Frequency Electronics, Inc.

Greetings and welcome to the Frequency Electronics first quarter fiscal year 2022 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, Stanton Sloan, President and CEO.

Thank you. Good afternoon, everyone. Thanks for joining us today to discuss FEI's first quarter of our 22 fiscal year. Following my comments, I will ask Steve to provide financial details, after which we will take questions. Underlying financial trends were generally stable this quarter, and while unusual legal expenses impacted income and cash generation, the bulk of these expenses are now behind us. Steve will give you a detailed explanation of the accounting associated with the litigation settlement in a minute. The COVID pandemic also impacted us in the quarter. due mostly to supply chain issues and customer delays in processing new contracts. Most exciting this quarter, however, is the new technology which we've embarked upon, highlighted in our August 18, 2021 press release, which will result in a new and very advanced atomic clock for space, defense, and commercial applications. This pulsed, optically pumped rubidium atomic clock will be a game changer in the marketplace. We also continue to evaluate other advanced technologies for potential development as well. These new technologies will be the growth engine for the company in the years to come and will enable spin-off technologies and products that will accelerate growth further. From my point of view, the company is at an inflection point. With the distractions of litigation behind us, some new and promising technology developments ahead of us, the imminent commencement of the qualification program for our space-qualified GPS atomic clock about to begin, and a robust portfolio of new business opportunities to tackle, FEI's prospects never been brighter. Now let me turn things over to Steve to discuss the financial data for the quarter.

Steve? Thank you, Stan, and good afternoon. For the three months ended July 31, 2021, Consolidated revenue was $13 million, which is consistent with the same period of the prior fiscal year. The components of revenue were as follows. Revenue from commercial and U.S. government satellite programs was approximately $6.7 million, which is consistent with the same period of the prior fiscal year, and accounted for approximately 52% of consolidated revenue compared to 51% for 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 Zephyr segments, were 5.5 million compared to 5.3 million in the same period of the prior fiscal year and accounted for approximately 42% of consolidated revenue compared to 41% for the prior fiscal year. Other commercial and industrial revenues were $725,000 compared to $965,000 in the prior fiscal year. Intersegment revenues are eliminated in consolidation. For the three months ended July 31st, 2021, the gross margin and gross margin rate were consistent with the same period of the prior fiscal year Gross margin was affected by variation in engineering costs associated with programs in their development versus production phase and external issues such as COVID-19 related supply chain impacts. For the three months ended July 31st, 2021 and 2020, selling and administrative expenses were approximately 34% and 25% respectively of consolidated revenue. The increase in SG&A expense was mainly due to an increase in professional fees associated with ongoing litigation and fluctuation in other expenses. The company anticipates that SG&A expenses will decrease following settlement of the litigation issue. R&D expense for the three months ended July 31, 2021 and 2020 increased to $1.4 million from $1.2 million, an increase of $200,000, and were 10% and 9% of consolidated revenue. The company's R&D expense increased year over year as R&D efforts have begun on new product development. The company plans to continue to invest in R&D to keep its products at the state of the art, as well as work on developing new technologies. For the three months ended July 31st, 2021, the company recorded an operating loss of $1.7 million compared to $300,000 in the prior year. In addition to factors cited above, increased professional fees associated with litigation significantly contributed to the company's operating loss for the period. Other factors that contributed were the continuing effects of the COVID-19 pandemic and engineering costs cited above. Other income consisted primarily investment income derived from the company's holdings of marketable securities. Earnings on marketable securities may vary based upon fluctuating interest rates, dividend payout levels, and the timing of purchases, sales, redemptions, or maturity of securities. The fluctuation in other income expense was due to less interest expense and higher other income compared to the same period of the prior fiscal year. This yields a pre-tax loss of approximately $1.6 million compared to $300,000 for the prior year. For the three months ending July 31st, 2021, the company recorded a tax provision of $1,000 compared to $9,000 for the prior fiscal year. Consolidated net loss for the three months ended July 31st, 2021 was $1.6 million or $0.17 per share compared to $300,000 net loss or $0.03 per share in the previous fiscal year. Our fully funded backlog at the end of July 2021 was approximately $37 million, down approximately $3 million from the previous fiscal year ended, April 30, 2021. The company's balance sheet continues to reflect a strong working capital position of approximately $40 million at July 31, 2021, and a current ratio of approximately 3.6 to 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 foreseeable future. Now for an explanation of the accounting associated with the legal settlement that was announced on August 25th via the company's 8-K filing. When you look at the balance sheet, you will see a current asset for $6 million called cash surrender value of life insurance current and a current liability of $5.3 million called deferred compensation current. The company surrendered life insurance policies and used available cash from deferred compensation plan assets, which were previously classified as non-current assets, to cover the $6 million mentioned above. The $5.3 million deferred compensation current is a liability previously accrued and was moved from long-term liability to current liability as a result of the settlement. The difference between these two amounts of approximately $646,000 was recorded as an increase to accrued liabilities current and a corresponding charge to deferred compensation expense in the P&L. The effect of this settlement will be to reduce deferred compensation assets by $6 million, reduce deferred compensation liability by $5.3 million, and increase deferred compensation expense in the P&L by $646,000. There is no effect on the company's cash, cash equivalents, or marketable securities as a result of the settlement. I will turn the call back to Stan, and we look forward to your questions soon.

