Frequency Electronics, Inc. (FEIM) Q3 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Frequency Electronics Third Quarter Fiscal Year 2017 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the conference over to Mr. Joel Girsky, Chairman of the Board for Frequency Electronics. Thank you, Mr. Girsky, you may now begin.

Good morning, everybody and welcome to our third quarter conference call. Before, I turn this over to our speakers, just one unfortunate commentary here to announce the passing of our past Chairman of the Board, retired General Joe Franklin. In Joe, we had a man of complete honor, integrity, loyalty and an absolute gentleman. His leadership will be missed not only by our country, but by all who knew him. Having said that I would like to introduce now the CFO of Frequency Electronics, Steven Bernstein, Steven please.

Thank you, Joel, and good morning. In Q3 of fiscal 2017, satellite revenues represented approximately 48% of consolidated revenues compared to approximately 59% of consolidated revenues in the same period of fiscal 2016. In dollar terms, it was down $1.8 million. As reported in previous periods, this decline is primarily due not to cancellations but delays in contract awards, many of which are sole-sourced to Frequency Electronics. Revenues from non-space U.S. Government/DOD programs, including sales by FEI-Elcom and FEI-Zyfer was 3.9 million or approximately 30% of consolidated revenues in Q3 of fiscal 2017 compared to 2.9 million or 21% of consolidated revenues in fiscal 2016. Revenues from network infrastructure and other commercial products that are reported in the FEI New York, Gillam-FEI and FEI-Zyfer segments were 21% of consolidated revenues compared to 20% in the prior year. As the nine-months ending January 31, 2017 satellite payload revenues both U.S. Government/DOD and commercial was 16.8 million and accounted for approximately 44% of consolidated revenues compared to $26.9 million and 58% of consolidated revenues for the same period prior year, a $10.1 million decline. For the nine-months ended January 31, 2017 sales to U.S. Government/DOD non-space end use were $12.9 million and accounted for approximately 34% of consolidated revenues, up from $10.8 million and 23% of revenues for the same period last year, $2.1 million increase. For the nine-months ended January 31, 2017 sales for network infrastructure and other applications were $8.4 million compared to $8.5 million for the same period last year. Gross margin was $3.7 million compared $4.7 million last year, yielding a gross margin rate of 29% in Q3 of fiscal '17 compared to 35% in the prior year. The decrease in gross margin percent resulted from higher cost product mix and integration cost as well as decrease in sales. Gross margin rate for the nine months ending January 31, 2017 decreased to 31.4% as compared to 34% during the nine months of the same period last year. SG&A expenses were 3.3 million as compared to prior year’s 3.2 million. Although, the net dollar amount of SG&A remains comparable to the net dollars of SG&A in the prior year their percentage increased reflecting the results of lower revenues. Internal R&D spending in Q3 of fiscal ’17 was 1.4 million or 11% of revenues compared to last year’s 1.3 million or 10% of revenues. During period of lower customer shipments, the Company can and will allocate increased available engineering resources to necessary R&D projects. Research and development expenses for nine months ending January 31, 2017, was 5.1 million, compared to 4.4 million during the same period in the prior year. Operating loss was 946,000 compared to an operating profit of 272,000 last year. Operating profits were impacted by the decrease in revenues, as mentioned earlier. Other income, which generally consists of investment income offset by interest and other expenses, netted to income of 96,000 in Q3 of fiscal ’17 compared to a net income of 30,000 in the same period of fiscal ’16. This yields pre-tax loss of 850,000 compared to pre-tax income of 302,000 for the same period last year. The provision for income taxes is a benefit of 1.2 million compared to an expense of 20,000. The change in tax effect is primarily due to a domestic operating loss, as well as the impact of deductible permitting differences between book and taxable income. As a result, net income for Q3 of fiscal ’17 is 338,000 or $0.04 per diluted share, compared to 282,000 or $0.03 per diluted share for Q3 of fiscal ’16. Our backlog at the end of the quarter was 42 million, up from 39 million last quarter and up from 32 million at year-end. During the nine months positive net cash flow provided from operations amounted to 2.5 million, compared to 1.9 million in the same period last year. Frequency continues to maintain a very healthy balance sheet with a working capital position of over 69 million. I will turn the call back down to Martin and we look forward to your questions later.

