Frequency Electronics, Inc. (FEIM) Earnings Call Transcript & Summary

Greetings, and welcome to the Frequency Electronics Third Quarter Fiscal Year 2022 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, constitutes 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, Stanton Sloane, President and CEO.

Thank you. Welcome, everybody. I'm glad that you could join us today. Before I turn this over to Steve to take us through the financial details, let me offer a few thoughts. Third quarter was challenging, particularly in our Zyfer operation due to delays in bookings and the reduced revenue that resulted from that. We haven't seen any competitive losses there, just delays. So we anticipate these bookings will still come in. We're taking advantage of the lull in production to transition manufacturing from California to the New York facility, which will have the compound effect of significantly reducing costs at Zyfer and reducing manufacturing overhead costs for the Zyfer products that will be manufactured in New York. This will result in benefits over the long run. In the New York operation, we were hit with a severe round of COVID-related employee absences, which affected the quarter's revenue and operating income. Despite the challenges, we saw an increase in revenue for the quarter compared to the first 2 quarters as well as compared to Q3 of fiscal year '21. Bookings for the fiscal year are solid, running well ahead of where we thought we'd be for the year and up about 30% from this point last year for the New York operation and up about 21% overall for the company. Backlog is now up to $41.6 million, and the overall book-to-bill ratio for the quarter was a healthy 1.27 for the company, but an even better 1.4 in the core New York operation. As usual, we generated cash from operations, $4 million for the year so far, and cash and marketable securities currently stand at $22.2 million, up $2.1 million from year-end fiscal year '21. We also remain debt-free. On the technical front, in our digital Rubidium Atomic Clock for the GPS IIIF program is progressing extremely well through its qualification testing. And we have in production additional units, one of which will be used for long-term testing on the ground by the government and one which is planned to fly on a GPS III satellite to validate its operation in space. Our Pulsed Optically-pumped Rubidium Atomic Clock is progressing well in its design phase also. Laboratory testing has indicated its performance will be outstanding, ultimately enabling better holdover times and helping mitigate GPS jamming and spoofing. The mercury-ion clock development is also underway. In addition to these 2 Office of Naval Research funded projects, we are pursuing a variety of new technology opportunities with various government agencies for not only advanced atomic clocks, but also some new technologies unrelated to clocks as part of our effort to grow top and bottom line. While I can't go into the details here, these are exciting opportunities, and I look forward to sharing more about these as things progress. With that, let me ask Steve to cover financial details for you. And after that, we will take some questions. Steve?

