Frequency Electronics, Inc. (FEIM) Q4 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics Inc. Fiscal 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 releases 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 provisions or changes after the date of this conference call. It's now my pleasure to introduce your host, General Joseph Franklin, Chairman of the Board for Frequency Electronics. Thank you. General Franklin, you may now begin.

Thank you very much, Shae, and thank you all for joining us this afternoon. We're very pleased to bring you our report for fiscal year 2014, particularly noting that we've increased our revenues, our profitability and we've got higher operating cash flow. Particularly, I have noted in, as you now see in our press release, that these results came during an extended period of very severe decline in our DoD spending. I'm joined today, as Shae has told you, by our Chief Financial Officer, Alan Miller; and Martin Bloch, our President and Chief Executive Officer. Martin and Alan, thank you very much. Can I ask Alan to begin with our financials?

Thank you very much, Joe, and good afternoon, everyone. For fiscal 2014, revenues were $71.6 million compared to last year's $68.9 million. Frequency's dominant market area is satellite payloads. For fiscal 2014, satellite revenues increased by 25% over the prior year and accounted for 60% of consolidated 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 about 25% last year. Total revenues for U.S. Government/DoD end use activities, both for space and non-space programs, accounted for a little more than half of Frequency's consolidated revenues. Network infrastructure and other commercial revenues that are recorded in FEI-NY, Gillam-FEI and also FEI-Zyfer were approximately 20% of consolidated revenues, down from approximately 25% in the prior year. Based on our current backlog and recent new satellite bookings for our legacy products, we anticipate continued strong revenues from the satellite payload market to continue in fiscal year 2015. In addition, we expect FEI's other segments to realize improved revenues from new opportunities. Cost of sales was $46.8 million compared to $43.8 million last year, resulting in gross margin of $24.8 million in fiscal 2014 compared to $25.1 million last year. Fiscal year 2014's consolidated gross margin rate was 34.6% compared to 36.4% last year. During fiscal 2014, costs incurred to increase production throughput at FEI-NY, higher engineering design costs at Gillam-FEI and low sales volume at FEI-Zyfer which resulted in a higher level of unabsorbed overhead costs of that subsidiary, all contributed to the lower gross margin rate. In fiscal 2014, we reduced SG&A expenses to $14.1 million or 20% of revenues as compared to last year's $14.7 million or 21% of revenues. Such expenses are in line with our target of approximately 20% of revenues. R&D spending in fiscal 2014 was $5.8 million compared to last year's $5.7 million. We continue to make investments on our new expanded satellite payload product line of microwave receivers and up/down converters in addition to other new products. Going forward, we will continue to invest in these new products and we expect the rate of IR&D spending to remain at less than 10% of fiscal 2015 revenues. The operating profit for fiscal 2014 is $4.9 million compared to $4.7 million last year. Other income, which generally consists of investment income, offset by interest and other expenses, netted to income of $1.4 million in fiscal 2014, which included a $740,000 gain on the sale of certain capital equipment to Morion earlier in the year. Fiscal 2013's other income was $407,000. This yields a pretax income of $6.3 million in fiscal 2014, compared to $5.1 million last year. The fiscal 2014 tax provision of $2.3 million has had an effective rate of 36% compared to last year's $1.4 million or a rate of 28%. The effective tax rate is impacted by the exclusion of operating results at our overseas subsidiaries. So this results in fiscal 2014 net income of $4 million or $0.46 per diluted share, compared to last year's $3.7 million or $0.43 per diluted share. As Joe mentioned, for fiscal 2014, we generated positive operating cash flow of $3.6 million compared to last year's $2.8 million. During the year, inventory grew by $3.7 million as we purchased parts in preparation for the production phase of several existing multi-satellite, multiyear programs. These purchases reduced operating cash flow during fiscal '14, but as we consume this inventory, we expect to increase revenues and continue to generate positive operating cash flow. These bulk purchases of inventory parts against fully funded contracts will generate cost savings, as well as safeguard against delivery delays as these programs go forward. Our funded backlog at the end of April 2014 was $47 million compared to $51 million at the end of fiscal 2013. 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'll turn the floor over now to Martin and look forward to your questions later.

