Frequency Electronics, Inc. (FEIM) Q1 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics, Inc. Q1 2014 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 Litigations Reform Act of 1995. Such statements inherently involve uncertainties that could cause actual results to differ materially from 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, Martin Bloch, President and CEO of Frequency Electronics. Thank you, Mr. Bloch. You may begin.

Good afternoon, everyone. This is Martin Bloch. Welcome to our conference call of first quarter of fiscal 2014. I'm going to turn this call over to Alan Miller, who will go through the financial details, and then I will try to give you some color on Frequency's progress and open the conference for questions and answers. Alan, please proceed.

Thank you, Martin, and good afternoon, everyone. For the first quarter of fiscal 2014, Frequency's revenues were $16.8 million compared to last year's first quarter fiscal 2013 number of $16.7 million. Revenues from satellite payloads remain the dominant market for Frequency and the area of largest growth going forward. Satellite payload revenues increased approximately 16% over the prior year period and accounted for over 55% of consolidated first quarter revenues. Revenues from non-space U.S. government DOD programs, including sales by FEI-Elcom and the FEI-Zyfer accounted for about 1/4 of consolidated revenues. Total revenues for the U.S. Government/DOD end use activities, both for space and non-space programs, continued to account for more than 60% of Frequency's consolidated revenues. Network infrastructure revenues, which are recorded in FEI-New York, FEI-Zyfer and Gillam-FEI, were about 15% of consolidated revenues. Based on our current backlog and new satellite bookings awarded at the end of the first quarter, we anticipate continued strong revenues from the satellite payload market in fiscal 2014. Our gross margin for the first quarter was $6.3 million compared to $6 million in the year-ago quarter. Now this increased gross margin is due to the increased revenues and improved gross margin rate from 35.8% to 37.2%. As we've discussed previously, our gross margin rate is impacted by product mix and the sales volume of our subsidiaries. Fiscal year 2014 SG&A expenses of $3.6 million were comparable to last year's $3.5 million and were at 21% of revenues in both years. This level of SG&A expenses is in line with our expectations and as revenues increase, we will do expect to see the ratio of SG&A expenses to revenues to decrease. As we noted in our press release during the first quarter of fiscal 2014, we continued to accelerate our R&D investment in the new satellite payload product line of Ku and Ka band receivers and converters. R&D spending in the first quarter was $1.7 million or 10% of revenues compared to last year's $1.4 million or 8% of revenues. We expect the rate of R&D spending to moderate during the latter half of fiscal 2014 and expect full year R&D spending to be less than 10% of revenues. The higher R&D spending in fiscal 2014 is reflected in the small decline in operating profit from $1,081,000 last year to $963,000 this year. Other income, which consists of investment income offset by interest and other expenses, netted to income of $93,000 compared to income of $117,000 a year ago. This yields pretax income of $1,056,000 compared to $1,198,000 last year. We recorded the fiscal 2014 tax provision of $380,000 or an effective rate of 36% compared to last year's $430,000, also just about 36%. Depending on the profitability of our foreign subsidiaries, we anticipate that our effective tax rate will fall in the range of 32% to 36% for all of fiscal 2014. This yields net income of $676,000 or $0.08 per diluted share compared to $768,000 last year or $0.09 per diluted share. Fourth quarter, we used the $2.2 million of operating cash flow, primarily due to the growth in accounts receivable and inventory. With respect to billed receivables, the balance at the end of the first quarter was $12.6 million, up $4.8 million from the $7.8 million balance at April 30. This growth results from our meeting contractual and production milestones during the first quarter, which will generate substantial positive cash flow in the second quarter of this year. Our reported backlog at the end of April -- I'm sorry, at the end of July was about $56 million compared to $51 million at the end of fiscal 2013. Except with respect to cost-plus contracts, we include in backlog only the funded portion of our long-term contracts. Over 3/4 of our backlog is for long-term satellite programs split about equally between commercial and U.S. government programs. As we announced in June, we established a $25 million credit facility with JPMorgan Chase. During the first quarter, we took down an additional $3 million, of which $1.5 million was used to acquire capital equipment in connection with expected future production requirements. For all of fiscal of 2014, we expect CapEx to be between $2.5 million to $3 million. I'll now turn the call back to Martin, and we'll respond to your questions a little later. Martin?

