Frequency Electronics, Inc. (FEIM) Q4 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics Inc. Fourth Quarter Fiscal 2012 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 brutal -- could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences are included in the company's press release and are further detailed in the company's periodic report filings with the Securities and Exchange Commission. By making these forward-looking statements, the company undertakes no obligation to update these statements for revisions or changes after the date of this conference call. It is now my pleasure to introduce your host, General Joseph Franklin, Chairman of the Board for Frequency Electronics. Thank you. Mr. Franklin, you may begin.

Okay. Thank you very much, Jen, and welcome folks. Thank you for tuning in this afternoon. I understand that GlobeNewswire has had some difficulties in our press release, which we sent out about 1 hour ago, may not yet be in your hands but will be soon, and we'll be covering all of the imported details of it. First and foremost to say that we've had a substantial increase in our revenues and profitability, and we are really pleased with how things went for us last year. Looking ahead for an excellent year in 2013, we're doing a great deal with the opportunities that are expanding in front of us and see this year coming up as another very good one. I'll be back at the end when we finish, but let me introduce both Alan Miller, our Chief Financial Officer; and Martin Bloch, Chief Executive Officer, who will be going over the details. And I'll begin with Alan. Go ahead with our financial report.

Thanks, Joe, and good afternoon, everyone. Revenues for fiscal year 2012, which ended last April 30, was $63.6 million compared to $53.2 million last year. The 20% year-over-year increase in revenues was generated from satellite payload programs, which accounted for almost 50% of fiscal 2012 revenues. Revenues were derived approximately equally from U.S. government and commercial satellite programs. All of the satellite payload work occurs in our FEI-NY segment. Combined revenues from our other 2 segments, FEI-Zyfer and Gillam-FEI, were 5% lower than last year. Only 2 months of revenues from our recently acquired Elcom Technologies, or FEI-Elcom, are included in the revenues of the FEI-NY segment and they did not have a meaningful impact for fiscal year 2012. Over 2/3 of our current backlog consists of satellite payload programs. Consequently, we expect satellite payloads to remain our dominant business area into the future. However, we also expect to see meaningful growth in our U.S. Government/DOD area during fiscal 2013. Also, sales for fiscal 2012 were $39 million, compared with $33.3 million last year, though the higher revenue enabled us to achieve a 23% increase in gross margin to $24.6 million from $20 million. Gross margin rate for fiscal 2012 was 38.7%, an improvement from last year's 37.5%. Note that the gross margin rate for the FEI-NY operations exceeded 40%. At this level of revenues and with a favorable product mix, we expect to achieve a gross margin rate of 40% or better in fiscal year 2013. As noted previously, increased revenues do not cause a comparable increase in operating costs. For fiscal 2012, our SG&A and our R&D spending combined increased by 7% compared to the 20% increase in revenues. Fiscal 2012 SG&A was $13.8 million compared to $11.4 million in the year-ago period, and both amounts are less than 22% of revenues. R&D spending was $3.9 million in fiscal 2012 or about 60% of revenues, compared to $5.1 million or 10% of revenues in fiscal 2011. As we have discussed previously, 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 improved gross margin and the modest increases in operating costs, we were able to almost double our operating profits to $6.9 million in fiscal 2012 from $3.5 million in the last year. Our operating profit was 11% of consolidated revenue, compared to less than 7% in fiscal 2011. Other income, which consists of investment income offset by interest and other expenses, netted to an expense of $121,000 compared to income of $105,000 1 year ago. Now the press release will detail it a little bit more, but other income this year included a $700,000 gain related to the step acquisition of Elcom. This gain partially offset previously recorded equity losses, impairment charges and the expenses related to the acquisition of Elcom in February of this past year. This yields nearly a 90% increase in pretax income to $6.8 million compared to $3.6 million last year. As we did last year and after noting the significant increase in profitability in fiscal 2012, as well as our prospects for continued high level of performance, we determined that we would be able to realize the tax benefits from the future deductibility of more items in our deferred tax assets. Thus, in accordance with GAAP accounting criteria, we reversed $3.1 million of a $4.6 million deferred tax valuation allowance resulting in a net tax benefit of $560,000. Last year's tax benefit included a $3.7 million reversal of the valuation allowance, resulting in a larger benefit last year of $2.4 million. Remaining valuation allowance is primarily related to deferred tax assets of our foreign subsidiaries and we do not anticipate further reversals in the near future. The end result is net income for the full fiscal year of 2012 of $7.4 million, compared to $6 million last year; $0.86 diluted share -- per share in fiscal 2012, compared to $0.72 last year. For the year, we generated positive operating cash flow of $2.1 million, and cash and marketable securities are at $22.4 million. This is after borrowing $6.1 million under our credit line at a very favorable interest rate rather than liquidate a portion of our investment portfolio, which has a higher yield. Our funded backlog at the end of April was about $57 million, and about 60% of that backlog is realizable in the next 12 months. This time, I'll turn it -- the call over to Martin Bloch and we'll be back to talk you a little bit later with your questions.