Good afternoon, everybody. Thank you, Alan, for a clear report. On this side, I don't have much to say when things are going well. The company is doing very well, and in spite of the stress with the DoD reduction and delay in programs, we've been able to maintain and improve our revenue, and this is primarily due to our very unique technology and our leading position that we have for space, timing and frequency control on this. So the 2 areas which are shining, this is -- one is space, and this includes our standard product line, and of course, we expect more as we are finished and completed development and qualification of the up/down converter which will be more of a manufacturing product rather than what we have been usually doing is custom building for each individual satellite on this. The other area that we are very encouraged and we have a lot of technology and test experience to compute -- to contribute is secure communication. This is a problem that's facing the nation in all our DoD and Homeland Security and every type of communication network that's in existence where we need to be able to develop hardware, as well as software that enables to maintain secure communication in the continuous threat of jamming, or even worse, spoofing the signal that we receive and we need to maintain on this. I'm happy also to report that we have received seed money to start developing on hardware to make this mission requirement. FEI is considered the world leader in space, timing and frequency control, and we are delighted that this is being recognized by many of the customers. And as we have announced recently, it illustrates also the next development contract for the next-generation timing hardware that we have just received for $11-plus-million, plus, after the development, we'll build the flight hardware as well. It's not only the development of this new system, but it also basically paves the way for additional capability in space hardware that Frequency will have on this point. So the question to everything is going so well: What's our challenges? As we have increased our business in space, we are also challenged in producing and delivering on a timely basis, and this is key to our being able to capture additional business in the future because our customers are watching us very carefully to make sure that we can deliver. They have no doubt that we have the technical capability, but they want to make sure that we have the manufacturing test and whatever else is necessary to make on-time delivery, which is a key element for space, as well as other hardware, but primarily for space. Delivery is becoming shorter and very critical. In order to meet this challenge, we are training additional people; we're instituting a night shift; we have added sophisticated tests, automatic test equipment and automatic assembly equipment to our manufacturing line; and what's also equally important, as Alan has mentioned on this, we are buying the third ingredient, which is a risk for delivery, and this is having the necessary high reliability part for building, and so we have increased our inventory to be able to meet that challenge. Qualified parts for space in order to meet the delivery is becoming a major challenge, and we are meeting this challenge by investing in some additional inventory that will help us meet the delivery schedule. I think I view things as being great. On this, we're looking forward to a good year of fiscal '15. And I want to appreciate all the hard effort of the employees at Frequency Electronics for working very hard to making the critical deliveries and doing the necessary development to take us to the next step. And by the way, our low g-sensitivity technology that is used at mobile to enhance the performance of mobile platforms such as remote pilotless vehicles, aircraft, tanks, ships are also a key part of our future product lines and we've had great success in improving performance in this area. I think, I've taken too much time as is. I'd like to open, at this time, for answers and questions. I'd appreciate very much if you address your question to either me, Alan Miller or General Joe Franklin. Go ahead.

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

The first question is directed towards Alan. Just regarding the gross margin, should we expect this to rebound as the help of Gillam and Zyfer improve moving forward?

Yes, I expect some improvement in gross margin. I don't anticipate a monumental jump at this point in time, but it will be better than the 35% that we had in this past fiscal year.

Okay. Great. And then, another question for you, Alan, just regarding tax rate. Could you go into a little more detail regarding specifically what happened to [indiscernible]?

Yes. I alluded to, we can't take effect any tax benefit for the losses that are incurred at our overseas subsidiaries for a couple of different reasons. So if you were to take them out of the equation, our effective tax rate would be about 30% or something of that nature, but because we get no tax benefit for their losses, and they did have losses there overseas, that increases the effective rate.

Okay. Got you. A question probably a little more for Martin. Can you provide an update regarding the RTUs and the French government and where they stand?

Well, I just came back there. I spent time at our subsidiary in Liège and explored on this. It's a great opportunity. The only variable is the French. Hard to predict on how and when they are going to incorporate it. There are now 2 qualified suppliers for these RTUs and we are one of them. And if I believe the numbers, they need 600,000 of them on this. So that's a big chunk of investment that France has to make in order to implement it and we are trying to define the timing. We know that there are going to be some additional procurement in fiscal 2015 on this point, but it's hard to pin down on when the production would really start. But the opportunity -- what I was happy to validate is that the opportunity is there and the product is performing exactly to the specification as the customer wants it, and we are very favorably regarded by the systems that they are installed and they are testing them in the field.

