3/10/2022

speaker
Operator

Greetings, and welcome to the Frequency Electronics third 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 constitutes 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 obligations to update these statements for revisions or changes after the date of this conference call. It is now my pleasure to introduce your host, Santon Sloan, President and CEO.

speaker
Santon Sloan

Thank you. Welcome, everybody. I'm glad that you could join us today. Before I turn this over to Steve to take us through financial details, let me offer a few thoughts. Third quarter was challenging, particularly in our Zephyr operation, due to delays in bookings and the reduced revenue that resulted from that. We haven't seen any competitive losses there, just delays, so we anticipate these bookings will still come in. We're taking advantage of the lull in production to transition manufacturing from California to a New York facility, which will have the compound effect of significantly reducing costs at Zephyr and reducing manufacturing overhead costs for the Zephyr products that will be manufactured in New York. This will result in benefits over the long run. In the New York operation, we were hit with a severe round of COVID-related employee absences, which affected the quarter's revenue and operating income. Despite the challenges, we saw an increase in revenue for the quarter compared to the first two quarters, as well as compared to Q3 of fiscal year 21. Bookings for the fiscal year are solid, running well ahead of where we thought we'd be for the year, and up about 30% from this point last year for the New York operation, and up about 21% overall for the company. Backlog is now up to $41.6 million, and the overall book-to-bill ratio for the quarter was a healthy 1.27 for the company, but an even better 1.4 in the core New York operations. As usual, we generated cash from operations, $4 million for the year so far, and cash and marketable securities currently stand at $22.2 million, up $2.1 million from year-end fiscal year 21. We also remain debt-free. On the technical front, our digital rubidium atomic clock for the GPS3F program is progressing extremely well through its qualification testing, and we have in production additional units one of which will be used for long-term testing on the ground by the government, and one which is planned to fly on a GPS-3 satellite to validate its operation in space. Our pulsed optically pumped rubidium atomic clock is progressing well in its design phase also. Laboratory testing has indicated its performance will be outstanding, ultimately enabling better holdover times and helping mitigate GPS jamming and spoofing. The Mercury ion clock development is also underway. In addition to these two Office of Naval Research funded projects, we are pursuing a variety of new technology opportunities with various government agencies for not only advanced atomic clocks, but also some new technologies unrelated to clocks as part of our effort to grow top and bottom line. While I can't go into the details here, These are exciting opportunities, and I look forward to sharing more about these as things progress. With that, let me ask Steve to cover financial details for you, and after that, we will take some questions. Steve?

speaker
Steve

Thank you, Stan, and good afternoon. For the nine months added to January 31st, 2022, consolidated revenue was $38.1 million compared to $38.6 million for the same period of the prior fiscal year. The components on revenue are as follows. Revenue from commercial and U.S. government satellite programs was approximately $20.9 million, or 62% of consolidated revenue, compared to $20.1 million, or 52%, 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 FAA New York segments. Revenues from non-space U.S. government and DOD customers, which are recorded both in the FEI New York and FEI's diaper segments, were $14.9 million compared to $16.3 million in the same period of the prior fiscal year and accounted for approximately 39% of consolidated revenue compared to 42% for the prior fiscal year. Other commercial and industrial revenues were $2.4 million compared to $2.2 million in the same period in the prior fiscal year, intersegment revenues are eliminated in consolidation. When the nine months ended January 31st, 2022, 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 an increased engineering costs on development phase programs that experienced particularly complex technical challenges as well as cost impacts on several programs resulting from supply chain issues. Lack of availability of parts and material and or quality problems with traditional vendors resulted 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 other mechanical parts was necessitated by quality issues in the supply chain, further contributing to increased costs. The nine months ended January 31st, 2022 and 21, selling and administrative expenses were approximately 25% of consolidated revenue. The slight 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 nine months ended January 31st, 22 and 21 increased to $3.9 million from $3.5 million, an increase of $400,000, and we're approximately 10% and 9% of consolidated revenue. R&D increases in the nine months added January 31, 2022, were due to higher levels of internal R&D associated with investments the company is making in new technology developments related to atomic box 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 nine months ended January 31st, 22, the company recorded an operating loss of $2.1 million compared to an operating loss of $1.1 million in the prior year. The factors cited above in gross margin discussion are applicable to operating income as well. Operating losses for the nine-month period ending January 31st, 22 resulted from lower revenue and lower gross margins. During both periods, the company experienced increased supply chain and other costs. The majority of the operating laws were experienced in Q1 as a result of higher professional fees associated with litigation that has since been settled. Other income consisted primarily of investment income derived from the company's holdings of marketable securities. Earnings on these securities may vary based on fluctuating interest rates, dividend payout levels, and the timing of purchases, sales, redemptions, and maturities of securities. In the nine months added January 31st, 22, 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 $1.8 million compared to a $700,000 pre-tax loss for the prior fiscal year. For the nine months ended January 31st, 22, the company recorded a tax provision of $3,000 compared to 37,000 for the prior fiscal year. Consolidated net loss for the nine months at January 31st, 22 was 1.8 million or 20 cents per share compared to 700,000 net loss or 8 cents per share in the previous fiscal year. Our fully funded backlog at the end of January 22 was approximately 42 million, up 2 million from the previous fiscal year ended April 30th, 21. The company's balance sheet continues to reflect a strong working capital position of approximately $40 million at January 1, 2022, and a current ratio of approximately 4.8 to 1. Additionally, the company is debt-free. The company believes its liquidity is adequate to meet its operating and investing needs for the next 12 months and the foreseeable future. I will turn the call back to Stan, and we look forward to your questions.

