Frequency Electronics, Inc. (FEIM) Q1 2015 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen, and welcome to the Frequency Electronics First Quarter Fiscal 2015 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. Any statements made by the company during the 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 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 revisions or changes after the date of this conference call. It is now my pleasure to introduce your host, Mr. Martin Bloch, President and CEO. Please go ahead, sir.

Thank you. Again, welcome, everybody. Martin Bloch and Alan Miller handle the conference; General Joe Franklin is working hard in Washington hopefully for all of us. And we'll set up in 3 sections, as has been our approach. Alan is going to give you an overview of the financial performance of Frequency on this quarter, and then I'll give you a brief color on what we are doing to enhance stockholder's value and Frequency's business, and then we'll open to questions and answers. And I would appreciate if whoever has the question if you address it to either Alan Miller or Martin Bloch. And now, Alan, please proceed.

All right. Thank you, Martin, and good afternoon, everyone. For the first quarter of fiscal 2015, Frequency generated revenues of $19.7 million, a 17% increase over last year's $16.8 million in fiscal 2014. Satellite revenues increased to 2/3 of the consolidated revenues, similar to the fourth quarter results and up from somewhat more than 1/2 of first quarter revenues last year. Revenues from non-space U.S. Government and DOD programs, which includes sales by FEI-Elcom and FEI-Zyfer, accounted for less than 10% of consolidated revenues, as compared to about 20% last year, representing a sum of about $2 million quarter-to-quarter. Issues related to the U.S. Government budget, that is sequestration, continued to push orders to the right. However, last year, we -- last quarter, excuse me, we reported that FEI-Zyfer had received initial funding on our new critical secure communication project. Additional funding was received in the first quarter of this year, and thus we expect to see higher, non-space U.S. Government revenues in subsequent quarters of fiscal 2015. Network infrastructure and other commercial revenues that are recorded in FEI-NY, Gillam-FEI and also FEI-Zyfer, were about 1/4 of consolidated revenues, up moderately from the first quarter of the last year. Included in these revenues are third-party sales by FEI Asia, which is part of the FEI-NY segment, which enabled FEI Asia to make a small positive contribution to operating profit. Overall, we anticipate higher revenues from both space and non-space business areas for the balance of fiscal 2015. Gross margin was $5.7 million compared to $6.3 million last year, resulting in a gross margin rate of 29% in fiscal 2015's first quarter, as compared to 37% last year. The low sales volume at the company's subsidiaries, Zyfer, Gillam and Elcom, were not sufficient to cover the fixed costs of each entity. The FEI-NY segment generated higher gross margin, but at a lower gross margin rate due to product mix since this segment includes FEI-Elcom and FEI Asia. As revenue increases at our subsidiaries, we expect to realize improved gross margin rates over the remainder of fiscal 2015. We continued to control SG&A expenses at $3.5 million or 18% of revenues, as compared to last year's $3.6 million or 21% of revenues. This level of SG&A expense is very much in line with our target, and should be sustained throughout fiscal 2015. R&D spending in the first quarter of 2015 was $1.2 million or 6% of revenues, which is similar to the result of the fourth quarter, and as compared to last year's $1.7 million or 10% of revenues. As we approach the final qualification stage on a new expanded satellite payload product line of microwave receivers and up/down converters, the rate of spending has tapered off. Of course, our R&D efforts include many other product developments, and we will continue to invest in products for space, U.S. Government and DoD and other commercial applications. We expect the rate of our R&D spending to remain at less than 10% of fiscal 2015 revenues. So this yields operating profit of $928,000, as compared to $963,000 in last year's first quarter. Other income, which generally consists of investment income offset by interest and other expenses, netted to income of $381,000 in fiscal 2015, as compared to $93,000 last year. The fiscal 2015 period includes a $280,000 gain on the sale of certain marketable securities. So pretax income comes in at $1.3 million in fiscal 2015 compared to $1.1 million last year. The fiscal 2015 tax provision of $590,000 is at an effective rate of 45%, which is compared to last year's $380,000 or a rate of 36%. Our effective tax rate is impacted by the exclusion of operating results at our overseas subsidiaries. During this first quarter, the rate is higher due to a higher ratio of foreign losses to consolidated income as compared to the prior year. We expect, for the full fiscal 2015, that our effective tax rate will be in the mid-30% range. So this yields net income for the first quarter of 2015 of $719,000 or $0.08 per diluted share compared to $676,000 or $0.08 per diluted share in fiscal 2014. Late in the first quarter, we achieved certain milestones and billed the customers on several large satellite programs. This resulted in a near doubling of our billed accounts receivable to $14.7 million at the end of July, as compared to $7.7 million at April 30. As a consequence, we had negative operating cash flow of $5.6 million for the first quarter. We expect to collect almost all of these receivables during our current quarter, which should generate positive operating cash flow in that period. And for the full year, we do expect to be cash flow positive. Our funded backlog at the end of July was $57 million as compared to $47 million at the end of fiscal 2014. 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 $80 million. I'll now turn the call over to Martin, and I'll look forward to your questions a little later.