Good afternoon, everybody. I hope -- by this time, I hope you have the press release, but that will make -- they got the press release? Hallelujah. This will make my presentation much easier. This -- there's very little to say when you have a great year and you're looking forward to a very successful fiscal 2013 and beyond on this. So the mission for Frequency Electronics is clear and I'll enumerate the major steps that we are taking in order to continue on our way upwards. We are improving our structure and facility to add automated test and assembly in order to be able to utilize the same fixed infrastructure to produce more outputs. This is, of course, as we have said in the past, that we can improve margin significantly by increasing our volume of sales since the interest -- the majority of the infrastructure is very constant. FEI technology is very important to achieve better, higher performance with existing platforms rather than building new platforms. And this is basically following the objective that the mission to get more business is to achieve more with less. And the basic technology of low g phase noise -- on low g, low phase noise and very, very good accuracy on the very ruggedized environment is one of our unique traits, and we are one of the few companies in the world, if not the only one, that achieved this from -- by vertical integration from raw material to finished products that gives us an enormous advantage to be able to custom build very difficult clocks for difficult missions at affordable prices and affordable size, weight and power consumption. We have been emphasizing a lot on common designs. So we've minimized the non-reoccurring engineering development cost and what's even more important is to shorten the cycle time from contract to delivery. And that's very important in this environment, since most satellites and especially host payloads have a much shorter cycle time than previous satellite programs. With respect to Elcom, as Alan has described to you, we now own 100% of Elcom and we expect Elcom to be profitable in fiscal 2013. What is more important is that FEI's technology and market position will help Elcom to achieve more business in their various areas of responsibility, but most significant is that the -- is the insertion of their technology in FEI's space programs. This will enable us to get larger dollar value per spacecraft, and even equally important, is to be able to speed up to get to that stage on this. We continue to support a very new, exciting area of business and this is host payloads, and we are supporting most of our major customers. And most of you, I'm sure, are familiar what host payloads is putting -- a small, dedicated payload on an existing satellite where space is usually available at a fraction of the cost of launching a dedicated satellite. Because of the high-precision timing low phase noise, we are key ingredient in most of the host payloads, which are growing at a very large rate on this. As a matter of fact, from 4 host payloads that we supported over the past 5 years, we now have over, I believe, 3 to 4 host payload programs in the house at this particular time and are supporting a lot of proposals for additional ones. We see that to be a major portions of FEI's business. I want to address, also, the issue of research and development at Frequency Electronics. We are not falling behind by skimping on IR&D. On this, we are very fortunate that many of the advanced development for the next generation hardware is being funded by our customers. And as Alan has indicated, FEI maintains all of the intellectual rights of this designs. The only thing the customer receives is the hardware. So we look forward to having IR&D pretty much in the same lines that we had it in, in fiscal 2012. I think now Joe is going to do the final remarks. But before I get off, I'd like to express my personal appreciation and thanks to the Frequency Electronics staff for doing a great job in producing a very productive year. And I'm sure I can count on all of them in this coming fiscal 2013. I'd like to open now, right now, to questions and answers that you have. And if you would be kind enough to mention to whom you address it, it will go faster.

