Frequency Electronics, Inc. (FEIM) Q2 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics, Inc. Second Quarter 2013 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 than 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 the conference call. It is now my pleasure to introduce your host, General Joe Franklin, Chairman of the Board for Frequency Electronics. Thank you, General Franklin, you may begin.

Thank you so much and thank you all for tuning in with us this afternoon. We're delighted to be able to bring you our news today. I'm joined by our President and CEO, Martin Bloch; and our Chief Financial Officer, Alan Miller, who will do all the talking with the details. This is just an opportunity to wish all of you a fine holiday season. And our comments, I think, will fit right in with that. Without further ado, let me introduce Alan Miller as our...

No, Martin will go on.

Oh, are you the first, Martin? Okay. Martin will be our first, and take it away.

Good afternoon, everybody. I'd like to make a brief announcement and after my announcement, I'll turn over to Alan Miller for details and when he is finished, I'll have some closing remarks on Frequency Electronics. And of course, General Joe Franklin as always has to say the last words. So without further ado. Today, the Board of Directors of Frequency Electronics, Inc. declared a special cash dividend of $0.20 per share payable on December 31, 2012, to shareholders of record as of December 24, 2012. The board took this action in recognition of the company's current financial strength, its recent performance and outlook for continued profitability. And I want to thank the board and our stockholders for being with us. I'd like to turn over now to Alan Miller for financial details.

Thank you, Martin and good afternoon, everyone. For the second quarter of Frequency's fiscal 2013, revenues were at $17.6 million compared to last year's $15.1 million. Revenues from satellite payloads remained approximately the same as the year ago and accounted for about half of consolidated revenues. With the Elcom acquisition, revenues from U.S. Government DoD non-space accounted for just under 30% of consolidated revenues. Total revenues for U.S. Government/DOD end-use, both for space and non-space programs, rose during the quarter and year-to-date account for 54% of consolidated revenues. Network infrastructure revenues recorded in FEI-New York, FEI-Zyfer and Gillam-FEI, were less than 20% of consolidated revenues. As anticipated, Elcom's second quarter revenues increased by more than $1 million over the preceding quarter, and we expect to see continuing revenue increases from FEI-Elcom for the balance of fiscal 2013. We expect fiscal 2013 consolidated revenues to continue to grow compared to the prior fiscal year of 2012. This is based on our current backlog, over 3/4 of which represents satellite payload business, plus the potential for new orders. Higher revenues resulted in increased gross margin dollars to $6.7 million in the second quarter of this current fiscal year compared to last year's $6.1 million. The gross margin rate of 38% in Q2 of this year is compared to 41% last year, and that rate was impacted primarily by product mix with lower-than-target margins realized at Gillam-FEI and FEI-Elcom. As revenues increased and with the favorable product mix, we expect to achieve our target gross margin rate of 40% or better during fiscal year 2013. SG&A expenses were $3.5 million, almost the same as the prior year, but were at 20% of revenues this year compared to 23% of revenues last year. For the second half of fiscal 2013, we expect SG&A expenses to remain at about the same level or around 20% of revenues. R&D spending was $1.2 million in the fiscal 2013 quarter or about 7% of revenues, compared to $900,000 or 6% of revenues last year. For the full fiscal 2013, we expect R&D spending to be less than 10% of consolidated revenues. Our increased revenues and higher gross margin resulted in a 14% increase in operating profit of $2 million or 11.5% of revenues compared to last year's $1.8 million and 11.8% of revenues. For the quarter, FEI-Elcom made a positive nominal contribution to operating profit, as opposed to operating losses recorded in the previous 2 fiscal quarters. We expect these trends to continue and anticipate that fiscal 2013's consolidated operating profit will exceed that of the prior year. Other income, which consists of investment income, offset by interest and other expense, netted to an income amount of $92,000, compared to net expenses of $369,000 a year ago. So this yields pretax income of $2.1 million compared to $1.4 million last year. In the current quarter, taxes are recorded at $670,000, which is an effective rate of 32%. Now this rate is impacted by the pretax income or loss of our foreign subsidiaries, which are non-taxed. We expect that fiscal 2013 effective tax rate to remain in the low 30% range. Now as a reminder, Frequency's trailing 12 months operating results include the reversal of a tax valuation allowance, which skewed the tax provision and net income for that period. We do not anticipate any similar recurrence in this current fiscal year. Therefore, net income for the fiscal 2013 second quarter is $1.4 million or $0.17 of diluted share compared to last year's $776,000 or $0.09 per diluted share. For the quarter, we used cash in operations in the amount of $580,000. Cash and marketable securities are at $23.9 million, offset by borrowings under our line of credit of $8.5 million. The interest rate on this credit line continues to be less than the yields on our investment portfolio. Year-to-date bookings exceeded revenue, and our funded backlog at October 31 rose to $63 million, as compared to $58 million last quarter. About 70% of the backlog is realizable over the next 12 months. And as I mentioned previously, over 3/4 of the backlog is for our long-term satellite programs. I'll now turn it over to Martin and we'll look forward to your questions a little later.

