Frequency Electronics, Inc. (FEIM) Q2 2022 Earnings Report, Transcript and Summary

Greetings. And welcome to the Frequency Electronics Second Quarter Fiscal Year '22 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 the forward-looking statements. Factors that would cause or contribute to such differences are included in the company's press release 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 to our second quarter fiscal '22 earnings call. Thanks for joining us. Before I turn the call over to Steve to take us through the financial details, let me offer a few comments on Q2. First of all, I'd say [ph] I'm very pleased with the improvement in operating income and net income for the quarter. Cash generation also very positive. It's the highest it's been, with the current cash and marketable securities balance now at approximately $20.6 million. Of course, we continue to be debt free also. While the revenues were a bit lower for the quarter, principally in our Zyfer operation, those bookings are just delayed, and we do anticipate that they will come in. So it's timing. Moreover, we've had some significant opportunities that we've been pursuing related to advanced technology developments, which we hope to announce contract awards in the near term. In Q1 and Q2, we ramped up our internal R&D investments in some of these new technologies related to atomic clocks and low-noise oscillators. And we expect these to produce long-term increases in revenue and position the company to compete in marketplace with next-generation products. If you recall, I mentioned those R&D investments also on our last call and said that I was hopeful of important contract awards. That was followed by the POPRAFS contract The Office of Naval Research, which we announced last quarter. We're working hard to continue that trend. And I'm optimistic that we'll see some additional awards in the near term. I believe we have the right focus on technology. I'm very optimistic that we will receive additional contracts for truly groundbreaking product developments. The research and development investments we've made are clearly starting to pay off, but obviously, we're not going to stop there. We'll continue to push FEI into the forefront of precision and time generation products for government space and telecom applications. With that, I'm going to turn it over to Steve for some comments, and then I'll be back with you. Steve?

Thank you, Stan. And good afternoon. For the 6 months ended October 31, 2021, consolidated revenue was $26 million compared to $27 million for the same period of the prior fiscal year. The components of revenue are as follows. Revenue from commercial and US Government satellite programs was approximately $13.3 million or 51% compared to $14.2 million or 53% in 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 US Government and DOD customers, which are recorded in both the FEI-New York and FEI-Zyfer segments, were $10.6 million compared to $10.9 million in the same period of the prior fiscal year and accounted for approximately 41% of consolidated revenue compared to 40% for the prior fiscal year. Other commercial and industrial revenues were $2 million compared to $1.8 million in the prior fiscal year. Intersegment revenues are eliminated in consolidation. For the 6 months ended October 31, 2021, 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 increased engineering cost on development phase programs that experience particularly complex technical challenges, as well as cost impacts on several programs resulting from supply chain problems, lack of availability of parts and materials and quality problems with traditional vendors, resulting 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, re-procurement of circuit boards and mechanical parts was necessitated by quality issues in the supply chain, further contributing to increased costs. For the 6 months ended October 31, 2021 and 2020, selling and administrative expenses were approximately 26% and 27%, respectively, of consolidated revenues. The 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 6 months ended October 31, 2021 and 2020 increased to $2.7 million from $2.2 million, an increase of $500,000 and were 11% and 8% of consolidated revenue. R&D increases in the first and second quarters of fiscal '22 were due to higher-than-usual 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 6 months ended October 31, 2021, the company recorded an operating loss of $1.4 million compared to an operating loss of $120,000 in the prior year. The factors cited above in the gross margin discussion are applicable [ph] to operating income as well. It is important to mention that for the 3 months period ending October 31, 2021, the company reported an operating profit of $303,000, a significant improvement from the first quarter. Other income - I'm sorry, for the 6 months ended October 31, 2021, the company recorded an operating loss of $1.4 million compared to an operating loss of $120,000 in the prior year. Other income consisted primarily of investment income derived 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 maturities of securities. For the 6 months ended October 31, 2021, investment income included $123,000 dividend from Morion compared to $105,000 dividend from Morion in the same period in fiscal '21. This yields a pretax loss of approximately $1.1 million compared to $92,000 of pretax income for the prior year. For the 6 months ending October 31, 2021, the company recorded a tax provision of $2,000 compared to $25,000 for the prior fiscal year. Consolidated net loss for the 6 months ending October 31, 2021, was $1.1 million or $0.12 per share compared to $67,000 of net income or $0.01 per share in the previous fiscal year. Our fully funded backlog at the end of October 21 was approximately $38 million, down approximately $2 million from the previous fiscal year ended April 30, 2021. The company's balance sheet continues to reflect the strong working capital position of approximately $40 million on October 31, 2021, and a current ratio of approximately 5 to 1. Additionally, the company is debt free. The company believes that its liquidity is adequate to meet its operating investing needs for the next 12 months and foreseeable future. I will turn the call back to Stan, and we look forward to your questions.

