Frequency Electronics, Inc.

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. 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 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 Sloan, 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 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 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 Zephyr 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, for 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 the 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 from 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 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 six 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 U.S. government satellite programs was approximately $13.3 million or 51 percent compared to 14.2 million or 53 percent 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 U.S. government and DOD customers, which are recorded in both the FEI New York and FEI Zephyr 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 six months ended October 31st, 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 costs 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 material, and or 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 six months ended October 31st, 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 six months ended October 31st, 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 six months ended October 31st, 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 to operating income as well. It is important to mention that for the three-month 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 six months ended October 31st, 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 on 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 six-month ended October 31st, 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 pre-tax loss of approximately $1.1 million compared to $92,000 of pre-tax income for the prior year. For the six months ending October 31st, 2021, the company recorded a tax provision of $2,000 compared to 25,000 for the prior fiscal year. Consolidated net loss for the six months ending October 31st, 2021 was 1.1 million or 12 cents per share compared to 67,000 of net income or 1 cents 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 30th, 2021. The company's balance sheet continues to reflect a strong working capital position of approximately $40 million at October 31st, 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. Ladies and gentlemen, the floor is now open for your questions. If you would like to enter the queue to ask a question at this time, you may press star 1 on your telephone keypad to enter the queue. We ask if listening on speakerphone this afternoon to please pick up your handset while asking your question to provide optimal sound quality. Once again, ladies and gentlemen, you may press star 1 on your telephone keypad at this time to ask a question. Please hold a moment while we poll for questions. And we do have a person in queue. And once again, as a reminder, ladies and gentlemen, you may press star 1 on your telephone keypad at this time. Enter the queue to ask a question. And we have a question from Michael Eisner.

Hi. 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. 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 I don't think that's just us. Our customers are telling us they have the same issues. So, you know, basic electrical parts are taking longer. And, you know, 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 delays.

I'm sorry?

We have seen some delays in delivery of parts.

All companies are having delays. I just wanted to know how extreme. I think you were working on to finish qualifications for GPS 3F, the stock deduction, if I remember.

That's correct.

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, 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 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 the performance on the clock is such that it's low risk to order it 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. Yeah. All right. Good job overall. You made money on the $12.9 million in revenue. Thank you. Thank you.

Yeah.

Thank you. Once again, as a reminder, ladies and gentlemen, anybody who would like to enter the queue may press star 1 on the telephone keypad at this time to ask a question. And we have a question coming from Brett Reese from Danny Montgomery Stock. Brett, your line is live. Please go ahead.

Hi, Stanton. Hi, Steve. Hi, Brett. 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, you know, metric on that? And who would your major competitors be in that, you know, 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.

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.

Right.

You have Asian competitors at the low end. You have European competitors that, you know, produce – fairly similar types of oscillators. And there's a variety of competitors in the U.S., depending on whether you're talking about the basic resonator part or the finished oscillator product.

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

For government and military, yes. Okay.

Okay. The R&D, you know, which keeps, you know, 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. 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, 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 impact 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 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 really got to think about it a little differently. You think about the company a little differently now.

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

Oh, yeah. I think we're – you know, it's – so it's easy for me to get excited about these new technology developments, but from a – a national from the U.S. 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, you know, 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. I think we're very well positioned.

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

You too. Thank you.

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

Good afternoon. Hi. Hi. I just want to try to continue the conversation you were just having. You know, 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 three or four or five 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's still moving along at a quarterly rate of $12 million, $13 million in in revenues and so it seems to me that they're in the relatively near term or at least you know well yeah the relatively near term aren't we due to start getting revenues from all of those bids that we put we put out there in recent years well we certainly hope so you know you have to you have to bid then you have to win the bid

before it converts to revenue. We're working hard to keep that pipeline going. As soon as those things are adjudicated and get on contract, then you'll start to see the revenue pick up.

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 companies are 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, you know, 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 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 still.

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're talking about doubling the revenue. That's pretty challenging, so it takes some time to do that.

Well, 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 two years that the bids would turn into orders. And that was more than two years ago. So, you know, 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. And as a reminder, ladies and gentlemen, if anyone would like to enter the queue, it is star 1 on your telephone keypad. We do have a follow-up question from Michael Eisner. Michael, please go ahead.

Thank you. One final question. That contract we're talking about, the post-optically pumped rubidium, does anyone in the U.S. make the same product in quality?

No, not that I'm aware of.

All right. You haven't even heard of anyone doing it, huh?

Europeans are researching 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 even if they had something... The government right now wants probably everything made in the U.S.

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

Well, probably this clock we're talking about, are you allowed to say whether it's military or it's government?

Yes, the contract 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 U.S. There may be, but we're not aware of it. There could be, I understand.

They could be not putting out any news, basically. All 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 Sloan 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. 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.