Good afternoon, everybody. As I said before, the company is doing very well, and we are at the crossroad where our technology of high precision, ruggedized timing and low phase noise microwave sources, we see this in down converters, which is going to come down the line, are found that they are niche. And to accomplish on the necessary slogan that everybody is saying, that we have to accomplish more with less. By this, I mean, if we can use better precision, to use an existing platform to perform the function, and this, rather than to build a new complex platform, it is a lot cheaper to do. So ruggedized, low g-sensitivity clocks do a great job on existing platforms such as airplane, remote pilotless vehicles, helicopter ships and moving vehicles on the ground. And our low phase noise and high precision timing do a similar function to enable to put more dense, more channels in a given satellite rather than to build a new one. So, we are looking forward to continuous increase in bookings. We have lots of proposals outstanding and we are spending a concentrated effort to complete the development of the next generation of receivers, down converters on this, which will enable us to capture a larger portion per satellite. And this, our challenge, is just to make sure that we produce our hardware on time and everybody is signed up at Frequency to accomplish this task. We are continuing to utilize the new acquisition of Elcom in helping us in completing the development on the next generation hardware for up/down converter for space use, as well as adapting their technology to satellite applications. And since everything is great, I don't have a lot to say. So I'd like to open at this time to questions and answers.

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

So a few questions here. I guess the first one, probably more so for Alan. Can you guys give us a sense, maybe, of how much revenue Elcom contributed in the quarter? And I guess whether or not they're profitable?

Well, as I said, they were nominally profitable, a little above breakeven. But for the quarter, we will disclose this in our 10-Q as well, they did 2.1 of third-party sales.

Okay. So just looking at it, I guess on the FEI-New York side, the majority of the increase came from that acquisition, right?

Yes.

Okay. And if I heard you correct, you said, also, that there was -- year-over-year, there was pretty much no growth in the satellite payload business. I guess, what caused that? And I guess, what do you guys expecting for the remainder of fiscal 2013?

Well, as we kept on continuously saying, the satellite payload business doesn't come on a quarterly to quarterly basis. It's quite lumpy, and we expect for the year to have an increase in satellite payload hardware delivered to the industry. We have a good backlog, as Alan has mentioned, and everything in that area is probably as rosy as it can be described.

Got you. So I guess, with the lumpiness of that, I mean, I know you guys don't give guidance or anything like that but you would expect the revenue from that to be a little higher in the second half of the fiscal year than the first, I'd imagine.

Yes.

Okay, and then just one more for me, I guess another housekeeping question. I guess for Alan, just in terms of the gross margin, I know you mentioned that you're still anticipating a 40% gross margin in fiscal '13, which I guess, kind of implies some pretty drastic expansion in the back half of the year, and I was kind of wondering where you're expecting that to come from? And I guess, why the gross margin hasn't been 40%, so far, in the year?

Well, first of all, in the first part of the year, it was quite a bit lower, primarily because of the Elcom transactions, because of the low volume that they were doing. And as we see that accelerate, that should fill up our gross margin from that particular arena. And it is product mix dependent from some of the other subsidiaries that we have. But as our volumes increase and we do expect to see some increased sales volumes, as Martin just indicated, that should cover more of the overheads. So we -- it doesn't take that much more of gross margin to get to the 40% for the full fiscal year. We're pretty close.

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

Let me say, I didn't have to ask this question. The board gave the $0.20. And hopefully, besides the possibility of higher taxes, we consider in the New Year, if we show improved profits, to give regularly, the semi-annually or quarterly dividend, but this is good. Now as far as the pipeline, I think it was around $100 million that you were bidding, or something like that. What is the pipeline like with what you're bidding on now with the additional Elcom, et cetera?

About the same. It's about $100 million of various proposals that we have outstanding. And it's a continuously revolving process. We booked some and new programs come in to view. So it stays about above it -- about at that level.

Okay. And I think you -- is it $10 million per satellite with a goal of $25 million and what kind of time frame do we expect to get to the upper range?

Okay. At this moment, as we have stated in the past, depending on the satellite, we have gone from $0.5 million to $5 million to $10 million per satellite and when we expand to the up/down converters, receivers, it's going to be between $20 million and $30 million. And the timeline is to complete the rest for development before the end of this fiscal year, which means in -- by May 1, 2013. And then to build TQM, the qualification models, by the end of the 2013 and hopefully do some bookings by the end of fiscal -- calendar 2013 or beginning 2014.

