Frequency Electronics, Inc. (FEIM) Q1 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics First Quarter Fiscal 2016 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. With that being said, it is now my pleasure to introduce your host, Martin Bloch, President and CEO of Frequency Electronics. Mr. Bloch, you may begin.

Thank you, Tim. Good afternoon, everybody. I will turn the presentation over to Alan Miller, who is going to go through all the statistics, and then I will give an overview and be open for questions and answers. General Joe Franklin is too busy in keeping -- trying to keep order in Washington, so we'll have to do without him today. Without any further, Al, why don't you begin?

Thank you, Martin, and good afternoon, everyone. For the first quarter of Frequency's fiscal 2016, revenues were at $16.7 million as compared to $19.7 million last year for the first quarter. Satellite revenues again, represent approximately 60% of consolidated revenues, similar to the last 2 fiscal years. Revenues from non-space U.S. Government/DOD programs, including sales by FEI-Elcom and FEI-Zyfer, accounted for approximately 20% of consolidated revenues, an increase over last year. Zyfer's revenues, in particular, nearly doubled from the year ago quarter to $2.1 million on the strength of U.S. government-related sales. Revenues from all government end-use sources, both for non-space and for satellite programs, account for more than 50% of consolidated revenues, and we expect this trend to continue. Revenues from network infrastructure and other commercial products that are recorded in FEI-New York, Gillam-FEI and FEI-Zyfer were approximately 20% of revenues as compared to approximately 25% of revenues in last year's first quarter. The decline of revenues in this market is primarily due to a $2 million reduction in third-party contract manufacturing sales at our FEI-Asia subsidiary, part of the FEI-New York segment. Gross margin was $5.8 million compared to $5.7 million last year, yielding a gross margin rate of 35% in the fiscal 2016 period compared to 29% last year. In our last quarterly report, we noted the high level of production and engineering costs incurred on delivering state-of-the-art satellite systems. Those costs continued into the first quarter of fiscal 2016 until the systems were delivered in July. These program costs, however, were partially offset by cost reimbursement from a vendor. Favorable contract and product mix also contribute to improved fiscal 2016 gross margin and gross margin rates. SG&A expenses were $3.7 million or 22% of revenues as compared to last year's $3.5 million or 18% 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 R&D spending in the first quarter of fiscal '16 was $1.1 million or 7% of revenues compared to last year's $1.2 million or 6% of revenues. Our R&D efforts include investments in products for space, U.S. Government/DOD and other commercial applications, but do not include development that is funded by our customers. Total IR&D spending may increase in fiscal 2016, as we bring new products to the market, but expenditures are still expected to remain at less than 10% of revenues. Operating profit is $941,000 or 5.6% of revenues compared to $928,000 and 4.7% of revenues in the last year's first quarter. Other income, which generally consists of investment income offset by interest and other expenses, netted to income of $650,000 in fiscal 2016 as compared to $381,000 last year. Regrettably, $400,000 of this income is attributable to the proceeds from an insurance policy on the life of a retired officer. This yields pretax income of $1.6 million in the first quarter of fiscal 2016 compared to $1.3 million in the year-ago period. The provision for income taxes is $700,000, or an effective rate of 44% compared to $590,000 or a 45% effective rate last year. Our effective rate is impacted by not receiving credit for any loss at a foreign subsidiary. In addition, if and when Congress reinstates the R&D tax credit for calendar 2015, we would expect our tax rate to go down. Net income for the first quarter of fiscal '16 is $891,000 or $0.10 per diluted share compared to $719,000 or $0.08 per diluted share for the first quarter of fiscal '15. During the first quarter, we used cash from operations in the amount of $1.8 million. This is primarily the result of an increase in unbilled receivables from $12.9 million to $14.6 million. As we meet contractual milestones, the unbilled amounts will be invoiced, and we thus expect to be cash flow positive for the full fiscal year. Our backlog at the end of July 2015 was about $27 million, of which over 3/4 is for long-term satellite programs. As we noted in the press release, potential bookings of orders for approximately $35 million have been delayed. On most of these programs, Frequency is the sole source provider. Thus, we are confident that we will book these orders and additional new business during fiscal 2016. At this point, I'll turn the call over to Martin, and we look forward to your questions later.

