Frequency Electronics, Inc. (FEIM) Q3 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the Frequency Electronics Third Quarter Fiscal Year 2018 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. Any statements made by the Company during this conference call regarding the future constitute forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements inherently involve uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences are included in the Company's press releases and are further detailed in the Company's periodic report filings with the Securities and Exchange Commission. By making these forward-looking statements, the Company undertakes no obligation to update these statements for revisions or changes after the date of this conference call. It is now my pleasure to introduce your host, Mr. Joel Girsky, Chairman of the Board of Frequency Electronics.

Good afternoon, everybody, and thank you so much for calling in. I’m sitting here this afternoon with three gentlemen, Martin Bloch, our CEO; Stanton Sloan, our COO; and Steve Bernstein, our CFO. Please let me turn this on over to Steve and he will go through the financial information for you. Thanks, again.

Thank you, Joel, and good afternoon, everybody. In our third quarter 10-Q and financial reports, the results of Gillam-FEI for fiscal quarters ending January 31, 2018 and 2017 are presented as discontinued operations. Unless otherwise stated, financial results discussed on this call refer to continuing operations. For the nine months ending January 31, 2018, revenues from commercial and U.S government satellite programs decreased approximately $5.4 million over the same period of fiscal year 2017, and accounted for approximately 36% of consolidated revenues compared to approximately 49% in fiscal 2017. Revenues on these contracts are recorded primarily under the percentage of completion method. Revenues from the satellite market are recorded in the FEI-New York segment. Revenues from non-space U.S government and DoD customers, which are recorded in both the FEI-New York and FEI-Zyfer segments increased by $1 million over the same period in fiscal 2017, and accounted for approximately 44% of consolidated revenues compared to approximately 37% in fiscal 2017. Other commercial and industrial revenue in the fiscal year 2018 period accounted for approximately 20% of consolidated revenues compared to 14% in the prior year. Inter segment revenues are eliminated in consolidation. For the 9 and 3-month period ending January 31, 2018, gross margin and gross margin rate decreased over the same period in fiscal 2017. The gross margin and gross margin rate decrease is primarily due to an increase in inventory reserve of $5 million and lower revenue, increased repair costs and unabsorbed manufacturing overhead costs. For the 9 months ending January 31, 2018 and '17, selling and administrative expenses decreased from $8.5 million to $7.8 million and were approximately 24% and 25% respectively of consolidated revenues. The majority of the reduction occurred in corporate deferred compensation expense, professional fees, and stock option expense. Research and development expenditures represent investments intended to keep the company's products at the leading edge of time and frequency technology and enhance future competitiveness. The R&D rate for the 9-month period ending January 31, 2018 was 16% compared to 14% of sales for the same period of the previous fiscal year. The R&D rate for the 3-month period ending January 31, 2018 was 16% compared to 12% of sales for the same period of the previous fiscal year. The company expects a high-level of development activity both customer and internally funded to continue through the current year and beyond to address new large opportunities in secure communication, command and control applications, next-generation satellite payload products and additional DoD and commercial markets. The company recorded an operating loss of approximately $9 million for the 9-month ending January 31, 2018 compared to a loss of approximately $4.3 million for the 9-months of fiscal 2017. The operating loss reflects approximately $8.3 million of non-cash charges to earnings compared to $3.8 million of non-cash charges during the 9-months ended January 31, 2018 and '17, respectively. The 9 and 3-month periods ending January 31, 2018 included a $5 million inventory write-down. The company recorded decreased revenue gross margin and gross margin rate in the 3-months ending January 31, 2018, leading to increased losses for the 9-months ending January 31, 2018 compared to the same period of the preceding fiscal year. Investment income is derived primarily from the company's holdings of marketable securities. Earnings on these securities may vary based on fluctuating interest rate, dividend payout levels, and the timing of purchaser sales of securities. Other income included a gain of approximately $1.1 million recognized in the first quarter of fiscal 2018, in which the company divested itself of its holdings in equity securities. Additional items of other income expense and changes for the periods were negligible. This yields a 9-month pre-tax loss of approximately $7.8 million compared to a pre-tax loss of $4.1 million for the same period last year. The provision for income taxes is $2.75 million compared to a benefit of $204,000 for the same period last year. During the quarter, the company recorded a reduction to the U.S deferred tax asset to reflect the new U.S federal tax rate. As a result, income tax expense for the 3-months ending January 31, 2018 included a non-income tax expense of approximately $4.8 million. There is no current tax liability for the company to pay. The company reported a consolidated net loss from continuing operations for the 9-months ending January 31, 2018 of $10.6 million or $1.20 per diluted share compared to a loss of $1.4 million or $0.09 per diluted share for the 9-months ending of the prior fiscal year. Losses from discontinued operations were $697,000 or $0.07 per diluted share compared to a loss of $599,000 or $0.07 per diluted share for fiscal '17 net of taxes. Accordingly, the company reported a consolidated net loss for fiscal '18 of $11.3 million or $1.27 per diluted share compared to net loss of $1.4 million or $0.16 per diluted share for the prior year. Our fully funded backlog at the end of January 31, 2018 was approximately $16 million compared to $21 million at the end of last quarter and $28 million at the end of fiscal '17. The company anticipates a significant increase in bookings during the balance of the current and the ensuing fiscal year. For the 9-months ending January 31, 2018, the company generated $2.8 million positive cash flow from operations. Frequency continues to maintain a very strong balance sheet with a working capital position of over $53 million. Cash position increased to $13.2 million at January 31, 2018, up from $10 million at the beginning of the fiscal year. The company believes that its liquidity is adequate to meet its operating and investing needs for the next 12 months and the foreseeable future. I will turn the call back to Martin and we look forward to your questions later.