Okay. Fantastic. One final question. I guess two-part question also directed to you, Martin. Just first, can you get into a little more color regarding the up/down converters with the manufacturing versus development and then also maybe an update just regarding some of the receivers as well?

Okay. Well, the challenge of the up/down converters is not just to make them, it's to make them smaller, less power, so it can provide more bandwidth, because the game is to provide a lot more for less. That means putting a lot more converters on each existing satellite so you can ink -- provide more bandwidth. So we have designed the unit that is small sized that functions. We have tested breadboards, we are now in a test of engineering models which we hope to complete before the end of this month. And at that time, we are going to go on a roadshow and show it to a couple of our most immediate customers to show that the size -- they know that we can build them, they know that we have flown them and we have the legacy. What we have to demonstrate to them is that we can achieve that smaller size and lower cost that they need. So I'm very encouraged, and we are testing both Ku and Ka band down converters. And to give you some relative size, they are approximately 1/5 the size and weight of what we previously flown on this, and I anticipate they are going to be approximately 60% of the manufacturing cost as well. So I'm very encouraged with the progress. Taking a little bit longer, but we continue with trimming the design to meet the present and future requirements for that large market.

[Operator Instructions] Our next question comes from Marcel Harwoods [ph] from Harwood Capital Management [ph].

The first couple ones are for Martin. You mentioned a large, new opportunity for your non-space subsidiaries in the emerging fiber security market. I was wondering what are the milestones from here to meaningful revenues with this and when would that be?

Okay. Well, I can tell you what's in our control, and I don't think I can control the U.S. government. But basically, the need is desperate and it's necessary because the jamming and spoofing is continuing on a basis and I'm going to repeat something that I've said before on this. It would take 6 taxi cabs with $100 worth of RadioShack parts to be able to jam all of Manhattan. So the danger that the secure systems need to be improved is there. The initial seed money that we have gotten is for concept development and hardware demonstration. We expected additional contracts within the next couple of months that will cover the building of demonstration hardware, and then, at that time, it's going to be DoD's -- actually, the government's schedule on how fast they want to upgrade their systems and how fast we can penetrate other critical secure markets. But I can tell you is that the need is great and immediate on this. But if I knew how to project what DoD is going to do, I would be a much more successful guy.

It sounds like this is a very large opportunity, like it sounds like $20 million plus, or am I being too optimistic here?

It's a great opportunity. I cannot define the quantity and the dollar value, but it is a great opportunity, and what's more, it would be hardware that would be not custom-built like most of our hardware in the past, that would be hardware that would meet -- that we could build in production quantities and implement it and then custom-adjust it to each site instead of our past, where everything was custom-built.

Okay. Regarding the 2005 WAAS program that has come to life again...

Are you talking WAAS?

Yes, the WAAS. you mentioned on the last call that there's a 2005 WAAS program that's coming up again, and I was wondering, what's the approximate of revenue potential from something like this and also would it be a 2015 opportunity or longer down the road?

Well, I don't know if I mentioned it or not, but we do have a contract for one more host payload that we have to deliver by the end of this year and we're working very hard to meet that. And that will be launched to validate the system. And then, there's going to be quite a few more of those payloads that will go in on host satellites to provide this augmentation for lending without the ability to jam. so the potential is there and it's viable because the FAA has approved to put the next host payload on and we are working on it right now.

Okay. If I may, a couple of questions for Alan. What level of capital expenditures and operating expenses are you targeting for fiscal '15?

Well, we spent about $5.5 million last year. I don't expect us to hit that same level. We really had to ramp up some of our capabilities with some of the equipment that Martin was referring to. But typically, we're probably in the range of $3.5 million to $4 million for fiscal '15.

And on operating expenses?

I would expect, as I said, the R&D would be less than 10% of revenues, which came in this year around 8%, and SG&A comes in about 20% or less. So that's pretty good numbers to hang on to.

Okay. And what are the bookings this quarter and what portion of your backlog is scheduled to be delivered in fiscal '15?

Well, you are trying to pin me down on numbers on this. But I'll tell you, on this we're -- this quarter, I mean, we booked -- the biggest single contract we booked is that $11-plus-million that we announced for this new clock development that came in, what, end of June?

Yes.

On this point...

And we're still -- we're not done with the quarter yet.

And we're not done with quarter and we still have -- we are more than on track on the budgeted booking for the year, but that was a nice shot for the first quarter and we are very proud of this contract because we got it because we provide the best solution for that space mission.

