Frequency Electronics, Inc. (FEIM) Q4 2017 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Frequency Electronics 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]. I would now like to turn the conference over to your host, Joel Girsky, Chairman of the Board for Frequency Electronics. Thank you. You may begin.

Thank you very much. Good afternoon, ladies and gentlemen. Thank you for dialing in today to our year-end conference call. With me here at corporate headquarters is Steven Bernstein, our CFO and joining us from Europe who is Martin Bloch, who's over in Geneva right now on company business. He is here. Everything is working fine. We're an electronics company and everything is set. Let me turn this meeting over to Steve Bernstein, our CFO. Thank you. Steve?

Thank you, Joel and good afternoon everyone. In our 2017 10-K and financial reports, the results of Gillam-FEI for fiscal years ended April 30, 2017 and 2016 are presented as discontinued operations. Unless otherwise stated, financial results discussed refer to continuing operations. Fiscal 2017 revenues from satellite programs, the company's largest business area, decreased by $10.5 million or 32% compared to the prior fiscal year. The decrease is in line with the protracted industry-wide slowdown in commercial communications satellite procurement and reflects reduction in orders received from satellite service providers by the company's major customers. Sales revenues from non-space U.S. government DOD customers increased by approximately $3.8 million, or 24%, compared to prior fiscal year. These non-space U.S. government DOD revenues accounted for approximately 38% and 28% of consolidated revenues for fiscal years 2017 and 2016 respectively. For the year ended April 30, 2017, other commercial and industrial sales accounted for approximately 17% of consolidated revenues compared to approximately 12% for fiscal year 2016. Sales in this business area were $8.6 million for the year ended April 30, 2017, compared to $6.9 million for the preceding year. For the year ended April 30, 2017 gross margin and gross margin rate both decreased compared to the prior year. The two major contributing factors affecting gross margin dollars include the $5.1 million revenue decrease and $7 million of non-cash adjustments. The gross margin percentage rate additionally reflects onetime non-cash adjustments. Consistent with the company's phase out of its wireline network infrastructure business area and the intended sale of Gillam-FEI, its Belgium foreign subsidiary, the company took a onetime non-cash write-down of approximately $5 million of inventory relating to wireline copper-based synchronization products in the FEI-Zyfer segment. Additionally, the company recorded $2 million of inventory adjustments in the FEI-New York segment. The gross margin rate for 2017 was 22%. The company targets 40%-plus gross margin rate on normalized revenue levels. Although the non-cash adjustments reduced recorded gross margin and the gross margin rate for 2017, the company generated positive cash flow from operations for the full year. In the fiscal year ended April 30, 2017 and 2016, selling and administrative costs were 24% and 21% respectively of consolidated revenues as overall dollar amounts were relatively flat. The percentage rate was higher because revenues were lower. Reduction in the majority of the SG&A costs were offset by an increase in deferred compensation expense. During fiscal 2017, the company accelerated its research and development activities. As a percentage of consolidated revenue, R&D spending for the year ended April 30, 2017 was approximately 14% compared to 10% in the prior year. These R&D efforts address large business opportunities in secure communication, commands and control, and satellite systems that require advanced technologies and capabilities going forward. The company believes it enjoys a competitive edge and has a head start in the development of these requirements. Operating loss was approximately $7.5 million compared to operating profit of $2.4 million last year. 2017 results, as outlined previously, include approximately $7 million of non-cash adjustments. Other income, which generally consists of investment income offset by interest and other expenses, netted to income of $460,000 in fiscal 2017 compared to a net income of $806,000 for fiscal 2016. 2016 results included approximately $380,000 of life insurance proceeds. This yields pretax loss of approximately $7 million compared to pretax income of approximately $3.3 million for the same period last year. The provision for income tax is a benefit of $2.1 million compared to an expense of $1 million for the same period last year. Consolidated net loss from continuing operations for fiscal 2017 was $4.9 million or $0.56 per diluted share compared to income of $2.2 million or $0.24 per diluted share for fiscal 2016. Income from discontinued operations for fiscal 2017 was $103,000 or $0.01 per diluted share compared to a loss of $1.2 million or $0.13 per diluted share for fiscal 2016 net of taxes. Consolidated net loss for fiscal 2017 is $4.8 million or $0.55 per diluted share compared to net income of $1 million or $0.11 per diluted share for fiscal 2016. Our fully funded backlog at the end of fiscal 2017 was approximately $28 million compared to approximately $30 million at the end of fiscal 2016. For fiscal 2017, the company generated positive cash flow from operations. Cash flow from operations increased to $3.5 million compared to $2.8 million in the same period last year. Frequency continues to maintain a very healthy balance sheet with a working capital position of over $60 million. Our cash position is approximately $10 million after paying off in full our line of credit. I will turn the call back to Martin, and we look forward to your questions later.