speaker
Santon Sloan

Thank you, Steve. The operator will now explain how you can submit questions. Operator?

speaker
Operator

Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star 1 on your phone now. We ask that while posing your question, you please pick up your handset if listening on speakerphone to provide optimum sound quality. Once again, if you have any questions or comments, please press star 1 on your phone now. Please hold a moment while we poll for questions. Your first question is coming from Brett Reese. Your line is live.

speaker
spk04

Thank you. Hi, Stanton. Hi, Steve. Hi, Brett. The delays in bookings that you talked about, could you go into a little bit more specificity as to what that's all about?

speaker
Santon Sloan

Well, I don't really know... in a lot of detail other than the bookings that we've been anticipating just haven't been processed through the, in this case, the largest one is through one of the government prime contractors. Why that is, I can't tell you. I don't believe it's tied to the CR, but it just seemed to be delayed in getting things on contract.

speaker
spk04

Do we have, like, lobbyists or people in Washington that when there are these type of delays, you can make inquiries so that you can find out how long the delays are going to be so you can plan our business?

speaker
Santon Sloan

You can't lobby the government prime contractors. So in the case where they're the customer, having people in Washington lobby things doesn't really do anything. We have access, of course, to government budget information and all the exhibits and all that stuff, which we look at pretty regularly. Those are of interest when you're looking at the program level, but you have to remember we're not the prime contractor. We're a second tier provider to the prime contractors.

speaker
spk04

Okay. The move of manufacturing from California to New York Can you quantify what the cost savings, what's the run rate on the cost savings going forward?

speaker
Santon Sloan

I don't want to put a number out, but I'll tell you that it does two things. It reduces the cost out in California because, of course, for a given number of manufacturing people there, we don't have the same number of manufacturing people here because we have other companies The administrative or the staff or overhead portions of manufacturing don't need to be replicated here. So if you take the cost out of California, the overall cost to manufacture that same product here is less. And, you know, how much less depends on the revenue and, you know, some other factors. So I'm not going to predict a precise amount, but it's a pretty significant effect.

speaker
spk04

Right, right. One last question, and I'm going to refer to a transcript. I subscribe to David Rosenberg. He's an economist in Canada, and he had as a special guest a Piper Malgrin, who's an expert on cybersecurity threats. And among other things, she lectures at Sandhurst in Great Britain. And I'm kind of quoting from her last talk, which was about a week ago. Understanding the strategic importance of space is crucial because you can see what's happening on the ground. because you can control everybody else's access to the main things that we care about these days, which is the digital domain. Can you cut off an entire nation's access to GPS because you knock out their satellites in space? Yes, you can. We've seen recently major incidents between the United States, Russia, and China in space. And then she went on to name two examples which were not in the mainstream media. You know, it was chilling listening to her describe what's going on. Aren't, you know, the various things, you know, the clocks and the ability to prevent spoofing and control satellites, I mean, aren't we in the catbird seat, you know, for order flow with, you know, where unfortunately the world is going?

speaker
Santon Sloan

So that's a very complicated thing to ponder. And, of course, there's all sorts of ways you can affect GPS, everything from denial of service type stuff to kinetic attacks. I have to leave that for the government folks in terms of their strategy. But what I would say is that the better clock you have up there, the more holdover you have. So if you're going to, for example, jam a GPS signal, then the clock becomes critically important because you need the satellite to be able to maintain sync until you get the signal back. So from that point of view, I would argue, yeah, we produce very high-performance clocks. That's our specialty here. And a lot of the programs we're working on, obviously GPS, that's the intent, is to provide better capability.