Thank you, Alan. I'd like to give you a brief color on where the company is moving and the challenges that we have to face this year. Satellite business is great. We are booking business on our legacy product, and we are going to finish testing this month on our new products and demonstrate them to our customers. Our customers are very interested in the up/down converter receivers because it offers a product that is cost effective and smaller in size and weight, and that's the game plan, to put a lot more capacity on existing satellite platforms. The key to our success in landing a major program on that type is to demonstrate to our customers that we have the capacity to deliver because one satellite of accounts -- of receivers and down converters adds a lot of units to be delivered on this. So our main customers are looking at us very carefully to see what we are doing to increase capacity, how we are doing on the delivery of existing programs that they gave us, and that is the major challenge that we have faced this year. We are -- we have been successful on hiring some skilled people from the outside, but more important is we have started a very significant program of retraining people that are involved in our military and commercial to be able to do space hardware. And that's quite a challenging fact independent on how good these people are. But we have been very successful in getting them up to speed. We are also working very hard and they have good progress at setting up a second shift in order to meet that capacity. Our proposal rate is very excellent, both on existing product, as well as the new products. And we are very encouraged by the opportunities that are in front of us. The secure communication that -- actually, Zyfer is taking the lead on there because it's related to GPS and other synchronization system, which they have experienced, but our technology at New York will come in very heavily into play, both providing the flywheels or the high precision timing that needs to be done in auto to achieve that improvement in security by eliminating the -- or minimizing the ability to jam or to spoof critical communication assets on this. As Alan has mentioned, our margins would have been considerably better at FEI on the satellite business if we didn't make this investment in automated test equipment in order to improve the throughput faster, and at the same time, the training and uptraining of people to be able to do that work. Then, a lot of R&D, in addition to what we are spending, fortunately, is also being funded on new programs from the government, which will help us to continue the flow of new products for this year and beyond. I think that's as good a summary as I can give you. Everybody is excited about our business opportunities, and we're all working hard to achieve better sales and revenue since fiscal 2015 and beyond. I'd like to open, at this time, the question -- the session to questions and answers. Please address it to whom you would address the question. And before I forget, we'll have our stockholders meeting on October 8th at FEI. You're all invited to come and kick the tires with -- more than welcome to see any of you come and visit us. Please proceed.

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

First question is directed towards Martin, and it's regarding capacity. The second shift, I know you've mentioned in the past, it's probably going to be focused a little more on testing and what have you. Is there a chance that, potentially, that could shift a little more towards production or assembly?

Definitely. That's -- that has a lot of advantages, and it's getting a lot of attention because you utilize the same space and the same capital equipment and you can get additional throughput. Unfortunately, at the east it's really a problem. As I mentioned before, I was on the West Coast, and people loved the second shift. They love to work from 5 to 11. It gives them a whole day, they still have enough sleep, and it's like heaven. On the East Coast, the second shift is considered like going to jail. We are getting traction on it, and we have added people to the second shift, but it's like pulling teeth. And -- but we're working hard to get it.

Okay, a couple of follow-on questions. Any idea of how many new employees you'd like to add?

To demonstrate our increased capacity for what we have right now on order and what we anticipate of lending an up/down converter program, we have to -- and it's not that many. We need a few good people, we need like less than 12 skilled people, and between 12 and 20 both a combination of what we'll hire and what we'll uptrain the people from internally.

Okay. And then just one final follow-on question for that. Just regarding when you mentioned transitioning training some of your current employees to work on satellite business, how long do you think that could take?

Well, that's -- some people, it takes 4 weeks, some people, never. It's just -- the skill that is required -- remember, you're trying to build something on earth, you send it out for 15 years, and you want to make sure that it works, since you cannot send anybody up to repair it, not yet. So the skills and accuracies are just, it's ingrained. And to give you an example, if we will start with 10 people to get them qualified to do soldering and assembly on this, we'll probably will end up with 6 that can do the job.

Okay, switching gears for a second, just regarding -- also directed at you, Martin, just regarding Gillam, could you maybe give an update on where the RTUs are with the French government, in terms of a possible order or what kind of time frame are we looking at?

Well, they have a small order, and it's moving as slow as molasses on this item, like the French. The opportunity is great, but we -- it's difficult to put numbers on it. I was there recently, and I tried to get a much harder number from the people, and the only thing that everybody says is yes, they must do it, but we don't know when we're going to really go into production. At this moment, there are still only 2 qualified suppliers for that. That's Gillam and who's that...

Schneider.

And Schneider, which you know is a company about 100x bigger than Gillam. And when they go into production, I think they are going to probably want to qualify at least 1 or 2 more of these companies, and the quantity is enormous, and units are performing very well in the field. But I have not been able to get a definite date on when they will start releasing the first production quantities. Soon is the answer I got.