Thanks, Steve. I'll turn the call over to the operator now who will explain how you ask your questions. Operator?

Certainly. [Operator Instructions] And we have a question from Michael Eisner [ph]

Good job. The last two contracts you announced in September and October, what percent of that is in the backlog?

Well, I won't give you a percent. Collectively, it's around $5 million, a little over $5 million between the two contracts.

That's what I meant. So about $5 million. How - as of now, how are the supply chains and custom, any delays?

Well, we're seeing longer times to get parts and materials. And I think that's universal. I don't think that's just us. Our customers are telling us they have the same issues. So basic electrical parts are taking longer, and we're doing our best to keep ahead of that. But I'm hopeful that things will start to settle down. We have seen some delay.

I am sorry.

We have seen some delays in delivery of parts.

All companies are having delays. I just want to know how extreme - did you - I think you were working on to finish qualifications for GPS IIIF, the stock deduction, if I remember.

That's correct.

What - did you finish qualifications, or where are you with that?

It's not quite finished, but it's getting pretty close. The qual program should be complete within the next, I'd say, a month or two. And at that point, we have a long-term aging test, which we have to go through, but the qual program will essentially be finished shortly.

So how long after that's complete can you start production?

We can start production today. I think the question is how far along do we need to be before the customers are prepared to you know, issue options to us. Theoretically, it could be at the end of that aging process, I'm hopeful that they'll do it sooner. I think our track record and performance on the clock is such that it's low risk to order right now. So we're working hard to get them to order it, but I can't tell you how that will come out yet.

So it will be a couple of months?

That's probably likely.

All right. And did you hire more people? I think you had like 255 employees last quarter?

Yeah, we're pretty stable since last quarter. I don't think we've changed much in employment. We have some job openings, which we're planning to fill. But the total number of employees from last quarter is about the same.

So you may hire a few more?

Yeah. We have some openings and we're actively recruiting.

Is it still hard to find people?

Always hard to find good people. We've been pretty successful in our recruiting efforts, though. I'm pretty encouraged by that. So I don't think we'll have a problem.

Well, qualified people, I should say. All right. Good job overall. You made money on a $12.9 million revenue.

Thank you. Yes.

Thank you. [Operator Instructions] We have a question coming from Brett Reiss from Janney Montgomery Scott. Brett, your line is live. Please go ahead.

Hi, Stan. Hi, Steve.

Hi.

Could you just give me a brief tutorial, what is a low-noise oscillator used for?

They're critically important for communications and radars and other systems where you want the purity of the frequency to be very good. So you don't want a lot of noise. It's noise that's off of the frequency that contributes to it. So basically, it's a high performance oscillator. I guess we could call it high performance instead of low-noise. But they're very important for things like radar and communications, Electronic Warfare.

Okay. And is there like a total addressable market metric on that? And who would your major competitors be in that part of the business?

Well, there's a variety of competitors depending on what level of performance you're specifying, so a little difficult to give you an answer. The market size for the kind of oscillators that we produce here is probably a couple of hundred million dollars.

Hello?

Yeah.

You cut out. I'm sorry, I don't know whether it's my end or your end.

Yes. A few hundred million dollars is the market for that kind of oscillator.

Okay. And who are our major competitors?

It's a variety of people, depending on - again, on the particular specifications that you have. But you have Asian competitors at the low end. You have European competitors that produce fairly similar types of oscillators. And then there's a variety of competitors in the US, depending on whether you're talking about the basic resonator part or the finished oscillator product.

Would there be an inclination by US customers to buy that type of product from a US manufacturer as opposed to a foreign manufacturer?

For government and military, yes.

Okay. Is the R&D, which keeps moving up, is it kind of equally divided between the atomic clock initiatives and the low-noise oscillator? I guess, which area are you most excited about and see the most opportunity for the company?

So the total R&D program lately is more biased towards the atomic clocks. And let me spend a little bit of time on that because I think it's really important to understand what we're doing to position the company for the long term. These - the optically pumped clock that we announced last quarter will result in a new type of atomic clock that has significantly improved performance over the current rubidium type atomic clocks. And that is going to open up a significant market opportunity for us. We're competing for some other technologies. And like I said in my comments, I'm optimistic that we're going to win one or more of those things. And the more of these new technology clocks and oscillators that we have, the more that we can think about the company having significant upside in terms of revenue. Now that - these things are developmental. So you can't look at next quarter's financial performance being significantly affected by these, although they do produce revenue. But you've got to think about the long-term effects of these things for the company. It's significant. You're talking about opening up hundreds of millions of dollars of market opportunity from these new products. So I want to make sure I convey that because we tend to get wrapped up in the current quarter or last quarter's financial performance, and I don't want to imply that we're not focused on continually improving that, we are. But you've really got to think about what we're doing with the company for the long term. And these things are very significant technical developments and advancements. You've really got to think about it a little differently and think about the company a little differently now.

