Frequency Electronics, Inc. (FEIM) Q4 2020 Earnings Report, Transcript and Summary

Greetings. Welcome to the Frequency Electronics Fiscal Year 2020 Fourth Quarter and Year End Earnings Release 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 forward-looking statements. Factors 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, Sherri. Welcome, everyone. Thank you for joining us today. I hope everyone is faring well during the pandemic. We have now reported fiscal year 2020 results. I'll just say it was a difficult year, and I'm glad to put it behind us. A combination of issues impacted us last fiscal year, some of which we have previously discussed. Late in the year, we had added impacts related to COVID-19, legal expense and reserve for a note that was due to us. Backlog for 2020 was down approximately $1 million, however, we did book a significant contract earlier this month, which we announced on July 1. Let me comment on COVID-19 issues, which impacted us mostly in Q4. While we had little impact to our operations in New York, we did experience delays in award of new contracts, which we attribute to government and prime contractor administrative process delays. We also had impacts from vendors in our supply chain, either being unable to deliver critical materials on time or having quality issues, which resulted from some of their key personnel being out due to direct or indirect COVID-19 impacts. Unfortunately, when this happens, it results in increased cost to us for either additional processing or for rework of materials. When there are delays, it affects revenue recognition, gross margin and, obviously, operating income, which is reflected in these financials. More importantly, however, we have lost no employees to the pandemic. As an essential industry, most of our employees have been here at work through the duration, and their health and safety is, of course, of paramount importance. In Q4, we continue to work through the programs that have had higher development-related costs, which we have previously discussed. Of those three problem programs, one is completed now, one is nearing completion with initial products delivered and working extremely well and one is in the acceptance test cycle. In summary, we should have all three of these behind us in about three months. Let me shift gears here and talk about the future a bit. I'm sure you all saw the announcement on July 1 of a significant contract award, which I mentioned earlier. We are now currently negotiating an additional contract for which we've been selected and which is also significant. I'm optimistic we'll be able to successfully conclude these negotiations and announce the award sometime soon. While there is no guarantee that this will happen, I am encouraged by progress. It is important to point out that revenue is key to improving our financial performance and new business activity, which is robust, is the best leading indicator of revenue growth. This fiscal year is very different from previous years and that most of the new contracts that are needed to generate revenue this year are either awarded or are imminent versus being planned later in the year, and that reduces the risk associated with revenue recognition. In order to meet these new contract demands, we are currently hiring personnel in both engineering and manufacturing. I also wanted to mention that we've had significant progress on key programs, which we were previously awarded that relate to the GPS satellite program. Both of these contracts are key to future business growth and both are on track. One of them successfully completed a critical design review last week, got very high marks from the customer and the initial engineering model for the other program is progressing very well through the development process. While the fiscal year 2020 financials are what they are, I am encouraged by progress of late, and I'm convinced that our future is brightening considerable. Let me now turn things over to Steve for a review of financial details. Steve?

