Frequency Electronics, Inc.

Greetings, and welcome to the Frequency Electronics second quarter fiscal 25 earnings release conference call. At this time, all participants are in a listen-only mode. 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 this feature 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, Thomas McClelland, President and Chief Executive Officer.

Good afternoon, everyone. By all financial metrics, the second quarter of fiscal year 2025 performance was excellent. For both the quarter and the year to date, revenue, gross margin, and operating income have grown substantially. The backlog is also holding strong at $81 million, which is, by the way, an all-time high, compared to $70 million at the end of the first quarter and $78 million at the end of the last fiscal year. The results reflect continued solid growth in our core businesses, which show every indication of continuing. The primary source of growth this year has been the U.S. government space business. The U.S. government space business is responsible for more than half the revenue and operating income for the first half of the current fiscal year. And we're very busy responding to inquiries and writing proposals for new government space programs. As we've discussed in the past, a significant portion of existing as well as new potential space work relates to heritage satellite systems and our core technologies. However, we are seeing a lot more, more and more new business in the proliferated small satellite domain. and it's very clear that this is the direction in which space technology is headed. At this time, less than 10% of our backlog is associated with proliferated small satellites, but it's anticipated that this will grow dramatically over the next decade. The potential is huge, but instead of one or two high-performing systems delivered on a given program, we're looking at hundreds of lower-cost, sometimes lower-performing systems on a given program and continuing replenishment business on those programs to replace systems on satellites which have exceeded their expected lifetime of three to five years. In order to be successful in this domain, we must develop products targeted at this market, In general, our existing technologies packaged in smaller, lower power, lower performing variants. It has become clear over the last few years that a significant amount of this development needs to happen now and must be funded internally. Our R&D expenditures are up this year because of this. Currently, about 10% of revenue compared to about 6% of revenue last fiscal year. It's anticipated that R&D will remain steady at approximately 10% of revenue for the foreseeable future, but we believe that the return on this investment has the potential to be extremely attractive in terms of new business wins with years of follow-on business behind them. In short, we should make it back in spades. In October, FEI hosted the Quantum Sensor Summit in New York City, a technical conference bringing together experts from around the world to share insights and expectations regarding this rapidly developing area of technology. This event was well attended. There were roughly 88 attendees, and we have obtained a lot of positive feedback from it. Quantum sensors is a rapidly developing market, one which FEI is well positioned to participate in based on our existing expertise and one which we are actively pursuing as an additional avenue to continued growth well into the future. Much of the development in this arena will be funded externally on U.S. government R&D programs. And in fact, some government funding is expected within the next two quarters. With a new administration to be sworn in in January, we're cautiously optimistic that a government fiscal year 2025 budget will be passed expeditiously, and that funding will thus be available sooner rather than later. In parallel, we're pursuing cooperative research and development agreements, or CRADAs, with NIST and other government laboratories in order to harvest their expertise in specific quantum technologies. All in all, I'm happy with our performance very excited about our future and proud to lead a workforce of talented and really dedicated individuals who deserve most of the credit for our current success. I'll now turn things over to our CFO, Steve Bernstein, who will fill you in on some of the financial details. Steve?

