Frequency Electronics, Inc. (FEIM) Q2 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics Second Quarter 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 constitutes 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 report obligations -- 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 as to the date of this 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 very much, Doug, and welcome, everyone, to our conference call for the second quarter of fiscal year 2014. I appreciate very much you all tuning into this and I certainly -- we look forward to your questions when we're done. With us today, of course, is Alan Miller, our Chief Financial Officer, who will have the financial report for our second quarter; and Martin Bloch, with his comments, our Chief Executive Officer, on how our company's done and where it's going. Very pleased again to have you here, we'll have questions and answers after this is done. Alan, why don't you go right ahead?

All right. Thank you, Joe, and good afternoon, everyone. For the second quarter of fiscal 2014, Frequency had revenues of $17 million compared to $16.8 million in the first quarter of this fiscal year and compared to $17.6 million in the year-ago quarter. Revenues from satellite payloads remained a dominant market for Frequency and the area of largest expected growth going forward. Satellite payload revenues increased nearly 20% over the prior year and accounted for over 55% of consolidated second quarter revenues, similar ratios as in the first quarter. Revenues from non-space U.S. Government/DOD programs, including sales by FEI-Elcom and FEI-Zyfer accounted for about 20% of consolidated revenues compared to the high 20% range last year. Total revenues for U.S. Government/DOD end-use both for space and non-space programs account for approximately 60% of Frequency's consolidated revenues. Network infrastructure revenues, which are recorded in FEI-NY, FEI-Zyfer and Gillam-FEI were about 15% of consolidated revenues, down slightly from the prior year. Based on current backlogs, plus our new satellite bookings for legacy products, which were awarded in the first half of this year, we anticipate continued strong revenues from the satellite payload market in fiscal year 2014. Cost of sales in the second quarter of both years was approximately $10.8 million, resulting in gross margin of $6.2 million in the fiscal 2014 quarter compared to $6.7 million last year. The gross margin rate was 36.6% in fiscal 2014 compared to 38.3% last year. As we have discussed previously, our gross margin rate is impacted by product mix and a lower sales volume at our subsidiaries. Fiscal 2014 SG&A expenses of $3.5 million were comparable to last year's $3.5 million, and were at 21% of revenues in this current fiscal year compared to 20% of revenues last year. This level of SG&A expenses is in line with our expectations and as revenues increase, we would expect to see the ratio of SG&A expenses to revenues to decrease. R&D spending in the second quarter was $1.5 million compared to last year's $1.2 million. As noted in our first quarter conference call, we continued to accelerate R&D spending on our newly expanded satellite payload product line of microwave receivers and up/down converters. Year-over-year, IR&D spending is up $600,000, which reduced fiscal 2014 profit margin by about 2%. We expect the rate of R&D spending to moderate during the second half of fiscal 2014. Thus, fiscal year second quarter operating profit is $1.3 million compared to $2 million last year. Other income, which generally consists of investment income, offset by interest and other expenses, netted to income of $897,000 in the second quarter of this year compared to income of $92,000 a year ago. During the second quarter, we recognized a gain of $736,000 on the sale of certain manufacturing equipment under a rubidium oscillator license agreement. This yields pretax income of $2.2 million compared to $2.1 million last year, and net income was about $1.4 million each year. Diluted earnings per share were $0.16 in fiscal 2014 versus $0.17 in fiscal 2013 due to a higher tax provision in the current year. In fiscal 2014, the tax provision was recorded at an effective rate of 36% compared to last year's rate of 32%. Now this depends on the profitability of our foreign subsidiaries, which we anticipate our effective rate to fall in the range of 32% to 36% for all of fiscal 2014. For the 6 months of fiscal 2014, we used $2.5 million of operating cash flow, primarily due to growth in accounts receivable and inventory. The growth in inventory is in preparation for the production phase of the multi-satellite Iridium program and other recently booked new contracts. As we consume this inventory, we expect to generate increased revenues and positive operating cash flow in the second half of this current fiscal year. Our reported backlog at the end of October was $57 million compared to $51 million at the beginning of this fiscal year. Except with respect to cost plus contracts, our backlog includes only the funded portion of long-term contracts. Following the end of the second quarter, we expect to receive additional funding of approximately $20 million on booked orders, which will be recorded in backlog at the time of funding as this year progresses. Over 3/4 of our backlog is for long-term satellite programs, split about equally between commercial and U.S. Government programs. However, based on recent satellite bookings, we expect the ratio of commercial satellite programs in our backlog to increase. Frequency continues to maintain a healthy balance sheet, with a strong working capital position of $77 million. I'll turn the program over to Martin and look forward to your questions later. Martin?

