrate DoD customers both in the U.S. and the friendly countries that they are selling because it will enhance their product capability on this item. Their technology, we will adopt their high-speed synthesizers and their Ka-band capability to expand our lines. We at this time are providing 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 on calendar year, was about $8.5 million.

Okay. So that $8.5 million. And one other thing. Now you all are real strong in satellite. Does any of this technology relate to drones? Or we're -- or is that something totally different?

No. This is 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 has been -- it's our standard product line -- and they provide us -- synthesize our 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 wraparound additional electronics to increase our share on drones as well as aircraft.

Okay. So they -- have you been designed into drones? Or...

Yes. We're a major supplier for ruggedized, low g sensitivity timing for U.S. drones.

Our next question is coming from Sam Rebotsky from SER Asset Management.

When we look at the numbers, I guess, at April 30, had $2.2 million of equity and you took a $500,000 write-down. So it would appear there would be some goodwill that you 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. So and the remainder will go to goodwill if, any. So we really don't have a firm number at this point in time.

Okay.

We'll have it before the next quarter.

Yes, I guess. 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?

Well, that's a very good question on this. So let me tell you, we have probably 1/2 dozen satellites that we have a significant payload right now. And those same satellites are migrating to Ka-band which will increase our ability to supply on the payload. And 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.

Okay. So do you think you could get 5 satellites increase?

Oh, no, no. I'm not pinning down the number of satellites. I'm saying -- what I'm looking for is to be able to increase our payload take from below 10 to around the 25 to 30. How many satellites we're going 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 property, but the stockholders equity went up only $564,000. Is there some foreign currency adjustments or what is that?

Yes. Typically there is foreign currency. Maybe roughly note that the euro dropped quite a bit in the last quarter, I think we got below $1.30 a -- $1.30 per dollar -- not quite [ph] the right. So the euro's activity it what’s caused most of that decrease.

Okay. Your presentation at the 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 of people who want to take us on a roadshow. And there are other opportunities that will probably present themselves, possibly out in the West Coast, as well as here in the East.

But we'll keep you advised.

Okay. I want to sort of address the large audience that you're getting, and I think 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 sort of convince them that you should be worth more than you are trading at.

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

[Operator Instructions] Our next question is coming from Robert Lemper (sic) [Rosen] from RLR Capital.

I have a question, of course, about Frequency. 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're looking at opportunities in Europe as well.

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

Of course. This is a big question that [indiscernible] is very possessive on this. We have to be very, 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 tee.

Our next question is coming from Michael Lamare from Amarco.

I'm still thinking it will be great for -- to bring FEI back to its glory by adding a small dividend on a semiannual basis of some kind. I hope you would consider this. I know you're using the money very prudently. But I think that would be prudent also to consider the limitation of some funds I would like to invest in the stock, but need that little dividend.

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. So 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.

[Operator Instructions] Our next question is coming from John Evans from Edmunds White Partners.

So you talk about, in your statement, that the acquisition is going to be accretive.

Could you [indiscernible] please?

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

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

So when you look at Elcom in general, I guess 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 in programs, but we expect that to turn around and we'll see some similar programs coming this coming fiscal year.

And do you think you guys can get into kind of your 10% that you've been targeting and that you achieved this quarter, pretax?

For corporate?

No, for margins. You did about 10%, you talked.

That's to be determined just yet. We have to get a few things straightened out first. But ultimately, that would 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 indicated at your 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 kind of the incremental margins? So 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?

No. Not that -- some expenses will be natural, but not to the same extent, of course, as we saw in just this most recent couple of quarters, that the increased gross margin does not equate to the same thing at the SG&A level. And obviously, $1 of additional revenue could create 50% better end results, but again dependent on product mix.

And this amounts to our guidance [ph]. As we have maintained all along, being in the technology business as we are for satellites and for DoD and there's a base of cost that's immaterial of the volume that we do. And as we get to 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 kind of insight into what type of topline growth you potentially would be looking for, for next fiscal year? I mean, so far you've grown a little bit more than 24%, the top line? Do you think that's repeatable, or are you just trying for double digits? Or what do you see? Can you give us any kind of insights?

As we've maintained for the past 50 years, we only give a trend. And the trend is that we see the next fiscal year on this to have increasing 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.

Our next question is coming from Frank Barresi from Ameriprise Financial.

I keep thinking about questions on this outcome.

Go ahead.

Yes. Because you were talking that, okay, on the low g, this would -- because you -- I don't know if I would say -- I don't know if you would say you pioneered low g, but you guys are like the leaders or you developed it. I mean, how much incremental revenue potential is there on this low g for outcome, your outcome group?

This is Martin Bloch. Well, 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 enabled, is to be able to accomplish on mobile platforms such as tanks, Humvees, aeroplanes, drones, ships on this in motion that with about 100:1 improvement in accuracy. So we see this as a continuous expanding business in all areas of electronics.

And the -- and I guess, well it will take -- but these are products they have that you'll be able to work together more closely with them to integrate it or --

That's correct. These are products that we now unique in supplying it to DoD and even on certain satellite applications on this. 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 2 technologies that enable to accomplish more with less money. That means upgrading existing platforms to improve the accuracy, to improve the secure communications, to improve the ability to isolate explosives, all 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 and I guess...

Ka-band. We're not -- 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, what -- the Ku -- no, I misspoke on those letters, I'm sorry about that. So the Ku, and I don't remember the other band that you have a lot of products, those will be -- this is like an addition in satellites where they'll have -- they'll still use the Ku and whatever the other --

No, they'll still use the old band because there's enormous amount of equipment worldwide are out in the existing bands, and the Ka band is up to increase throughput and bandwidth, and these are the ones that are being implemented.

Okay. And so, and then you are still looking -- you are still developing more on your own Ka-band to, I guess, to fill out the capability of the system?

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

[Operator Instructions] It appears there are no further questions at this time. And I'd like to turn the call 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 in 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 the best to all our shareholders. God bless our soldiers and go Army.

And all our employees.

I already said that. And all our employees. Okay. Thank you all. Thanks, Martin.

Okay, 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.