Thank you, Tom, and good afternoon. For the six-month ended October 31st, 2024, consolidated revenue was $30.9 million compared to $26 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 $17.7 million or 57% compared to $9.5 million or 37% in the same period of the prior fiscal year. Revenue on satellite payload contracts are recognized primarily under the percentage of completion method and recorded only in the FEI New York segment. Revenue from non-space U.S. government and DOD customers, which are recorded in both the FEI New York and FEI Zephyr segments, were $12.1 million compared to $15.1 million in the same period of the prior fiscal year. and accounted for approximately 39% of consolidated revenue compared to 58% for the prior fiscal year. Other commercial and industrial revenue were $1.1 million and $1.4 million for the six months ended October 31st, 24, and 23, respectively. The significant increase in revenue for the period was primarily related to an increase in U.S. government customer sales for space products. For the six months ending October 31st, 24, gross margin and gross margin rate increased as compared to the same period in fiscal year 23. The gross margin dollars increased as direct result of the increase in revenue. The gross margin rate increase was particularly attributable to a large space program that completed a major milestone in its production, as well as the older programs at lower margin are complete or near completion. For the six months ending October 31st, 24, and 23, SG&A expense was approximately 20 percent and 19 percent, respectively, of consolidated revenues. The increase in SG&A expense during the three and six months ending October 31st, 24, was mainly related to an increase in payroll-related expenses, costs from the realignment of employees from overhead to SG&A, and the costs related to Frequency Electronics' first Quantum Summit in October of 24. The annual run rate for SG&A for the year is expected to be approximately $3 million per quarter. It should be noted that the payroll-related expenses, which are driving the majority of the increase, approximately 25% are non-cash transactions, such as stock compensation and 401 expense. R&D expense for the six months ending October 31, 24, increased to $3.1 million from $1.3 million for the six months ending October 31, 24 an increase of approximately 1.8 million and were approximately 10 percent and 5 percent respectively of consolidated revenue. R&D increased for the six months ending October 31st, 24 was primarily due to a focus on advances and modernization of products as opposed to fiscal 24 where the company was primarily focused on customer production orders resulting in much lower R&D expense than initially planned. The company plans to continue to invest in R&D in the future to keep its products at the state of the art. However, actual quarterly spend is expected to vary. For the six months ending October 31st, 24, the company recorded operating income of $5 million compared to operating income of $3 million in the prior year. Operating income increased partially due to large space program that completed a major milestone in its production during the three months ending October 31st, 24, as discussed earlier. However, the increase is also a result of the successful efforts of the company to complete complex and costly programs and to work more efficiently in bidding, building, and testing our products. The company believes the improved operating income results for the first half of this fiscal year are a tangible outcome of these efforts. Other income can be derived from reclaiming of metal, refunds, interest on deferred trust assets, or the sale of fixed assets. Interest expense is related to the deferred compensation payments made to retired employees. This yields pre-tax income of approximately $5.4 million compared to $2.9 million for the prior fiscal year. For the six months ended October 31, 24, the company recorded a tax provision of $272,000 compared to 13,000 for the same period of the prior fiscal year. Consolidated net income for the six months ending October 31st, 24 was 5.1 million or 53 cents per share compared to 2.8 million or 30 cents per share in the previous fiscal year. Our fully funded backlog at the end of October 24 was approximately 81 million compared to approximately 78 million for the previous fiscal year end April 30, 24. The company's balance sheet continues to reflect a strong working capital position of approximately $23 million at October 31st, 24, and a current ratio of approximately 1.8 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 the foreseeable future. I'll turn the call back to Tom, and we will look forward to your questions soon.

Thanks, Steve. I think we can now take questions.

Thank you. At this time, we will 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 your line is in the question queue. You may press star 2 if you'd 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. Once again, please press star one if you have a question or a comment. Okay, the first question comes from Chris Bukowski, private investor. Please proceed.

Hello. Congratulations on great results first. And I wanted to ask you to talk a little bit about these new products you will be developing for these smaller satellites. Tell us about what kind of competitive advantage you have there. Presumably these products will not be as difficult as your usual products as the satellites have shorter lifetimes and they don't require that much precision. What is your competitive advantage?