Thank you, Alan. Just to address shortly the backlog. Since we reported the backlog, we have gotten early funding on the first $10 million worth of programs, but our tradition is to book when all the paperwork is finished and we get the full funding. And so the proprietary programs look very good. Our outlook looks great for business in fiscal 2016. Now I want to go through some of the difficulties and achievement that we have done. In the past 15 months, as Alan has mentioned, we had some very difficult engineering and manufacturing issues with the very unique space hardware that we built, and I'm happy to report they are behind us and that will enable us to move forward at a much faster pace. We've also established the credibility that we can build significant quantity of space hardware and ship it to our customers, primarily through the ability to ship significant quantities to the Iridium NEXT of master timing systems and L-Band Up/Down converters. We're now planning the future to be able to ship approximately 12 systems a month, and this is a major accomplishment in throughput at FEI. We have also been very successful in completing the development of 2 new product lines. One is the up/down converters from C-Band, Ku band and Ka band. And in fact is the very small synthesizer lines are primarily for government LEO as well as commercial LEO application. Digital [ph] products open the ability of Frequency to address a much larger market in both GEO and LEO satellites. Our secure communication business, in conjunction working with FEI-Zyfer, which combines our expertise in GPS and software programs as well as the precision of atomic and very good short-term stability clock, enables us to address some of the major issues facing the security of critical sites for the U.S. government, and we're under contract to deliver demonstration models very shortly. As a matter of fact, the first few systems have been delivered to our customer. We also see significant opportunity in the combination of the low g-sensitivity clock, including the very ruggedized atomic rubidium clock, for application in secure communication and in mobile platforms such as missile sites and RPVs. The proposal is on a very high rate, and we are addressing government GEO and LEO programs as well as commercial communication GEO programs. And of course, we're involved within mega LEO constellation opportunities that are now being proposed, where we're talking about thousands of satellites to cover the world for Internet and other services. I want to take this opportunity to express the very great effort that FEI employees have put on over the past 1.5 years to overcome some great challenges and deliver some great hardware to the industry. And of course, to our loyal stockholders, my great thanks. I would like to at this time to turn over the floor to answers and questions.

[Operator Instructions] Our first question comes from the line of Alan Radlo of Frequency Electronics.

This is Alan Radlo with CI investments. And I've been following the company for over 30 years. And it's now 3 years with down earnings and I just don't understand technology companies. I truly believe if a company has unique technology, they can get paid for it and show it in their earnings. So I don't understand what's going on. Is the company not have unique technology, or is the company just cannot [Audio Gap] quickly and produce earnings on the bottom line? I don't mind lumpy earnings, but you can't have 3 years of down earnings when the industry is growing, and we get all these promises, promises and big proposals and they don't matriculate. And I just -- this is a long time with this company, and it's time I think that the company start producing year-over-year up earnings.

Okay, this is Martin Bloch, I'm going to try to answer you on this. Well, we are very high tech and really supply most of the critical programs for DOD and commercial space and the industry. And we have grown, and we have developed new products. We are trying to get a larger share of the market. And basically, with especially in the space business, you have a very large infrastructure that is very sensitive to volume. As the typical example, our support structure for space is, let's say $10 million a year. And that supports let's say, $30 million worth of space business. The $11 million would support $100 million worth of business. So the approach that we are working very hard is to increase our take per satellites so we can increase the volume. And that's why we have put a lot of effort in developing the up/down converters as well as the small synthesizers to be able to address a larger market. Like I say, the outlook is good and we're doing the best we can to achieve it.

Well, as I said, I'm not a traitor. I've been in this stock fidelity, and where I'm at now from as much 15% holdings to 5% holdings. And this company has technology and that's why I'm invested in it. It has a solid book value, and that's why I'm invested in the company. When are you going to bring money to the bottom line? It's just not right. This company has new technology like this and there's always expenses for this or there's miscues over here, or there's delays or there's things taken out of backlog. There's just -- doesn't seem to see an orderly progression here.