Thank you, Alan. I'd like to provide some color of Frequency and what initiative we have started and doing. As you have heard, Frequency Electronics had excellent bookings in New York, primarily on both military and commercial satellites, subsidiaries like Elcom -- FEI-Elcom and FEI-Zyfer were impacted by program delays due to government inaction at this point. They weren't sitting on their hands and praying; they used the time to improve their product line and to support product developments at FEI. Our Up/down converter initiative, which we started to accelerate at the beginning of this year has made great progress. We've gone through the engineering phase and demonstrated the new smaller sized, lighter weight converters to our customers, and we are now in a process of finished qualification of both the Ku and the Ka band up/down converters receivers. We expect to finish them in the third -- fourth quarter of fiscal 2014. Initially, we were shooting for the end of December, but changes in demonstrating the engineering models, which were suggested by our customers -- they were minor changes but they caused us to incorporate them at this time, before going through the final qualification. At the same time, we are -- we've had very active proposal effort on this new product. Although we haven't booked anything substantial on this item, we have quite a few proposals outstanding for the up/down receivers, both at Ku and Ka band. I would like to emphasize that our excellent booking at FEI-NY is based primarily on legacy product and has very little of the new initiative in our backlog funded and non-funded. We have gotten a very interesting program that has come to life again. In 2005, we participated on the WASP program, which will eventually be used for secure commercial aircraft automatic landing, and that experimental up/down receiver converter was flying since 2005. Based on the excellent results that the FEA has gotten on this one experimental, we are now putting another host payload on -- and we think that this program will eventually take root and that it has legs on it. Again, this is our C band up receiver and a L band down converter. We've also started initiatives in supplying equipment that are made by FEI-Zyfer, FEI-Elcom and FEI for the new initiatives to provide secure, very accurate timing, for secure communication and for other functions on this. I'm happy to see the progress that we are making on the satellites and as Alan has mentioned, between commercial and the military satellites, that's the majority of our backlog, and we see that the major growth will be in that area. As of -- including November, we now have larger bookings on commercial than we have on the military satellites, but both have increased in the month of November. I would like, at this time, to open to questions and answers. So go ahead, guys.

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

Martin, you talked about excellent bookings for legacy products. Is that the $20 million that you referred to in the press release?

Well, we actually booked a lot more in the first half of the year. Alan, what was the number? I think it was about $44 million.

Right.

Of which we got most of the funding in, and we expect the remaining of the funding on that booking card to be done in the next couple of months.

But those bookings that you expect to come in are for the...

They're all on legacy products.

All legacy products.

Almost all.

Okay. Does that have positive margin implications for the company?

Yes.

Okay.

I couldn't have asked a better question. Obviously, you have the lowest risk and the least amount of engineering effort in order to get them out of the house.

Right. And on the new products, you mentioned that it's been delayed slightly because of customer requests. Is that -- can you elaborate on that? Is it they want experience [ph] , they want different form factor, or is it...

No, no, no. Let me give you a very simple example on the point we took. Our engineering bread both [ph] have demonstrated to all of our major customers in the United States and getting their inputs and one wanted a little bit larger bandwidth, a little bit better suppression of spurious, a better noise figure, all just minor tuning on our concept and we felt that their inputs were very useful and we can incorporate it in the qual models, so we don't have to make any changes subsequently. So they were all very constructive inputs that we got from the ultimate users. And we incorporated those changes and we're now building the -- and they are slightly modified units to put them through the final qual testing.

Okay. And then, Alan, you talked about inventories building for anticipated product shipments. So once those shipments have occurred, where would be a reasonable expectation for inventories to land?

Yes, I think a mid-30 range is more appropriate. We've been growing NEXT for the last, probably 3 or 4 quarters now, I think, as we've got some long lead materials in house for this program, which is going to go into the production phase early next year, next calendar year, I should say.

Right. And that's the Iridium NEXT program, did I hear that right?

Yes. Yes.

That's the main one. There's 2 other programs and it's very cost-effective, by the way, to buy the material in one lump sum because you save a lot on screening. And since the cost of money is very inexpensive, it really makes a lot of sense and that programs will go from inventory into final products, which should end up as revenue and as cash flow.

And is there a few million of receivables that will -- will receivables come down by a few million as well in the next couple of quarters?

Oh, yes. Actually, November was a very good collection month for us. We have about $7 million in billed receivables on the balance sheet at the end of October, and we collected probably about $8 million -- $9 million of that here in just the 1 month.

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

One real quick housekeeping question. Regarding the asset sale, should we expect anything like that moving forward? Or was this really just a onetime event?

The asset sale was really onetime. It was manufacturing equipment that we're selling to these people under a license agreement. There may be some additional revenues related to that license agreement, but it won't be anything of that similar magnitude.

Okay. And then, could you maybe provide a little bit more color regarding the -- you mentioned the Ka band up receiver and the L band down converter where they are in terms of qualification.

