Frequency Electronics, Inc. (FEIM) Q3 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics Q3 Fiscal Year 2014 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now turn the conference over to your host, Martin Bloch, President and CEO of Frequency Electronics. Thank you, sir. Please begin.

Good afternoon, everybody. Chairman Joe -- General Joe Franklin is listening on the call. He's not here. This -- the presentation will be given by Alan Miller, our CFO; and myself. And at this time, I'd like to change our model because Alan Miller is going to read the safe harbor statement before we start with this presentation.

And explain why.

Okay. Thank you...

And it's because the conference people lost it real soon, we assume. All right, let me give the Safe Harbor statement first. The statements in 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. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. These risk factors are detailed in our filings under the -- with the SEC. And by making these forward-looking statements, the company undertakes no obligation to update them for revisions or changes after the date of this call and of our earnings press release. And now let me turn to the numbers.

Right.

For 2014's third quarter, Frequency's revenues were $18.2 million, as compared to $17.1 million for the third quarter of last year. Revenues from satellite payloads, Frequency's dominant market area, increased over 20% over the prior year and accounted for nearly 60% of consolidated third quarter revenues. 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. However, total revenues for U.S. Government/DOD end-use activities, both for space and non-space programs, continued to account for more than half of Frequency's consolidated revenues. Network infrastructure and other commercial revenues recorded in FEI-New York, FEI-Zyfer and Gillam-FEI were approximately 20% of consolidated revenues, roughly comparable to the prior year. Based on current backlog, including new satellite bookings of -- for our 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 and beyond. Cost of sales in the third quarter was approximately $12.1 million compared to $10.4 million last year, resulting in gross margin of $6.1 million in the fiscal 2014 quarter compared to $6.8 million last year. The fiscal year 2014 gross margin rate is 33.5% compared to 39.4% last year. During the fiscal 2014 quarter, our gross margin was impacted by snowstorms in the Northeast, higher engineering design costs at Gillam-FEI and low sales volumes at FEI-Zyfer, creating a high level of unabsorbed overhead costs at the subsidiary. We estimate that these items reduced our consolidated gross margin rate by as much as 5% during the third quarter of this year. Fiscal year 2014 SG&A expenses of $3.5 million are compared to last year's $3.9 million. Expenses as a percentage of revenues improved to 19% in fiscal 2014 compared to 23% of revenues last year, and they are in line with our target, of up to -- 20% of revenues. R&D spending in the third quarter was $1.4 million compared to last year's $1.1 million. As noted in previous conference calls, we continued R&D spending on our new expanded satellite cable product line of microwave receivers and up/down converters, in addition to other new products. Year-over-year, IR&D spending is up over $850,000, which reduced fiscal 2014 operating profit margin by approximately 2% compared to the prior year. We expect the rate of IR&D spending to remain at less than 10% of fiscal 2014 revenues. Fiscal 2014's third quarter operating profit, then, is $1.3 million compared to $1.8 million last year. Other income, which consists of investment income, offset by interest and other expenses, netted to income of $378,000 in the third quarter of this year compared to income of $70,000 a year ago. So this yields pretax income of $1.6 million compared to $1.8 million last year. The fiscal 2014 tax provision of $420,000 is at an effective rate of 26% compared to last year's $300,000 or a rate of 16%. In both years, tax law changes occurring during Frequency's third quarter reduced the overall expected tax provision. For the full year, Frequency expects the effective tax rate will be in the low-30% range. This results in net income of $1.2 million or $0.14 per diluted share compared to $1.5 million or $0.18 per diluted share in fiscal 2013. For the 9 months of fiscal 2014, we generated positive operating cash flow of about $700,000. For the third quarter alone, operating cash flow exceeded $3 million. During the year, millions of dollars of parts were purchased in preparation for the production phase of several multi-satellite multiyear programs. These purchases reduced cash flow during fiscal 2014, but as we consume this inventory, we expect to generate increased revenues and continuing positive operating cash flow. These bulk purchases of inventory parts against fully funded contracts will generate cost savings, as well as provide safeguards against delivery delays, as these programs go forward. Our reported backlog at the end of January was $55 million compared to $51 million at the end of last fiscal year. Over 3/4 of our backlog is for long-term satellite programs split about equally between commercial and U.S. Government programs. Frequency continues to maintain a healthy balance sheet with a strong working capital position of $78 million. I look forward to your questions later. At this point, I'll turn it back to Mark.

