Frequency Electronics, Inc. (FEIM) Q1 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics First Quarter 2013 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. Any statements made by the company during the conference call regarding the future constitutes as a forward-looking statement in 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 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, Mr. Martin Bloch, President of Frequency Electronics. Thank you, Mr. Bloch, you may begin.

Thank you. Good morning, everybody. Sorry, Joe Franklin -- General Joe Franklin is not with us. He's participating in the memorials of 9/11, and it's like we all feel that's an event we should never forget. Going to the more cheerful part, I'd like to turn this conference call to Alan Miller to cover most of the salient points. When he is finished, I'll have some final concluding remarks and open the session for questions and answers. Mr. Miller, go ahead.

Thank you, Martin, and good afternoon, everyone. Before we get into the specific line items of our first quarter results, let me first note that the acquisition of FEI-Elcom during the fourth quarter of our last fiscal year had a notable impact on fiscal year 2013's first quarter. During the 3 months ended July 31, 2012, FEI-Elcom's third-party revenues were less than $1 million, and we absorbed approximately $1 million of additional cost. This in consolidated profitability for the quarter. This lower level of business for a period of time following the FEI-Elcom acquisition was not unanticipated, and for the first quarter, resulted primarily from contract definition delays on one major contract. They're currently manufacturing product under this contract and will recognize revenue as units are shipped. Frequency remains confident that FEI-Elcom will become accretive during this fiscal year. In his remarks, Martin will provide additional comments regarding FEI-Elcom and its benefits for Frequency. Now to the P&L for the current period. Fiscal year 2013 revenues were $16.7 million compared to $15.9 million last year. Revenues from satellite payloads accounted for approximately 50% of consolidated revenues versus 40% a year ago. Revenues from U.S. Government/DOD non-space, which are recorded in the FEI-Zyfer and FEI-New York segments, including FEI-Elcom, were approximately 15% of consolidated revenues. Together with satellite payload revenue for U.S. Government end use, total U.S. Government revenues rose to 49% of consolidated revenue. Network infrastructure revenues, which are recorded in FEI-New York, FEI-Zyfer and Gillam-FEI were 1/4 of consolidated revenues. We expect fiscal 2013 revenues to continue to grow compared to the prior fiscal year 2012. This is based on our current backlog, over 2/3 of which represent satellite payload business, cause the potential for new orders, as well as increase revenues for FEI-Elcom. Gross margin for fiscal 2013's first quarter was $6 million or 36% of revenue. This is compared to $6.1 million last year or 38.5% of revenues. Gross margin was impacted by FEI-Elcom's cost whose first quarter revenues were insufficient to fully cover its production cost. FEI-Elcom reduced the consolidated gross margin rate by about 2%. Product mix and lower revenues at Gillam-FEI and FEI-Zyfer had an additional nominal impact on our gross margin rate. As the FEI-Elcom's revenues increased and with the favorable product mix, we expect our gross margin rate to rise to 40% or better during fiscal year 2013. SG&A expenses were $3.5 million in the first quarter of fiscal 2013 compared to $3.2 million a year ago. Again, FEI-Elcom accounted for the quarter-to-quarter increase in SG&A, offsetting reduced expenses at other segments. As revenues increase in the following quarters of fiscal 2013, we expect SG&A expenses to be approximately at this level with a decline as a percentage of revenues. R&D spending was $1.4 million in the first fiscal 2013 quarter or about 9% of revenues compared to $1.2 million or 8% of fiscal 2012 revenues. Again, FEI-Elcom's R&D expenses offset modest reduced expenses at other subsidiaries. For the full fiscal 2013, we expect R&D spending to be less than 10% of consolidated revenues. This result in operating profit of $1.1 million in fiscal 2013 compared to $1.8 million a year ago. As we noted previously, the incorporation of FEI-Elcom in our consolidated results for 2013 reduced operating profits by approximately $1 million. As FEI-Elcom's revenues increase, as well as those of our other subsidiaries, we expect operating profit to improve and to exceed that of the prior year. Other income, which consists of investment income, offset by interest and other expenses, netted to income of $117,000 compared to $199,000 a year ago. Therefore, pretax income was $1.2 million in fiscal 2013 compared to nearly $2 million last year. Fiscal 2013 tax provision of $430,000 is at an effective rate of 36%, which was impacted by the pretax losses at our foreign subsidiaries. As those subsidiaries generate profits, we expect the effective tax rate for fiscal 2013 to drop to the low 30% range, similar to last year's first quarter results. Net income for fiscal 2013's first quarter was $768,000 or $0.09 per diluted share compared to $1.3 million last year or $0.16 per diluted share. For the quarter, we used cash in operations in the amount of $400,000. Cash and marketable securities are $22.1 million. Borrowings under our line of credit remain at $6 million. Interest rate on this line of credit continues to be less than the yield on our investment portfolio. And we fully expect that fiscal 2013 will generate positive cash flow. Our funded backlog at July 31 remains at a historically high level of $58 million, which excludes approximately $5 million from contract awards that are expected to become funded in the near term. About 70% of this backlog is realizable in the next 12 months. I'll turn the call over now to Martin and look forward to your questions later.

