Frequency Electronics, Inc. (FEIM) Q4 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to you Frequency Electronics' Fourth Quarter and Year-End 2019 Earnings Release Conference Call [Operator Instructions]. And now for opening remarks and introductions, I am pleased to turn the floor to Chairman of the Board, Mr. Martin Bloch. Please go ahead, sir.

Thank you. I have with me the Chief Executive Officer, Stan Sloane, and our Chief Financial Officer, Steve Bernstein. And I'll turn over the first phase of it to Steve. Please begin, Steve.

Thank you, Martin. Good afternoon. Fiscal 2019 consolidated revenues were $49.5 million, up 25% from $39.4 million for the prior fiscal year. The components of revenue are as follows. Revenue from commercial and U.S. government satellite programs increased to $22.8 million compared to $14.2 million for the previous fiscal year and accounted for approximately 46% of consolidated revenues compared to approximately 36% in fiscal 2018. Revenues on satellite payload contracts are recognized primarily under the percentage of completion method, and are recorded only in the FEI-New York segment. Revenues from non-space U.S. government and DoD customers, which are reported in both the FEI-New York and FEI-Zyfer segments, were $22.7 million compared to $17.6 million in the prior fiscal year. Other commercial and industrial revenues declined to $4 million compared to $7.6 million in the prior fiscal year. Inter-segment revenues are eliminating consolidation. For fiscal 2019, the gross profit percentage increased to 31.9% from 13.1% in fiscal 2018. The higher gross profit and gross profit percentage is primarily the result of higher revenues. Fiscal 2019 gross profit includes a charge of $1.1 million resulting from new inventory reserve policy implemented at the end of the year. The prior year's gross profit and gross profit percentage reflected significant inventory write-downs. In fiscal year ended April 30, 2019 and 2018, selling and administrative costs were 24% and 27% respectively of consolidated revenue. SG&A decreased as a percentage of consolidate revenue, primarily due to the increase in revenue for fiscal 2019. SG&A expense in fiscal 2019 included a one-time charge of approximately $1 million for the loss associated with the sale of the company's wholly-owned foreign subsidiary, FEI-Asia. Increases in deferred comp expense and professional fees were partially offset by cost savings from consolidating certain manufacturing from New Jersey into the company's New York facility. As a percentage of consolidated revenue, R&D expense for the years ended April 30, 2019 and 2018 were approximately 13% and 18% respectively. The $500,000 decrease in expense year-over-year reflects a higher level of customer funded R&D as a portion of the total R&D effort. These R&D efforts address large business opportunities in secure communications, command and control and satellite systems that require advanced technologies and capabilities, going forward. The funds received in connection with customer funded R&D are included in revenue and associated expense included in the cost of revenue. For fiscal year ended April 30, 2019, the company recorded an operating loss of $2.8 million compared to an operating loss of $12.4 million in the prior year. The operating loss reflects approximately $1 million for the loss on the sale of FEI-Asia and the charge of $1.1 million related to the company's new inventory reserve policy. The prior year's operating loss included approximately $5.6 million of inventory write-down and approximately $3 million of unabsorbed manufacturing overhead. Other income consisted primarily investment income derived from the company's holdings of marketable securities, which for the current fiscal year was approximately $300,000 compared to approximately $1.3 million in fiscal 2018 other income, including gains from divesting the company's holdings in equity securities. This yields a pre-tax loss of approximately $2.5 million compared to a pre-tax loss of approximately $11.3 million for the previous year. For the fiscal year ended April 30, 2019, the company recorded a pre-tax provision of $56,000. For the prior year, the company recorded a tax provision of $11.3 million due to the full valuation allowance against the U.S. deferred tax assets. Consolidated net loss for the fiscal year ending April 30, 2019 was $2.5 million or $0.28 per share, down from a loss of $23.8 million or $2.69 per share for the prior fiscal year. The company generated positive cash flow from operations for the full fiscal year 2019 of $2.4 million. Our fully funded backlog at the end of April 2019 was $37 million, up from $30 million at the end of the prior fiscal year. The company's balance sheet continues to reflect the strong working capital position of over $47 million in April 30, 2019 and a current ratio of over 9:1. The company believes that its liquidity is adequate to meet its operations and investing these for the next 12 months and the foreseeable future. I will turn the call back to you, Martin, and we look forward to your questions later.

Thank you, Steve. I'd like to turn the call over to Stanton Sloane. Stan, please proceed.