Well, I don't see it that way, but I can understand your frustration. And I just want to tell you, one of the things that we are also looking very extensively is to see if we can partner with the appropriate companies that can use our technology, and who has larger resources for producibility, marketing and additional engineering so we can exponentially accelerate our products. So we're doing well and it's sometimes difficult times, but we have always made a profit. And that has -- while we are developing new products and making a profit, like I said, we're doing our best to produce the best for the stockholders.

All right, maybe I'm just a little bit jealous that I think that I'd like to see the company be doing better. As I said, I'm not a fly-by-night person who's here 1 week and out the next week in your company. Yes, I've had higher and lower positions. And yes, I know you have the most unique technology. As I said, I've been involved since 1981. I believe in this company, when Bear Stearns brought it public, watched it go to $103. I don't remember what the market cap was in those days. But it's been a long ride here, gentlemen and ...

I understand. And visualize that I am also one of the single largest stockholders and our objectives are the same.

Okay. And like I say, it's one thing to say something but I look at the numbers and that's what my results are, okay?

I understand.

Our next question comes from the line of Richard Johns, a private investor.

I'm a long-time investor. I listen to your calls every quarter. And I have a few questions, please, for Martin Bloch.

Okay, go ahead.

First, why was the order representing the first production sized opportunity for the new up/down converters postponed?

Well, as much as I can disclose, primarily, the program got delayed because the charter for the U.S. EXIM Bank expired on June 30, and that's why the program got delayed. And we are waiting anxiously to see if they can work out the details.

And I think I've seen on the news that some people want that EXIM Bank, some people don't. Does this order depend on actually re-creating the EXIM Bank?

That is above my pay grade. I really don't know on how it's being worked. But I know that this was one that we actually, got already a little bit of money to get started on long lease. And then it just came to a hold until they work out the details. We'll keep you advised as it develops.

All right. And aside from that one order, do you still expect orders for the up/down converter line before the end of the calendar year?

No question about it. As a matter of fact, we have gotten a couple of orders for up/down converters for secure satellite systems, which -- that's as much as we can say about them, so the product line is gaining traction. And we are also proposing the same type of technology for the mega LEO constellation, which is also part of the development that we have done for those converters on Ku and Ka band.

Okay. And would you educate me a little bit, what does mega LEO mean?

Okay. Well, there are a couple of programs that are very heavily funded and like one web is an example where they're going to put 900 satellites all over the world to make Internet available to everybody everywhere. And basically, they are LEOs and they require lots of up/down converters as well as clocks in order to perform the function. And we are working with a couple of those constellations. And I wish I were a better prophet to see what's going to happen. Everybody thinks it's going to happen instantly. But you can keep in the press as much information as we get on this.

Yes, yes. Okay, and listening to your calls over the years, I've gotten the impression and the hope that this would be a $100 million company, maybe a $200 million company with a 50% gross margin before too long. I guess, my question has to do with your comment about gaining a partner. In order to grow exponentially, as you put it, do you need a partner? Or can you grow very rapidly on your own?

We can grow on our own, but we can grow a lot faster by somebody who can provide this additional marketing reach and productivity involved. And we are -- right at this time, in the mid-70s, we're pushing $80 million. So we're not far away from the $100 million mark that I set for myself as well. And I promise that I'll work very hard to achieve it as soon as possible. We will achieve it on our own. However, it behooves us to look at partnering if we can get there a lot faster and address the enormous market that is out there. If you take a look at some of the reports that have been published like Euroconsultants, they recently put out a report saying that they see a significant increase in satellites over the next 10 years, and expect that the business in satellites will exceed $250 billion. We want a larger share of it, and it will be easier to get there faster if we get a good partner. But we can do it on our own.

Our next question comes from the line of Marcel Herbst at Herbst Capital Management.

This one's for Alan. On the call, you mentioned that extra -- these extra nonrecurring costs that were offset by vendor reimbursement. I was just wondering, what would the gross margin have been if you exclude those 2 nonrecurring items?

Well, probably would be somewhat offset one or another. So the gross margin might be roughly in the same ballpark, maybe 0.5 point here or there, because it's not necessarily a one-for-one match for the cost reimbursement. But it's actually for costs that are not only incurred in the first quarter of this year, but also costs that we had first initially incurred in the last quarter of fiscal '15.