Okay, good question. I think that fundamentally we're talking about the same products that we sell today to the satellite business, but we're going to modify those products to optimize them for the small satellite applications. Now, one of the things to understand right from the start is that this whole thing is evolving fairly rapidly. It's a little bit unclear where the world ends up in terms of this spectrum of cheap and inexpensive and small on one side and very, very high performance and long-lasting on the other end of the spectrum. We believe that the portion of this that we're going to be able to address is not necessarily the absolute smallest and absolute cheapest, but somewhere moving in that direction from the exquisite, long-lasting kind of satellites that we're used to dealing with in the past. So we do believe that there's a sweet spot in there that we're well positioned to address. And we think that we have products that we can develop that are much smaller than the things that we deliver today on the larger satellites and much lower power and lower cost but still have pretty good performance, not necessarily as good as the absolute best that we've been able to do when money is no object, but still high performance. And we think that this is the right place to be going forward, but this is something that we have to kind of... monitor as we go so that we get this right going forward. It doesn't pay to have better performance than what people are looking for out there. But on the other hand, it doesn't pay to have tiny very low cost products but that don't perform and deliver the kind of performance that's needed for the applications that are out there. So it's a bit of a challenge but we do feel that we have a pretty good idea of where we need to be and how to go about it.

So you're saying that your advantage is just your history of designing high quality products and it will be easier for you to delete your products and make them a little bit cheaper than for somebody else to come up from below.

Yeah, I think the fundamental advantage that we have is we have technologies and capabilities that nobody else has. And I think a corollary to that is that I think we have a pretty good understanding of the applications and what kind of performance is necessary to make those applications work. And so, yeah, that's what we bring to the table.

All right. That's good to hear. And another question, and this is a little bit playing devil's advocate. Is there any danger of those more cheaper satellites of kind of taking away your business of the expensive satellites, which seems to be still 80% of your business?

Well, you know, sure, there's a potential for that. But, you know, I think the thing we have to understand that, you know, there are small satellites that are up on orbit as we speak. And we have not participated in those programs. And the reason we haven't participated in those programs is because there was nothing our technology brought to the table that couldn't be procured from somebody else at a much lower cost. And so there's definitely a portion of the business that we will never be able to address. But the higher-end performance, the part of the satellite business that requires precision, time, and synchronization, I think we will participate in. There are trade-offs, and this is something that we're monitoring very closely. There are various other technologies that can be brought to bear that have an impact on just how much precision, time, and frequency is needed for particular applications. That's something we have to monitor, but we do believe that as people demand more from these systems in the future, the need for high-precision frequency and timing hardware will be there, and we're going to be ready to address those needs.

All right. So to simplify, I think you're saying is that even if your clients decide to serve the same functions with smaller satellites, they'll probably still need precise timing, and they'll still need some kind of a product from you. Is that correct? Yes.

That's correct. There are applications that will require our products. Yes.

Right. Yeah, that's good to hear. And congratulations again and good luck. That's it for me. Thank you. Thank you.

The next question comes from Brent Garrickson, private investor. Please proceed, Brent.

Hello, guys. Congratulations on a fantastic quarter. And I think I speak for everybody. I really appreciate the long hours and the hard work you guys are putting in. Everybody at Frequency, I just want to say a big thank you. My question is, we've seen kind of a breakout here in the backlog. And I'm just kind of wondering, when do we start seeing a breakout in the revenue and EPS going forward? Thank you.

I'm not sure I understand the definition of breakout, but I think the revenue has been growing. And, yeah, I think, yeah, I don't know what else to say beyond that. I mean, I guess we can't necessarily look at... You know, it's not fair to assume that the percentage change in backlog is going to be instantaneously reflected in the percentage change in revenue. But I think they do at least qualitatively track.

All right. Thank you very much. I appreciate the answer.

Okay. The next question comes from George Maroma. with Pareto Ventures. Please proceed.

Hey, thanks, guys. Hey, Tom. Along the line of this smaller, cheaper satellite direction, how would you describe the technical lift to get there? Do you need breakthroughs in physics and engineering, or how would you characterize the difficulty in getting to a smaller, cheaper version? of what you have today to be competitive?

