Frequency Electronics, Inc. (FEIM) Q4 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the Frequency Electronics Fiscal Year 2015 Earnings Release Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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 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 will 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, Martin Bloch, President and CEO of Frequency Electronics. Thank you, Mr. Bloch. You may begin.

Thank you. Welcome everybody to the Frequency Electronics' conference call. General Joe Franklin is in Washington on business, so its going to be and Alan Miller handling the conference call. And I'd like to turn it over right now to Alan Miller to go through the financial performance of FEI. I will then give you an update and open the session for questions and answers. Alan, please proceed.

Thank you, Martin, and good afternoon everyone. For fiscal year 2015, Frequency recorded revenues of $76.6 million as compared to $71.6 million last year. Satellite revenues continue to represent 60% of consolidated revenues, similar to the ratio in the prior year, but in dollar terms, up 8% 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. In actual dollars, non-space DOD sales are about the same as the prior year, however revenues at Frequency-Zyfer grew by 15% due to sales related to the U.S. Government’s Critical Secure Communication program to prevent GPS jamming and multi-path. Revenues from all government end-use sources, both the U.S. Government non-space and U.S. government satellite programs, account for approximately 50% of consolidated revenues in fiscal 2015. Revenues from network infrastructure and other commercial products that are recorded in FEI-New York, Gillam-FEI and FEI-Zyfer were approximately 20% of consolidated revenues, about the same rate as the prior year. While third party contract manufacturing revenue increased at our FEI Asia subsidiary, Gillam-FEI revenues were down by about $2 million. In fiscal 2016, satellite revenues will continue to be our dominant market area, and based on our current backlog, we expect a greater percentage of revenue from U.S. government programs and from commercial satellite. Gross margin was $23.5 million compared to $24.7 million last year, yielding a gross margin rate of 31% in fiscal 2015 compared to 35% last year. In addition to increased costs associated with expanding production capacity, we also incurred exceptional engineering costs late in the year, in order to deliver state-of-the-art satellite systems. These investments are expected to pay off in future periods, to greater production efficiencies, as well as additional satellite business. Also in the fourth quarter, we recorded a $450,000 expense accrual at Gillam-FEI. The accrual is to provide for the additional expense required to modify certain inventory for the wireline communication industry, in order to make it saleable for non-U.S. markets. Along with product mix, these additional costs contributed to the reduction in our fiscal 2015 gross margin and gross margin rates. SG&A expenses were $14.2 million as compared to last year's $14.1 million, both of which are less than 20% of revenues. This level of SG&A expense is very much in line with our target, and should be sustainable at this level of revenues. Internal research and development spending in FY 2015 was $5.7 million or 7% of revenues compared to last year's $5.8 million or 8% of revenues. Our R&D efforts include investments and products for space, U.S. government DOD and other commercial applications, but do not include R&D that is funded by our customers. Total IR&D spending may accelerate in fiscal 2016, but is expected to remain at less than 10% of revenues. Our operating profit for fiscal 2015 is $3.7 million or 5% of revenues compared to $4.9 million and 7% of revenues last year. For fiscal 2016, with improving gross margins over the balance of the year, we expect to realize increased operating profit. Other income, which generally consists of investment income, offset by interest and other expenses, netted to an income number of $861,000 in fiscal 2015, as compared to $1.4 million last year. Other income last year included a $736,000 gain on the sale of certain capital equipment, and there was no similar gain during fiscal 2015. This resulted to pre-tax income of $4.5 million for fiscal 2015 compared to $6.3 million last year. The provision for income taxes is $1.7 million or an effective rate of 37.7% compared to $2.3 million and a 35.9% effective rate last year. Our effective rate is impacted by not receiving credits for any loss at a foreign subsidiary. So net income for fiscal 2015 is $2.8 million or $0.32 per diluted share compared to $4 million or $0.46 per diluted share for fiscal 2014. During the fourth quarter, we continued to generate positive operating cash flow of $2.7 million, such that we are cash flow positive for the entire fiscal year at $1.9 million. Our backlog at the end of April 2015 was approximately $37 million, of which over three-fourths is for long term satellite programs, split about one-third for commercial and two-thirds for U.S. government programs, and we are in the final negotiation stage on certain major programs, which we expect to add to our backlog in the near future. Frequency continues to maintain a healthy balance sheet, with a strong working capital position of about $75 million. At this point, I will turn it over to Martin, and look forward to your questions later. Martin?