Thank you, Alan. I would just like to say that, in general, things are very, very well at Frequency Electronics, with business and product mix and the opportunity of future business. I'd like to address a few remarks on Elcom. The main objective on Elcom acquisition was to help Frequency Electronics accelerate the development of the products for inclusion on satellites so we can get a bigger portion of the payload on future programs. And that is on schedule, and it's moving, and it's getting a lot of attention from FEI and the engineers at Elcom. I'm confident that with their help, we will be able to qualify these products within 1.5 years from today and try to insert them in satellite. Some of them will already be inserted as early as December of this year. The delay in finalizing the contract at Elcom is a paperwork mill that will be straightened out in the near future. FEI has been very successful in supplying over the past 50 years to over 250 space and exploration and satellite programs, and we expect the future to be just as bright in this area. We are working on a lot of new proposals in addition to the product. And the team at Frequency Electronics is ready to undertake the challenge to produce a profitable year with increase in revenue and increase in profitability. Things are good. We don't have to do a lot of talking. I'd like to open this to answers and questions. Louis, are you with me?

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

I apologize if I missed it, but what was the loss in the quarter from Elcom on a per-share basis in terms of EPS? Did you guys give that number?

No, I didn't give it. As I said, it cost us probably about $1 million to the pretax line. So if you want to multiply that out by the effective tax rate, you'll get something pretty close.

Got you. Okay. Let's see, and were any of the cost, the additional cost that you guys took on a result of Elcom, were any of those onetime in nature or were those all just basically running the business type costs?

Some of them were onetime costs. And the main impact is actually this contract that wasn't definitized, and they couldn't ship, which will -- although the material was being built, so we'll catch up on it in the near future.

Okay. It seems like you guys are pretty confident that Elcom will get these contract delays situated by the end of, I guess, your fiscal 2013, is that safe to say?

No question about it, sooner than that.

Okay. And then just lastly from me, have you guys begun any of the work on the $10 million contract that you guys announced in July? Or is that still waiting -- are you guys still waiting on that?

We are working 24/7.

Okay. So everything is up and running on that one?

Absolutely. Just in general, you understand what's happening, and this is a great opportunity is that the cycle time for satellite contracts is under a lot of pressure to reduce and do it faster, and that gives us the opportunity because we can do it faster as a small company than the giants. That gives us a lot more opportunity to pursue those products.

The next question comes from the line of Frank Barresi.

Hey, things sound like they're going really well. And if you could just like kind of reassure me because your company has been around a really long time.

Fifty years.

Yes, but that is a long time. And you're -- you've had, I guess, good period and bad periods. But you've got these growth plans, which sound very good, but what assurance do I have you guys can get that big and handle all that volume?