As far as our backlog is concerned, our rule of thumb is typically about 75% to 80% is realizable in the coming fiscal year, so the $47 million, that's roughly what was done for that.

Okay. When I asked about the bookings, actually, I was referring to this fourth quarter that's completed.

Okay.

And it sounded like you were referring to on the quarter we are in.

Yes, he was -- Martin was talking about the booking that we just had for that satellite bookings...

We just announced just a week ago on this that we got in June.

Yes, but do you have the bookings number for fourth quarter? Usually, you provide this in the call, I think.

I don't think we typically talk about that on a quarterly basis. We talk about backlog because historically, on a quarter-to-quarter basis, it really isn't all that relevant. Like we say, we're lumpy. So yes, the $47 million, I think, is less than what it was at the end of the third quarter. Our backlog was less, but we do expect to see bookings that -- to be better.

And the booking for the year was higher than what we planned.

Excellent. And finally, one last question, what tax rate do you expect for '15?

Well, it's always a hard number to pin down, as I try to explain with Tristan with our foreign subsidiaries, but we kind of use a rule of thumb roughly around the low 30s to mid-30s.

Our next question comes from Sam Rebotsky from SER Asset Management.

Tell me, the $11 million, when we add that to the $47 million, what would the backlog -- and I assume the $11-plus-million is fully funded. What would the backlog be compared to the same time last year?

I don't know. I didn't calculate. It's up. And for your information on this, because of the demand on the schedule for the $11 million, we got the seed funding and we're right now working out the detail for the full funding of the program which we expect to complete sometime in August. But that's difficult. The basic idea on this DoD contract is you don't want to screw up schedule with paperwork, so you'll get a chunk of funding to make sure you can do the work and schedule while you work out all the details of the contract. But this is a fully funded program.

Yes. I believe, in the last quarter, Martin, we were talking about 3, I think, satellite contracts that we were bidding on, and we were hoping to get them versus the other competitor. Is this the $11 million which we got or is it anybody -- did they award any of these 3 contracts that we were bidding on?

Well, we didn't lose any. So I don't remember. You're testing my memory on this item is all, but we were very fortunate on this. But we got substantial government as well as commercial contracts in the past -- I guess it was the past quarter. I have to look it up exactly when they come in, but we didn't lose any contracts. So we got everything we went after.

Okay. Now as far as the amount per satellite, what kind of numbers are we looking -- how much per satellite did we get based on the end of the year, this fourth quarter? And what do we expect to get per satellite going forward?

Okay. We basically run about $5 million to $10 million per satellite in the MEXSAT timing system and the microwave LO generators. And with our -- hopefully, with our capturing and got the up/down converters, our take per satellite will go up from $20 million to $40 million.

So this is in the current year, where we're going to get that kind of money, $20 million to $40 million per satellite, or when do we expect that to...

Well, we have proposals outstanding, and we hope they'll materialize in fiscal 2015.

So we're looking for an award soon or at the end of the year? What is the timing? What is...

It's very difficult to put dates on it. I would say that probably in the next 6 months would be a realistic target to look for them.

So 6 months, okay. All right. And the $1 million loss that we have in the FEI, the Gillam, when do we -- that, is it supposed to be profitable and not have losses in the first or second quarter, or what do we expect out of that?

You’re saying Gillam's? It wasn't quite that much. It was combined Gillam and Zyfer combined loss to $1 million. We do anticipate, not necessarily on a quarterly basis, but for the full fiscal year, we expect to see vast improvements on their operating results. There won't be huge profits or incoming numbers at this point in time but they should be able to offset the losses that they incurred in this past fiscal year.

So in the fourth quarter, was there any of these losses in the fourth quarter or was this prior to the fourth quarter?

No, no. They've had some struggles throughout the year.

This was just on this FEI-Zyfer and Gillam on this, their bookings moved to the right and they've had small losses almost every quarter. I'll have to check, but I believe that there are no surprises. There wasn't any.

So is it fair to say in the first quarter we'll start making a profit or not making any losses?

It's hard to say at this point in time. It all depends on how their revenues turn out for the quarter, and if any of the other bookings continue to move to the right. So I know we're partly to the quarter at this point, but I don't have any metrics on them yet.

Are you asking on Gillam and Zyfer or FEI?