Good afternoon everybody. Fiscal 2015 was a challenging and very gratifying year. The challenges were to really overcome some major development issues that we had on programs, which gave us the capability of more complex, complete systems for space, including a receiver up-down converter line. I am happy to say that, as of today, those challenges are behind us. We also had to make some major commitments, in order to demonstrate our ability to produce systems on time and in larger quantity. For this, we have invested a considerable amount in automatic test equipment, which we have now operating online. We improved our documentation process, and this is necessary from a -- basically a company that can do everything with tribal [ph] knowledge, to being a manufacturing capability to produce larger quantities and shorter cycle time. We have also invested and successfully trained the additional personnel that is necessary to accept our business. We are ready now, and demonstrated to our customers that we can deliver on time and within the required extra quantities and waiting breathlessly for them to place additional contracts with us. We are a little disappointed that its dragging a little bit, but the opportunities are there, and I am confident that we will be able to lend the additional business in fiscal 2016. It was a very important step to demonstrate to our customers, that not only can we deliver the technology which we have always done, but we can deliver the technology and quantity and on time, to meet the new challenging requirements. We also in fiscal 2015, invested in a family of new products, which is necessary in order to keep us at the state-of-the-art. Its typical of the products. We developed smaller, lighter weight, less power up/down converters, that is absolutely necessary to address the emerging Leo Satellite market, where weight, size and power is at a premium. We have improved the development of the quartz clocks and the Rubidium clocks, both for space and for the challenging secure communication business. And what's most important, is we improved the producibility, so they can manufacture much more economically. With all this said, I am looking forward to a prosperous and profitable fiscal 2016, and as Alan has mentioned in his presentation, we have some considerable contract in final negotiation right now, which should significantly improve our backlog in the very near future. With this said, I would like to turn it over to answers and questions. So operator?

Thank you. [Operator Instructions]. Our first question comes from the line of Sam Rebotsky with SER Asset Management. Please proceed with your questions.

Yeah. Good afternoon.

Hi Sam.

Good afternoon. Now, the backlog of $37 million, last year it was $48 million, and you say you expected -- now you say in the presentation, that you delivered recently in the first quarter, the up/down converter. When did you deliver it, and is it just to be tested or --

No, it has been delivered and it is integrated on the satellite, going through final integration at our customer for launch.

So when was it delivered?

Well about three weeks ago. Three-four weeks ago. It was a very challenging performance, because its not only a multi-channel receiver up converter, but it had enormous performance requirements, way above the communication of down converters that we [indiscernible].

So is this the customer you are expecting to get significant new orders for?

Well, we have proposals on outstanding to many -- to all of the aerospace giants on this. We have contract negotiations with four of them right now that we expect -- in the very near future, within weeks, to conclude on some of the additional contracts, which will significantly increase our backlog.

Is it fair to assume that you will increase your backlog above $50 million by the second quarter?

That's a good target.

Good target. Okay. Now, in the first quarter, do you expect to record a loss? Are your expenses fully charged, because you talk about additional expenses in the first quarter? Could you sort of give me some kind of idea, what --

Its good. Challenge is to predict that particular gain or loss. We know that there will be some additional costs, but we don't expect that we would necessarily have a loss in the quarter.

Sam, I believe a good estimate we will know in a couple of weeks that we will not have a loss in the first quarter.

Okay. So it appears that its taking you longer than you expected, because you were sort of -- we expected everything to start the new year with a more significant backlog. And hopefully, look at this point in time -- and hopefully, as far as your cost, have you gotten it down at the losses subsidiary, with the additional, what Gillam? Do you have the --

Well we are working very hard to reduce the cost, and then at the same time, to open some new product capability for them to do. And everything is in works. We have started a very serious program. We expect to implement it before the summer is over.

So you are not going to get rid of that subsidiary.

Well, that's an option.

Okay. I assume there are other questions in the queue. I will come back. I will let somebody give a chance. I will come back.

Okay Sam. Very on the money. Thanks.

[Operator Instructions]. Our next question comes from Marcel Herbst with Herbst Capital Management. Please proceed with your question.

Good afternoon. Thanks for taking my questions. Can you give us a bit more detail on what caused the production challenge?

We undertook some -- this is Martin Bloch. We undertook some really advanced performance requirement on a couple of programs, and they turned out to be a lot more difficult than initially anticipated. Plus the fact that we had some unfortunate help from a couple of our suppliers that screwed us up on the hardware that they had to deliver to us. But our challenge was to make sure that we get the performance and deliver it to the ultimate customer. We don't accept failure. So we worked our bums off to get it done and to deliver hardware, full performance, in spite of all the difficulties.

Okay. So it sounds like this was an internal problem only, it didn't affect the customer?

Well the customer -- a little bit the customer, because we were a little bit late because of this challenging. But we are in very good standing, because we delivered the hardware that meets all the requirements, and we caused them a little bit of anxiety, but we didn't cause them any delays in launch, which is the key?

Okay, good. Quick question on the R&D, you mentioned you are going to ramp-up the spending. How much should we expect in fiscal 2016 for ramp up?

Less than 10%, as Alan has mentioned on this point. And we have been running about what --

7% or 8%, so we were at 5.7%. I would expect in the $6 million to $7 million range.

Yeah. That's a good estimate.

Okay. And there was -- regarding that lawsuit that's out, that claims you breached your fiduciary duty, what is that about?

Non-event. There is no lawsuit. Our take on it is, this is a guy -- kind of [indiscernible] business for himself in the future.

Yeah, we have had no input on this side. I just want to mention one more thing which you brought to my attention. A lot of the development and size and power reduction is that now, significant outstanding proposal for the Leo market that is developing, and that's some of the investment that we are going to use the same existing technology that we have. But to reduce size and power consumption and weight, since the Leo -- the Leo orbiting, unlike the geosynchronous, weight and power is of utmost important, since they are very small satellites.