[Operator Instructions] Our first question comes from the line of Nick Halen with Sidoti & Company.

So the first question I had, I guess, more so for Martin. Just in terms of the -- I know you mentioned a few projects -- about 3 or 4 projects that you're working on in terms of the hosted payloads. And I was just wondering, can you give us some insight or have you guys disclosed at all who exactly you're working on those projects with?

If I did, I'd have to shoot you. No, unfortunately we cannot disclose this. I think the only one that is in a public domain that you might have seen some publications on it was that Boeing had a host payload on Intelsat 25, which verify the secure communication payload in orbit. It got a lot of publicity. This is a typical example on this. The other type of host payloads which has recently got publicity is that Harris is going to put an 82 payloads on Iridium for communication with planes over the open borders on this to give you just a few example. But basically, almost every government agency and even some commercial applications are looking at this as a very economical way to getting a mission accomplished at the fraction of the cost of launching a dedicated satellite.

Okay. And then also, I don't know maybe -- just maybe more so for Alan. I was just kind of wondering where we stand now in terms of capacity and I guess at what level of sales do you -- are you expecting to need more?

Well, let -- that's more for me than Alan. Alan has to keep me in control, make sure I don't spend too much on this. It's my responsibility to make sure that we have the capacity. I mentioned, Nick, in the beginning that as a one mission is we're putting in additional automated test equipment to supplement what we have and automatic assembly areas in order to meet that capacity. But space -- and space hardware doesn't require a lot of volume because, like you know, the modules are small, they require skill and cautions and a lot of tender loving care rather than a lot of people. So we don't expect to need any significant additions in that area. The most significant item that we added was in the acquisition of Elcom. We got a large family of RF microwave engineers, which we desperately needed to really supplement and accelerate our development into up/down converters and receivers for satellite payloads.

Okay. And then just lastly, just so I'm clear, that I believe Allington's [ph] $57 million backlog number for the year?

Correct. [indiscernible] on April 30.

And is that -- and I'm assuming that includes that $4 million order from Elcom as well?

No, it does not include the $4 million order. That came in after the end of the fiscal year.

Okay, okay. I got you, yes, all right. So end of April, it's $57 million, that's right, including anything you'd -- okay.

Correct. Yes, just a follow-up on that, Nick. The backlog probably is in excess of $60 million today because of recent orders in the bookings.

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

The news was so hot that the Globe couldn't handle it, huh?

That's it! That happens.

So tell me, with the Elcom, you're talking of going from $10 million to $25 million. And did -- in the 2 months, did you include a loss on Elcom or a profit, what did you include?

Yes, Elcom was continuing to suffer some reduced levels of business, and so we did incur a loss in the most recent quarter as a result of their operations. In fact, if you look at the press release, you'll note we did give a little more metrics. For the full year, they cost us about a $1.2 million of pretax income, both in operating costs as well as transaction costs and other prior-to-the-acquisition charges that we took.

And in the 2 months, what kind of -- what was the lowest, how much was that of the $1.2 million?

They had a $700,000 operating loss.

Okay. And did you report any goodwill on the transaction? And if so, how much?

Yes. Yes, there will be goodwill. It would be about roughly $360,000, not a very big number.

Okay. Now if we could expect to go from $10 million to $25 million, how many satellites do we expect to be able to handle in the next fiscal year?

Well, on the payloads, remember on this, most of the early payloads in this year are going to be in the $10 million range rather than in the $25 million. It's going to take us another year to really finish the development and getting the equipment qualified for flight to get more revenue per satellite. So we expect to have an increase in revenue, so obviously, we're going to have anywhere from 5 to 8 more satellite payloads or partial payloads in that period.

Okay. Now at this point in time, Alan, did we record 100% of the tax benefit or is there still another piece to be added?

