Frequency Electronics, Inc. (FEIM) Q2 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics Inc. Second Quarter Fiscal 2015 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 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 for Frequency Electronics. Thank you, Mr. Bloch, you may begin.

Good afternoon, everybody. Mr. General Joe Franklin is busy in Washington, so the conference call will be handled by me and by Alan Miller. And we'll set it up that Alan Miller will give you a rundown on the financials, I'll give you some color on what Frequency is doing to promote growth and profitability, and then we'll open it to answers and questions. Alan, please.

Thank you, Martin, and good afternoon, everyone. For the second quarter of fiscal 2015, revenues were $19.2 million, up 13% from last year's $17 million for the second quarter of fiscal '14. Satellite revenues continue to represent approximately 60% of our consolidated revenues, similar to the ratio in the prior year. But in absolute dollars, space revenues were up nearly 20% year-over-year. Revenues from non-space U.S. Government/DOD programs, including sales by FEI-Elcom and FEI-Zyfer, accounted for approximately 20% of consolidated revenues, similar to the ratio of such sales in the year ago quarter. As we indicated last quarter, FEI-Zyfer had received initial funding on a U.S. Government critical GPS anti-scooping project, and during the second quarter, began to deliver against that program. When we combine U.S. Government/DOD non-space revenue with revenue from U.S. Government satellite programs, this accounts for approximately half of second quarter revenues and a little over 40% of consolidated revenues year-to-date. The remaining 20% of consolidated revenues is from network infrastructure and other commercial products that are recorded in FEI-New York, Gillam-FEI and FEI-Zyfer, which is compared to approximately 25% of consolidated revenues in the second quarter of last year. Overall, we anticipate higher revenues from both space and non-space business areas for the balance of fiscal 2015. Gross margin for the second quarter was $6.7 million, compared to $6.2 million last year, resulting in a gross margin rate of 35% in fiscal 2015's second quarter compared to 37% last year. With higher second quarter sales volume and the company's subsidiaries, FEI-Zyfer and Gillam-FEI, gross margin rates improved from the 29% rate which we recorded in the first quarter of fiscal 2015. Product mix remains an important factor in our gross margin rates. As consolidated revenues increase, we expect to realize improved gross margin rates over the remainder of fiscal 2015. As we continue to control SG&A expenses at 3.5% or 18% of revenues, this as compared to last year's $3.5 million or 20% of those revenues. This level of SG&A expense is very much in line with our target, and should be sustained throughout fiscal 2015. Internal research and development spending in the second quarter was $1.4 million or 7% of revenues, compared to last year's $1.5 million or 9% of revenues. Our R&D efforts include investments in products for space, U.S. Government/DOD and other commercial applications, and we expect the rate of IR&D spending to remain at less than 10% of fiscal 2015 revenues. So these results in operating profit of $1.8 million or 9.3% of revenues compared to $1.3 million and 7.4% of revenues in last year's second quarter. Other income, which generally consists of investment income, offset by interest and other expenses, netted to income of $153,000 in fiscal '15, which is similar to last year before accounting for a gain of $736,000 on the sale of certain manufacturing equipment. So pretax income was $1.9 million at fiscal 2015 second quarter compared to $.2.2 million in the same period last year. The fiscal 2015 tax provision of $660,000 is at an effective rate of 34% compared to last year's $770,000 or a rate of 36%. The effective tax rate is impacted by the exclusion of operating results of our overseas subsidiaries. For the full fiscal 2015, we expect the effective tax rate to be in the mid-30% range. So net income for the second quarter of fiscal 2015 is $1.3 million, or $0.15 per diluted share compared to $1.4 million or $0.16 per diluted share in fiscal '14, which also included a one-time gain on equipment sales. As a result of the [indiscernible] billings and milestone payments, we had negative operating cash flow of $2.5 million for the first 6 months of fiscal 2015. However, in this past second quarter, we generated positive operating cash flow of $3.1 million. With recent billings and milestone payments, we expect to generate positive operating cash flow over the balance of fiscal 2015. Our backlog at the end of October 2014 was $52 million, which is compared to $48 million at the end of fiscal '14. And again, 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 about $80 million, which is more than sufficient to support substantial growth. I'll turn it over now to Martin, and we'll probe [ph] your questions later.