In the meantime, we are selling a similar product to other entities in Europe, but that are much smaller volumes than what the French electrical grid would promise us.

Yes, we're selling it to Belgium and England and some of the other...

In North Africa.

And some of the installations in North Africa. So it's starting to move, but very slow.

Okay. One final question for me, it's regarding Zyfer. It seems like you're expecting some type of recovery this year. Is that going to be driven more by the security products? Or some type of recovery or rebound in your G4 ISR spending from the government?

Again, could you ask the question?

G4 ISR.

Okay, I'm just -- we are -- it's hard to project what the government is going to do. On the security, we know it's a must, it's not a luxury. So that, by far, is going to drive the most. The rest of the products, and this is hard to tell because I hope you know our government better than I do. I spent a lot of time in Washington, and I cannot get calibrated on this. But the security we know is not a choice; that must be done. So the way I see it is the significant increase is going to come from the security products and both commercial and military satellites. That, we have great visibility. The rest of the government products, we'll have to wait and see.

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

Now I'm trying to understand, the revenue went up about $3 million, and the research and development went down about $0.5 million, and the operating profit went down by $40,000. I don't understand what you're saying why -- where's the more expenses that we're putting out, that we didn't achieve better profits?

As I tried to explain in my comments, Sam, the low sales volume really was not sufficient to cover the full operating costs that we incurred in our subsidiaries primarily. Gillam had a loss for the -- operating loss for the quarter, as did Elcom and Zyfer, because of that low-volume.

So was the profits -- was it an improvement for Zyfer and Gillam over the previous quarter?

No. It's comparable, quarter-to-quarter.

Quarter-to-quarter was comparable.

In terms of those subsidiaries, yes.

So where did the sales came from?

Sales come from our New York segment, primarily.

So -- but they didn't produce a better profit margin?

Well we had a higher gross margin in terms of dollars from the segment but at a lower rate.

This is Martin, again. Remember, one of the 2 things that we have also invested very heavily is in automatic APE equipment to be able to increase the throughput with less touch labor and retraining of the people because the key to our success on capturing a major programs on this, going from the $5 million to the $10 million per satellite to the $20 million to the $40 million is to demonstrate to our major 6 customers that we will be able to deliver on time. Because the cycle time from contract to delivery on our new satellites is brutal. It has gone down from 40 to 50 months to 18 to 26 months. So everybody is very, very concerned about making sure that the subcontractors can deliver on time, and that is getting a lot of everybody's attention at Frequency to increase capacity.

So in essence, we spent the money on training. And is it depreciation on new equipment, or is it equipment that's expensed?

Both. Both.

Yes, some combination of both.

And because -- we use logic. If it's a $10,000 piece of test equipment that we build up, it's -- and we call this as a jig and we charge to the program. If it's a big one, like $1 million ATE, we capitalize it.

So in the subsequent quarters with the backlog at $57 million versus $47 million, do we expect to see the quarterly revenues increase, and the profit margins improve in the next quarter? Or when do we expect that to happen?

It's definitely in fiscal 2015. The quarter-to-quarter, it's very difficult because of the lumpy business we have, but we can see, as Joe Franklin said, and his stockholders said and Al indicated, we can see an increase in revenue and profitability for the fiscal 2015.

Okay. And how much per satellite did we put in this quarter?

We're basically at the same levels we have been in the past.

Okay, okay. Let me switch one thing to the balance sheet. At the year end, we had $1 million of gross unrealized gains and $189,000 of unrealized losses, and we picked up $280,000 of gains in this current quarter. Does our -- so is it -- do we assume that we have the $280,000 less than we had last year? And we have the same amount of unrealized gains in this quarter?

You're talking about our marketable securities?

Yes, yes, fixed income and equity, you had a carrying value of $16 million fair market value at the end of last year, April 30.

He's checking, give him a minute.

We have about $1 million of unrealized gains.

So we still -- so we improved that a little bit and we took some...

So it was the same as where it was last year, in terms of, April, I should say, about $1 million of unrealized gains.

Okay, okay. All right. Hopefully, we get some more profit sooner.

So listen, the objective is to make a lot more profit rather than a little bit now. So we are shooting for the big apple.

[Operator Instructions] It appears there are no further questions at this time. Gentlemen, do you have any closing comments?

Yes. I'd like to thank all the stockholders for being with us, and all our employees for working hard to realizing our objectives. We are doing very well, and we'll continue with the maximum effort to realize our gains and profitability, as everybody over there is looking forward, and so are we internally. Again, thank you very much for listening in. I want to mention, again, if you have the opportunity, please join us for the stockholders meeting on 2014, October 8th at FEI headquarters, and we will serve doughnuts and coffee for everybody who comes. Thank you, and have a great -- a great year. Bye.

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