Okay. That sounds very good. Now I think you basically have said that you didn't expect the sequester to have an impact on your backlog and your business, et cetera. It's that still the way you're looking at it? Or. . .

What is -- what will happen?

The U.S. government issue.

U.S. Government issue? Yes, well, basically, most of the programs that we have, especially in the satellite and the low g-sensitivity hardened clocks for DoD, those are not luxury items. And we see a minimum impact at this time. That's why our backlog is up not down, and we expect this to continue in the same trend.

Okay. And as far as appearing before various conferences, as far as broker's conference, what's your plan for the rest of the year or the New Year, I mean?

Well, we are scheduled to present at the Needham conference in early January on the 15th or 16th, I believe it. And we did present that conference back in D.C. last month.

[Operator Instructions] Our next question comes from the line of Lawrence Goldstein [ph], a private investor.

I find it very interesting that when you put out your results today, the stock went up and then when you announced the dividend around the hour, the stock went down. So I'm glad to see we do have some intelligent investors. I never understood that chap on the calls who constantly calls for paying a dividend. I mean, dividends make no sense at all, they serve no purpose. When you pay a fat dividend, it reduces your book value and should reduce your share price. Incidentally, all these companies, these major companies paying big, fat, special dividends of several dollars a share, and then you'll see the stock goes up. I mean, it just shows you how, I hate to say people are stupid or dumb. But just how stupid and dumb, so-called investors are because, obviously, the company is worth that much less. So I'm not thrilled with dividends for 2 reasons. The first is, the company -- I would rather see the company plow the cash, and you've got some substantial cash, into the business and make it grow. And that leads me to wondering, after all, the stock has been selling for years under book value. Last I looked, your tangible book was about $9.40 a share, and with this special dividend and the current earnings, the book value is not going to change much from the last quarter. And you consistently sell under book, which is the oddest thing. And so I'm wondering, I mean, after all, if you're going to be a growth company, you should sell at a multiple of book. Do you have, I'm not asking you to tell me what it is unless you care to, do you maintain a 5-year business plan, a 3-year business plan? And if you could share anything with us, fine. If not, I'm just wondering if you keep one going and update it as time passes.

Okay. This is Martin Bloch. Let me take a few of your points and go on there. Obviously, the board at Frequency Electronics is neutral on dividends. We just felt that we are at the time where we had extra cash without taking away any of our ability to continue develop and then plowing into the business. And that's a good token to the stockholders and to express that we are in great financial shape on this item. This is just the answer for the dividend. With respect to the plans, yes, we have an internal 3-year plan, which we update continuously. And we look at the opportunities for business and growth, and at the same time, identify any partnering that we might want, acquisitions or merging with another company, that can boost our growth in our specialty area.

And do you care to share anything with us about what your long-range plan is? I'd like to put it this way -- I'm sorry, go ahead.

I can share with you that we plan to have continued growth in revenue and profitability.

And what period of time do you think it reasonable, that you might double the size of the business, the revenues and the profits both, either on?

Less than 5 years.

Our next question is a follow-up question from the line of Sam Rebotsky.

I've just want to respond to Lawrence Goldstein [ph]. He's a very smart, and bright investor, very long-term oriented. And the rationale for paying dividend at this point and on, is to attract the new investor to Frequency. Unfortunately, the stock has traded rather erratically and the spreads have been wide. And I would think it's a rather smart approach at this time to get more investors into the stock, to get a more rational valuation for Frequency. And I commend the board at this point for declaring a dividend. The possibility is the tax rate will go up next year. That's the way it appears. And a -- some type of format will attract new investors into the stock, hopefully. And if your performance continues, you'll get a much higher valuation relative to what you had a long time ago, as you may -- as you know, Martin.

Well, thank you. And I'll tell you, our mission over here is to create wealth and not to pay too much attention to the day-to-day fluctuation of the shares, for which we have no control of. What we do have control, is to put our energies to grow the company, both in revenue and profitability, and to continue with our excellent mission that we have performed for the United States Government, the space industry and our DoD efforts.

You're doing a good job and when you were buying the stock, when it was lower, that was -- gave a smart attention to it. And hopefully you could continue to improve and find some acquisitions, as the Elcom you were aware of and familiar with, and things that fit into, you could get more of a payload into the satellites or whatever. And get a greater valuation.

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

Okay. General Joe Franklin had to leave to catch a plane. And this -- so it's Martin Bloch. I want to wish everybody a happy and a healthy New Year, and a Happy Holiday. I want to express my appreciation to all our stockholders and especially to the employees of Frequency Electronics that are working very hard to generate continued growth in revenue and profitability. And to have a Happy New Year. Thank you.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.