Thank you, Stan, and good afternoon. Fiscal 2020 consolidated revenue was $41.5 million, down 16% compared to $49.5 million for the prior fiscal year. The components of revenue are as follows: revenue from commercial and U.S. government satellite programs was $20.4 million compared to $22.8 million for the same period of the prior fiscal year and accounted for approximately 49% of consolidated revenues compared to 46% for the same period of the prior fiscal year. 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 recorded in both the FEI-New York and FEI-Zyfer segments are $16.9 million compared to $22.8 million in the prior fiscal year and accounted for approximately 41% of consolidated revenue compared to 46% for the prior fiscal year. Other commercial and industrial revenue was $4.2 million compared to $3.9 million in the prior fiscal year. Intersegment revenues are eliminated in consolidation. For fiscal 2020, gross margin was $5.8 million compared to $15.8 million for the prior fiscal year. Gross margin rate decreased to 13.9% as compared to 31.9% for the same period in fiscal 2019. The lower gross profit and gross profit percentage was the result of lower revenues and was impacted by increases in engineering costs incurred on several programs, which were in the development phase and which encountered unanticipated technical challenges related to customer-driven system packaging and environmental requirements for state-of-the-art performance demand. In fiscals years 2020 and 2019, selling and administrative expenses were 28% and 24%, respectively, of consolidated revenue. The actual dollar value of the expense decrease compared to the same period of the prior fiscal year. SG&A increased as a percentage of consolidated revenues due to the decrease in revenue. SG&A expense in fiscal 2019 included a onetime charge of approximately $1 million for the loss associated with the sale of FEI-Asia. Depreciation and professional fees were up this year however, we expect that our D&O coverage will cover a percentage of the legal fees. 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 fiscal 2020 was 12% of sales compared to 13% of sales for the previous fiscal year. The approximately $1.4 million decrease in R&D 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. For fiscal 2020, the company recorded an operating loss of $10.9 million compared to $2.8 million for the prior fiscal year. The increase in the operating loss in the current fiscal year is a result of decreased revenue as well as increased costs related to technical challenges on certain programs in the development phase. Other income consists primarily of investment derived income from the company’s holdings of marketable securities. Earnings on securities may vary based on fluctuating interest rates, dividend payout levels and the timing of purchases, sales, redemptions or maturity of securities. Included in other expenses for fiscal year ended April 30, 2020 is a provision related to a $1 million note receivable from the sale of Gillam, which is due in fiscal 2021. This yields a pretax loss for fiscal 2020 of approximately $11.7 million compared to a pretax loss of approximately $2.5 million for the prior year. For the fiscal year ended April 30, 2020, the company recorded a tax benefit of $1.7 million compared to a tax provision of $56,000 for fiscal 2019. For fiscal year ended April 30, 2020, consolidated net loss was $10 million or $1.10 per diluted share compared to a net loss of $2.5 million or $0.28 per diluted share. Our fully funded backlog at the end of April 2020 was approximately $36 million, down approximately $1 million from the previous year. However, subsequent to year-end, we announced a significant contract win and expect to announce additional wins in the near-term. The company’s balance sheet continues to reflect the strong working capital position of approximately $38 million at April 30, 2020, and a current ratio of approximately 4:1. The company believes that its liquidity is adequate to meet its operating and investing needs for the next 12 months and for the foreseeable future. I will turn the call back to Stan, and we look forward to your questions soon.

Thank you, Steve. With that, we’ll be happy to take some questions. We would ask that you to please limit yourself to one question and with that, I’ll turn it back to the operator, who will explain how to get your question to. Sherri?

Thank you. [Operator Instructions] Our first question is from Brett Reiss with Janney Montgomery Scott. Please proceed.

Hi, Stan. Hi, Steve.

Hi.

Hi.

In the past calls, you stated the amount of proposals outstanding. I think on the last call, it was $660 million. I guess, you subtracted $28.6 million. So do we have $631 million in proposals outstanding, yes, presently?

It’s actually closer to $690 million, but you got to be really careful with that number, Brett. It changes daily, stuff goes into and out of the Q, if you will. So the current number is around $688 million, if I remember exactly, but that’s likely to change.

All right. Just to follow-up on that, and I’ll drop back in queue because I respect your protocols. Base case scenario, what percentage of that $688 million becomes firm business for Frequency?

Very difficult to answer that question. Obviously, we’re trying to convert all of them, but you’re not going to win 100% of all the opportunities. So also sometimes programs get cancelled or restructured or whatever. So hard for me to give you a number.

Okay. I’m going to drop back, because I’m sure you got some other course examiners.

Okay.

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

Yes. Good afternoon Stan and Steve. As far as the $36 million funded and the $29 million funded, whatever you have utilized in the quarter ending July, the $65 million funded that would appear that you would be ready to make a profit in one of the next quarters. And with the other contracts coming up being pretty serious, would it appear that you’re going to be profitable in the year 2020, 2021?