Right, right. There isn't a day, Stanton, that goes by that you don't read about the increasing competition between the United States and China in the satellite space arena. Are all - I would take it that, that's a tailwind for potential market opportunities, not a headwind.

Well, yeah. I think we're - you know what - so I - it's easy for me to get excited about these new technology developments, but from a national - from the US perspective, staying ahead of the players that you just referred to, is critically important. So to me, it's a very significant tailwind. And that's why the government is investing in development of these new technologies. And that's the best indicator that I can tell you that there's going to be a tremendous market there. The government sees it, and they're funding it. So I think we're very well positioned.

Great. Thank you for taking my questions. And if I don't speak to you or Steve before the holidays, have a good holiday and a good New Year.

You too. Thank you.

You too.

Thank you. Your next question is coming from Richard Johns [ph] Richard, you line is live. Please go ahead.

Good afternoon. I just want to try to continue the conversation you were just having. I'm an old guy, and I'm not sure what the long term is going to bring for me. And I understand that you've made great technical advances recently, and I'm encouraged that they might bring revenues in the long term. But over the past 3 or 4 or 5 years, we've talked about bids out there for $500 million, $600 million, $700 million worth of possible orders and we were hoping that maybe we'd get half of those. And the company is still moving along at a quarterly rate of $12 million, $13 million in revenues. And so it seems to me that in the relatively near term or at least - well, yes, the relatively near term, aren't we due to start getting revenues from all of those bids that we put out there in recent years?

Well, we certainly hope so. You have to bid, then you have to win the bid before it converts to revenue. So we're working hard to keep that pipeline going. And yeah, as soon as those things are adjudicated and get on contract, then you'll start seeing the revenue pick up.

And so is your message really that the new exciting technical developments that you've achieved can bring in significant revenues in the long term, but that in the near to intermediate term that the company is going to start to see a surge in revenues related to this business that I've been talking about?

Well, we're always working hard to get the revenue base up. So we bid everything we can bid. That's a near term thing. My point about the longer term was that if you think about the company's growth over the long term, I don't see it being a sort of a linear process. I think it's going to be a large step function. That's the way I see the market, and that's how I think these products will end up in the marketplace. Between here and there, we keep bidding, we keep working on improving profitability and operational efficiency and that sort of stuff, so.

So for the company to get to $100 million in revenues, are we going to need that big step in the long term? Or are we going to get there sooner than that?

I wish we could get there Monday. But you talk about doubling the revenue, that's pretty challenging. So it takes some time to do that.

Well, I'm not - I've got to say, Stan, I'm not timid about talking about a doubling of revenue because when we were talking about the $500 million, $600 million, $700 million of bids out there, the next question was, well, how long would it take for those bids to turn into revenues? And my recollection of the answer - and I know that you don't have a crystal ball. But my recollection of the answer was that maybe within 2 years that the bids would turn into orders, and that was more than 2 years ago. So I'm feeling a little frustrated.

Well, we're working hard to get the revenue up. So all I can tell you is everybody's got their nose to the grindstone.

Okay, all right. Thank you.

Thank you. [Operator Instructions] We do have a follow-up question from Michael Eisner [ph] Michael, please go ahead.

Thank you. One final question. That contract you were talking about, the Pulsed Optically Pumped Rubidium, does anyone in the US make the same product and quality?

No, not that I'm aware of.

All right. Is anyone - you haven't even heard of anyone doing it?

Europeans are researching a similar technology. That's actually how we got started on this a few years ago. But I'm not aware of them having a product ready for market. As far as I know, it's still a research over there.

So where the - well, even if they had something, the government right now wants probably everything made in the US?

For government and military programs, that's a true statement.

Well, probably this clock we're talking about, that's - are you allowed to say whether it's military or - it's government. So it does say it's a US Government?

It was from the Office of Naval Research.

Yeah. So we're the only one that can do this at this point?

Well, no, let me - I don't want to misstate. I'm not aware of anyone else working on a Pulsed Optically Pumped Rubidium Clock here in the US. There may be, but we're not aware of it. We...

There could be. I understand. They could be not putting out any news basically.

Right.

All right, thank you.

You bet.

And there are no further questions in queue at this time. I would now like to turn the floor back to Stanton Sloane for closing remarks.

Thank you, and thanks, everyone. From all of us here at FEI, we wish everybody a happy, safe, healthy holiday and a great 2022. We look forward to talking to you on the next call. Thank you, everybody.

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