Thank you, Marin. Let me start by saying I'm pleased with progress this year. I think revenue growth of 25% over the previous fiscal year is a particular highlight. We also continue to have very robust portfolio of new business opportunities, currently about $450 million of outstanding bids. We've added additional business development resources to not only prosecute those bids, but also identify and pursue additional opportunities. We also continued our efforts to improve operational efficiency, including the new ERP system, which will help us plan projects to monitor across much more effectively. We continued healthy level of investment in internal research and development, advancing several key technologies, which we expect to produce significant downstream revenues and earnings. Disposition of our Asia's subsidiary was finalized as well, as Steve mentioned. Cash flow continued to be positive. Backlog at year-end was up 23% compared to the end of the prior fiscal year. As we continue to improve our performance, I'm very encouraged by what I see in FEI's future. Martin?

Thank you, Stan, and thank you for all of the effort you're putting in. He's working very hard and for all of us. I would just like to add the following comments before we open up for question and answer. This is the first time in the history of the company that we have outstanding proposals of over $400 million on programs that will materialize in near future. I think it's clear the emphasis of precision times becoming a very, very important commodity. And as each day demonstrates, as a typical example, the Galileo system, which is a competitor to our GPS system, just went out of service. Now, if the GPS would go off of service, it would be a major catastrophe. The only safety that involves is for people to have their own precision time in their home environment like planes, anything mobile or ground SS in order to be able to continue procurement communication. So timing is becoming more and more important as we enter more uncertain environment in this commodity are total dependent on GPS has to be supplemented with significant timing investments. And FEI is one of the very few companies in the world that has the capability to lead demand, and it's our mission to make sure that we have the resources and the products to do it. Stan's responsibility of running the company has given me the luxury of spending more time on the defense product development, and I will come to that position and I'll do my best to fulfill the mission. So again, we're looking forward to a bright future of this and our advanced products are getting a lot of attention. And I emphasize over and over again, timing is becoming more and more critical with each day in our society. At this time, I would like to turn over to questions and answers. I would appreciate if you address the questions to either Steve Bernstein, Stan Sloane or Martin Bloch.

[Operator instructions] We will take our first question today from Sam Rebotsky at SER Asset Management. Please go ahead, your line is now open.

Congratulations Stan, Martin and Steve. You seem to have gotten behind you all these things that were dragging. Hopefully, going forward, that there is no issues and everything could be profitable. Let's look at the $450 million, Stan. Is that -- what number of years and when do they make decisions on the bids that we're making $450 million?

Well, no. The decisions in terms of the disposition of those particular bids that will probably take place in the next 12 to 18 months. Now, contract execution associated with those things varies of course depending on what the nature of the project is. It could be anywhere from 10 to 12 months, to couple of years or even longer in some cases. Couple of those bids have long production opportunities associated with them, and would go on for some period of time. So, it's a mixed bag. But the current bids outstanding will be decided in the relatively near-term.

Now the $37 million firm, what was the number at the end of the January quarter? Steve, do you have that number?

The backlog?

Yes, the funded backlog at the end of January 31st?

It was $39 million.

So we went down $2 million, okay. And we did about $13 million in sales and if you subtract the $101 million, you breakeven in this quarter assuming without these items. Is it fair to say that we'll do more than $13 million going forward per quarter and that this is enough to break even or be profitable in each quarter?

Sam, you haven't changed in all the years I know you. And you know FEI's policy. We do not make any prediction. We just give you our long-term view. So I appreciate the question but we spend on our legacy.

This is not a question. Is it fair to say you need $13 million to breakeven?

No.

Because you would have broken even, presumably if you take the $101 million. Steve, is this a breakeven if you take those numbers out?

This is Stan. I was just telling you that the business is very sensitive to revenue that the gross margins in the bottom-line because of the infrastructure is harder to manage costs below that level.

Okay, then the number of employees we have as of April 30th. What was the number of employees compared to the January 31, taking out anything that you may have sold out?

So, the employment across the enterprise is in the 200 range. That does not take into account Asia, which we have been -- a difference last year and this year…

So in the fourth quarter, did we add more employees that we had at the end of the third quarter?

It's about the same.

No.

And we'll take our next question from the line of George Marema with Pareto Ventures. Your line is open.