speaker
spk04

Stanton, you know, you've been doing a fantastic job, but are you frustrated that the order flow has not, you know, been more robust to date?

speaker
Santon Sloan

Well, I think it's been pretty robust. I mean, you know, I guess you can be the turtle or the hare. You know, in my mind, continuous improvement is important. is a pretty good strategy, and that's what I see. So, you know, I think we're doing pretty good. You know, every now and then you get these extremely large opportunities that come along, and we'll continue to chase those. But, you know, I think overall our strategy in terms of growing the revenue base is panning out. You know, I would appoint the 2.0 in our contracts as a great example of that. And in my comments I mentioned we're chasing some new stuff that's – you know, a little different than our traditional business as another way to go about that. And as long as I can keep incrementally growing the business, I'm pretty happy.

speaker
spk04

Okay, great. Thank you for answering my questions. I'll drop back in queue. Thank you.

speaker
Santon Sloan

You bet.

speaker
Operator

Your next question is coming from Michael Eisner. Your line is live.

speaker
Michael Eisner

Thank you. Hi. How's the COVID situation in New York now?

speaker
Santon Sloan

Settled down now. We had a bout of it here basically in January, and we had quite a number of folks out, 32 or 33 folks out with it. Because we didn't have any significant effects prior to that in terms of our employees and why it, you know, why it hit us in January, I really can't tell you. But it seems to have settled down. I think we're, at the moment, we have just one employee who's out for testing positive and expecting back next week. So, you know, it seems okay now, but it did hit us in January.

speaker
Michael Eisner

Well, I had COVID, the Omicron, at the beginning of January. It was very high level then. at that point. The supply chain going forward from now, not in the core, how is it looking?

speaker
Santon Sloan

Well, there's still issues in the supply chain. There's two things. One is shortages or delays, if you will. You know, a lot of stuff, a lot of the parts that we use, you know, we used to be able to get in a few weeks. You know, some of them now are four, six, 12 months deliveries. That's one problem. The other problem, of course, is costs are going up. I think you see in the news, you know, things that are sourced from Russia like nickel and titanium and some of those things are all going up pretty rapidly. So that's the next challenge. On the component parts side, the issues seem to me to be more in the active components. So things that, you know, are the more expensive and longer lead things are seem to be more problematic. But I'm hoping that we'll start to settle down a bit. Of course, the crane situation throws a wrench in a lot of different things because of raw materials. But that's where we are. We're holding our own so far. But we have, as we said in the comments, we have had some delays. And some of those cause other costs because you've got to redesign stuff for components that can source.

speaker
Michael Eisner

Yeah, every company's had delays. It's nothing at your fault. You said GPS-3, I think. Did you mean GPS-3F in your comments?

speaker
Santon Sloan

No, I meant GPS-3. We're going to fly one of our DRAPS units on a GPS-3 satellite. It's basically a demo because the satellite is designed not for our clock, but they're going to put our clock on there so it can demonstrate its performance in space.

speaker
Michael Eisner

You didn't think you, I think last call, the call before, you didn't think you were going to get on GPS 3, but you are going to get one.

speaker
Santon Sloan

Yep, we are, yep.

speaker
Michael Eisner

And if everything goes good, you start production of GPS 3F?

speaker
Santon Sloan

We are in the cycle on GPS 3F with the call unit. That's going through the final stages of qualification. We do not yet have orders for the flight units, but I would expect that to be imminent as soon as we finish qual here.

speaker
Michael Eisner

Like a month or two?

speaker
Santon Sloan

A couple of months.

speaker
Michael Eisner

Oh, still a couple of months?

speaker
Santon Sloan

Well, look, they may elect the unit. I don't want to get too much into detail, but the unit has a qualification program After that qualification program, it has what's called a long-term aging test. But once we're done with the qual program, we've basically proven the design of the clock, and my hope is that at that point they'll start to exercise flight options and not wait all the way through the long-term aging test. But I don't know that yet.

speaker
Michael Eisner

That would mean a continuous stream of revenue if they approve it.

speaker
Santon Sloan

Well, sure, yeah, if they exercise the options, yep.

speaker
Michael Eisner

Well, there's, I don't know, I forget how many clocks in the GPS3F. Was it 21?