Good afternoon, everybody. Frequency Electronics is experiencing great success with our existing product line on satellite; of timing, precision timing; and the microwave frequency sources. And we'll see continued improved opportunities in the new product line that we're developing, which is the Ku and Ka band receivers up/down converters. We have many proposals outstanding for the product right now, and I can see the beginning of revenue in fiscal 2015. It is a very exciting product line. It will supplement what we have done and enable us to get bigger chance per satellite. And the market is expanding. The demand for bandwidth is -- both in the military and the commercial, are just enormous. And to give some examples, I'm not allowed to name the satellite program, but I can tell you the magnitude: The present satellite that's being launched in 2016 has 41 channels. The satellites that are going to be launched in 2017, '18, '19 and '20 will have a minimum of 140 channels. Each channel provides us an opportunity for a receiver down converter in the Ka and Ku band. Now Frequency has the tickets and the legacy since we have launched this type of receivers and other programs, but what we needed to do is complete our development on making the unit smaller, lighter weight since the same platform will be used to carrying a lot more channels. And we are -- we have finished the engineering models and we are now in the process of building the delta qual models, which we expect to complete within the next couple of months on this. It's very exciting, many, many outstanding proposals and greater opportunities for this new product line, actually, new -- updated product line. Now the key to success on that product line is -- first is, of course, you have to have the technology and legacy, which we have. Second is to make them smaller and lighter weight since a lot more channels will be -- have to be put on the same satellite on this. Third is to reduce the power consumption because power is at a premium on this. And the fourth, which is equally important, is to have a very attractive cycle time. And as Alan has mentioned, we buy parts on this in wafer form so we can have the inventory to respond quickly, and that is a big advantage in obtaining business. Obviously, being competitive is also a very important criteria. And we have spent a lot of effort to design this product line to be producible using a lot of automated test capability and to minimize the touch labor that's involved on there. Another great opportunity of new business for FEI is coming to the surface, and this is to secure communication on this, especially with the jamming, and cyber security, which is necessary for our critical assets and for all communication. And being a scientist, I want to go back a little bit on what caused our dilemma now and what corrective action we have to take as a nation in order to safeguard it. When wireless communication first started, there was a requirement that you had to have a nice precise time to be able to operate autonomously for 72 hours. As GPS became much more readily available and available on what we thought was 100% secure basis, the autonomy period of -- for timekeeping for secure communication was reduced from days to seconds because if you continuously calibrate a clock from GPS, you don't need a great clock. So a $2,000 atomic standard that was used in the early base stations was reduced by a $5 quartz clock. And it's, of course, a lot cheaper, but it has no autonomy. Thus, any jamming or spoofing of the GPS signal, you lose the communication link. If it jammed and if it spoofed, you -- it's even worse. You get the wrong information to the wrong people. As part of the corrective action which the programs has already started because of FEI's legacy and precision timing is to provide a flywheel, which means much, much better timing on the base station, to be able to have this autonomy period, depending on the communications side, to have it from seconds to hours to days and then, sometimes, weeks on this. We have the expertise and the precision ruggedized timing to provide this for both fixed and mobile platforms. And like I mentioned, we are already working on this first phase of this program. It's a great opportunity, a non-space business to expand our marketplace. Again, we did -- we have the technology and the legacy of this. We have the ruggedized low g-sensitivity clocks for the mobile platforms that's required. And the business we've -- is starting, and it's going to be of a very significant proportion to FEI, almost as important as the satellite business. So future lies in the satellite product line and in the secure communications, which will be initially for critical assets of DOD and other secure agencies, and then the same types of requirements will really have to be extended to the commercial sector because getting the wrong time or the wrong secure line for banks and stock transactions is becoming just as important. And I think this is exciting news which I want to share with you. And now I'd like to open this session to questions and answers. I would appreciate if you -- when you address the question, please address it to either Alan Miller or Martin Bloch. Thank you.