Thank you, Stan, and good afternoon. For the 9 months ended January 31, 2022, consolidated revenue was $38.1 million compared to $38.6 million for the same period of the prior fiscal year. The components of revenue are as follows: revenue from commercial and U.S. government satellite programs was approximately $20.9 million or 62% of consolidated revenue compared to $20.1 million or 52% in the same period of the prior fiscal year. Revenues on satellite payload contracts are recognized primarily on 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 recorded both in the FEI-New York and FEI-Zyfer segments, were $14.9 million compared to $16.3 million in the same period of the prior fiscal year and accounted for approximately 39% of consolidated revenue compared to 42% for the prior fiscal year. Other commercial and industrial revenues were $2.4 million compared to $2.2 million in the same -- in the prior fiscal year. Intersegment revenues are eliminated in consolidation. For the 9 months ended January 31, 2022, gross margin and gross margin rate decreased as compared to the same period in fiscal year '21. The decrease in gross margin and gross margin rate was due to an increased engineering cost on development phase programs that experienced particularly complex technical challenges as well as cost impacts on several programs resulting from supply chain issues. Lack of availability of parts and material and/or quality problems with traditional vendors result in the need to redesign certain electronic units to replace unavailable parts with different parts that were available in order to maintain contract delivery schedules. In several cases, reprocurement of circuit boards and other mechanical parts was necessitated by quality issues in the supply chain, further contributing to increased cost. For the 9 months ended January 31, 2022 and '21, selling and administrative expenses were approximately 25% of consolidated revenue. The slight decrease in SG&A expense is mainly due to the decrease in professional fees. We expect this trend to continue as expenses normalize. R&D expense for the 9 months ended January 31, '22 and '21 increased to $3.9 million from $3.5 million, an increase of $400,000, and were approximately 10% and 9% of consolidated revenue. R&D increases in the 9 months ended January 31, '22 were due to higher levels of internal R&D associated with investments the company is making in new technology developments related to atomic clocks and low noise oscillators that are intended to produce long-term increases in revenue and position the company to compete in the marketplace with next-generation products. The company plans to continue to invest in R&D to keep its products at the state of the art. For the 9 months ended January 31, '22, the company recorded an operating loss of $2.1 million compared to an operating loss of $1.1 million in the prior year. The factors cited above in gross margin discussion are applicable to operating income as well. Operating losses for the 9-month period ending January 31, '22 resulted from lower revenue and lower gross margins. During both periods, the company experienced increased supply chain and other costs. The majority of the operating loss we experienced in Q1 as a result of higher professional fees associated with litigation has since been settled. Other income consisted primarily investment income derived from the company's holdings of marketable securities. Earnings on these securities may vary based on fluctuating interest rates, dividend payout levels and the timing of purchases, sales, redemptions and maturities of securities. In the 9 months ended January 31, '22, investment income included a $123,000 dividend from Morion compared to a $105,000 dividend from Morion in the same period in fiscal '21. This yields a pretax loss of approximately $1.8 million compared to a $700,000 pretax loss for the prior fiscal year. For the 9 months ended January 31, '22, the company recorded a tax provision of $3,000 compared to $37,000 for the prior fiscal year. Consolidated net loss for the 9 months ended January 31, '22 was $1.8 million or $0.20 per share compared to $700,000 net loss or $0.08 per share in the previous fiscal year. Our fully funded backlog at the end of January '22 was approximately $42 million, up $2 million from the previous fiscal year ended April 30, '21. The company's balance sheet continues to reflect the strong working capital position of approximately $40 million at January 1, 2022, and a current ratio of approximately 4.8:1. Additionally, the company is debt free. 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 Stan, and we look forward to your questions.

Thank you, Steve. The operator will now explain how you can submit questions. Operator?

[Operator Instructions] Your first question is coming from Brett Reiss.

Stan, Steve, the delays in bookings that you talked about, could you go into a little bit more specificity as to what that's all about?

Well, I don't really know in a lot of detail other than that the bookings that we've been anticipating just haven't been processed through the -- in this case, largest one is through one of the government prime contractors. But why they didn't, I can't tell you. I don't believe it's tied to the CR, but it just seems to be delayed in getting things on the contract.

Do we have like lobbyists or people in Washington that when there are these type of delays, you can make inquiries so that you can find out how long the delays are going to be so you can plan our business?

You can't lobby the government prime contractors. So in the case where they're the customer, having people in Washington lobby things doesn't really do anything. We have access, of course, to government budget information and all the exhibits and all that stuff, which we look at pretty regularly. Those are of interest when you're looking at the program level. But you have to remember, we're not the prime contractor. We're a second-tier provider to the prime contractors.

Okay. The move of manufacturing from California to New York, can you quantify what the cost savings -- what's the run rate on the cost savings going forward?

I don't want to put a number out, but I'll tell you that it does 2 things. It reduces the cost out in California because, of course, for a given number of manufacturing people there, we don't have the same number of manufacturing people here because we have other -- the administrative or the staff or overhead portions of manufacturing don't need to be replicated here. So if you take the cost out of California, the overall cost to manufacture that same product here is less. And how much less depends on the revenue and some other factors. So I'm not going to predict a precise amount, but it's a pretty significant effect.