Okay, good. And then a quick question for Martin regarding the orders of $35 million that you anticipated to be booked in the early part of this year. You mentioned one reason. What were some of the other reasons for the delay? And when do you think those are being resolved?

Well, some of them have already resolved. As I mentioned, about $10 million of that, we have already gotten funding to proceed. But our policy is not to book orders except to push that are funded. And because some of them are taking longer to straighten out the paperworks and the politics, and they cannot lose schedule. They give us partial funding to get started and to obtain long-lead material. So I expect all of them to be booked in, in fiscal 2016. And we're looking forward to some of these programs to really be finalized in the next 30 to 60 days. But we're sole-sourced and it's our job, so we're quite comfortable, especially since the customer has given us early money to get started.

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

Let me understand, what is the backlog that's funded and nonfunded?

As of July 31, we have a funded backlog of $27 million, okay? The unfunded, which is orders, and I can give you one example on a $9 million contract, we are funded $1 million. So in the backlog, it's only $1 million to get the long lead and to get some of the engineering tasks to be done until we work out the paperwork for the full contract funding, so that's the difference.

So the $35 million, as of July 31, is unfunded and you got $10 million funding towards the $35 million as of now or...

In the past -- within the past 30 days.

$35 million is not been booked -- had not been booked as of July 31.

We did not book it. We don't book -- we'll only book fully funded contracts.

But $10 million of the $35 million, subsequent to July 31, has gotten $10 million of the $35 million, so that would be funded?

Well, I -- don't hold me to those numbers. I have to look it up, but that's approximately a good number.

Okay. You spoke of delivering 12 systems a month. How many systems a month are you currently delivering?

Well, what happens is -- the total number of systems we have to deliver on the Iridium is 160 16-channel up/down converters and 82 master timing systems. And we've been delivering approximately 2 to 3 a month, and we just built up the throughput capacity without the Medi-Test equipment that we hope to stop [ph] shipping in September, October approximately 4 master clocks and 8 LCDs.

So September, October, you're going to start delivering 12 systems a month?

That's our goal, yes.

Your goal. And what is the dollars for 12 systems? What is the dollar amount?

Well, that is a little bit sensitive since our customers keeps us -- doesn't want us to disclose that number.

However, we'll add that as we deliver, we will get paid. And that's part of the issue with respect to the unbilled receivables we talked about that this particular contract is dependent on actually delivering the product to get paid. Not on revenue, but on the cash flow.

Okay. Now, we spoke of doing $10 million to $20 million per satellite. When does that happen?

Well, we have a couple of programs that we are already are, but not in the up/down converters. The up/down converters, the first big job is the one that got delayed, and we have a couple of proposals outstanding. And we are waiting anxiously for decisions on those.

At the time of the last call, you were delivered the up/down converter. I think, it was in the neighborhood of maybe $4 million or some kind of number.

Yes, $3 million. We delivered the WAAS up/down converter receiver, which was approximately $3 million. And I'm happy to report, we got the follow-on contract for another up/down converter on the WAAS system as well, which will be delivered this fiscal year.

So what the -- is that in -- that's not in the backlog July 31? But it will be in the backlog subsequently, or...

I think, WAAS 2 is partially in the backlog.

Partially. Yes, it's partially funded.

It's partially funded, like all of this contract. It's been very, actually getting a lot worse since the paperwork takes so much time and they cannot wait for schedule slippage, they've gone into the practice of giving partial money, so we can proceed until they work out the details. That's about our contract of that similarity on this where we got partial funding and they are finalizing the details.

Now as far as this one customer, how many other customers do you have for the up/down converter? Presumably, this customer has indicated and has proven that it works, so what kind of backlog, what kind of other customers can you get?

We are -- I understand the question, Sam. We are -- since this is a product line, we are really approaching all 6 of the satellite -- major satellite manufacturer with this product. So it's not only for one customer. And also not only the very large communication satellites that are very complex, but the up/down converters also have use in event type of satellite. So we are opening the opportunity to market it to a much larger audience.