A question for Stan Sloane. Last couple of years has had a lot of noise in the numbers. What would be a target model business model you guys are striving for? Let's say you're doing a $100 million of revenue for easy math. What gross margins and operating margins would you hope to achieve at that level?

At that level the gross margins, I will take I would be in the 40s. The mix of business, I think as the company grows, you probably see in the near-term the number of bids that we have outstanding that $450 million number I mentioned are probably more dominated by space related opportunities. Overtime, I would anticipate that the portion that's not space related would grow. I wouldn't take that would vary gross margin very much, but that would be the way to think about it.

And what kind of OpEx from that margins would you think achieve on something like that at that scale?

I think -- say that question again, I'm sorry this is Martin…

Yes, at that level of gross margin revenue, what kind of OpEx, operating expense or net margin, net income level, would you hope to achieve?

Well at that level, I would think the bottom line would be double-digit, approaching double digit.

So like 10%-ish of that net income, like $10 million?

For argument's sake, sure, yes.

Yes, just rough ballpark stuff, okay…

As you understand -- this is Martin. We have a certain fixed expense independent of the level of business and we're very sensitive, as Stan has stated, to any increase in revenue. So, any increase in revenue gives an opportunity to improve our performance. But I'll tell you, our emphasis is to capture the market, not on the short-term dollar.

Our next question will come from Michael [Einser], Private Investor.

A year-over-year growth question. Is Asia completely written-off, there'll be nothing on the first quarter?

We sold them on May 21st. However, it was an immaterial amount for the three weeks. So we have pruned it all and the end result is there will be no effect of Asia in Q1.

And this is for Stan. You commented slip in schedule. Did you mean you got pushed back some contract?

You're referring to the new business opportunities?

Yes, so potential program awards put in schedule.

So things just didn't get awarded on the timeline that we anticipated. They moved to the right.

Also they're not lost?

No. Our win rates and our number of proposals are both holding pretty steady. So it's not that we've lost it, but it slipped to the right.

So you think it was followed over time and you'll see you should get that?

Well, they're still out for evaluation, whether we win them or not is still to be determined. But programs does not -- if we didn't lose them in competition, they just haven't been evaluated and awarded.

Is that in the $450 million number?

Yes.

Mark, this is Martin. I want to emphasize again this is the first time in the history of Frequency since it was established in 1962 that we have firm proposals outstanding. We have lots of opportunities. But this is the first time we have firm proposals outstanding for approximately $450 million.

On your last call, you had $200 million…

That's correct.

And that was I guess four months ago roughly…

Well, we had more opportunities.

And in February 2018, you received development contracts advanced electronic warfare and production. How is that coming along and what is the size of the market on that?

I think you're referring to the Air Force program, the optically pumped rubidium clock?

It was the advanced electronic warfare, it was a product development…

Yes, I think you're talking about airborne offshore off-board electronic warfare…

Yes, that's it.

Yes, that's progressing pretty well. We in fact delivered the first, what's called master reference oscillator, that's -- it to deliver in the next few days. And that's a product being developed here in New York. Over at Elcom, we're doing the other couple of pieces of that project. And those are going to be delivered the next, probably 30 to 45 days. So that program is progressing pretty well. Extremely state-of-the-art technology really advanced stuff. So, it's pretty encouraging…

And a big investment that we have done in order to be in the game.

You mean R&D wise?

That's correct.

And what size of the market on that?

That could be -- well, with the particular project is, could be in the $70 million range eventually. That's probably not on the contract. But this will become the standard part of the shipboard of EW suite that the Navy has. But what's probably also as important is this that the product that's being developed for AOEW is applicable for a whole lot of other EW systems. And we've already had several inquiries. In fact, we have a couple of bids out for that same product not for that particular program but for other programs. So, that's pretty exciting.

Is anyone else other companies working on this?

I'm sure…

Well, other companies obviously produce EW stuff. In other word, we're more complicated because AOEW is part of a larger EW program for the Navy. And I'm not sure what other people are doing on other parts of it. But the part we're doing we believe we're the single source for the particular modules that we're developing.

And in principle most of the R&D is already done, or a good part?

A good part of it is. We still have some to finish up with, but that's true.

One more question. GPS is huge in space. How's the digital rubidium atomic clock coming along contract?

Excellent…

It's doing very well that is initial part is in production, it's being product, it's been manufactured now. It's progressing well.

And you think you can get that?

Well, we got that. That was on contract. The question is it has to be tested, evaluated and qualified. But we're highly optimistic that we're going to get significant production results from that.