In my remarks, you may recall I said that there is a remaining valuation allowance, about $1.5 million roughly, and that primarily relates to our foreign subsidiaries because they have some continuing loss carryforwards that they're not able to fully utilize. So it may be years before we take that down. So I think this is it for the near term in terms of extraordinary tax situations.

Okay. Now the -- what is your pipeline? What do you -- what does it look like now that you have Elcom as part of the family? How much are you bidding on or -- compared to previously?

This is Martin Bloch on this. We have -- well, Elcom is pursuing their routine business, while at the same time, helping us in development of the -- of next-generation satellite hardware. FEI's pipeline, we have about $100 million of outstanding proposals right now for various programs, which include proposals for satellite, for host payloads and for equipment that go for DOD, utilizing our advanced low g-sensitivity technology.

That sounds wonderful. Now Martin and the whole team, I know you have made your presentation at Sidoti, you went to Needham, where do you expect to go next and what kind of -- how are you going to tell your story? The story seems rather profound. And I think I need not repeat what the valuation was way back and you're very insignificant relative to that valuation and people should know about your story.

We will pursue it aggressively.

[Operator Instructions] Our next question comes from the line of Michael Miamari [ph] with Americo Inc.

Let me ask you, what is the number of employees now that you have Elcom? Are you above 100 or -- what's going on?

Employees at Elcom or just employees in total?

In total.

In total, we're at low 400s.

What was that again?

At low 400, around 425, something like that. That's worldwide.

Worldwide.

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

One question. Your revenue looks like you're one up, about 11% if, I'm correct. I read the press release late for the quarter.

Michael, I hope you give up your banking job since your arithmetic is quite off. It's 20%.

Your revenue from -- no, from that -- from previous quarter.

We don't -- how many times in the history of Frequency...

No, no I'll tell you where I'm going.

I'm telling you that we cannot -- Frequency is not a quarter-to-quarter.

Martin, I'll tell you -- no, I'm telling you where I'm going. I'm not asking you to predict quarter-to-quarter. What I'm asking you is -- let me ask my question. You went up $1.8 million roughly from the third quarter. What part of that $1.8 million was Elcom is what I'm getting to?

Not much. Insignificant, actually. Under $1 million.

Under $1 million? All right, so you had a nice increase, and that's what I was looking for. So you -- all right, that's what I was after.

Again, Michael, I want to correct you to make absolutely sure is that you visualize, as Alan has indicated that on a year-to-year basis, our revenue went up by 20%.

I realize that. I was just -- wanted to see the breakdown of what was with and without Elcom.

Okay. I understand.

That was my whole -- that was the whole question. And I couldn't heard the backlog before. What was it, $60 million now?

It's over $60 million today. It's $57 million reported at the end of April.

And so it is over $60 million today.

Our next question comes on the line of Frank Barresi with Ameriprise.

Your backlog -- I had a couple of questions. Your backlog was $57 million and -- does that mean that you expect that to be filled in the next year? That will be the first question. Then the second one was you were talking on these hosted payload projects and it was in your earlier presentations. You were saying -- I take it that you don't face as much competition in that area because of some of your technology and I think you were talking at one time that you have like $15 million or something like that. I mean, it's just a very substantial portion of the revenue, and I was wondering if you expect that to continue to grow substantially. And...

That's #2? Okay.

Yes, that's #2. And that would be enough, if you could just answer those.

Okay. On this -- let me take the first part of this on the hosted payload. We offer our customers a big advantage on this host payloads because of our basic technology, which enables -- hosted payloads have very unique requirement. It has to maintain the security and it has to be able to have a large bandwidth throughput over a very narrow channel. So low phase noise, microwave sources, very high stability, volts and atomic clocks are key building block of that technology. So that gives us an advantage to support this type of payloads. We also have invested in common designs in order to reduce the cycle time. And host payloads is, in many cases, is a kind of an opportunity on this. Spacecraft is going to be launched in 2 years or in 18 months, and there's a slot available so the cycle time to get a hosted payload is much faster and we are able to respond with much faster response time in delivering our hardware. So we are becoming a very good partner to people that are pursuing that business and we expect that to be a significant portion of our future revenue. With respect to the backlog shipment...