Thank you, Steve. This is Martin Bloch. I am confident that the drop in bookings that we’ve experienced has hit bottom, and we’re looking to imminently book some significant contracts which will boost our backlog and also provide the necessary revenue for the next fiscal year on this point. I’m also very encouraged on Stan Sloane's work at the company in trying to put more control structure on our inventory and efficient of manufacturing, of integrating Elcom's manufacturing into our New York facility and most important is interaction with DoD customers for business which we have great expertise and there's a need for. For many years we waited for DoD to come us and beg us to solve problems, because the space business was very exciting and very lucrative. We now are recognizing that there's a much more lucrative business in secure communication and in EW from DoD, and I and Stan and Elcom and Zyfer are putting their emphasis to go after that business on the side. I'm looking forward to a bright future. Our cash is up on this -- as we’ve mentioned on the last call, we expect in this calendar year to book more than $50 million worth of new business with a good portion of it happening in the very near future. I'd like Stan, since you’re the younger man, I will give you the opportunity to say a few words before we turn over for answers and questions.

Now, I'd just echo what Martin said, I think there's been a lot of progress in the last few months on getting control of inventory, you see that in the adjustments this quarter, but also what you don’t see is the -- all the process and all the change underneath that, that has to take place to make that happen. So that’s all going well. The integration of manufacturing here is going well. And probably the most exciting thing, I think is the new business opportunities and very, very excited about that. So like Martin said, I’d share that. I think the future is very bright -- getting bright.

This is Martin again. I also want to emphasize that Stan's addition to Frequency is giving desperately needed time to emphasize more on research and development and product and interfacing with critical customers which is a very useful tool to getting business and producing significant growth. I think, at this time, I’d like to turn it over to -- for answers and questions. Please, if you can be specific on who you address the questions, that would be very helpful. Either Martin, Steve, or Stan. Go ahead.

Thank you. [Operator Instructions] Thank you. Our first question today is from the line of Sam Rebotsky with SER Asset Management. Please go ahead with your questions.

Yes. Good morning, gentlemen. Hopefully the next quarter we have these positive contracts that you will be able to record very soon. So we could make some money.

I believe that that's reality and we are also looking forward to really reporting them and we will try to get permission from our customer to make them public.

Okay. Now, let's see the $5 million write-down in inventory, I believe there was also like a $5 million write-down in inventory overseas previously. Are we finished with the write-downs and when are we suppose to close on the sale, which we hope we’re going to make to change what's going on overseas?

You are talking about Gillam, right?

Yes, yes.

Well, this was a real heated discussion on our Board meeting today and we’ve five opportunities and our goal is to conclude -- to try to conclude it this fiscal year. It would have to be some very opportune event to drag it on past the 28th of April.

Okay. Now the possibility, we stated that the Gillam inventory was worth more, but for the U.S we had to write it down. So conceivably we can make a gain on the sale of this asset overseas?

What -- say that again?

In other words, we wrote the inventory down, I think by $5 million and you stated on the conference call that the reason you wrote it down was for the U.S., it was more than a certain years old and you had to write it down, but it's still utilizable. Do we think we’re going to be able to get some value-added to this inventory?

Yes, Sam, we are trying in some of the people looking at Gillam, they would buy a certain amount of that inventory, and we're trying to conclude this as soon as possible.

Okay. Now as far as the backlog, the $35 million, you need approval from the client to announce or what is the basis of announcing the backlog -- the contract?

So a lot of our contracts as you can appreciate, Sam, this is Stan, are for sensitive or classified programs. And many times we’re not allowed to release publicly very much information about that. So we have to get through that with the customer. That’s what we’re referring to.

Okay. But as far as backlog in order to express a backlog number, even though you can't express the name of the customer. When do we expect to be able to state? In other words, would we state the backlog is increased even though we haven't gotten the customer's name?

So when we -- we will obviously. It's a material event. It's a significant contract. When its signed, we'd announce it. Irrespective of whether we announce the name of the customer or not.

Okay. Now as far as profitability go, we did a lot of these situations, the taxes and all the write-downs, do we expect to be profit -- when do we expect to be profitable now? What is our plan?

Our plan is to be profitable in fiscal 2019.