Thanks, Steve. We'll take some questions now, and we'll let the operator explain to you how you can submit those. Operator?

Thank you. We'll now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is from Michael Cooper, private investor. Please proceed with your question.

Hi, Stan. Hi, Steve.

Hi, how are you? Fine. So I've been a pretty patient investor in frequency electronics for five years, and I know a lot of people have been in there for 20 or 25 years and with very little to show for it. And now you've come up with what seems to be some very strong technology that introduces new value to the company, but we have, as investors, no way to assess what that is, what it means. Can you give us some kind of, like how does this leverage the leadership position of frequency in your current space markets, in your military and defense markets? but also the new commercial markets that could open up to you. What does this mean? Thanks.

So in the world of atomic clocks, it's really all about stability. And this technology will produce a clock that has much better stability than, for example, our current products. And it will have applications Not only for space, but we intend to develop versions of it for non-space and also potentially for communications, commercial communications. Now this development, we're just starting the development. The initial technological hurdles that, you know, impeded the development of this sort of thing, we have behind us now. So we're starting the development. The development will take some time depending on, whether we can attract government money or not. But once this is developed, we would expect it will be a game changer initially for the space market. And then I think the defense and tactical market would follow shortly and then commercial potentially after that.

So what's your total addressable market with this?

technology or space and defense that's on the order of 450 to 500 million dollars annually and then commercial a little harder to calibrate but probably equal or bigger on the commercial side is the database or a data center

market. There's half a million data centers out there and I understand that synchronization of high speed data flows could be an application for atomic clocks. Do you fit into that kind of market now?

Yes, we would want to target that market as well.

So there's one major supplier that has 90% of that market, correct?

I don't know if it's 90%, but depending on where you're talking about geographically, but okay.

So your technological strength, your reliability, and your cost, I assume, advantage, you think that would be enough to dislodge the current force in the market?

I think that we should be able to capture significant market share. Now, I do have to point out that this product's not completed development yet. So if you take the space version and the terrestrial version for defense and then the commercial version, those all look quite different. They're targeted at different markets. They'll have different features. All of those things are subject to development now. We're just starting the development process.

And for taking these things to market, especially the new markets, would you partner with people that already have significant channels into those markets?

Sure. You know, there's a variety of business markets, particularly if you're talking about the commercial marketplace, that we would leverage. So, yes.

Okay, great. Sounds very exciting.

It is. I'm very excited about it.

Thanks, Dan.

Yeah.

Thank you. Our next question comes from Richard Johns, private investor. Please proceed with your question.

Good afternoon. My first question has to do with this $650,000 final, apparently, litigation settlement expense. Did it show up in the July quarter, or is that going to be accrued in the October quarter?

No, it was accrued in July. It's on the P&O now.

Okay, okay. And the news about the new rubidium clock is exciting. I want to go back, though, and refer to the other products you have. You've mentioned in the past that you've had bids outstanding of, 600, upwards of 600 million. I think the last number I remember was 500 million. Are we still looking at, now those numbers don't relate to the new rubidium clock, so are we still looking at that kind of potential for the existing products?

Yes, the bids outstanding hasn't changed a whole lot, and I have to recognize that things come into that and things go out of that, so it's dynamic. But it's about that level right now, and you are correct. That does not include anything associated with this new technology development.

Okay. And I know you don't like to make specific forecasts, but is the period of development for the new rubidium clock, the applications, Is it going to be measured in quarters or years? What would you say?

It's very dependent on whether we can attract government funding or not, which we're working on. But without the government funding, you're talking about a few years to get that to the market.

And, I mean, with this kind of technology, wouldn't government funding be pretty much a sure thing? We would certainly hope so. Okay. All right. Thank you.

Thank you. Our next question is from Sam Robotsky with SDR Asset Management. Please proceed with your question.

Good afternoon, Stanton and Steve. When do we expect this to flow into the backlog? Do we expect to get products out there in a year or two years? What do we expect to accomplish?

You're referring to the advanced development I just talked about, correct?