Okay, that's a really good question. I think that the interesting point is that we actually have products that we sell for terrestrial applications that are smaller and cheaper. The problem is that the fundamental way that you make electronic products smaller and cheaper is you use a lot of digital electronics. And of course we all know from our own experience that with cell phones and everything else that digital electronics gets smaller and lower power all of the time. So the, the fundamental way that we make things smaller and cheaper is we employ more and more of those digital electronics. The problem is when you want to utilize those things in space, you have to contend with the fact that there's nuclear radiation in space. There are protons and electrons and various other types of nuclear radiation in space. And it's well known that there's very high density digital electronics are sensitive to what's called the single event upset. So particles, radiation particles in space can cause upsets. They can cause bits to flip and these can cause severe problems in those small devices if we try to take the things that we use here on Earth and utilize them without any modifications up in space. So this is the primary thing. What we are really looking at is taking products that we sell currently on the ground and adapting those to be able to survive and function properly in the space environment. And so this is actually a fairly big challenge. In some cases we have to replace some digital parts with radiation hardened digital parts, but that's difficult because A lot of the things that are designed for space that are radiation hardened are bigger than the same kind of devices that don't have those features. In other cases, it's a question of doing adequate testing of the parts on the ground in order to verify that they will survive in space. Now, a lot of the applications in space for these small, lower-cost devices are at low Earth orbits, where the radiation isn't as severe as in higher orbits, but still we have radiation. And, of course, the lifetimes of these devices are shorter, so we can get away with some radiation problems. So one of the biggest challenges is to just figure out how to do this good enough. You know, we need something that's going to survive and be effective for three to five years in these low orbit kind of environments. So I think that's not the whole story, but that's a huge part of the story and the biggest challenge in developing these things.

Tom, have you looked at the... It's in the final phase. It's not commercialized today, but there's a project being done for Skywater with QuickLogic and Honeywell, which is an FPGA radiation-hardened technology for space. Have you looked at that?

We've looked at any number of... and worked with any number of these radiation hardened FPGAs. And there are various different levels of them. So, you know, part of the challenge is figuring out what's the most effective thing. Some of those devices are extremely expensive. And, you know, for our small products, we don't require huge FPGAs that have a tremendous amount of capabilities. We need smaller things. And so sometimes the larger FPGAs aren't really appropriate for our needs. And also, there are just different levels of radiation tolerance or intolerance. And again, the challenge is getting the lowest cost, smallest items that we can get away with using without having problems. And some of it's trial and error, a lot of testing, et cetera, in order to optimize things.

And one last thing about government budgets. I was Happy to see the backlog increase by, it looks like, just rough math, 25 million in the quarter over the last quarter. Given an election and a new administration, I was happy to see that during this time. It appears from all available information that the space race is really going to be amped up for the next several years. There's a lot of talk on on-orbit space services. NASA is doing stuff. DOD has a lot of plans. how would you describe the budgetary environment in the next few months? And you kind of made some comments about 25, hopefully, but is it difficult right now in the transition period? Are a lot of things getting gummed up or not necessarily?

Well, yeah, not necessarily. I think the one thing where there's always a certain level of frustration with – you know, government funding. It's never as fast as we would like it to be. And, of course, we're pretty concerned with the election this year and the way things turned out. And independent of one's political leanings, I think the good thing about the result is that it looks like we will not have a divided Congress. And so I think there's at least some hope that we get an actual budget sometime soon after the inauguration. And that will just be helpful. You know, the continuing resolution thing... limits the ability of a number of these programs to move forward. And, you know, so usually what these kind of things mean, your comment about space growing for the foreseeable future, I think, is correct. And so it's not a question of... the business disappearing. It's just a question of it moving to the right, moving out further in time. And, you know, we have a pretty good handle on what things look like over the next few months, and I think we're in really good shape. After that, it's anybody's guess. I think we'll start to get some clarity on that hopefully in the next few months.

Okay, thank you, Tom, and I'm glad you're hitting the gas pedal on the innovation. Have a good day. Okay, thanks.