Thank you, Alan. I just want to indicate on where we're going, that as I mentioned before, our greatest challenge in this coming 6 months is to increase capacity in order to meet our present commitment and anticipated additional future programs that are in the works. We are improving it through. We've taken 4 major steps: one is to set up a night shift; second is to transfer work to Elcom, our subsidiary across the river in Hudson and to train them and to get them certified for HiRel work; third is to build, deliver and then put in work automatic test equipment, which basically reduce attached labor and are able to increase throughput; and the fourth, which is equally important, is up-train our personnel from other commercial and DOD program to space skills. We are meeting this challenge for present as well as future programs that we're sure to get. Third, Ku and Ka development is progressing well. We have demonstrated the equipment to our customers. The units were well received because they are considerably smaller in size and power, and that's where the big advantage lies. We have outstanding proposals for both military and commercial satellite programs. We are ready to accept orders on them now and expect that we will play -- get some orders on the up/down converters before the end of fiscal 2015. We are making a lot of progress on the secured timing project that is -- that we are honored to have been entrusted with, and this is basically to improve security for communication and to eliminate the multi-test problems that exist due to GPS possibly being jammed. We have delivered the first phase of the paper program, and some demonstration hardware is in the work, and we expect to get additional programs within the next couple of months on: one, to improve the clock -- the timekeeping clock to make it more rugged and more stable over harsh environment; and to improve the timing accuracy by using low g for mobile platforms. We have a good backlog and many proposals in the work and look forward to increase revenue and profitability for fiscal 2015 and beyond. And when things are going well, we can make my presentation very short. So I'd like to open it now to questions and answers. And if you will be kind enough to please address your question to either me or Alan, that would be very helpful.

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

A couple of questions. I'm traveling, so I may have missed something, I apologize. Can you just touch on what improved the profitability in Gillam and Zyfer? Was it revenue growth? Or was it product mix or a combination of the 2?

Both. They had -- as we mentioned in the first quarter, they had some very low levels of sales and that we're happy to see that they were able to pick those values -- volume up in the second quarter that helped them to really improve their profitability, overall.

Okay. So does that mean that...

Tristan, I just want to tell you, we have chosen, from a corporate point of view, to make FEI-Zyfer the focal point to improve the secure communication program. So they are heading up that effort.

Okay. Great. So, Alan, just to kind of jump back to what you were saying, so does that this level of sales is kind of normalized what you expect for the balance of the year? Or do you think you're going to see more growth from some of the secured timing products you're now offering?

Well, I think the level of sales would probably be something comparable going quarter-to-quarter. They only do $2 million to $3 million a quarter. So little ripples here and there will have an impact. So -- but it's much better than what they did last quarter. I think they both were around $1.5 million, and now they're both about $3 million.

Okay. And then just one final question regarding that. Can you maybe give a little more color regarding a possible time frame for some of those new products?

Well, are you talking about the Ku- and Ka-band converter? Or the timing of the...

No. No. I'm talking about more...

The timing?

The timing, yes.

Well, basically, there's a need to improve communication network to improve security and to improve errors which are caused by multitest or possible inter-operational availability of GPS, and we have come up with an approach that will enable to do it, and we have demonstrated it on paper. We are building models that will demonstrate it in hardware, and after that, we will proceed to update many communication site for this to improved security and performance.

Just one more follow-on question. So when you're talking about timing going for some of these models, a year out, is it 2 years out? Any kind of color on that?

Sorry, can you repeat it? Tristan, I didn't understand it. Could ask it again, please?

Just when you mentioned the time frame in going for some of these models developing, when you think they'll actually begin to contribute revenue, is it a year or 2 years?

Well, we're going to see increase in revenue in this fiscal year for FEI-Zyfer and some advanced developments for FEI-New York. And implementation of this program is to be done on a very fast basis. We will get better timing as we proceed, but it's a high-priority program since this is a risk for all secure communications.

Our next question comes from the line of Marcel Hertz [ph] with Hertz Capital Management [ph].

Regarding the Ku/Ka-band converters, and I think the question is for you, Martin, what would be the lead time once you get a contract win to booking revenues?

Well, that's the game that is very important. You hit the nail right on the head. With this new, especially commercial satellite, the lead times needs to be very short. And we have invested a lot of IR&D in order to be able to respond quickly. From order to flight delivery, we will have to do it in less than a year and the target is 9 months. This compares to 26 to 36 months for the older designs. So this is one of the main objectives: smaller size, test the response time, less power to be able to put a lot more of them on the same existing platforms.

That's great. And the gross margins on the new converters, is that close to your target range of about 40%?

Well, LM's are 40%, mine are higher.