Quickly speaking of those, that first small KU/KA band converter deal, where you shipped product. You mentioned on one of the previous quarters that the very first time you get a deal, its almost losing your virginity. Its really very important. Was that debt kind of deal in those small, or are you still waiting for that special event?

Not a virgin anymore.

Okay. One more question if I may? I understand that Iridium is planning to launch 72 Iridium, next satellite between the second half of 2015 and 2017. And I read that those will be built by Thales Alenia Space of France. I was wondering, are your products contracted to go in all of those 70 satellites, and also what level of revenue opportunities attached to this?

We have a contract approximately of $30 million to supply the master clock and the L-band up/down multichannel converter for all 82 satellites.

And we have also recognized a lot of revenue over the last three or four years now on that program, even though we are still in the process of delivering the product -- the hardware to Thales Alenia.

And so Thales Alenia schedule, is I believe -- the latest they gave us an input is they are going to start a launch at the end of 2016. But we are delivering products right now, and the launch schedule is something that's up to them.

Okay, great. Thank you very much.

You're very welcome.

Our next question is a follow-up from Sam Rebotsky with SER. Please proceed with your question.

So the product that you delivered three weeks ago, has that been launched?

No. It has been integrated there by our customer in a large satellite, and is scheduled to be launched some time in the next couple of months.

So I guess, the best to understand you, you're going to have -- whether your products that you delivered is 100% satisfactory will be before the launch or after the launch or --

Sam, you got to make sure that the product meets all their requirements before launch. Once you launch it, its gone. There is nothing you can do about it. And to demonstrate that this week, we have gotten a follow-on contract to be completed in this fiscal year on the same program.

So, you know that your product is 100% satisfactory as of now?

Absolutely.

Okay. So, what kind of bids do you have out there, sizes of bids?

We have quite a few proposals in the $10 million range, and we have one giant proposal out in that $50 million to $70 million range.

And how much dollars can we put on a satellite, say, in the next quarter, and then by the end of the year, some kind of range?

Well typically right now we are putting between $5 million and $10 million on the satellite. And our goal is to raise it to around $20 million to $40 million per satellite.

That being the goal, but -- do we expect -- are we bidding on contracts right now, that will get it to the $20 million to $40 million?

Yes.

Okay. And so, we have solved all the problems we have had?

All the problems we knew, were solved. But in the space business, there is always a challenge, since we are in the state of the art. So everything that we had, issues were resolved. Tomorrow is always a new horizon.

Okay. And how many employees and how many in the first and second shift do we have now?

We have a total of 226 employees in New York. And I presume this is in New York, where we are pursuing the space business, and we have approximately 15 to 18 people on night shift.

Do we want to get more than 15 to 18, when we finally get?

Yes.

And assuming we have -- we are still looking for qualified people to hire, I assume?

Absolutely. We are looking for qualified people. Especially people that are willing to work the second shift, because that adds capacity at the minimum cost; because you use the same facility, same test equipment; so its very cost effective to add people to the second shift.

Okay. So at this point in time, I know its close to getting more contracts. But by the -- say by October 31, do you feel you will definitely have significantly more contracts, and if you do -- and put some kind of idea of the contracts you have? And then tell your story to Wall Street?

Absolutely. And we expect to have that type of increase by that time.

And do you plan to hire Investor Relations and tell your story to Wall Street? Do you feel you have achieved what you need to know, that there are no bugs, that you -- what we don't know, is something could happen. But you feel that you have enough contracts that you would want to tell your story to Wall Street?

Yes.

So will you hire somebody and start telling your story?

Its on the plate.

Its on the plate.

I just want to tell you, its not that we had a bug, its basically -- you have an automobile that you design to go to 120 miles an hour and do it on 50 miles to the gallon, and you are achieving 115 miles an hour and you're getting 40 miles to the gallon. It’s the less performance that you're trying to squeeze out for space application which is the challenge. So I wouldn't put it as a bug. Its more as a challenge to get optimum performance on our hardware.

Martin, I appreciate everything you have done, and I can understand by the difficulty in pinpointing when the contracts would begin. And I know that was what was going on, where you were difficult to give any concrete fixed date. And it appears that you're ready to finally go forward and tell your story a little more. Hopefully, this is the case, but it appears you are more ready than you have ever been, and hopefully, that is the case. And good luck, and hopefully the contracts come and we could make some profits, and we could talk about the profits.

Despite of all of our issues and investments, we still made money.

This is true, Martin. Okay. Good luck.

Thanks Sam.

At this time, there are no further questions in queue. I would like to turn the conference back over to management for closing comments.

Okay. Thank you all for listening on this. We are very encouraged at FEI with the opportunities we have. I want to express my thanks to all of the people at Frequency that are working very hard to achieve progress and to all our faithful stockholders. And I am confident that we will achieve our objective in the very near future. I want to wish everybody a very good year. Until we talk again. Good bye.

Thank you. This does conclude today's teleconference. You may disconnect at this time and have a great day.