Right, right. One last question, and I'm going to refer to a transcript. I subscribe to David Rosenberg. He's an economist in Canada, and he had as his special guest, a Pippa Malmgren, who's an expert on cybersecurity threats. And among other things she lectures at Sandhurst in Great Britain. And I'm kind of quoting from her last talk, which was about a week ago. "Understanding the strategic importance of space is crucial because you can see what's happening on the ground, because you can control everybody else's access to the main things that we care about these days, which is the digital domain. Can you cut off an entire nation's access to GPS because you knock out their satellites in space? Yes, you can. We've seen recently major incidents between the United States, Russia and China in space." And then she went on to name 2 examples, which were not in the mainstream media. It was chilling listening to her describe what's going on. Aren't the various things, the clocks, and the ability to prevent spoofing and control satellites, I mean, aren't we in the cat bird seat for order flow with where, unfortunately, the world is going?

So that's a very complicated thing to ponder. And of course, there's all sorts of ways you can affect GPS, everything from denial of service type stuff to kinetic attacks. I have to leave that for the government folks in terms of their strategy. But what I would say is that the better clock you have up there, the more holdover you have. So if you're going to, for example, jam a GPS signal, then the clock becomes critically important because you need the satellite to be able to maintain sync until you get the signal back. So from that point of view, I would argue, yes, we produce very high-performance clocks. That's our specialty here. And a lot of the programs we're working on, obviously, GPS or -- that's the intent, it's to provide better capability.

Stan, you've been doing a fantastic job, but are you frustrated that the order flow has not been more robust to date?

Well, I think it's been pretty robust. I mean I guess you can be the turtle or the hare. In my mind, a continuous improvement is a pretty good strategy, and that's what I see. So I think we're doing pretty good. Every now and then, you get these extremely large opportunities that come along, and we'll continue to chase those. But I think overall, our strategy in terms of growing the revenue base is panning out. I would point to the 2 ONR contracts as a great example of that. And in my comments, I mentioned we're chasing some new stuff that's a little different than our traditional business as another way to go about that. And as long as I can keep incrementally growing the business, I'm pretty happy.

Your next question is coming from [ Michael Eisner. ]

How is the COVID situation in New York now?

Settled down now. We had a bout of it here in -- basically in January. And we had quite a number of folks out, 32 or 33 folks out with it. And why -- because we didn't have any significant effects prior to that in terms of our employees. And why it hit us in January, I really can't tell you. But it seems to have settled down. I think we're -- at the moment, we have just 1 employee who's out for testing positive and I expect him back next week. So it seems okay now, but it did hit us in January.

Well, I had COVID, the Omicron, at the beginning of January. It was very high level then at that point. The supply chain going forward from now, not in the quarter, how is it looking?

Well, there's still issues in the supply chain. There's two things. One is shortages or delays, if you will. A lot of stuff -- a lot of the parts that we use, we used to be able to get in a few weeks, some of them now are 4, 6, 12 months deliveries. That's one problem. The other problem, of course, is costs are going up. I think you've seen in the news things that are sourced from Russia, nickel and titanium and some of those things are all going up pretty rapidly. So that's the next challenge. The -- on the component parts side, the issues seem to me to be more in the active components. So things that are the more expensive and longer lead things seem to be more problematic. But I'm hoping that will start to step down a bit. Of course, the Ukraine situation throws a wrench in a lot of different things because of raw materials. But that's where we are. We're holding our own so far. But we have -- as we said in the comments, we have had some delays and some of those cause other costs because you've got to redesign stuff to -- for components you can source.

Yes. Every company has had delays. It's nothing your fault. You said GPS III, I think. Did you mean GPS IIIF in your comments?

No. No, I meant GPS III. We're going to fly one of our DRAFS units on a GPS III satellite to -- it's basically a demo because the satellite is designed for -- not for our clock, but they're going to put our clock on there, so we can demonstrate its performance in space.

You didn't think you -- I think last call or the call before, you didn't think that you were going to get on GPS III, but you are going to get one.

Yes, we are.

And if everything goes good, you'd start production of GPS IIIF?

We are in the cycle on GPS IIIF with qual unit. That's going through the final stages of qualification. We do not yet have orders for the flight units, but I would expect that to be imminent as soon as we finish qual here.

Like a month or 2?

A couple of months.

Still a couple of months?