Thank you, Alan. When things are going great, my remarks can be very short, and I'll give the most time to questions and answers. We have accelerated the conclusion of development of the up/down converter down receiver line because of the business opportunities. We have tested the engineering models and we expect to perform the delta qualification before the end of calendar 2013. It is much easier for us to do it because we have legacy on the receivers and we are flying them already for quite a few years in space, and this is just an improvement in size, performance and the ability to produce large numbers per satellite instead of the isolated receiver down converters we've built for many of the sensitive programs on this. I would also like to emphasize that there is significant opportunity in increasing profitability on space programs, as they are now the most profitable portion of FEI's product line because there's a certain baseline of cost that you have to be in the space business. And as a typical example, a baseline of $10 million will be there in place if you ship $20 million of space product. It will go up to $12 million if you ship $80 million worth of space product. That's why I'm very bullish on Frequency's future, since the majority of our backlog is in both commercial and military space programs. Most of the orders that we have received are very fortunate on legacy of products that are already flying and therefore, we expect to be able to meet the much demanded shorter cycle time and the risk for being on budget and maintaining good profit margin are excellent. We have already significant proposals outstanding on our new product line with the programs that are scheduled to be concluded by the end of this calendar year or beginning of calendar 2014. This what makes Frequency very attractive at this time to our customers, which is, of course, the bloodline of -- is the demand is for shorter cycle time on this and lower power, lower weight to put more capacity on existing platforms, and that was Frequency Electronics' investment in the past, and every program that we have, this is our main focus on how we can reduce size, weight and power and still maintain the space legacy. And short cycle time is becoming not only important on standard space programs, but very, very important on host payloads, which the opportunities is that space -- the train is going to leave on a given date if your host payload is ready or not. So cycle time is becoming very, very, very important. And because of our legacy, our inventory of critical parts and what's also making a substantial difference is our ability of quartz products from raw material to finished product, on this we are able to meet that demand and satisfy our customers' requirement. I look forward to increase in revenue on profitability for the next -- for the last 2 quarters of fiscal 2014. And of course, the timing is how these programs that we have can be phased in and shipped out. Many of the programs that we have booked in the first quarter on this will result in revenue in fiscal -- in the later part of fiscal 2014. I'd like now to open this conference to questions and answers. Please be kind enough to address the question either to Alan Miller or myself so we can give you a very precise answer. Thank you for listening in. Go ahead.

[Operator Instructions] Our first question comes from the line of Jim McIlree with Chardan Capital.

It's Jim McIlree which Chardan Capital. Alan, in your prepared remarks, you said 25% of revenues came from something, and I just missed it. What was that? 25% from what?

About 1/4 revenues were generated from non-space U.S. government-related work.

Non-space U.S. G. Great. And Martin, you confused me a little bit on the converter products. It sounds like you might get orders by the end of this year, but revenues, by the end of next year. Did I hear that correctly?

Well, almost. Okay, we already have orders on up/down converters on units that we have space experience. But this is very high-revenue, single type of up/down converter for special missions. The new converters that we are finishing development is -- will be for military and commercial communication satellites of which there are not 1 or 2 receivers per satellite, but 40 to 140. And so those are the products that we have outstanding proposals. And yes, we expect the progress on there at the end of this calendar year or definitely before the end of this fiscal year.

Okay, great. That makes sense. And can you just -- just 2 more, if I can. Can you give us an update on GPS and the next programs?

Well, we are fully funded up to develop -- to finish development of the clocks for GPS 3. We're going through right now in the process of getting units built for qualification and for anticipated flight. And at that time, this is going to be a competition between us and then one other supplier on who's going to fly clocks on the next 36 -- 33 to 36 GPS satellites. And then the basic philosophy is that there's going to be both suppliers on the satellites and whoever has the most cost-effective product will fly 2, the other one will fly 1 in order to make sure that we have mixed technologies for best reliability. And we'll do our best to be the one with the most attractive price.

And on the NEXT program, the Iridium NEXT program?

The Iridium NEXT program, that's fully funded, and we have delivered the engineering models. We are going through qual and will be producing all of the timing, all of the equipment over the next 3 years per schedule. As a matter of fact, we are blessed today with having Thales Alenia team right here for a progress review.

Great. And my last one. Martin, you talked about the leverage in the model, and I think I missed the denominator on the first one. You said if you -- you were talking about that $10 million to something and $12 million to $80 million, and I just...

Yes, okay. Alan has it in more clear language. In order to be in space business, you need a certain infrastructure, which is certain of your research laboratory, certain of the quality control system, certain of the procedures, and that's roughly a $10 million bite. And the $10 million -- you need $10 million in place if you're going to ship $20 million of space product. You're going to go from $10 million to $12 million if you ship $80 million worth of products. In short, what that means is that, although we have very good margin on space products, they will continuously significantly improve as we capture and ship more volume on both commercial and military space.

Our next question comes from the line of Tristan Thomas with Sidoti & Company.

Two quick questions. The first one regarding the capital equipment purchase. How soon is that expected to be implemented and really online?

Should be almost immediate, should it? With the install…

Yes. Some of it is immediate and the other portion is some 80 equipment for the anticipated increase in volume. This is we want to do more with machine and less with touch labor, both for accuracy and throughput. So I would expect that half of it will -- is being implemented immediately and the other half, I would say, within the next 3 to 4 months.