Good afternoon, everybody. As you probably realized, the commercial satellite business in calendar 2015, 2016, and so far in 2017 has been the worst since 2004. It isn't that the satellite industry is gone, the service providers have had two major challenges, one is to incorporate new technology to improve the bandwidth and the second is to gear up for a new set of customers which have come to life primarily the aviation passengers, of which there are 3.7 billion annually, and there's enormous market that provide high-speed Internet, affordable and high definition video to that market. This offers a great opportunity in the future for Frequency Electronics for which we have invested a good portion of IR&D to take advantage of the future. Because more transponders on the same satellite require smaller size, lighter weight, less power, and less cost on this. And I feel that FEI has a competitive edge to get that business. Other things that happened in fiscal 2017 is we have completed the delivery of over 2,900 up-down converters for the Iridium NEXT program and 82 dual redundant timing systems, of which 64 are in orbit and they've been launched in the past three to five weeks, including two dual redundant timing systems, and they are operating very well. This is for the first time demonstrating to industry that Frequency Electronics can deliver large quantity of space hardware. And I want to congratulate the team at FEI for doing a great job with the new technology and a very challenging schedule. On the terrestrial area, we have delivered many prototype systems for secure communication and command and control, both to government and to the government prime contractors. We feel that our technology of precision time and low g-sensitivity offers a unique opportunity for FEI to gain an enormous foothold in that very expanding market on this area. We have, in the past five years, invested IR&D in that area as well and the challenge over here in the future is to improve stability because that gives more security and, at the same time, make the product more affordable for use. Taking a look at the overall, on this between the satellite and the secure communication and command and control, FEI, over the next four years, is looking at market opportunity of approximately $1.3 billion. It's hard for me to provide exact timing on bookings because that's unpredictable, but the opportunity is there for us, and we have the key technology to take advantage of. And again, I want to commend the team at Frequency Electronics for working during very hard times in order to move the company forward and put them in a position to be able to take advantage of this large opportunity market. I would like, at this time, open for questions-and-answers. And I turn it over to you, again.

[Operator Instructions]. Our first question is from Robert Smith [ph] from Center for Performance Investing. Please proceed with your question.

Oh, yes, thanks for taking my call. Could you give us some color and flesh out your approach to the private sector in commercial satellite development?

Are you talking about like commercial satellites that are being provided, like, by Boeing, SS/Loral and Lockheed Martin on this side as well?

More like SpaceX and the new entrants.

Well, those are deals which are very difficult at this time to define on this. We are addressing the market of more professional providers like, I mentioned, Boeing, SS/Loral, Orbital, and Lockheed Martin, and people like Thales Alenia with low -- primarily geosynchronous and medium orbit and low orbit like Iridium NEXT on this. It's hard for me to give any comment on what SpaceX is going to do and how successful they're going to be.

Yes, but there are any number of new entrants that are especially making some efforts in this area and I'm wondering what you're doing to essentially establish some connection with them.

Well, we are working with applications for LEOs, for both for -- primarily for the military this time. And of course, the challenge over there is to make it smaller, less power, and a lot less expensive on this. And we are working in this area. And one of the examples of us providing some major hardware for LEOs is the Iridium NEXT because that's 76 satellites in a 700-kilometer orbit, and we have successfully delivered the up-down converters, and we will address that market as well. Like I say, [indiscernible] what he's doing, I have no idea.

Can you give us some color on your international efforts in other countries?