That's the iridium, correct?

No. The iridium has all been done, delivered in space. This is the GPS…

Yes, I'm sorry the GPS IIIF. Thank you.

We'll go next to the line of Brett Reiss with Janney. Your line is open.

Thank you for letting me ask a question or two. I guess this is for Stan. The language in the press release that you're pleased that you executed on several very technical development programs. Could you just explain that a little bit further and couch your explanation, you are talking to a non-engineer?

So that's going to be a bit difficult. So, the R&D developments include activities related to optically pumped rubidium clocks, advanced quartz oscillators, and what I would describe as some of the miscellaneous technologies. But we do think here that our very high-end performance in the quartz oscillator realm being one example, a very low phase noise, low-G sensitive oscillators, that’s been a fair chunk of the R&D development from last year.

And this is Martin Bloch. For the layman I can explain. Precision time is becoming more and more important the becoming very important on mobile platforms. So, on mobile platforms, you have the motion and the vibration that affect the accuracy. And we have a key patent and we also have the best performance of GE sensitivity in the field, and that's a big part of our development, both in quartz and in quartz-controlled atomic standards.

And to help you understand why that's important. So if you -- for example, radar systems and electronic warfare systems, noise that comes from oscillators and other sources affects the radar performance. So having a very high performance oscillator means that you're going to have a better performing radar.

So since you were successful in what you just cataloged to me, it should not be an impediment to sales since you've been successful in your execution in these tactical development programs?

I'm not sure what you mean by impediment to sales, it's an advantaged sale, I think.

Let me take it. We have provided this type of technology to about a dozen programs, and that is part of the $450 million proposals we have outstanding. So, we have done the heavy lifting. Now it's a matter making sure that we cash-in on the production that is bound to follow.

So you have to go to the customer base and educate them that you have successful products in these areas, because you've executed on these tactical development program?

Well, in many cases, we have delivered the engineering models to the customers. So the majority of our critical customer know our capability and our mission is to get the production.

Now, the key opinion leaders at the customer level that will make the decision to purchase your product. Is it a long time lag? Or once they looked and kicked the tires and see that you've got the goods, you can get a fairly quick decision?

The answer is yes to both. Some of the programs are going to mature fairly quickly, and because they are than some, will require significant development. Because this product has to be incorporated with a much larger system to provide the total answer for the military to provide secure timing for the mobile environment.

[Operator Instructions] We'll go next to Michael [Cooper], Private Investor.

Congratulations on your Q4 results, which I think are up 76% over Q4 2018. It's a pretty good number. One main question here -- no, maybe two and then just a comment on Stan's math on $100 million revenue. So first question is what is your capacity before you have to invest in plant and equipment and/or staffing up more? I think, you've been through a good staff rejuvenation. But what could you produce with this investment in facilities and infrastructure that you've got going now?

So I'll give you a couple of answers. One, the revenue base in the business here has been as high as $80 million. And so obviously, we're capable of running defense capacity. I would tell you that given the facility here, we could -- I hope we can make $100 million of revenue assuming current product mixes and phases. I don't think that would be a problem. I would tell you that as the revenue picks up, we would handle that capacity a couple of ways, including some outsourcing and other things. So I don't think that would be a problem.

I want to Stan's saying. One of the great advantages that FEI has is that the key building blocks. Like the quartz resonator and atomic clocks we build from raw material to finished products. So at that part, we're in great shape to be able to react very quickly and to get the necessary performance. And the wraparound electronics, as Stan has indicated on this, there's no reason why we couldn't outsource quite easily to get it done and to keep our facility. And I think Stan is very conservative by saying $100 million in these facilities should not represent a problem.

Now, Stan, on your math when you ran a $10 million number when you get to a $10 million income number after you get to $100 million revenue. I didn't like that number all that much for a $100 million market cap company. So I just sketched out some numbers here. I mean, really, if you're running at 40% gross margin, so that would be $40 million on $100 million revenue. And then you're removing your SG&A, which doesn't seem to move, I mean, it seems very stable overtime. And your R&D expenses, if you keep those stable. Looked to me like a number closer to $25 million net profit before tax on $100 million revenue. Does that sound more -- I mean, it sounds more enticing to me as an investor. Does it sound more in the realm, I know you just threw it up pretty quick number at that $10 million.