Okay. You're looking for a partner, so you could produce more products, sell more products. How is that getting along? What's the -- have you discussed with people, you negotiating? What is the deal?

We are continuously talking.

Okay. To more than one party? Or is it ...

Definitely more than one party on this side. Remember, we need somebody who is suitable to Frequency Electronics product line and to our customers in order to get advantage of this type of partnership. So we are continuing talking to many parties.

So right now, you're not discussing merger, just working as a joint venture, or to work on the product. Would you consider a merger or somehow, if you could get to first base or home run sooner, or what is that?

We are open to all possibilities.

Okay. Okay, and as far as the insurance, I see the interest in other -- you've got $650 million versus $381 million. How much is the insurance proceeds in that?

It's about $400,000.

$400,000. Okay, okay, okay. All right.

Some of it's been paid out for.

It will be.

Yes. Unfortunately, he was a very great guy, and he passed away and as a young man. At what, 69?

No I think, at 70-something.

70?

70.

Time flies when you're having fun.

All right. Look, hopefully, you could get the -- and so Al could be happy that he could keep the -- go back up to 16% instead of staying at 5%. And other people who could be more happy to sit with the stock and get a bigger position if you could show some consistent profits. So look, for the new year...

[indiscernible]

For the new year, let's hope it happens.

We'll do our best, Sam.

At this time, there are no more questions in the audio portion of this conference. I would now like to turn the call -- actually, we have one more question coming in. The question is from George Marema [ph], a private investor.

My question's for Martin Bloch. Can you give us a little update on these -- we talked a lot about satellites today, but on your security side and your M2M deal with the French government, is there anything, any movement over on these other areas?

Okay, let's take them one at a time. With the French government, there's a large potential but with -- we have no visibility on when it's going to happen. They only thing is that we provided product to the French electric system, and that they need to update someplace around 600,000 sites. But when they are going to do it, we have no idea. So we are just waiting anxiously to see that motion. With respect to the secure product, I'm happy to say that we have a so far development contract for that system and that we have -- we're delivering hardware to demonstrate the capability, which is a combination of FEI's atomic and very good quartz clock and FEI-Zyfer GPS and software combination. So we are very happy with the progress, and we expect significant additional business in that area.

And how about the anti-spoofing stuff?

Well, that's part of our secure system. That's the whole idea. This moment, our secure communication systems are vulnerable, and we came up with an approach that will significantly increase the security of the system.

And then one clarification for either of you, gentlemen, whoever wants it. But on the systems we were talking about earlier, from the last questioner, you talked about, you currently could do 2 to 3 a month and that would be ramping up to 8 to 12 a month in September, October and going forward. Does that -- it sounds like those items are not in backlog. Those are sort of pay as they go and therefore, would revenue be going up then in the next few quarters as that ramps up along with that?

We have to ship it. We have built up all of the building blocks, all of the modules, and we now have to finish the job and really get paid for it.

It's more of a cash flow than it is a revenue issue.

It's going to give us a lot of cash, and I just want to tell you, more than the cash, which is always a good thing, is it demonstrates the capability of putting some major complex hardware through FEI system. That's been a concern to all of our major customers. They are frightened to overload us. And this demonstrates clearly that we can handle some major throughput of hardware.

Our next question comes from the line of Richard Johns, who is a private investor.

I'd like to share with you my fantasy for Frequency Electronics. I believe you have great technology and my fantasy is that sometime soon, you'll be earning $1 a share and the stock will get -- people will get excited about your technology and your company and then will get a 30 [indiscernible], and then you'll earn $2 a share. My fantasy has you up at $50, $60 a share. So I just like to say that if it turns out that you sell out for $20 a share, I'd be disappointed. So that's my comment.

No, that's a -- thank you very much. That's a comment. Well, we have been declared a national treasure. Now we have to make sure it pays up. Okay, thank you, anyway, to all of our Jewish listeners, we want to wish you a happy new year. And again, my appreciation to all of FEI's employees and all of our stockholders and we're looking for a prosperous and profitable fiscal 2016. This ends the FEI conference. Thank you, everybody.

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