Well, we are -- we've been a major supplier to Thales Alenia on this and wherever we can with the security of our products that we can supply. And we're quite limited in the precision timing to supply the products to other markets, except where the State Department allows us to participate. So our major effort over there has been with Thales Alenia that's been our customer now for about 30 years.

Is India a potential market?

Say that, again?

India?

India. I don't know how the State Department will allow our equipment to go to India, because it's very difficult to obtain from India end-use statement. That means the satellites that they're putting in who will be -- have access to them. So in the past, the State Department did not allow our precision products to be provided to India.

And what do you feel about the opportunities in the current fiscal year looking forward?

Again, please, I didn't hear you.

So what do you feel the opportunities are for the remainder of the current fiscal year?

Well, we have a significant proposal outstanding. And we're working very hard to get -- a lot depends on the releases. What we hear from our major customers is that they expect many satellite programs to be released at the end of the calendar year of 2017 and beginning of 2018. And we are quite dependent on their estimates. They get their orders, we will get our portion of it without any questions. On the military portion, we are a little bit more secure in that area. We have some significant proposal outstanding for the military satellite industry.

And you'll continue to announce their contracts?

Whenever we are allowed to, we will definitely do that. There's, again, commercial contracts. There's no issue. We can announce them with the permission of our customers, which is usually not an issue. On government, they are a lot more limiting, but we can announce the contract and the dollar value, but not the specifics. And we will do that.

Thank you very much and good luck going forward.

Thank you.

Our next question is from Sam Rebotsky with SER Asset Management.

Hi, good afternoon Martin, good evening. On the backlog, the $28 million, how much is up-down converters in the $28 million and is there any -- how much is discontinued operations and what is the backlog, say, July 27th?

Well, I don't know the exact backlog of July, but of the $28 plus million, this was fully funded. It is not orders, the orders are higher, but we've only taken backlog that are fully funded on this area. And I don't know the exact value of converters, but I'll take your next item to determine that and disclose it to you.

So is it like 10%, 20%, is it -- a range?

I would say, 10% to 20% is a good number.

Okay, now is any of this discontinued as part of the $28 million?

No...

Absolutely not, absolutely not. There's a -- we've only taken to account funded backlog.

Okay. Now funded backlog, as of July, would we say the $28 million has increased, has decreased, is there a range of what we could think?

I really don't have a number on this. Steve, do you have an indication on that? I think it's pretty much flat.

I would say that would be a safe guess, but we're still waiting on results. The quarter is not over yet. So in another couple of days, we'll have final, where we stand.

But no significant changes Sam, up or down. It's about flat.

Okay. The inventory write-downs, was it because the inventory, was it obsolete, because we had too much inventory, we expected contracts, and we built to supply the jobs that we expected to get? Do we need to lower our inventory relative to a lower ratio going forward so that we don't have this problem? I assume it didn't happen all of a sudden at one date, but it may have been over a period of time.

Well, the major write-down of inventory is due to discontinue of the copper synchronization business with Gillam, and that accounts for approximately $5 million. The $2 million write-down of FEI New York is primarily -- there have been new rules instituted by the satellite industry that you cannot use a part that are older than 10 years. And that was a portion of our inventory and the inventory is perfectly good, but the new rule is that no components can be used that's older than 10 years. But we'll look very carefully and use our best judgment to eliminate any type of inventory that cannot be used.

So at this point, what would you say the average year of the inventory that we have?

Average, I would probably say three to five years.

Okay. And we expect to have $5 million cost reductions going forward. How do we accomplish that, and the -- when we made the acquisition of Elcom, this is some -- that we're consolidating everything?

Well, let's take one at a time on this. I think the press release clearly indicates our efforts on reducing cost and modernizing the company to the new circumstances. And it's basically we've done it in fiscal 2017, which resulted in $3.5 million of positive cash flow, and we continue doing on the same going forward in fiscal 2018 and beyond. And Elcom is doing quite well. They are booking EW business. Our plan is to consolidate some of our efforts to better service our customers and, at the same time, to improve efficiency of manufacturing the product. And we hope to get it all accomplished, or the majority of it, in fiscal 2018.