So, we should be able to do that or better at that sort of revenues, the $10 million or better. How much better? Your arithmetic is not too far out, but I think it'd be a little more conservative.

And just the last, can you talk a little bit more about the NASA program that you just launched that you announced a week ago or so? And then a little bit more about some of these new larger opportunities that you're referring, give us some color on…

I think you're referring to the NASA, the deep space atomic block press release…

Yes.

So for that program, for JPL, we produce the ultra stable oscillator, which is a high precision quartz oscillator, which is the mercury-ion the clock in the DSAC relies on. And so that was our role. The other opportunities in that $450 plus million include things related to GPS. There's some large -- there is couple of large commercial satellite constellations that are possibilities. And then there is a few classified programs that are very good size. So, it's a pretty broad mix. And the good part of it is, it's not highly dependent on one or a couple of extremely large opportunities. There is numerous opportunities to make up the $450 million. So I like that. It makes me feel more comfortable that the outlook is more likely to happen.

This is Martin Bloch, again, to supplement it on this. We have great opportunities in space, both for military classified programs and commercial. But what's also very exciting is that precision time is becoming an necessity for many terrestrial applications. And between the atomic clock, the good quartz and the low-G sensitivity, we have lot of opportunities, so I have to take advantage of it.

We will take a follow up from Sam Rebotsky.

The July 1st, the NASA. Do we have a number? Is that $37 million backlog that we could attribute to that program, or do we need somebody to make a decision on that?

You're referring to the NASA launch I just talked about, the deep space atomic clock?

Yes…

Since revenue in -- that was sold over two years ago, three years ago...

Yes, that's old…

So we don't have any backlog, any of this -- the fact that they just launched it, we don't have more business that we have in backlog to produce more of this item?

Similar items, we have in the backlog for other program. That precision quartz clock was developed for many DoD and secure programs. It's a key building block. And we have contracts employing the same technology.

And do we have some kind of statement of approval of the quality of our product in this launch, it's succeeded or do we need to wait for somebody to tell us it worked 100% and better than that?

Well, it was just launched on the 22nd of June. And it's going to be monitored before the next year and we'll get data. I'm sure that we'll make a point on our next conference call to give you an update.

And relative to the cyber securities GPS and the spoofing, has that revenue been growing? Is this an area that you're exerting some pressure? Does our product differentiate from others for cyber security, going forward?

The short answer is yes.

And now that you have such a good story to tell, when are you ready to make some presentations and where you're going to make the presentation?

We will advise you, Sam. It's on the plate.

We don't have them scheduled but I'm anxious now. I think we do have the story, so we'll let you know…

I think and as far as I can see, there shouldn't be any negatives to bite you. So everything should be kind of positive going forward. So good luck guys. You're working hard and let's make the stock go up.

From your mouth and to God's ears…

All right, maybe God's listening. Okay, thanks Martin.

He's sitting right here next to me.

Okay, there you go. Okay, thank you.

And we'll move now to a follow up from Michael [Einser].

One on…

Only a short one…

All right. Who is the main builder for Galileo contract?

Sorry, what's again?

The Galileo that just had the issue.

Yes. All of the European has decided that they do not want any U.S. product involved. So this was a total European effort.

And are any of those people competition to you though here?

No, because the U.S. has the same type of policy. We don't want any foreign clocks on U.S. critical missions.

So this is actually, I hate to say, good news because they're looking at the quality of companies that work on GPS?

Well, Mike, to me the good news is that the important from having your own timing, because any type of satellite system can go out of sync or be jammed or spoofed, so precision time is becoming a more important commodity.

Which is what you're known for…

That's our specialty.

And on final thing, the $37 million Air Force contract how's that going?

Slow.

Why is that?

Say that again?

Why is it going slow?

It's going slow for reason of a new breakthrough in technology and that the Air Force is trickling out very little funding.

You think it's going to be complete though?

One way or another, we will complete it.

Okay, good news. Thank you.

And at this time, we have no further questions from the phones. I'll turn it back to the leadership team for any additional or closing remarks. End of Q&A:

Okay. Again, thank you all for participating. We're working hard to make opportunities come through. I want to thank all the participants and my personal express as usual to the employees of the FEI family who make our future possible. Thank you again. And we will be talking to you in September. Thank you.

Ladies and gentlemen, this does conclude today's meeting and we thank you all for your participation. You may disconnect your lines and we hope that you enjoy the rest of your day.