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

My question for -- the question is probably a little more towards Martin. On the last conference call, you mentioned some of your customers had gone back to you just regarding some changes they wanted to make in some of your products under development. Are we still looking at the same time frame we were at the end of the last quarter?

Are you -- I'm sorry, can you repeat this? I'm -- I got...

I guess I just wanted to make sure that the time frame on your new products, the qualification, is the same as the -- your last conference call...

Yes, within a month or so. Yes, they're very similar. We've demonstrated the engineering models and the processes. You first build an engineering model and then you build an identical qual model. It has all the bells and whistles all cleaned up. And then you put it through some delta testing. And we are pretty much on schedule within a month.

Okay, great. Another thing you mentioned -- you mentioned this also on your last quarterly call, that -- you mentioned the backlog excluded $20 million that was booked but not funded. Can you give a little color on that? Have some of that been funded? Or is that still sitting there?

Oh, yes, some are -- some of it is funded and some of it will -- I -- will be funded. If -- the contract is in total. It's just that you have to straight now some paperwork in order to get the full contract value. And this is -- we are -- all contracts, commercial and military, is buried in paper. And you have to cross every I and every t before you can have the final contract. So to eliminate delays in the program, you know you'll get a chunk of money. And if for any reason we run close to that and the contract is not finalized, we call them up and they fund the delta. But -- and it's a continuous process, but it's no issue. It's all 100% guaranteed contracts.

Okay, got you. And then one final question and I'll kind of jump back in the queue, just regarding Zyfer, the most recent budgetary agreement. Have you seen any change in maybe customer order patterns coming from that?

Customer order patterns.

For Zyfer?

Yes.

Zyfer cut a few of the programs. They haven't lost anything, but it will move to the right. We definitely did see it there...

So you're saying -- was it pushed out, or did they evaporate?

No, they did not evaporate. They were pushed to the right on this. As a matter of fact, we just went through it. I didn't see anything that disappeared. It's just things are being done a little bit slower in the government.

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

1 -- 2 questions, actually. Is R&D going to go back down to where it was, or continue at this pace?

Well, I -- for the near term, it probably will stay roughly where it is. And going to 2014, we could see, as we complete some of these up/down converter work, that number -- gross number might decline somewhat, but it's in that -- in the same ballpark, assuming a 7% to 8% of revenues.

Okay. And second question is, you were hoping to get some business away from competitors because you could do it cheaper. How is that coming along?

Well, I -- they go real as our customers, and it's going well. We're being well received because our new product line that we presented to them and the budget pricing that we gave them, they feel we're very competitive. And they are anxiously waiting for us to complete the delta qual in for them to win some new jobs. So we're in great shape on that. But that's the areas -- 90% of this business is now done in-house by people like Boeing, SS/Loral, Lockheed Martin and Northrop Grumman. So that's our big competitors. The small other competitors are really in-sequential in our business growth.

And you can build it cheaper and smaller.

And we can build it cheaper and smaller. And what's equally important, Mike, is cycle time, plus the fact there's an enormous emphasis on the commercial. It was always fixed price. Even the military are switching more and more to fixed price. So there's a lot of pressure from top management in this corporation to buy what you can buy and rather than to build it in-house because, in-house, it's always cost-plus. So getting a fixed-price contract from the -- another type of supplier is very attractive now, and a lot of pressure by the government on future buyers of satellites to go fixed price, with people like Boeing and Lockheed Martin.

[Operator Instructions] We have no questions in queue at this time. I'd like to return the floor back over to management.

Okay. Well, it just shows how well a complete job of presentation we have done. And again, we are looking forward to a very good fiscal '14 and beyond. And I want to thank our stockholders and our employees for all the good work they are doing. And we'll continue our best effort to grow a profitable, healthy company for all of us. Thank you again, and goodbye from me and Alan and Joe Franklin.

Thank you.

Thank you.

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