speaker
Santon Sloan

No, there's 22 satellites. 22, yeah. But some of the initial satellites are already in production, and, of course, those don't have our clocks on them yet because we're not through qual.

speaker
Michael Eisner

Yeah, the first 10 or 11, I think it was. You know, you said you got money from Morion, right? Is that going to be a problem in the future? They're in Russia, right?

speaker
Santon Sloan

Yes, they are. We get dividends. We have a small equity position in Morion, and we get dividends from them. It's not substantial, and frankly, I don't expect to get them anymore. So given what things are, we're just not dependent on Morion for anything, and I wouldn't expect that we'll be able to do much business with them in the future.

speaker
Michael Eisner

And the ruble is worthless. You know, going back to Sam's question on Zypha, are you moving the production and keeping the technology out there? How are you doing this?

speaker
Santon Sloan

Yes, manufacturing will move. You could think it's analogous to them deciding to have a contract manufacturer of the unit. The engineering development and everything else will remain there as it is. We're just going to shift the manufacturing part here.

speaker
Michael Eisner

So that means, are you going to a smaller office?

speaker
Santon Sloan

Well, no, not a smaller office. I mean, we'll absorb their manufacturing into the current facility.

speaker
Michael Eisner

Not an office, but a manufacturing plant.

speaker
Santon Sloan

Yeah, we'll absorb that here.

speaker
Michael Eisner

We don't need any additional space. No, you have space in New York, but will you reduce space in California? Yeah.

speaker
Santon Sloan

Yeah, eventually, yes. We have a lease, and, of course, we have to either sublet part of the building, or when we renew the lease, we won't need all that space. When's the lease up? I think it's got another couple of years.

speaker
Michael Eisner

All right. So how long is that going to take to move into New York?

speaker
Santon Sloan

Probably another month.

speaker
Michael Eisner

All right. So that's going to save some good money on people.

speaker
Santon Sloan

Yes.

speaker
Michael Eisner

You're not going to have to hire any new people in New York for this, do you?

speaker
Santon Sloan

Yes. We will hire additional manufacturing people, but we won't replace the manufacturing workforce out there one for one. We won't need the infrastructure part. We already have that here. All we need is the people that do assembly.

speaker
Michael Eisner

How many people do you have in California?

speaker
Santon Sloan

Now there's roughly 32 or 3, I think.

speaker
Michael Eisner

All right. And I know I'm asking a lot of questions. Just get this over with. The mercury ion atomic clock, how much of that is in the backlog?

speaker
Santon Sloan

Oh, let's see. In the backlog of mercury ion. Do you know offhand? It would be the first piece. These are approximations. It's about $2 million.

speaker
Michael Eisner

And the same thing for the space-qualified precision oscillators. You're talking about the pop rafts, the other ONR contract? It was announced October 15th. October 15th. Okay. I'm sorry. No, the post-opically pumped verbigium was in September.

speaker
Santon Sloan

Yeah.

speaker
Michael Eisner

How much is that backlog? That's roughly the same. Two million?

speaker
Santon Sloan

Roughly, yeah.

speaker
Michael Eisner

And the other one, the final one, the October 15th contract? If you don't know, it's wrong.

speaker
Santon Sloan

I don't have the press release in front of me. I don't remember which one that is. Sorry.

speaker
Michael Eisner

No, it's okay. What's your bids outstanding at this point?

speaker
Santon Sloan

A bid's outstanding. I don't know offhand. I'm going to guess probably a couple hundred million dollars.

speaker
Michael Eisner

And you expect to get most of it?

speaker
Santon Sloan

Well, you know, we don't win 100% of things. Our win rates have run in the 30% to 40% range.

speaker
Michael Eisner

You know, you're trading. If you take out the cash, you're about $6 a share or $6.20 a share.

speaker
Santon Sloan

I'm not sure the current market conditions are a good calibrator, but okay.

speaker
Michael Eisner

No, I'm just saying it's ridiculous because the technology you have in the plant is worth a lot.

speaker
Santon Sloan

It is. We're underappreciated. This is a national asset. Yeah. I agree with you.

speaker
Michael Eisner

All right. Sorry I asked so many questions while I have you. Thank you. You bet.

speaker
Operator

There are no further questions from the lines at this time. I would now like to turn the floor back to Stanton Sloan for closing remarks.

speaker
Santon Sloan

Great. Thank you. Well, thank you, everybody. I'm glad you're able to join us today. Until we talk to you next quarter, please stay safe and healthy. Have a great day. Thank you very much.

speaker
Operator

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

Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

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