Frequency Electronics, Inc.

Greetings and welcome to the Frequency Electronics second quarter fiscal year 2020 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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 for today, Mr. Martin Black, Executive Chairman of the Board of Frequency Electronics.

Welcome, everybody. I'd like to turn this call over to the Chief Executive Officer, Dr. Stan Sloan. Stan? Thank you, Martin. Welcome, everybody. Thanks for dialing in. Let me start off with positive news on the new business front. The number of opportunities we are currently pursuing continues to be robust, about $500 million in potential contracts. We ended the quarter with $40 million of backlog, up from $35 million the previous period. This does not include contract value, which is not yet fully funded, or the value of production options, which are not yet exercised. Quarter two ended with the largest backlog the company has seen since quarter three of fiscal year 2015. Subsequent to the quarter end, we added another $4 million of backlog. The increase in backlog is, of course, a good leading indicator of revenue trends. I'm also pleased to tell you that immediately prior to this call, we received another contract for an additional $4.2 million, which is not yet reflected in our backlog numbers. We continue to be cash positive and have no debt. Now to financial results for the quarter. Steve will walk you through the details, but let me offer a few thoughts before we turn the discussion over to him. Firstly, margin was impacted this quarter by additional engineering costs incurred on a few programs that are finishing up their development phase. Keep in mind that much of what we do is pushing the state of the art, and the amount of effort required to solve complex technical issues can sometimes be unforeseen. This is typical of development programs where the technical issues tend to appear at certain cyclical points in the process, and that creates a lumpiness in the amount of engineering needed to resolve them. As we complete development and transition to production on these programs in the coming months, I would anticipate less cost fluctuation. These programs will generate future top line and bottom line growth once through this transition. Secondly, revenue reductions resulting from SLFs and anticipated contract awards impact not just the top line but bottom line as well due to underabsorption of overhead costs. I think the best indicator that this will turn around is what I said in my opening about increasing backlog. Finally, we will maintain our continuing focus on improving operational efficiency, cost reduction, and quality, not to mention technical innovation and excellence. With that, let me turn the call over to Steve, and he can take you through the financial details. Steve?

Thank you, Stan. Good afternoon. For the six and three months ended October 31, 2019, consolidated revenue was $21.6 million and $9.1 million for the prior fiscal year. The components of revenue for the six-month period are as follows. Revenue from commercial and U.S. government satellite programs was $9.4 million compared to $11.3 million for the same period of the prior fiscal year and accounted for approximately 44% of consolidated revenues compared to 49% for the same period of the prior fiscal year. Revenues on satellite payload contracts are recorded 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 Zyphra segments, are $9 million compared to $10.4 in the previous fiscal year and accounted for approximately 42% of consolidated revenues compared to 45% for the prior fiscal year. Other commercial industrial revenues was $3.2 million compared to $1.4 million in the prior fiscal year. Intersegment revenues are eliminated in consolidation. For the six- and three-month periods ended October 31, 2019, gross margin and gross margin rate decreased to 12.8% and negative 13% as compared to 35.8% and 33.1% for the same periods in fiscal 2019. The gross margin and gross margin rate was impacted by increases in engineering costs incurred on several programs which in development phase and which encountered unanticipated development challenges related to customer-driven technical requirements. Gap accounting requires that at the time a loss is anticipated on a contract that the entire estimated cost to complete is accrued at that time. In the quarter just ended, we had two development programs fall into this accounting with an impact of recognizing an approximately $4 million charge to cost the goods sold. For the six and three months period ended, October 31st, 2019, S&A expenses decreased compared to the same periods in fiscal 2019. For the six months ended October 31, 2019 and 2018, selling and administrative expenses were approximately 22% of consolidated revenues for both periods. While S&A expense remains even as a percentage of consolidated revenue, during the six months ending October 31, 2019, as compared to the six months ended October 2018, the actual dollar expenditures decreased by $439,000. Research and development expenditures represent investment intended to keep companies' products at the leading edge of time and frequency technology and enhance future competitiveness. The R&D rate for the six months ending October 31, 2019 was 17% of sales compared to 14% of sales for the same period of the previous fiscal year. The R&D rate for the three months ended October 31, 2019 was 16% of sales as compared to 13% of sales for the same period of the previous fiscal year. For the six and three months ending October 31, 2019, The company recorded an operating loss of $5.7 million and $4.9 million compared to $146,000 and $230,000 for the prior fiscal year. The change is largely attributable to the increasing engineering costs described previously. The increased costs affects gross margin and operating income. Other income consists primarily investment income derived from the company's holdings of marketable securities. With the six-month period ending October 31st, 2019, other income included $125,000 dividend from Morion compared to $105,000 dividend in the previous fiscal year. This yields a pre-tax loss for the six and three months period ended October 31st, 2019 of approximately $5.5 million and 4.9 million compared to a pre-tax income of approximately $131,092 for the prior year. For the six months ending October 31, 2019, the company recorded a tax provision of $29,000 compared to $23,000 tax benefit for the same period of fiscal 2019. For the six months ending October 31, 2019 consolidated net loss was $5.5 million or $0.61 per diluted share compared to income of $153,000 or $0.02 per share for the same period of the previous fiscal year. For the three months ending October 31, 2019 consolidated net loss was $4.9 million or $0.54 per diluted share for the same period of the previous fiscal year. For the six-month period ending October 31, 2019, the company generated positive cash flow from operations of approximately $180,000. Our fully funded backlog at the end of October 2019 was approximately $40 million, up approximately $5 million from the previous quarter. Thank you, Steve. I'm sure our