And if I could clarify one point. Martin talked about delivery time of the Ka and Ku band. Most of these programs are to be large enough that we will recognize revenue almost immediately because they're going to be on percentage-of-completion basis. So we don't have to wait 'til delivery to recognize revenue, in other words.

I see, that's helpful. With your current capacity, how many satellite contracts could you accept?

Well, we are putting the things in work that we wanted. We don't want to be limited. I just want to tell you that in order to satisfy our business plan, we only have to capture 3 or 4. And that's the capacity we are preparing by the second shift, by getting FEI-Zyfer to be able to do it and the investment in automatic test equipment that we have already done at this point. And with the decrease of people in the commercial and DOD to up-train those people, which takes a long time, but a long journey starts with a first step. So we feel that, that is necessary for us to do it.

Okay. Now I've read that, on another topic, Google plans to deploy a proprietary fleet of 180 low-orbit satellites in a 5-year mission to deploy broadband services. I was wondering, is this a project that you would be bidding on? Or is this a different technology that's needed there?

No, we might be bidding on, but I don't really -- I have to see their plan and their architecture. There have been those plans a couple of times in existence. The first time, it was 900 satellites to provide this inexpensive access. So I don't know the technology they want to deploy, but when there are satellites and they need synchronization, timing will be a necessary part of the satellite.

Good. And moving on through the end-to-end technology, you mentioned that France will choose, out of the 2 companies, a winner that -- where the winner gets 2/3 of the volume while the runner-up will get 1/3. And I was wondering, has this race been decided yet?

No. And this is up in the air. And if one supplier has technical issues or performance issues, the other supplier will get all of it.

Okay. Is this anywhere closer to a decision to a time? Or are they still saying soon?

No, all I can tell you is that we have been asked to do everything in our power to accelerate the program, and we're doing that.

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

Now as far as of the up/down converter, is there -- say, between a 1 and a 10, with 10 being the highest, do we expect to receive, by April, an order? Have the various people that are looking what you're doing prepared, do you think, to give you an order before April 30 of the current fiscal year?

I would give it a 7 to an 8.

7 to an 8, okay, okay. So with -- and as far as the next year, do you think we would be at $20 million-plus satellite versus $10 million to $20 million, $5 million to $10 million?

As my mother would say, from your mouth and to God's ears. I'll just, if we win, the basic idea at this moment, we are $5 million to $10 million per satellite, and winning a converter job on one of the satellites will easily put us in that range.

Okay. So -- but now, based on what you expect for the rest of the current year, do you expect to do, more or less, in the $20 million-per-quarter range for the January and April quarter? Is that...

Sam, on the grounds that I might incriminate, we have never given projections, and I'm too old to start now.

All right. But you said you're going to do what you did in the current quarter for the rest of the year, is that what you just said?

No, I didn't say it. Alan indicated that we plan to have increase in revenue and profitability for this year compared to fiscal 2014. And I can definitely tell you that that's the case. The exact number is out of my league.

Okay. And the backlog at the end of the previous quarter was $57 million. Now we're down to $52 million. Do we -- so we -- without the major satellite contract, do you think we will be improving what we're doing now above the $57 million backlog?

Alan, I don't know. What was it in April?

It was $48 million, and we were at $57 million in -- at the end of July, so he's correct. But, to use a technical term, we're lumpy, we know that.

Well, I'll tell you, we only report programs that are fully funded. And we are now in negotiation with 3 major programs that we have. They are secured, they are ours. But until the contract is negotiated, we're being incrementally funded. As soon as this is done, our backlog will be up to the same level. We're really in good shape on having enough backlog and enough in the pipeline to support our increased revenue and profitability for fiscal 2015 and beyond.

So also as far as what we're bidding on, is it fair to say we're bidding on more contracts today versus the previous quarter? Or is it the same?

Probably more. I'll have to take a look on this. Lots of proposals that we're working on, on a day-to-day basis. I didn't take the numerics, but it's as equal or more than the previous times.

Okay. All right. Hopefully, in the next quarters, you can make everybody happy and make some more profits and more sales.

We made profits, Sam.

More, more profits.

Okay, okay. That's my objective. My objective is profitability and growth, and we need both.

Thank you. Ladies and gentlemen, we have no further questions at this time. I would now like to turn the floor over to management for closing remarks.

Again, I would like to express my appreciation to all our shareholders and to the employees of Frequency. We're all working hard to move this company and its products forward, and I want to wish everybody a happy holiday season from all of the management and employees of Frequency Electronics.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.