Okay. Well, let's take the L band up/down converters for Iridium have finished qualification and we're now starting the production phase on that area. And this, of course, we have already delivered the EMs, the EQMs and the first PFM, which is the first flight models and they will go in into a fairly significant rate sometimes in the middle of 2014 and complete in 2015. They have to ship 160 up/down converters and 82 timing systems for that program. When it comes to the higher frequency, the Ku and the Ka band up converters, they are primarily targeted for military and commercial communications satellites where they want to put a lot more capacity, a lot more channels on the same platforms, and we have lots of proposals outstanding for that type of work. Our mission was to make something that is smaller, lower power and lower weight so you can put more converters on the same platform.

Okay. Got you. And then, one final question. I was just curious, especially regarding your Zyfer segment. What are they really seeing regarding sequestration from their customers? Are people still delaying orders? Are we at the point where we're canceling orders now?

Well, FEI on the satellite, it was the exact opposite. We had a boom on this when it came to FEI-Zyfer and FEI-Elcom, the contracts got delayed. Didn't hit a little bit.

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

The $20 million, if we add that to the $56 million, has that been booked or we expect it prior to January 31? And does this make this an unusually high backlog? And when does that $20 million get recorded as income and revenue and profit? Then do we get bigger sales and profits in the second half of the year, or the rest of the year?

A bunch of questions in there. These programs, of course, are multi-year programs so funding -- immediate funding is not essential for us to start working on them and getting revenues. So we have partial funding and we're working on them now and getting revenues and cash where we're billing the customers as we go. So we anticipate that the additional funding will come in the balance of this fiscal year and therefore will be part of the backlog and then we'll continue to work on those into balance of '14 into 2015, and it should increase our revenues opportunities because the opportunity is there, we have the higher volume of business in house now.

This increased backlog, does this increase the dollar per satellite? We're shooting for higher numbers, we're assuming you're around $5 million per satellite. Do you get to a higher number with these backlogs?

We are in the range of between $5 million and $10 million dollars per satellite on that regard. And I want to clarify, you asked a good question on this. We have established rules at Frequency that in backlog we only report the portion that's fully funded. So if we get a $10 million contract and they are funded to $5 million -- it's a firm contract but we will only use $5 million in the backlog and $5 million is booked business. And on those $20 million on this about -- we booked a total of $40-plus million in the first 6 months, and we got funding on most of them, and we expect like Alan said that we'll get the rest of the fundings in the very near future, but definitely in this fiscal year. And it should turn into significant business in fiscal 2015 and the second half of fiscal 2014.

So now we're going to start seeing -- I guess, do you think, we have to wait to -- do we see significant increases in the end of the year or just normal increases?

Normal increases on this but significant in fiscal 2015.

Okay. You do work on drones?

Yes.

Did you -- did that -- Do you do anything with Amazon? Is there any potential?

Are you kidding? You got caught by that? I'll tell you, if they put 100,000 drones on the United States, they'll kill a couple of people. I don't know how many packages those hold -- but we are the major supplier on precision timing for real drones that are used in surveillance and attack for the U.S. Military, and we provide a very ruggedized rubidium quartz low g-sensitivity standard that we have on many of the SS's that are now flying and this is a product that we expect will grow.

And have you hired an IR firm yet? And are you ready to start making more presentations? And what is the timetable for this?

Well, we haven't hired an IR firm, but we are scheduled to go to a couple of conferences. We'll be at the Needham conference in January and the Cowen Aerospace and Defense Conference in February.

Our next question comes from the line of Michael Eisner, a private investor.

I'm not sure if you mentioned, I came on late. Anything with Gillam and I think you call it the Smart Grid?

The RTUs? They are progressing, they are in tests, and the French will do it at their own pace, but it looks very promising as a future product with lots and lots of slots for their substation in France and in other countries. So far, the testing is going great. We don't know when they are going to start procurement, but we hear that it's going to be in late 2014, beginning 2015.

Your calendar fiscal or...

I didn't hear. Calendar years.

So maybe like in a year...

The French don't work on FEI fiscals, they work on the calendar year, so they expect to start procuring end of 2014 calendar and beginning of 2015, that's the latest we hear from them, but all the testing is going very well.

And you'd be -- how's the -- how are you going to produce these? Are you ready to produce them rather?

I'm sorry, I didn't understand Michael.

Do you have the manufacturing capability to produce these?

Absolutely. It's in place and ready to go.

There are no further questions in the queue. I'd like to hand the call back over to management for closing comments.

Thank you very much, all of you, for tuning in. We really appreciate it. We look forward to March when we'll have our third quarter report for you. And in the meantime, we wish you all the best for the coming holidays. God bless America and go Army.

Thanks, folks.

Happy New Year, have a healthy one.

Allan?

Thanks, everybody.

Thanks, everybody. That's it.

Thank you, very much.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.