Okay. And the inventory -- the discontinued operations, what portions in Belgium, what portions in the U.S., et cetera?

Well, all of the $5 million, by coincidence, were shipped to FEI-Zyfer because they were doing the installation for their copper industry in the United States, such as AT&T and Verizon. So the physical inventory is at FEI-Zyfer. But it's all inventory that's been built by Gillam on the side. And...

What I'm referring to, Martin, is the current assets held for sale, the $8,165,000 is that -- what part might be in Belgium, what part might be here?

Steve, I think, all of it is in Belgium.

It's all -- all is in Belgium.

Okay. And we -- so this inventory -- we're not using it. We're not -- we don't have contracts to work on this during this...

Well, once we've decided that this is our business on the future on this side, if we find it prudent to really take a reserve against it, if there's a possibility that whoever acquires Gillam that they will be interested in buying back some of that inventory. But we took the most conservative approach at this time.

Okay, alright, that sounds positive. Alright, good luck Martin and the whole team. Hopefully, we could get some profits at some point -- how much on R&D or we get a continuous spending there?

Well, actually, with the slowdown that happened in the satellite industry, it gave us opportunity to really address the IR&D more aggressively at this time, and to be -- and to put us in an advantage of future business. So that's a blessing in disguise.

Okay. Well, good luck. Hopefully there are some other questions because this is a very trying time and I'm glad you added all the people to the Board and made this decision so we could be profitable, again. Hopefully, it's sooner than later.

That's my objective and everybody at the Frequency family. Thank you, Sam.

[Operator Instructions]. Our next question is from Richard Jones, private investor.

Hey, good afternoon. I know Martin that in the past you've talked about having six major defense companies as possible customers for your up-down converters and anything else that you would -- may have in the new product area to add to the satellite business. How many of those six, without giving names, would you think would be active possibilities for being customers over the course of the next couple of years?

Everyone of them. We have done an outstanding job of delivering on every program we've ever undertook and submit the requirements. And we have maintained an excellent relationship with all of our customers.

Okay. And I know in the past, you've talked about going from a certain amount of sales per satellite that you have now to $20 million or upwards of that. What would you give us as a current potential figure for the per satellite revenues that you could do?

Well, right now, our satellite -- our take is between $5 million to $10 million, with the exception of some secure satellites that are a lot higher at this point. And our objective is still to move, adapt to around 20 plus million per satellite. And with the new satellite requirement, where they will require a lot more hardware, we have a good opportunity of achieving it.

Okay. And on the secure communications, I think you've mentioned that, that was terrestrial business. Is it strictly terrestrial and military or not?

No, not at all. As a matter of fact, the Homeland Security is one of the potential customers. Even some of the financial community is affected by the necessary to improve the timing, accuracy and to be more autonomous from GPS, because GPS unfortunately can be easily jammed and also spoofed. That means you might get the wrong time information. So we have submitted proposals to Homeland Security and of course, the big gorilla in that is DOD, because they have most of the stationary assets and probably over 100,000 of mobile assets that are at risk. So they are the big customer.

What's the reason for calling that business terrestrial, aren't there satellites involved?

Well, that's excluding, that's a separate. We are working on improving the clocks necessary for satellites, but the terrestrials are bases all over the world and fixed on earth and everything that's moving on earth, such as ships, airplanes, helicopters, every mobile, and every fixed assets that is -- are on the terra of earth. And that's a very large market for us to pursue.

Sounds pretty good. Thank you.

You are welcome.

Our next question is from Michael Eisner [ph], private investor.

Good, question, did you give a time frame on the military contracts?

Well, we have -- we're working very hard with a lot of effort to provide the initial systems that we have on order. And that's a challenge on this. And they have to be ferried inside the field and proven that they do the job. And time is of the essence. So we are working very hard to get it down as quickly as possible. It's hard for me to give you a time frame at this time. I can tell you that it's urgent and it's getting a lot of our attention at FEI New York especially, Elcom and the EW. And as you probably have seen, the performance of FEI-Zyfer has been significant because we provide the precision timing in the low g-sensitivity and they provide the wraparound electronics with their GPS knowledge and provided structures into the field. So we'll have a better angle on this within the next three to six months to give you a better timetable. It's a very encouraging and a very large opportunity for us.