Good morning, everybody. This is Martin Bloch. I want to add to Joel Girsky’s remarks. General Joe Franklin was a very close personal friend of mine and I will miss him a lot and my respect goes out to his integrity and his service that he has given to the country and the company and my sympathy to their whole family. With this behind us, I’d like to address on what happened on the last quarter and what our way forward is. The performance of the last quarter were affected primarily by two significant factors. One is one-time non-recurring costs that happened which was our cost of dollars out of our pocket and the second and more significant is the delay in satellite programs that we expected to be moved by the middle to the end of December which are still being delayed. As we have described in our press release, this is a problem that faces all of the satellite customers, our customers especially in the United States and while they are expected 20 to 30 satellites over the last two years, some of them have booked us fewer two. Now it isn’t that the satellite business is going away, as there are dramatic changes that has suddenly come to lights that are changing the industry and they are primarily in the following categories. One is the insertion of new technology is happening much faster than in the past and there was an enormous trend to build satellites that are shorter life, so let's say five years typically instead of 15 to 20 years, so new technology can be integrated. Second of all, the enormous demand for bandwidth for high-definition video and internet service which requires enormous amount of more capacity in this area. So that has caused the service providers to really take a hard look on what type of configuration satellites we want to build in the future. To add to this problem there was lots of satellite waiting to be launched due to problems in the launch vehicles that have not -- that it don’t make any sense to build new ones to put in storage when you cannot launch the ones that are staying in storage. And this is the problem with the launch vehicles that I hope gets resolved quickly. The third, which didn’t add to this situation is that the Exane Bank was non-functional and a couple of programs got delayed and might possible actually be canceled because financing could not be arranged. In spite of this, Frequency is employing the resources and engineering talent to meet the challenge of this new requirements and the new requirements is there are going to be more ups and down converters and Low G, but they are going to be a different natured, the mantra is lighter weight, smaller size because the quantity per satellite will increase considerably and with a very careful view of designing and for the intended lower cost for shorter life since technology will be inserted more frequently in this area, and we are investing a lot of efforts to meet the challenge on this avenue. I'm also very happy to report that the key technology of FEI-Zyfer and the unique technology of precession time and Low G sensitivity of FEI New York has given us a great opportunity in meeting the challenge for secure communication and secure command and control and that accounts for the significant bookings of FEI-Zyfer and then we have some soul-source contract to develop that technology and implement it and I feel very bullish on the great opportunity because it's a threat that’s really effects our whole military and even homeland security and even commercial. We have to have means of being independent from GPS to be able to have secure communication and that depends on precision time and precision time in mobile platform also requires the technology of Low G which FEI has the great expertise in the world. Besides we are looking forward to significant business opportunities in this area as well as in the satellite business. So we put everybody to work to meet the new challenge. We have to put significant additional efforts in this secure communication arena because our customers and the need of the country is to accelerate the implementation of those programs for which FEI has a unique solution. So we are looking forward to a profitable fourth quarter because we have taken certain steps to reduce our operating cost as well as getting some additional delta business in the fourth quarter and to a profitable fiscal 2018. I would like at this time to open to questions and answers. And if you would be kind enough please address the question either to Steve Bernstein or to Martin Bloch, we can be most responsive. Go ahead.

Thank you. [Operator Instruction] First question is from Mike Fifer [ph] of Oppenheimer. Please go ahead.

I was wondering if you can accelerate the R&D and investment spend in order to speed up your place and positioning in the secure communications area? Thank you.

That’s right on the money, you are absolutely right at this. We are looking very carefully on what we can do to accelerate and make more investments because the opportunity is enormous between the fixed side and the mobile side are very, very large quantity of this equipment that will need and by us being able to muster the resources to accelerate the development and putting this equipment in production will significantly increase the opportunity on the dollar value that Frequency can capture. And that’s an excellent suggestion and we are putting the pen to paper to see what we can do, to get it implement as soon as possible.

Thank you. The next question is from Michael [indiscernible], a Private Investor. Please go ahead.

What was the backlog at Zyfer?

Zyfer backlog will be booked about 18 million of new business. Steve, you know that?

It was roughly 14 million, I don’t have the exact number of Zyfer in front of me. But I believe, it was about 14 million.

And what was that last quarter?

Well, they book an additional 10 million, so there was a significant champ. We look at it and give you the exact number.

I’ll give you the exact number for Zyfer.

Okay. I just wanted to realize that equipment that Zyfer is delivering is a combination of their expertise in GPS to be able to jamming and spoofing, and a precision timing unit that FEI New York is building and it's incorporated in that equipment. And all of the booking is going into Zyfer.

Yes. It seems like a huge increases see that keep on going up next quarter?

It looks very promising. And this is a matter of how fast this equipment can be implemented on this [indiscernible] like everything in the United States. We can fix everything, but we don’t foresee problems and prepare for ourselves. So that’s a major challenge to implement this equipment and to feel that in all of other world and in the United States. There is a lot of pressure to get it down as quickly as possible and for the first time with the meetings we recently had with our customer money is the secondary issue. Time is the most important criteria and we are going to put the best resources we can to assist in getting it implemented, because it’s not only good for great business for frequency, it’s mandatory for the safety of the United States.

So it seems to me the only hold up with this, Zyfer is different than the satellite because it’s all about how quickly you can get this going, and that’s dependent on someone else?

No question about it. And it really also depends on designing equipment that is affordable since the quantity is so large. We want the security, but we want to be able to afford it. So it’s not just not building equipment that can do the job it's building equipment that can be built economically and can be implemented in existing structures. So it’s being worked, development of the timing units and the Low G sensitivity is being done in New York facility and their software and electronic wrap around electronics that is being implemented in FEI-Zyfer. So getting a lot of attention and we're doing and we’ll do a lot more to accelerate that process.

And to the satellite business. How quickly can you adapt to the changes they're doing?