Just what you're referring to, that there was a loss of $1 million the way you're sort of meshing it together. What I'm just sort of looking at that losses that you had are finished or the companies that you're referring to in the bullet point, where it says operating loss in excess of $1.0 million. And you say improved results are anticipated in fiscal 2015. I'm looking to understand that you will not have losses in the first quarter, and thus, expect to have profits or breakeven going forward.

Like I say, I can't really predict on a quarter-to-quarter basis, but I'd say, for the full fiscal year, we expect them to show about breakeven or better. But there will be potentially some quarters in which they might have a loss and some where they'll have some profits. Gillam historically on the second quarter is holiday time in Europe, as you know, so things kind of slow down there. So it's difficult for us to predict necessarily on a specific quarter-by-quarter basis.

Okay. And one other question about the research and development. In the current quarter, it was $1.224 million versus $1.996 million, so is that -- and for the year, it's $5.813 million versus $5.727 million. So if there is any increment, in other words, it would be of abnormal to have expected this reduction in R&D in the April quarter based on your percentage expectations and this would have been normal, this reduction in R&D in the current quarter?

You're talking about just the year-over-year comparison?

Yes, year-over-year, the $1.224 million versus $1.996 million.

To some extent, we are somewhat opportunistic, as we see opportunities to spend some money on R&D. So I think, last year's fourth quarter, the $1.996 million is relatively high by comparison to what we'd ordinarily expect to spend. But again, we're opportunistic. When we see a situation arise, we want to spend some money on it. We'll then put some resources to it.

Like I said, the $5.8 million, $6 million, that's about a typical run rate for us annually.

I think one final question. The fact that your business in the satellite area has been improving substantially and is there any way that the other business you expect that did not materialize to improve more where, therefore, your other business, non-satellite business, will not go down and stay the same or increase?

Yes. This is Martin. Taking a look at the way the grass is growing on this, like I said, I visited Gillam and looked at their business plan and they looked like they are going to be able to make fiscal 2015 profitable. We're looking at FEI-Zyfer and they'll be handling a lot of the secure development of the hardware. So we see encouraging in that area. And FEI-Elcom, we're using as a development source and they should also not have any losses.

Okay. That sounds good. And as far as investor relations, is there any plan to do that any more so than you've done or what's in the plan?

We don't have anything extraordinarily different from what we've been doing in the past. So we wait for some invitations and we probably will perhaps do some roadshows in the fall.

[Operator Instructions] Our next question comes from Michael Esner [ph] from -- who is a private investor.

Great top line revenue. I have a question. How many people are on the night shift now?

We have 12 and we are training an additional 6 on this, and this is part of this that's been a little bit slower and painful on this because we want to make sure we train the people during the daytime before we put them on night shifts since we want to make sure that there is no compromise in quality on the second shift. But we're making good progress in that area.

All right. On the $47 million funded backlog, that was at April 31 year end, correct?

Correct. Correct.

All right. And final question. Can you touch on the deadlines, like if you get one of these did go from $20 million to $40 million per satellite, do you feel comfortable that you're going to get it done on time?

Can you repeat, I'm sorry, I didn't understand.

You said you're going to go up to -- on some of these satellites, you're going to go up to like $20 million to $40 million in the next year or so, how do you feel about the deadlines and getting these done on time?

Well, we're working very hard and we're investing time and effort to make sure. As I mentioned, we have built and have actually got first delivery of a major automotive test equipment for satellite hardware. On this we have installed and qualified automatic assembly and test equipment and automatic inspection equipment, and we're training them to touch labor that we're going to need to do it. We haven't got a choice, Mike, we got to meet that commitment. That's what's been our passion and our obligation to our customers.

Okay. Because the way it sounds is revenues are going to increase over the next year, and it sounds like you just -- one problem could come up is the deadlines.

To meet the schedule, that's one of our challenges. But it's a matter of Frequency. The impossible just takes a little longer.

At this time, we have no further questions. I will turn the call back over to our speakers for closing comments.

Thank you very much, Shae, and thank you all for joining us today in this conference call. We're looking forward to reports for the coming quarter and this coming year. Things are looking up for Frequency Electronics and we are very pleased to have you with us. I wouldn't close, please don't let me close, without offering thanks to our officers and our employees who are the ones that really make this happen. Thanks to all you folks at Frequency Electronics, thanks to our shareholders for joining us and we'll see you for our first quarter.

Thank you.

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