Okay, and that's a very good question. This is Martin speaking. First of all, a lot of our growth is based on research and development that is already mature and that's flying in space and has legacy. So we don't have to invent any new widgets in order to do it. Second and most important is the environment that we're facing over the next 4 to 5 years where the objective is how to accomplish more with less. That means how to put more technology, more bandwidth, more capability on existing platforms, and that's where our best knowledge really shines. And the third, which is equally important, and I'm sure you heard it over and over again, is that especially on the government satellites and the military programs there's enormous movement on fixed cost instead of cost plus. And it becomes conducive for the major satellite suppliers to engage companies like us to supply more of the hardware because, A, we are more -- we are a lower cost; B, we have shorter cycle time; and C, by integrating our technology in a larger package, not only is it lower cost in buying the hardware, but it's lower cost in integrating on the satellite; and the last and most fundamental item is that we want to put more and more capacity on an existing platform. That means reducing size, weight and power consumption. And we've had a very effective program pursuing this, where our units are lighter weight and this takes less power, and more important, take a much smaller footprint so you can put more channels per platform. And that's where the effort at FEI and some of the work that Elcom is doing for us. So it's a solid plan from -- and we've analyzed it and have tested [ph] from all angles, and we're on solid ground.

Okay. And you're -- I missed the beginning of the call, I'm sorry. I had -- I was out of the office, but the...

Prep points.

I'm sorry?

Fifty demerit points.

Okay. Yes, I deserve -- I got off easy. But this Elcom acquisition, you mentioned that, Martin, that they were -- that it would be like 18 months you would have all the -- you're trying to accelerate the development of some of your new components.

Right, products. Basically, receivers, down converters that expands our ability from $7 million to $10 million per spacecraft to $25 million to $35 million per spacecraft. That's the game plan.

Okay. And then -- and some of that you think will be accomplished you said by December?

Yes, some of the hardware, the early stages, we're already integrating it, and the programs that we have and the input on host payloads immediately, and the main products in 18 months.

Okay. And if you have it integrated, ready to go, how long before -- because I imagine the lead times on these are pretty long, how long before this would be -- produce sales?

We expect to have it -- we are proposing it right now. We expect at that time to be able to participate in contract awards at the end of the 18-month period, and so -- and start providing that type of hardware after the 18-month development and qualification period.

Okay. And then so the results of this would show up in, well, 18 months. We're talking about sometime in calendar 2014, I guess?

Yes. And maybe a little sooner.

All right. Now the earlier -- now you're at $7 million to $10 million you're saying now. How much -- were you at that same level a couple of years ago or...

Well, yes, we've been fighting at that level between $7 million to $10 million now for about 2, 3 years. And the next jump is like, I said, is providing the receivers down converters, and where there's a lot more units per spacecraft and higher dollar value.

Well, I just had 2 more questions. One would be, are there a lot of other companies? I mean, your competitor is doing the same thing trying to integrate more, or you just think you're going to have lower cost than just about any...

Well, we have a few competitors, but the largest competitor is a major satellite builder where they do it in-house. And we feel that this is where we can harvest the most opportunity since they are being forced to be more cost-effective and to reduce their cycle time. So the major competition was in-house. They would buy the guts, the most critical parts from us and do all the wraparound electronics in-house. What we want to do is supply to them a complete solution.

And they're very receptive to this?

Well, they are fighting it with nails and tooth, but they don't have a choice. They have to reduce their cost, and they have to reduce their cycle time. Nobody wants to give up their bowl of rice, you know?

Right, of course.

But I don't think with a fixed -- with the most of the contracts in the future going in fixed cost and the cycle time being pressured to reduce from 36 months to 24 months, I don't think they have an option.

And so -- and the fixed, the other part, then you would also be in the fixed cost situation?

We've always been in the fixed cost. We have a couple of cost plus contracts not by our choice, it's been imposed on us. We do best on fixed cost. We know our cost very well, and that's the best way, most efficient way to run a contract.

And so because -- and you're confident that you'll be able to not get yourself in a big bunch of trouble where your cost, you underestimate that -- because you are going to be making a lot more, I mean, how can you have -- I'm just trying to...

Yes, I understand what you're trying to say on this. Well, we have good models. And basically, the key is to have solid engineering designs because the cost primarily -- the uncertainty of cost is when you run into the unknown. And we are putting the research and development and building a more common set of toys to put together, and that mitigates the risk on dollars. We have demonstrated in the last couple of years that we can do it effectively, and I have high confidence that we'll be able to do it in the future.