The next question comes from Michael Eisner, private investor. Michael, please proceed.

Great job all around. Thanks, Michael. Everyone in the company did a really good job. You know, your gross margins went up to 48%, which I thought was very impressive. You went up on the... cost of R and D rather. Do you see that coming down or that's going to continue at this point until you get government funding?

Well, let's see. I think, uh, uh, I, uh, several comments first on the gross margin. I think we've been talking over the next couple of, or the last couple of years about, uh, uh, gross margin. And I think, uh, we've been targeting just the kind of numbers that we're delivering at this point in time. We won't always be able to do that. It depends on the mix of work, but that's kind of where we really ideally want to be. With respect to R&D, I think I did talk about this a little bit just a few minutes ago. I think it's up there. significantly from last year. I guess the thing to say is we probably underspent where we really need to be in terms of R&D last year, and I think we're about where we need to be in terms of R&D spending right now. So I'd like to look at it as a percentage of revenue, and we anticipate for the foreseeable future. Right now, this year, we're at about 10% of revenue, and I anticipate being somewhere near that point over the next couple of years.

All right. One thing on gross margins, a lot of companies say they're going to get their gross margins up, but they never do. You did. 48% is a very impressive number. I hope it continues. What was that?

I hope so, too. We're working hard to actually achieve it.

Is any of the revenue that you had this quarter, is any from quantum sensing?

I hesitate to get into any specifics in this regard. But suffice it to say, there's not a significant amount of revenue this quarter from quantum sensors.

I didn't even expect you to have anything, really, because everything is getting going. We're at the beginning of this, I was thinking. That's why I thought the gross margins weren't going to be high until like next year sometime. I think you reach them like six months to nine months before I thought you could get there even. Is Leo the future? Of the company?

LEO as in low Earth orbits?

Yes.

Yeah. It's part of it, but it's not the whole story. And I think lots of times for people that follow satellite stuff, the low Earth orbits are talked about a lot. But we're looking at small satellites. low-cost satellite applications that are not LEO orbits. So it's not exclusive to LEO. And in fact, you know, the LEO environment is going to get pretty crowded here over the next decade or so. So exactly what that's going to mean for some of this stuff is not 100% clear. But there's going to be a lot of LEO stuff, but that's not the only game in town.

Do we work with the GEO also, an MEO, Medium Earth Orbit?

Yes, absolutely. Okay. A lot of our heritage satellite work is geosynchronous orbits, or geo, and of course the most well-known medium Earth orbit satellite system is GPS, and there are some other global navigation satellite systems that are also in medium Earth orbits. So, yeah, we're involved in all of that stuff.

All right, final question. Are we working on our GPS with Astronis? I don't know if you can answer that. That's a backup GPS by Space Force.

Yeah, I'm... Yeah, we're very familiar with resilient GPS, and we're actively pursuing that. That's one of these programs that we'll see with the new administration how things go. The funding for that is very limited at the moment. But we are working, actually, the government has funded four different prime contractor teams. Astronis, who you mentioned, is one of them. And we are actually talking to and working with three of the four prime contractors at this point in time.

Oh, you're working with three out of four. That's very impressive.

I want to emphasize we're not under contract with anybody at this point in time, but we're working with three of the four. If that program moves forward and gets some additional funding I think we're in a pretty good position to be involved with several of the prime contractors.

Yeah, because it seems like all these companies I mentioned work with different types, like Astronis uses GEO, Space Link uses MEO, and they're all connected.

The resilient GPS, our GPS program is specifically targeting MEO orbits at this point in time.

I never heard you say the medium-earth orbit before. I don't think you mentioned that. All right. All around, fantastic job. I'm very impressed. Thank you for your time.

Okay, thanks, Mike.

Yep.

Once again, if you have a question or a comment, please indicate so by pressing star 1. The next question comes from Frank Wisniewski, private investor.

Frank, please proceed. Good evening, