Frequency Electronics, Inc. (FEIM) Q1 2019 Earnings Report, Transcript and Summary

Greetings and welcome to the Frequency Electronics First Quarter Fiscal Year 2019 Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. Any statements made by the company during this conference call regarding the future constitute forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation 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, Martin Bloch, Executive Chairman of the Board of Frequency Electronics.

Good afternoon, everybody. The first order of business is, I would like Steve Bernstein to go through the effects of this fiscal, and then we’ll open it to questions. And I would appreciate if you address the question to either me, Steve or Stan Sloane. Go ahead, Steve.

Thank you, Martin, and good afternoon. For the three months ended July 31, 2018, revenues from Commercial and U.S. Government satellite programs increased approximately $335,000 over the same period of fiscal year 2018, and accounted for approximately 50% of consolidated revenues, compared to approximately 43% during the same period of fiscal 2018. Revenues on these contracts are recognized primarily under the POC method. Revenue from the satellite market are recorded in the FEI-New York segment. Revenues from non-space U.S. Government Department of Defense customers, which are recorded in both the FEI-New York and FEI-Zyfer segments increased approximately $230,000 over the same period of fiscal 2018, and accounted for approximately 43% of consolidated revenues, compared to approximately 38% during the same period of fiscal 2018. Other commercial revenues for the three months ended July 31, 2018 decreased approximately $1.6 million, compared to the same period of fiscal 2018, and accounted for approximately 6% of consolidated revenues, compared to 19% during the same period of fiscal 2018. Intersegment revenues are eliminated in consolidation. For the three-month period ended July 31, 2018, the gross margin rate increased and the gross margin decreased, as compared to the same period in fiscal year 2018. The higher gross margin rate was due to favorable product mix and effective cost management. For the three months ended July 31, 2018, selling and administrative expenses declined approximately $172,000, as compared to the same period in fiscal year 2018, and was approximately 23% of consolidated revenues. The reduction occurred in various accounts. There was no specific account that made up the majority of the decrease. The company continues to monitor and manage expenses of the business. Research and development expenditures represent investments intended to keep the company’s products at the leading edge of time and Frequency technology and enhance competitiveness for future contracts. R&D spending for the three months ended July 31, 2018 was comparable to that of the same period in the previous year. The R&D rate for the period ending July 31, 2018 was 15%, compared to 14% of sales for the same period of the previous fiscal year. For the balance of the fiscal year, research and development activities will include a significantly higher level of customer funded R&D. Operating profit for the quarter ended July 31, 2018 was $84,000, compared to an operating profit of $180,000 during the first quarter last year. Investment income is derived primarily for the company’s holdings of marketable securities. Earnings on these securities may vary based on changes in interest rates and payout levels. For the three months ended July 31, 2018, investment income was lower than the same period of fiscal year 2017, mainly due to in quarter ending July 31, 2017, the company divested of its holdings in equity securities in its investment account. As a result, the company recorded a gain of approximately $1 million during the three months ended July 31, 2017, as compared to no realized gain or loss in the same period of fiscal 2018. This yields a pre-tax income of $38,000, compared to pre-tax income of approximately $1.3 million for the same period last year. The provision for income tax is an expense of $7,000, compared to an expense of $485,000 for the same period last year. Consolidated net income from continuing operations for the quarter ending July 31, 2018 was $31,000, or a fraction of $0.01 per diluted share, compared to $830,000, or $0.09 per diluted share for Q1 of the prior year. Our fully funded backlog at the end of July 2018 was $37 million, up from $30 million at April 30, 2018. The company balance sheet continues to reflect the strong working capital position of over $47 million at July 31, 2018, compared to $46 million at April 30, 2018, and has a current ratio of over 10 to 1. 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. As I stated in the press release, I’m very encouraged by Frequency’s progress in reducing operating costs and in new bookings and a very good outlook for fiscal 2019 and beyond. We’ve been able to capture significant amount of business, and it’s the highest backlog we’ve had in a long time. And we’re still very actively involved in many proposals for both satellite and terrestrial applications, where I see a very bright future. I’m also happy to report that on May 1, the Board has elected Stan Sloane as President of the company, and he’s working hard for you guys to make Frequency grow in revenue and in the bottom line. And most important, make the proper investment in research and development to project significant growth for the future. Please feel free. Stan, do you want to make any comments?

No.

But please address your questions and the operational questions on Frequency, address to Stan Sloane. Steve and I are here to help him out. So with this, I want to turn over to questions and answers.

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Please address your questions to either Martin Bloch, Steven Bernstein, or Stan Sloane. One moment please, while we poll for questions. Our first question comes from [Richard Doscher] [ph],National Securities. Please proceed with your question.

Yes. Thank you for taking my call. You have on your balance sheet $17.4 million in other assets. Could you pretty much explain exactly what those are and what you intend to do with them?

Well, this – the $17 million of other assets are made up mainly of our – in our cash value of our policies, the majority of it. That’s a $14 million of it. It’s been there. It continually grows. It’s their life insurance policies.

Oh, okay, thank you. I thought you had some assets put aside for sale, and I wasn’t clear as to what that…?

No, no.

Okay. Thank you for answering that.

Our next question comes from [Michael Cooper], [ph] private investor. Please proceed with your question.

Hi, guys.

Hi.

Can you first of all, I saw a new story that Frequency Electronics was going to increase your employments base 80% and hire 116 people in your New York facility. Can you give a little bit of a timing and color on that? And then my second question is, what is happening with your industrial business in terms of new products and customers? And I was surprised to see the revenue drop there when it has been growing at double-digit rates over the past, I don’t know few quarters or so?

Hi, Michael, this is Stan. So on the news article you’re referring to, that’s associated with incentives that we negotiated with state and local government here. And those incentives run over essentially a 10-year period. So, given the outlook for the business that Martin articulated and what see in the horizon, we don’t think it’s unreasonable that we’ll grow the business. Of course, that will depend on how well we do in the marketplace. But that’s what that is, it’s tied to that incentive program. On the industrials, we’re – that’s a small part of the business and most of business is space and terrestrial electronics for DoD. So that’s not a significant focus for us going forward.

Okay, great.

Our next question comes from Richard John, private investor. Please proceed with your question.

Thank you. Good afternoon.

Good afternoon.

There was a time, Martin, that you were thinking that with the up/down converters, you might earn revenues of $20 million per satellite on some of the business. But in your release today, you say proposal activity is up substantially over last year from non-space DoD applications, the largest business area for FEI’s future. Is there an implication that you can’t really have the potential anymore for the sophisticated up/down converters and the $20 million satellite?

No, that’s not implied. We’re still pursuing that business that those up/down converters are primarily focused on military satellites, because the commercial satellites are trying to introduce some new technologies and it’s difficult to define on how we can do it. But we’re still pursuing and have this type of participation on many of the military satellite. But also very exciting is that precession time, both for space and terrestrial, are becoming the most important commodity for the security of this nation for now and the foreseeable future. And we’re pursuing many programs that, that are absolutely necessary for the safety of the United States in getting us that capability. And we’re one of the unique people that can supply low g-sensitivity and precision time for that mission, both for space as well as for terrestrial bureaus. So we have given up on the up/down converters, but they are – with the slowdown of the commercial satellite, as you know, the last three years have been death to many of the programs, about 10% of the satellite orders were issued, because they are all looking on possibly new technology and new missions and a different way of possibly skinning the cat.

Okay. And now that business is – more business is being developed from the military and also on the commercial side, I guess. Have you, or any of your six major aerospace customers getting more interested in having you make the up/down converters?

I – the military, absolutely, yes. We are participating with those companies right now and, of course, we just finished the largest job of up/down converters for Iridium NEXT. We supplied a total of, what 62 – 16 channel up/down receivers for this system. And I think, we delivered all, but seven of these units, of which 50 satellites already in orbit and functioning very well. So that was the big job on up/down converters, which – that was worth about $30 million.

That was a great piece of business. But based on what you said in the past the – those converters are less sophisticated than the ones you’re hoping to sell right?

Well, yes and no. They were lower frequency, they were not less sophisticated. The Iridium is operating at L-Band and we provide up/down converters all the way to 50 gigahertz. L-Band is approximately 1.5 gigahertz. But they were very – that was a very sophisticated transceiver business. In some aspects more sophisticated than the converters at the higher frequency.

I see.

But we’re very proud of doing that. And that job served one other very important purpose, which is important for DoD and future business that we are pursuing that FEI demonstrated that we can deliver large quantity of space hardware in a reasonable time, because our reputation for the past 55 years is that, we can do anything, but we have never had the opportunity to demonstrate in space significant quantity. Iridium was a key program for us to demonstrate that.

Okay. And on the last call, you said, I believe that the satellite life for lot of the business was down now to five to eight years versus 20 years in the past. Does that reduce the $20 million potential that you might have per satellite the fact that their lives are shorter?

It probably does, because they would need a lot – their whole idea is to build them cheaper, make them more vulnerable and replace them more often, because launch costs have gone down.

Okay.

So the aim of the new satellite is to make them a lot cheaper. Are they going to be successful, that’s something we’re all waiting to see. Nobody has been successful to date.

Okay. All right. Thanks very much.

You’re very welcome.

Our next question comes from [Michael Eisner], [ph] private investor. Please proceed with your question.

Martin, how are you.

I’m good. Why don’t you address it to Stan. I – my voice is running out.

All right. I’ll address it to Steve, I think he would be able to answer this. Last conference call, you had about $50 million in bookings for the calendar year. Where are we with bookings today?

For the calendar year?

Yes, this is Martin, Mike. What you’re referring is, we projected that we’ll be able to book $50 million in calendar 2018. We have booked that amount, I think, we have exceeded $60 million to date.

For the calendar year.

For the calendar year and we still have, what, five months ago, but very happy.

I see at $60 million now roughly.

Over $60 million. I’m sorry?

Over $60 million and we still have five months to go.

All right. You just said, you completed something for Iridium. Is that going to affect next quarter’s revenue?

No. As – read my press release. This – I basically – I discussed it with Stan and we’re looking forward to increase revenue on profitability for fiscal 2019.

All right. And last, I think, last quarter is the fourth quarter was like $7 million or $8 million, am I correct? Now we’re at $11 million?

Of revenue.

Sales, yes.

Q4 was about 0.4.

Yes.

Of revenue this quarter, it’s about $11 million.

And so I’m sorry, it’s hard to hear you.

Last Q4 was about $7.4 million, a little over $7.4 million of revenue. This quarter is just over $11 million.

Did most of that come from $37 million Air Force contract?

No.

No.

Very little for that one.

Yes.

Really, very little.

Yes, running it.

Well, remember, we got that contract, I think the 24th of April. So it went into the bookings for fiscal 2018, but very little in the revenue. Most of the revenue of this contract will be in fiscal 2019 and beyond.

For the next couple of quarters? Beginning next quarter?

Well, the year. I mean….

It’s spread out. It’s not lumpy. It stretches out over a little bit of time. So you won’t see it.

It’s going to take you a couple of years to complete?

Correct.

So it’ll be broken up over, I guess, the next two years. I’m guessing hypothetically give or take?

That’s a good number.

All right.

I just want to tell you, you mentioned it Michael, so I’m going to jump in. This is a very exciting contract to us, because we were chosen to develop a timing system, which is 10 times more accurate than it’s now being used in satellites and terrestrial applications. And we are very excited that the Air Force chose us out of a large group and we were not – we’re never the cheapest. They chose us, because we feel – they felt that we have the best capability for success. And we’ve demonstrated great progress on this job and that’s a major milestone for us to get the 10 to 1 improvement in stability and rubidium clock.

I see this is a big turnaround from last quarter, because you went up from $7.5 million to $11 million in revenue and you barely touched the Air Force contract, it sounds like in revenue?

Yes, that’s fairly accurate. The sequential financials, of course, are very encouraging. So yes, you’re right.

All right. Thank you. Good job.

Thank you, Michael.

Our next question comes from Sam Rebotsky, SER Asset Management. Please proceed with your question.

Good afternoon, Martin, Stanton and Steven. The backlog at the end of the year, $30 million, and you expect it to complete 37% in the fiscal year. Now you have $37 million. What do you expect to complete in the current fiscal year?

We always ask, Sam, a loaded question. As you know, FEI policy, we never predict exact revenue or income. All I can tell you is, for the year, we see a significant increase in revenue and profitability.

Okay. No, because you said of the $30 million in the 10-K, you expect to complete 37% in the fiscal year. That’s what I’m – so that meant of the [indiscernible]. Yes, that meant…

Well, I don’t know exactly. It’s going to be a higher percentage this year. We have a bunch of jobs that we’ll be finishing.

Okay, okay. And then we expect to be profitable for the year. We’re currently profitable in the first quarter. Do we expect to be profitable and do whatever sales we need, at least, break-even in each quarter, or is it going to be uneven lumpy?

Well, we’re working hard to be profitable going forward, not just…

Break-even.

…next quarter and not just this year, but that’s the intent.

Okay. And as far as our bids out, that are out there, are they significantly higher than it was at the end of the year, or at the same time – what is – what are our bids that are out there relative to previously – quarter, the year-end?

So we have probably the highest level of new business activity in certainly since I’ve been associated with the company. But when you add all that up, we probably have, I don’t know north of $100 million worth of things pending. Now we also have – we start with, in many cases, we get people estimates and then those get followed up with proposals. So we have the rounds and the firm bids that we have out it, like I say, it’s probably north of $100 million, lot of activity on…

Right. Yes, congratulations. And hopefully, I guess some of the offices bought some stock most recently, and I look forward to seeing some more Form 4S being filed, because the stock seems to be trading at a low level relative to your future. Hopefully, this will – your future will come true. Good luck, everybody, and for a new Good New Year.

Thank you.

Thank you.

Our next question comes from Brett Reiss, Janney Montgomery Scott. Please proceed with your question.

Yes. Hi, Thanks for letting me ask some questions. I guess, this one is for Steve. The cash is $4.2 million less this quarter than last quarter. Just where did it go?

Well, we – the decrease in cash went – AR went up. Our payables went down almost $1 million, and we purchased some equipment for a little over $0.5 million.

All right. Receivables were up $1.7 million, inventory was flat, and your current liabilities were down like $800,000.

Correct.

So the other $2 million is equipment?

No, it wasn’t. It was over a $0.5 million in equipment, and the receivables went up more than that. It was – the rest was in receivables, the majority. There was a couple of the small accounts, but the receivables was the larger part of it.

Okay. And you were cash flow positive this quarter? And if so, how much?

No, we were not.

Okay. What was the cash flow drain?

I don’t have the number with me.

Okay. Listen, you’ll take it as an actual item and you’ll report it.

I’ll get it back to you.

Okay. Okay. Just – could you just comment with specificity and what you’re seeing on that – on the secure communications market?

Okay. You’re just – this is Martin Bloch. You just touched on my new love. There’s no question that, that the largest opportunity that FEI is addressing, both in space and terrestrial, GPS has become very vulnerable. I keep on saying the same things, but it’s becoming more critical for both jamming and spoofing, and the only short-term solution is precision time. And FEI is one of the few world companies that offers that capability to provide precision time as a backup for that threats. And we see very, very brisk business on this – in this for space, as well as terrestrial applications, it’s a very exciting field.

All right. Can I ask you this and then I’ll go back into queue. I as an outside shareholder in the company, to monitor your progress in landing business in secure communications, how should I monitor that? Like, for example, you said you have north of $100 million in bids pending.

Yes.

Is a portion of that in secure communications? But how can I – how much of it is secure communication? How do I monitor the company’s progress in this exciting area of your business?

Okay. So a couple of things here. One, we report in segments. And one of our segments is Zyfer. And that Zyfer does a lot of work in the..

Terrestrial…

…in the – yes, non-space-related secure comps arena, so that’s one way to look at us.

Right.

Of that $100 million, I didn’t really include much in secure comps. So the number is probably off the cuff, probably $170 million or $180 million if you were to include all the secure comps opportunities, and that’s a rough estimate. So it will give you a feel for the size of things.

I’ll tell you. This is Martin Bloch. I’ll tell you one way. Whenever our customers will allow us, we will definitely make public releases, as we capture the business. In many cases, the application is sensitive and our customers are really prohibit us from putting a much release. So we’ll – the most we can do is put kind of benign release that we’ve gotten $5 million contract or $30 million contract, but we cannot be specific – the end use.

Right. Now because of the – yes, I’m sorry. Go ahead. I’m sorry, Martin.

It’s a sensitive business.

Right. Now because of the – I’m sorry, go ahead, gentlemen.

Go ahead. You go ahead.

All right. Because of the unique things you’re capable of doing in secure communications, do you have a limited amount of competition in that specific niche?

Very, very limited. I think worldwide, there might be four or five companies that have the capability and maybe one or two in the United States, but we consider that we are the best.

All right. Thank you for answering my questions.

You’re very welcome.

[Operator Instructions] Please address your questions to either Martin Bloch, Steven Bernstein or Stan Sloane. One moment please, while we poll for questions. Our next question comes from Richard Doscher, National Securities. Please proceed with your question.

Yes. Thank you for taking my follow-up. This is for Stan. You mentioned in your press release that a great deal of increase in your R&D spending will be coming from customers. How should we think about that? And is the company going to continue its own separate R&D, so that we’ll see that part rise, or are you going to reduce your company R&D? And what’s the final takeaway on that? Thank you.

So – yes, this is Stan. So we have – when we talk about R&D, we have internally funded R&D and then we have customer funded R&D. Typically, our contracts, particularly for more complex electronics include R&D in the form of development funds. And so the more business we pursue, the more customer funded R&D, we would anticipate, that usually precedes the production programs, the development. On the internal funding for R&D, we would expect that to continue or increase. We have very significant opportunities ahead of us. Martin mentioned a couple of them. And we need to make sure that we continue the development to position the company for those things. And several of those also have potential longer-term production contracts associated with them. So I would expect that number to stay reasonably close to what it is or increase.

Okay And that just leads me into a question that I asked on the last call. I’d like to see the R&D, which is the heart of your future growth and value, stay robust and getting customer assists on that is a bonus. But on our last call, you mentioned that you didn’t really find it important to file patents. But I’d like you to answer that a little bit more fully how you’re able to feel that all the R&D you’re spending and discoveries you’re making can still be protected and stayed within the company’s control? And can speak a little bit more about that differential between filing and not filing on some of your discoveries?

Sure. This is Stan, again. So I think what we said the last time around is that, we find that maintaining trade secrets for us seems to be a more effective strategy for protecting our IP. We look at it individually and make decisions about whether to file patents or not file the patents and whether to establish them as trade secrets. We’ll continue to do that going forward, but we don’t have a firm strategy of trying to file a lot of patents. We haven’t found that, that helps protect the IP.

I think typical example is the low g-sensitivity. We filed a patent and then 10 years later, we found lots of copiers. This was still the best in the world on that technology. And we found that keeping the know-how private and just exposing it to secure customers is a much better protection than a patent. It’s not like a drug that you can really patent for 17 years. People try their best to find way around it. So we have – we’ve been very good in being able to protect our technology in that way.

All right. Well, thank you.

You’re welcome.

Our next question comes from Michael Cooper, private investor. Please proceed with your question.

Hi, guys. On your $75 million contract that you won four or five months ago…

$37 million.

No, that was the atomic clock, the next generation atomic clock.

Yes.

And then you had announced a $75 million series of contracts, I believe, it was. Am I incorrect there?

We haven’t – to my knowledge – this is Stan. We haven’t announced that. We said we’re talking about opportunities perhaps. The contract for $37 million is the one you talked about. But we certainly haven’t announced anything else of that magnitude.

Wasn’t there a $75 million news release earlier this year?

Are you sure you’re talking about the same company?

Yes.

Not to my knowledge. But like my mother used to say, from your mouth and to God’s ears.

Okay.

The less significant contract that we booked was the Air Force contract for the advanced development of the rubidium clock, which was $37-plus million. Now what we did say in the beginning of the year is that, we planned to book a minimum of $50 million in calendar 2018, of which we have so far to date exceeded. We’re over $60 million in total bookings in calendar 2018.

Okay. Okay, let’s move over to gross margins. In this new business that you are after, are we looking at stronger gross margins? And the other question is, what is your current win rate on when you have bids out to companies? And I know you – there are different categories in that $100 million number that you gave us, or actually the $170 million when we add in the secure communications. But what would be your win rate that you might expect on that?

So I’ll give you a couple of answers. First of all, the gross margin rate, we’d expect that to increase. That does track revenue to some degree, so more the revenue picture improves, the better the gross margins will become. But we are focused specifically on improving gross margin rate. Martin mentioned the cost reductions and other things we’ve been doing to ensure that. On the win rates, there’s two ways to track win rates. One is on the number of opportunities won, and the other is on the basis of dollars won. I didn’t – I haven’t calculated it, but I’ll give you an off the cuff answer. On the basis of number of opportunities won, it’s well north of 50%. And on the basis of dollars won, that’s very much skewed by that Air Force contract, so that number is very high.

Okay. Excellent. Thanks a lot.

Yes.

Our next question comes from Richard John, private investor. Please proceed with your question.

You’ve mentioned in the past 5G, and there’s a lot in the news now about 5G coming for telephone companies. But is that one of the business that Frequency sold, or do you still have that potential?

Well, we pursue a very little of it.

Okay.

Most of our focus now is satellite and secure communication on this item. This 5G business is a cutthroat business that we have found very difficult to make any money on it.

Okay. Thanks.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Stan Sloane for closing remarks.

Well, thank you, everybody. We appreciate your attention very much appreciate the questions. We look forward to talking to you again on next call. And with that, we will say goodbye and thank you.

This is Martin Bloch. I have one to our Jewish stockholders. I want to wish a happy and a healthy year and the same to everybody else. Thank you very much for participating with us. We’re looking forward to a good prosperous and profitable year. Bye, everybody.

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