And just one last thing, and you're expecting -- even before these extra products are developed, you're expecting to see growth in the next 18 months before you can even offer these or...

Yes.

[Operator Instructions] Our next question comes from the line of Sam Rebotsky with SER Asset Management.

It's a good quarter, I guess would like to get the FEI-Elcom profitable sooner. The $1 million sales, I assume, is in the FEI-New York. And with the loss of $1 million relative to this new acquisition, do we expect to be profitable in the quarters going forward for FEI-Elcom, or when do we expect that to contribute?

You're asking about Elcom?

Yes.

We expect Elcom to be profitable for -- in fiscal 2013.

So what do we expect to lose for the rest of the year in the...

We expect to be profitable there. So we got to make a profit at Elcom, not lose anymore.

Okay. So for the rest of the fiscal -- the year 2012, the rest of the year, we're going to be profitable? Are we not going -- or breakeven or...

Well, FEI-Elcom is going to be a component of FEI-New York as we've indicated before, as far as the segment is presented. So we do expect FEI-Elcom to make a positive contribution to earnings going forward.

Okay. So it will be profitable for the rest of the year? Okay, that's good. And do we have any visibility on what kind of sales that you could share for the rest of the year? Because you did only about $1 million, and do you need to do $2 million a quarter? Or what do you need to be profitable there?

Yes, $2 million plus, at least.

Okay, okay. And the backlog you indicated is $58 million, and you expect to have another $5 million. Is the -- could you indicate what the -- how much you're bidding on currently? Or what are you seeing? Is it an excess of $100 million or what kind of...

That's about -- this is Martin again. That's about the level of all proposals that we maintain between $80 million and $120 million on a continuous basis.

Okay. And once you're ready to go with the Elcom in the 18 months, your proposals would be significantly higher, I guess?

Definitely. Because at that time, we are taking a much larger portion per satellite.

Okay. Now just a couple of questions relative to the stock. At this point, is there any consider -- is there any acquisitions that you're looking at, or do you want to consider dividends, or what do we want to do at this point?

Alan, on acquisitions.

Yes, the acquisition opportunities, if they present themselves, we're always interested in pursuing. Obviously, we can't comment if we're looking at anything currently, but that's always an option for us that we want to consider. Dividends also is something that is considered at every single board meeting. And obviously, our Board of Directors has taken the position at this point not to continue the dividends that we had paid out over a period of time in years past.

But it will be brought up on the October 17, right?

Yes.

With our stockholders and Board of Directors meeting. And as usual, this is reviewed on every board meeting.

Have you found that a good deal of the shareholders, both institutional and regular, have sort of said that this would be a good idea to sort of institute a small dividend? Because I know Value Line has looked at you and gave you more of a positive rating. And where do you expect to be making additional presentations? Could you talk where you expect to appear to make presentations in the future?

This is Martin. Yes, we will try to keep the Street more informed on this. We've been so busy developing product that we figured our good work will take -- will show by itself. However, we realized that we have to make some more presentations, and we will have luncheons and presentations going forward on a more frequent basis.

Yes. In fact, we are invited to the Needham conference, but that's not till January, first week of January. And then there are other things that Martin has alluded to.

Martin and Alan, you've done a good job, and you've -- I'm sure you've looked at the Elcom for a long time because you had an interest in this.

Yes, I was Chairman of the Board, and we had a 25% interest for 5 years. So we know what they are. There's -- and we know exactly, and I feel it was a great opportunity to acquire that asset.

And hopefully, it gets integrated. And you get to the 18 -- before the 18 months and start meet the requirements to bid on new contracts and get more people involved in Frequency. Good luck.

Thank you very much.

There are no further questions at this time. I'd like to hand the floor back over to management for closing comments.

Okay. This is Martin. I want to thank everybody for participating and for the people that observe, a happy Jewish New Year, that's coming up in a few times, and we're looking forward to talking to you on the next quarter. I'm sure you'll be satisfied with our efforts. Again, thank you, all, for participating, and good day.

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