Well, as far as revenue, it's probably 60% to 70% realizable in the next 12 months.

Okay. And how does that compare to that backlog, $57 million. What was it 1 year ago?

Just short of $71 million. And at that time, we also said about 60% realizable in the next 12 months.

Okay. So you guys -- so 60% or 70%. Well, I guess, you've got to get a lot of new orders.

As usual, as usual. I mean, last year, we did have that -- at the very end of our fiscal year, we had a large very order came in, that $25 million, and that really spiked it up. And that is a long-term contract, probably about 4 or 5 years, that we'll be working on that one.

Basically the backlog -- in the past, the spike of the Iridium NEXT program, which was a $26 million contract, which really distorted the backlog figure and that's deliverable over about a 4-year period on this item. But our booking, it is ahead of sales.

You're booking more than sales?

In the current period.

In the current quarter.

Okay, good. Good, and so now this -- I missed some of the -- I got on late, I'm sorry about that. But did I understand -- they were -- people were talking about $25 million versus $10 million. That's the size of each satellite you're going to be able to do once within 12 months? Is that...

That -- I -- what -- okay, let me clarify because there's certain amount of confusion on this. I mean as we go historically back, we were delivering just a clock, which was between $0.5 million to $1.5 million per satellite and then we started to supply the microwave sources and we came up to $7 million to $10 million to satellites. The next escalation over that is to deliver -- is to provide up/down converters and receivers up to the satellite, which will enable us to compete for $25 million or more per satellite. And we expect to be in a position to compete in that arena within 1 year.

Okay. And then 1 year and it'll -- it takes several years, I guess, from the time -- I mean these are usually, maybe not in the case of the hosted, but normally they're awarded -- you get the award, you don't see revenue for several years. Is that the way it would go or...

No, that's not the case on this because we would recognize on the percent completion method revenues as we receive the contract. So we don't have to wait a couple of years to recognize their revenue.

Okay. And Martin, how long ago did you get into this microwave sourcing where you could do $7 million to $10 million per...

On this, about -- seriously, in 2008. I'm giving you an approximate time frame. I think that was the first step, and then -- and we invested a lot of money at that time in order to get to that point and to establish the product and the production capability to doing it and the reliability necessary for this product.

Okay. Can I ask you one last question? And I'll let somebody else...

Go ahead.

Okay. With all this talk about a tighter Defense budget, how are you seeing -- since Defense is most of your revenue, how do you see that affecting you guys or can you -- have you seen anything?

Well, as a matter of fact on this, I think we stand to benefit significantly from this because the model, as I keep on saying over and over again, is how to do more with less, which means on this, instead of building new platforms, building new satellites is increasing the capacity and the performance on the existing platforms. That's why FEI Technologies is a major facilitator and we are fortunate enough to be in a position and for the next couple of years, to be in a position where we will benefit from it rather than get penalized by it.

So you think like Defense revenues should grow than the next couple of years anyway?

Yes.

Let me correct one thing, Sam. Our Defense business is only about half of our business. When it comes to the satellites in particular, it's roughly 50-50. The revenue comes from commercial sources as well. The Iridium satellite program is just one example of that.

[Operator Instructions] Gentlemen, it appears there are no further questions at this time. Do you have any closing comments?

Yes, thank you, Jen. Folks, we really appreciate you tuning in and the stockholders as well. We want to thank you for being part of it. And we'll be doing everything we can to keep you there and rake the benefits for you. In the same vein, every morning, our doors open and our wonderful, hardworking employees come. I hope some of them are listening in now that work is ending. They know how much we appreciate what they do for us because if it we're not for them, you would not see the results that you're hearing today from us in this report. We're counting on them going ahead into 2013 and beyond and looking forward to reporting to you all again. Thanks for tuning in. That's it.

Thank you, everybody.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.