Well, look, they may elect -- the unit -- I don't want to get too much into detail, but unit has a qualification program. After that qualification program, it has what's called a long-term aging test. But once we're done with the Qual program, we've basically proven the design of the clock. And my hope is that at that point, they'll start to exercise flight options and not wait all the way through the long-term aging test. But I don't know that yet.

That would mean a continuous stream of revenue if they approve it.

Well, sure. Yes, if they exercise the options, yes.

Well, did those -- I don't know, I forget how many clocks in the GPS IIIF. Was it 21?

No. There's 22 satellites and [indiscernible] clocks in a satellite, but some of the initial satellites are already in production. And of course, those don't have our clocks on them yet because we're not through qual.

Yes, the first 10 or 11, I think, it was. You said you got money from Morion. Is that going to be a problem in the future? They're there in Russia, right?

Yes, they are. We get dividends. We have a small equity position in Morion, and we get dividends from them. We don't -- it's not substantial, and frankly, I don't expect to get them anymore. So given how things are, we're just not -- we're not dependent on Morion for anything, and I wouldn't expect that we'll be able to do much business with them in the future.

And the ruble is worthless. Going back to Sam's question on Zyfer. Are you moving the production and keeping the technology out there? How are you doing this?

Yes. Manufacturing will move. You could think it's analogous to them deciding to have a contract manufacturer of units. The engineering, development and everything else will remain there as it is. We're just going to shift the manufacturing part here.

So that means are you going to a smaller office?

Well, no, not a smaller office. I mean we'll absorb their manufacturing into the current facility.

Well, not office, but manufacturing plant.

Yes, we'll absorb that here. We don't need any additional space.

No, I know you could -- no, you have space in New York. But will you reduce space in California?

Yes. Eventually, yes. We have a lease. And of course, we have to either sublet part of the building or when we renew the lease, we'll -- we won't need all that space.

When's the lease up?

I think it's got another couple of years.

All right. So how long is that going to take to move into New York?

Probably another month.

All right. So that's going to save some good money on people.

Yes.

You're not going to have to hire any new people in New York for this, do you?

Yes. We will hire additional manufacturing people, but we won't replace the manufacturing workforce out there one for one. We won't need the infrastructure part. We already have that here. All we need is the people that do assembly.

How many people do you have in California?

Now there's roughly 32 or 33, I think.

All right. And I know I'm asking a lot of questions, just get this over with. The mercury ion atomic clock, how much of that is in the backlog?

Let's see, in the backlog of Mercury Ion, do you know offhand? It would be the first piece. So it's -- these are approximations, it's about $2 million.

And the same thing for the space-qualified precision oscillators?

You're talking about the POPRAFS, the other ONR contract?

The -- it was announced October 15.

October 15.

I'm sorry if I didn't have -- No, the Pulsed Optically Pumped Rubidium was in September.

Yes.

How much of that backlog?

That's roughly the same.

$2 million?

Roughly, yes.

And the other one, the final one? The October 15th contract you -- if you don't know [ it's fine ].

I don't have the press release in front of me. I don't remember which one that is, sorry.

No, it's okay. What's your bids outstanding at this point?

Bids outstanding. I don't know offhand. I'm going to guess probably a couple hundred million dollars.

And you expect to get most of it?

Well, we don't win 100% of things. Our win rates have run in the 30% to 40% range.

You trade -- and if you take out the cash, you're about $6 a share or $6.20 a share.

Yes. I'm not sure current market conditions are a good calibrator, but okay.

No, I'm just saying it's ridiculous because your technology you have in the plant is worth a lot. And if you take out the cash...

We're underappreciated. This is a national asset. I agree with you.

Yes. All right. Sorry I asked so many questions but -- once again, while I have you. Thank you.

There are no further questions from the lines at this time. I would now like to turn the floor back to Stanton Sloane for closing remarks.

Great. Thank you. Well, thank you, everybody. I'm glad you were able to join us today. Until we talk to you next quarter, please stay safe and healthy. Have a great day. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference call. You may disconnect at this time, and have a wonderful day. Thank you for your participation.