That’s a very good question. We’re looking at this point. I believe it will take us six to nine months to implement the changes and basically, they’re very challenging. The hardware that we have has to be reduced to half to one-third the size and half the power, because if on the same platforms you’re putting in a lot more hardware, weight and power becomes important and of course as always the challenge to try to do it as economically as possibly. We have started that effort and as this was suggested in the first question, we're going to take a look very carefully how much additional R&D we put in to accelerate the process. But my target would be to be in a position to capture business by the end of this calendar year.

Can you do it quicker than the bigger companies, can you adapt?

That's what a small company is best for. We do it by edict, we don't do it by committee. So yes, we can -- we have always been able to move and make changes must faster than a large company, in time. I believe we have the talent to really march in that direction and it's going to be my job to make sure that happens.

And final question, I guess Gillam any update?

With Gillam as we've said in our press release, this cup of business is not of any interest to us and has very little future and we're working now very hard to divest itself.

Any timeframe or unknown really?

Well we're looking to have results within the next couple of months.

Thank you. [Operator Instructions] The next question is from Sam Rebotsky of SER Asset Management. Please go ahead.

In the last quarter you indicated you would be profitable in this quarter and with the tax benefit you're showing a profit and you talk about being profitable in the fourth quarter, but at this point in time is it possible to make up the loss for the first nine months or is that [technical difficulty].

I don't have the dynamics, I don't think so, but our objective is to be profitable for the fourth quarter.

Do we have a number on how much we're getting up on a satellite of our product at this point in time and what is --?

Very little because I just want to tell you that our customers and one of our main customers, that in the past two years was planning for some place between 15 and 20 satellites, booked only two. So, our number -- and the new designed satellites, the number will still be between $5 million to $10 million per satellite, but there are going to be three times as many satellites. They have shorter life, but more satellite to be able to insert new technology. So there is a dynamic, I spend a couple of days with all the senior executives at Satellite '17 in Washington and they all had the same story. They were blindsided by the change that's taking place in the satellite industry on trying to insert new technology to the new demand and building basically a new fleet of satellite, shorter life with more capability and not anymore of this 15 to 20 years reliability model.

For example, this morning Airbus and OneWeb announced an agreement. OneWeb is building the facility to get more satellite ups, do you do business with Airbus or can you participate in a venture like this? It seems to be everyday somebody is doing something with satellite. I assume you should be able to get your products up on some of these satellites.

We're working very hard to do it, and Airbus and OneWeb, I don’t think we will participate in that area. Their model is so aggressive and so lower cost that we didn't think that we can really contribute to it, but many satellite programs that we are now in the proposal area and I'm confident we will participate in many of them. This OneWeb is enigma, but they sure have created a lot of noise is in the satellite systems.

Okay, what about the joint venture possibilities that you have been looking, is anything happening there that could be helpful to get additional work for Frequency or to share expenses?

Well, we are looking, we are keeping our eyes open. Like I said Sam, our most exciting two areas of business with or without a joint venture is, one is, the secure communication, which is really growing at a phenomenal rate and a phenomenal opportunity. If you multiply the numbers there, enormous what needs to be done for the safety of the United States, to safeguard our sites against that -- heaven that GPS will supposed to provide and has ended up to be so vulnerable. And of course for that New York family of satellite that we are pursuing with a vengeance. So those are the areas, and we are continuously looking for joint ventures and partnership.

Okay, now as far as fiscal 2018, we in February -- in March, so you just have April and the year is over, can we -- our visibility based on potential sales, can we look to be profitable on a quarter-to-quarter basis going forward now? Or do you think that’s behind us, have you gotten your cost down where you could be profitably each quarter?

The answer is yes.

Okay, okay I’ll take that as a good answer Martin. I am positive like you. Let’s make money and get the stock up.

I think what’s more important is to pursue programs that can significantly increased the revenue from our present level and the two opportunities, I want to emphasize again the secure communication and the new number of satellites offer great opportunities and it’s for us to win them.

Good luck. Good luck.

Thank you.

Thank you. The next question is from Michael Eisner, Private Investor. Please go ahead.

Yes. Just one follow-up question. In short, say over the next year, Zyfer’s revenue can take over the satellite revenue?

No. Satellite revenue will still be the major portion of that corporation because that has the commercial satellite, as well as the DOD satellites and we are proposing in both arenas significant -- we have outstanding proposal both in the commercial and the military arena. But we expect FEI-Zyfer bookings and shipments to go up in the coming year. [Multiple Speakers] That automatically takes the credit for the precision time and Low G sensitivity portion that FEI shift to that, it's on their book.

Their margin is higher, isn’t it, Zyfer?

Well, they are 40%. We have -- our goal is to get it at FEI into the same range. So we are in the low 30s and we have to take the action to get there.

All right. Thank you.

Thank you. We have no further questions in the queue at this time. I’d like to turn the conference back over to management for closing remarks.

Okay. I just want to thank all our stockholders for their patience and my great appreciation to the employees of FEI that are working very hard to take the new challenges and get them executed this as quickly as possible. And yes, I express great compassion to the Franklin’s family for their loss. Good bye everybody. Thank you very much for participating in our fiscal third quarter earnings report.

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.