Okay, great. And last question. Obviously, the satellite business is doing very well. Regarding Zyfer and Elcom, can you just do a quick comment on either profitability or the lack thereof in those 2 segments?

Okay. Well, Elcom, let's take that first. There are -- one of the main functions is to help us finish the development of the new space product, and that's one of the main reason for our acquisition. On their own product line, they're holding their own, but they are affected to a small degree with a savings that the U.S. government applies. The same applies to Zyfer. They are affected a little bit by the reduction in military spending. But again, we are trying to give new missions incorporating FEI's product line and their objectives. Another mission that FEI-Zyfer is pursuing very actively and has great opportunity in the future is to improve the security of government interoperability between services. And that is being pushed as a high-priority program at FEI and at FEI-Zyfer.

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

Martin, I'm not sure if you said this. I'm on a cellphone and it's not as clear. How many millions are you running on a satellite right now? And how many satellites are you -- do you have? And is it different from the previous quarter?

The number of -- I think Alan has mentioned that our backlog of orders is 75% on satellites. And some of them are new satellites and a good portion are just legacy satellites that are now being pushed very high into service in order to get bandwidth, both for the military and the commercial ones.

I know the objective was $25 million per satellite. Are you at $10 million? Have you increased from the previous quarter? Or how much millions per satellite?

We are still in between -- depending on the satellite and the complexity, between $5 million and $10 million just because we have not implemented any of our new product line in our satellites at this time. Our goal is to do it by the end of this calendar year.

End of this calendar year, okay.

And have by them running by end of this fiscal year.

Our next question comes from the line of Jonathan Brolin with Edenbrook Capital.

I have 2 questions for you. The first is on GPS 3. You mentioned that there will be one provider who gets 2 clocks and one who gets 1. What is the revenue differential between those 2? Is it 2:1? And what is the total revenue opportunity there?

Well, the total opportunity for GPS 3 on the clock is -- and this is my personal estimate, so don't take it to the bank. It's probably someplace around $100 million for the program.

Okay. And so if you were to divide that, is it reasonable to assume that the person that's getting 2 clocks gets $66 million and the person who's getting 1 clock gets $33 million and change, something around that ballpark?

Roughly. I would imagine that since a larger portion -- assuming the quality and performance is a given. You have to meet the quality and performance on this point. Then whoever has a better cost model will get the 2/3 and the other one will get 1/3. So that's not a bad estimate that you made.

At that plays out over how many years?

Well, only God knows for sure, but the present plan is to get all of the GPS implemented in the next 3 to 4 years.

Okay. And then outside of that, there was an announcement this morning of Heiko acquiring Lucix, which plays in the microwave module integrated subsystems for commercial and military satellites. Do you have any comment on that transaction, either what it means for the industry or your thoughts? Do you run in to Lucix in competition? Do you have thoughts on Lucix being owned by a larger company, and does it have any impact on Frequency?

Yes. The answer is we do run into Lucix. Second, I don't see any impact in this. I want to put one differentiator between us and Lucix. They do provide microwave reference sources for both military and commercial satellites. The big differentiator is that one of the key ingredients in this product across low phase noise oscillator, which FEI is fortune to build it from raw material to finished product. That enables us to considerably shorter cycle time and better performance, and I think that gives us a significant advantage. But I don't see any difference if they operate it by themselves or a part of Heiko. Though I don't know very much about Heiko, although I've never run into them in any space programs.

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

What is going -- any update on the smart electrical grid in France?

Yes. I'm just -- we just had a review with Gillam. We had the official board meeting just 2 hours before. They are pursuing. It's a great opportunity for upgrading the France Telecom equipment, and they're working it on a day-to-day basis. And we should have some more inputs within the next 3 to 4 weeks.

Great. And what was the backlog? I couldn't catch that.

The backlog at the end of July was $56 million.

That's what I thought you said. You said -- but you mentioned in the release $30 million were booked in the first quarter?

Yes. But not all of that was funded.

Those are orders. And you know the way the orders are placed is that you place the order and you do a funding for the first 6 months until you work out all the detail, cross the Is and dot the Ts. And we only include in our backlog what is funded, not what is on order.

But that's still a huge amount, I think.

Yes, it is. We were very delighted on this. It's one of the highest quarters in our history.

That's what I thought. And you never had that much did -- or you did?

It was very exciting.

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

Okay. Again, thank you for listening in. We expect to have a great year and beyond. And our products are meeting the need of shorter cycle time and more cost effectivity. And to all our Jewish listeners, I want to wish you a happy new year. Goodbye, and we'll see you next quarter.

Bye.

This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.