So Sam, you know that we do not give guidance, but let me just say a couple of things. I tried to point this out in my commentary. The business is very revenue sensitive. And given these recent wins, the – my expectation is that the revenue will trend upwards. Obviously, that helps the bottom line performance. We're working hard, obviously, to make the place profitable, and that's my objective. So I'm encouraged by what I see in the way of new business activity. And I'm going to do my best to make sure that that produces improving results.

And just a little follow-up relative to the funded, do we expect this $65 million to be complete in the year 2021? Or what is the time frame we expect the $65 million to be completed in?

So I'm not sure where you're getting the $65 million from, Sam. But let me back up. So I think you might be referring to the contract announcement from July 1, which was $28.6 million. That's not all funded. That – if you read that release, that would include options, which were not exercised. So that again, doesn't – I don't know how you get to $65 million, but you may view…

So that's – how much of the $29 million is funded?

I think it's about $3.5 million? $3 million?

Initial funding was about $3.5 million.

Okay. Okay. Because I took the $36 million, I assume that $29 million was funded. And – but you're saying only $3 million. When do we find out the funding of this $29 million?

Yes. So let me see if I can help you here. So funding, sometimes you get a contract. Let me give you an example, not this specific contract, a hypothetical example. You get a contract for $10 million that has an option for another $10 million. So the total contract value would be $20 million. The base contract for the $10 million may not be fully funded at the onset. So in other words, you can get a contract for $10 million, they only put $2 million of funding against it. But you do have a contract for $10 million. They just fund it incrementally. That's very typical of our contract. So in the backlog, we're only telling you what is actually funded, but that doesn't mean that we don't have additional contract value that – and then on top of that, we have other options, okay? So maybe that make things a little bit clearer for you.

Okay. I’ll come back to the queue.

Our next question is from Michael Eister, Private Investor. Please proceed.

How are you guys doing?

Doing great, Michael. Thank you. How are you?

Hi. The three problem contracts, how much do you think – is that going to affect our earnings in this first quarter?

So, I’ll just give you my confidence level. One of them I said is complete, and that is complete. That's behind us. The numbers are…

Yes, but when was that? Was completed in year-end or in the first quarter?

A few months ago. That one is complete. We have one that is not complete, but we have delivered the initial units. So the risk associated with the engineering development is largely complete. That program will finish up in August, September timeframe. Then we have one program, which is in its final test acceptance, and that finishes up in the late October timeframe, barring some additional problems. So all of them are – one’s done and the others are nearing being done.

All right. I was just wondering if we were going to get hit more on expenses.

The likely scenario is that there won’t be significant additional cost. Now, I can’t guarantee that until we get through the test programs, we’re not done. So, we have to finish up that one. But the signs on the middle one, if you will, are very good because the product works, and it works very well. So it’s been delivered and accepted by the customer. So, the only remaining risk there is really if you have to fix something that the customer finds sort of warranty-related things. The third one is we’re through, partially through the test process. And I don’t think there’s significant risk remaining, but until we finish testing, I can’t guarantee that.

The second one, can you get orders from that?

Yes. There are significant orders downstream associated with that. That is an EW, electronic warfare system, which we’re delivering. And it goes into a navy program. And that’s one – we have been making announcements through the year about that program, which I’m sure you’ve read. So that one we’re looking forward to additional revenues. And that will be a profitable program come down the road.

Oh, that's the Elcom advanced warfare contract?

Yes.

You remember, all right. Thank you.

You bet.

Our next question is from Kurt Caramanidis with Carl M. Hennig Company.

Hi, thank you. As you guys see your revenues probably picking up, do you have a gross margin target in the next six to 12 months?

Higher. We're – I'd like to see it in the 40 range, I guess, would be my reaction to that.

Okay, thank you.

Welcome

Our next question is from [indiscernible], Private Investor. Please proceed.