Okay. And one more question. I think you said, over the next couple of years, the opportunity was $1.3 billion. It was hard to hear you.

Over the next 5 years, we've identified the opportunity, the market available for FEI to pursue of someplace around $1.3 billion.

That's up quite big from I know you used to mention like $200 million or $250 million over the next couple of years?

Well, there's an expanding opportunity in the satellite business and even a more expanding opportunity in this field, secure communication, command and control, of which FEI has quite an edge in their precision timing and low g-sensitivity technology.

Is Zyfer going to grow -- over the next couple of months, is Zyfer going to grow quicker than the satellites?

Zyfer will focus on terrestrials only and FEI New York will be the focus for satellites.

Alright, thank you.

You are welcome Michael.

Our next question is a follow-up from Sam Rebotsky with SER Asset Management.

Yes, hi Martin again. Look, the situation is difficult in the satellite and difficult -- and you're cutting down expenses to hopefully achieve profitability. Are there any companies that are available that you could acquire that would fit in, that would be significantly profitable and worthwhile buying, even while you're dealing with selling your overseas business? Have you been looking at anything, is there anything that makes sense, or are they all too expensive, or you're too busy just getting rid of the…?

No, Sam we're not too busy, and we are looking very aggressively to see if we can partner or join forces to take care of that market on this. Divesting ourselves from the Belgium operation is painful, but it doesn't take any of my time to begin with on this.

So what kind of opportunities are you seeing, are there -- I mean, have you looked at things that you've turned down or are they too expensive, do you think you could...

I think what's more important is to find a fit that adds opportunity to us on this, and we are looking very hard. And when we find one, you'll be the second one to know.

I don't want to be the second, I could be the third.

Okay.

Look Martin, do you see profitability in the current year based on, right now, you have a $28 million backlog, that's for a year, the backlog?

Well, that's a good quality backlog because that's the same thing that we have -- we almost have a year ago, we have $30 million on them. And like I said, the long-term profitability of Frequency Electronics, I have no reservations on it. To give the exact timing is difficult, because the industry is in so much turmoil on the satellite portion. And on the secure communication, it's a question on how fast this can be implemented. The money is there, the need is there, but like always in the United States, we can fix every problem. But we fix it that becomes a major issue. So, now secure communication and control is on top of everybody's plate and to get it moving, it's difficult. But a lot of people are working to get it done as fast as possible. And the exact timing is hard for me to, at this time, to say, but we'll keep you informed as we make progress.

And do we have a quarterly sales or a yearly sales number that we feel we could break even before taxes, etcetera. But just…

Sam, the objectives and the steps that we have taken are painful because it involves some headcount reduction, it is to get to profitability and we're working very hard to initiate those savings as we go along in order for us to get to profitability.

Did we take any salary reductions in this difficult time?

Well, no, we didn't, but we did save in that respect, in overtime and in other expenses in this area. Salary reduction, I looked at it and came to the conclusion that it would be to the detriment of the company to do it at this time, because we really are doing -- we're not doing that bad and if we just set a bad example and it would be foolish for us to lose our talent at this stage of our development and challenge that we have.

Alright, Martin. You're the pilot, let's get it up there. Alright, GOOD luck.

You got it. I'll do my best.

Okay, thank you.

Our next question is a follow-up from Robert Smith with the Center for Performance Investing.

Yes, I just wanted to know how long the telephonic replay of this is going to be, I know you have the archive on your website, but how about the telephone replay, how long then will that be up?

I believe its 30 days.

Okay, thanks very much.

Ladies and gentlemen, there are no further questions at this time. I'd like to turn the floor back to management for closing remarks.

Joel, you've got the floor.

Thanks, Martin. Thank you all so much for listening in. Thanks for your questions. As always, they are insightful and penetrating. I look forward to our next conference call. And gentlemen, ladies have a great evening and thanks again. Good night now.

Thank you. Good night, everybody.

Take care. Bye.

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