Okay. So do we expect to be profitable in the fourth quarter?

I doubt it. Because I don’t know the timing, but I would say that this year has just been taking all of the satellite business that went down in the tubes that profitability, we’re very certain to be profitable in fiscal 2019.

Okay. Good luck. I will come back to the queue, because there must be other questions.

Thank you, Sam.

[Operator Instructions] The next question is from the line of Michael Aisner, a Private Investor. Please go ahead with your questions.

Good afternoon. This question is to Martin. In February, you announced an advanced warfare contract with a future value of $75 million. Can you talk about that?

Yes, Stan is handling it since he is doing a lot of emphasis on the DoD contract. He will answer you and I will save my voice.

That’s fine.

So, Michael, that’s -- the announcement is associated with three contracts, three separate contracts. The contracts have variable quantities in them and they’re a little bit different in terms of the period of performance. But collectively there -- that $75 million that you referred to, we think that’s a reasonable estimate of the value. The actual potential full value of all three of those contracts is a little higher, but we were a bit conservative in our forecast.

What’s the timeframe on that?

The contracts are signed and underway. They will be executed over the next 3 to 4 years.

But nothing's really showing in the backlog yet?

The contracts we -- the contract values are variable. So you won't see the backlog effective until we get quantities of production orders. We wouldn’t put that in backlog until we actually have those production orders.

And funded.

So none of its -- at this time, none of its in the backlog?

No, that’s not correct. There's some in the backlog. It's associated with non-recurring engineering and the preproduction work.

Couple million, right?

Yes, its couple collectively.

When do you -- all right. When do you think any timeframe on that, actually getting it -- where you could say it’s funded?

Probably two years, I’d say for the initial production orders, the development time is depending on the contract is about, 18 months to 22 months, if I remember right.

Yes, the shortest one is about 14 to 22 months.

So we’re not going to see anything in the backlog for a while basically?

Not significant.

Couple of million there, yes.

Yes.

And do you still think -- I think you mentioned that the $35 million contract that Sam mentioned, you still think you’re going to have that on the third quarter? You have that on your last two presentation.

We think its imminent, that’s about -- that’s all I could tell you.

All right. And how is the Elcom move?

Elcom move is on track. We will be in new facility shortly and that will become an engineering development center. The manufacturing will be transitioned here. We are actually starting production of some of the Elcom units here in the next couple of weeks. So, minor glitches here and there, but generally, it's on track.

Yes, we expect it to be completed by the end of this month.

Yes, your lease is up, isn't it?

Yes, the lease is up. We may extend over a few weeks. Just we’re having some wiring and some other sort of odds and ends, but nothing significant.

All right. And how many people are going to be left in Elcom over there, in the New Jersey part?

It's around -- yes, 14 to 16, roughly.

Okay.

Some of the residual headcount comes here. So that’s associated with the manufacturing part.

How is the move coming along with all the technology you have to move? I assume there's some [multiple speakers] all on track?

It's all on track. Yes, it's an engineering lab, so it's not a big move.

A very similar technology and there's similar assembly and test and two of the people from Elcom are coming to Frequency, so it's going according to schedule. No difference.

All right. Thank you.

Thank you, Mike.

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

Yes. Martin and Stan, it was very positive to see here the presentations you guys have been making. I presume there seems to be a lot of interest when you go around and make presentations. Could you sort of indicate does that seem to be when you're meeting in potential investors? How is that going?

We're on plan and we plan to continue. As we started, I think we had Needham and Cowen.

Cowen.

And whenever there's a conference that falls into our discipline, we will participate.

Okay, okay. And as far as, I guess, at some point there's been, your former board member, I guess, to prove it they have been selling a little stock and I guess maybe their stock is for sale and I guess this is something you can address, but did the extent you put out some more positive news, I’m sure and -- they might be happy to sell more stock and you might be able to find a new buyer for their stock, if they want to end their relationship with Frequency. But I know that’s something you can respond to, but this is a possibility I guess.

There's always a possibility.

Okay. And the -- your presentation showed all these opportunities, whether it's cyber security, such large numbers and do we -- and I guess as far as Michael, is there any timeframe when you expect? I mean, when a significant contract will come from cyber security or …?

Well, we expect very shortly.

Okay. Okay, right. Look -- looking forward to seeing good numbers, a turnaround and the sale of Gillam and just beneficial earnings going forward.

We will do that. I think though [ph] what’s more important is our investment in IR&D to meet the new challenges and we’re making great progress on that area and I’m sure that will result in significant increase in bookings.

Well, that’s wonderful. Looking forward to seeing that. Good luck, gentlemen.

Thanks.

Thank you. At this time, there are no additional questions. I’d like to turn the floor back to management for closing remarks.

Gentlemen, thank you so much, and ladies, for calling in. I look forward to seeing you in person at our annual meeting and reporting back on the end of our fiscal year in the next couple of months. Thanks again for paying attention and investing in our company, in time and money. Good afternoon, now.

Good afternoon, everybody.

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