Hey guys I have kind of a two-parter. Just are you guys involved with the SpaceX program where they're putting up 60 satellites every few weeks now?

No.

Is that something that they're getting products from other people?

I don't know too much about that one. So hard for me to tell you. I think they're – I think it's largely commercial-type stuff, but I'm not too sure.

Okay. And are you looking at doing more contracts on a cost-plus basis? So you – seems like you have more and more of these contract problems over the last year or couple of years now.

So we don't really get to pick the contract type. Cost-plus contracts are used pretty rarely for the types of things we do. So I wouldn't anticipate a significant increase in the percentage of the business that's from cost plus contracts.

Okay. So most of your satellite are not commercial. They're all mostly military-oriented right now?

I'm sorry, which ones are you referring to?

Well, they're putting up the big range on SpaceX, every 10 or 12 days another rocket goes up. And that's all commercially, you're saying?

I'm really not familiar with what you're talking about. If the – we don't bid to SpaceX. We bid to the satellite prime contractors.

Okay. So the end user, I guess, is not what you're talking about.

Yes.

Okay. Thank you.

[Operator Instructions] Our next question is follow-up from Brett Reiss with Janney Montgomery Scott. Please proceed.

Thank you for letting me ask additional questions. You mentioned, Stan, in your prepared remarks, that you're looking to hire additional personnel and engineering talent. Can you describe what type of people you're looking to hire? How many engineers? And is there any issue with finding the people with the skill sets that you're looking for over the next year or so?

So it's a variety of disciplines, mechanical engineering, RS systems engineers, manufacturing engineering, and then on the manufacturing side, it's assembly and test people. We're also hiring some engineering analysts. We do – a lot of what we do – has to do with delivery of analytical reports, which require engineering work. So it's sort of across the board. And we've already hired, I don't know, probably 4, I think, about 4 or 5 folks in the last couple of weeks. And we're interviewing, I don't know, another 3 or 4 this week. So far, we've had no problem finding the people that we need.

Great, thank you.

Our next question is from [indiscernible], Private Investor. Please proceed.

Yeah. Hi, guys. My question is also twofold. I would like to know, besides the Martin lawsuit, are there any other employees who are in the company for age discrimination? And if Martin is the lawsuit, does the company have enough money to survive?

So, yes, we’re not concerned about that. I don't think it would be appropriate for me to comment further on legal stuff at this point.

So were there any other employees that filed suit against the company?

Other employees that filed suit, so I think we have 1 – I don't know which ones you're referring to. I think we have 1 else.

For age discrimination?

Yes, I think we have one.

Besides Martin?

Yes.

Okay. Just curious to know if he wins the suit, are we going to have enough money to move on.

No, I don't think it would be appropriate for me to comment further on the legal cases right now.

Okay, thank you.

Our final question is a follow-up from Michael Eister, Private Investor. Please proceed.

Hi, the 2.7 million contract in June, is that – what part is funded, the synthesizer contract?

Yes, I think it was $1.5 million. I think it was about approximately $1.5 million, Michael.

And are you okay with the materials now that were held up for corona?

Yes. We’re mostly okay. A lot of that had to do with the program I talked about for the EW system, and that caused us some delays there, but we've resolved most of that, and we're delivering – as I said, we delivered that product. So we got that stuff taken care of.

It’s good to hear. And that the big – the $28 million contract, that was what, GPS IIIF?

No, we're not disclosing the specific. It's a classified program.

All right. And how is GPS IIIF coming along?

Very good. That was what was in my comments about the two contracts related to that. We have two different contracts for equipment that goes on to GPS IIIF, both of which are doing very well.

All right. So that big contract, that was a classified contract. All right. Thank you.

Welcome.

We have reached the end of our question-and-answer session. I would like to turn the conference back over for closing remarks.

So thank you, everybody. We appreciate your joining us today, and look forward to talking to you on the next time.

Thank you. This does conclude today’s conference. You may disconnect your lines at this time and thank you for your participation.