Yes, the rubidium.

Again, that's highly dependent on the government. Let's say, hypothetically, that Monday the government awarded us a contract. Well, that will immediately go into backlog. It depends on that. Without any government funding and internal developments, you're not looking at a backlog impact in the near term.

Okay. And I guess our main customers are Lockheed and Grumman, and they would be the ones that would give us some more business, whether it's for Bidium or what we're working on. Is that what we're looking for?

So for the space version of that clock, it would be our usual customer set. So it would be the big aerospace primes for the U.S. defense market. And then commercial, there are some potential commercial space and non-U.S. government space jobs that, you know, for folks that – are currently fielding satellites in Europe, for example. And then on the terrestrial side, it's the fence primes, also potentially some direct government sales to the government agencies that install and operate communication networks themselves, for example.

All right. Thank you very much. Hopefully you'll get some contracts soon and that you could be profitable going forward. Good luck.

Thank you. We're working on it.

Thank you. Our next question is from Brett Reese with JANI. Please proceed with your question.

Hi, Stanton. Hi, Steve.

Hi, Brett.

Hi. You mentioned in your prepared remarks that, you know, apart from the Rebidian advanced atomic clocks, you're working on other advanced technologies, you know, without, you know, letting the cat out of the hat with trade secrets. Can you just give us a little bit more color on, you know, the areas you're working on there?

I can't get into too much detail, but we're evaluating another potential atomic clock technology that, It's premature to get into too much detail about, but on the atomic clock side, and that's technology totally different than the rubidium clocks. And then, of course, we continue to work on our, what I would call our core technology portfolio, the precision quartz oscillators and frequency conversion stuff and all of that. That's still ongoing, and that's part of our internal research and development program.

Right. Now, the type of clock that is on the satellite that helps a customer prevent hacking and spoofing, what type of clock is that?

It's a very good clock.

All right.

Okay. You want a very precise clock, a very good holdover, so it tends to be a very high-performance type of clock.

Okay. Now, on the last call, you were looking to hire another 10 people. In this last quarter, were you successful in accomplishing that?

Yeah, I don't remember exactly the timing, but our employment's up about, I think, about 15 people since the start of the year, roughly. So I think my answer to you is yes.

Okay. Great. Thank you for always taking my questions.

You bet.

Thank you. Our next question is from Michael Eisner, private investor. Please proceed with your question.

Good day. How are you? Hi, Michael. Hi. All right. I'm guessing you have about 255 employees now from what the numbers are, if I'm correct?

Yeah, that's approximate system-wide.

All right. Was the lumpiness for this quarter, was that because of when revenue is recognized or COVID issues or supply chain issues?

All of the above.

Everything. All right. And you mentioned before one company is 90% of this business. Are we 10 times better time stability than they are, as in your press release on August 18th?

I'm sorry, Michael. I missed the last part of your question. You broke up. Would you say it again, please?

All right. On your August 18th press release, you said you're 10 times – Better time stability with this technology.

Yeah, that's what I was alluding to earlier. The better the clock, the better the stability. Or the better the stability, the better the clock, I guess.

Then the customer that has 90% of the market now.

I think the reference that you're talking about there was to market share, a company.

Yes, yes. Yes.

So our intent is to provide a better clock at competitive price and capture part of that market share.

Well, is it 10 times better time stability compared to them?

Yeah, much better time stability. That's the objective of this clock, much higher stability.

And we may not see revenue for a while.

Well, it's going to take a little while to get it developed, again, depending on... how successful we are in attracting government funding.

All right. And the GPS 3F, I saw that SVO 06, 07, and 08 are ready for launch.

That's not GPS 3F. That's GPS 3.

All right. So where are we on 3F?

So on 3F, our DRAFs, our Digital Rubidium Atomic Frequency Standard, DRAFs, is about ready to start its qualification program. So that, to me, is a great success. We've got to get through qualification, but all indications are that that clock is performing exceedingly well. So that process will start now. It takes a couple months to get through qualification.

Was that number 11 that you're trying to get on, or were you able to get on number 10?

Number 10, SV-10 is a GPS-3 satellite, not GPS-3F. We will not be on 11. We won't be on the early GPS-3F satellites. It will probably be the later ones.

Which is what number?

Well, I don't know. That depends on the qual program and when Lockheed Martin elects to exercise its options.

All right. Thank you.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for any closing comments.

Great. Thank you. Let me thank everybody for joining us today. It's been an interesting quarter, an exciting one, I think, from my point of view. And we look forward to updating you with more news next quarter between here and there. I would encourage you to watch the press releases and see how we're doing. So thanks, everybody. We'll talk to you next quarter.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful evening.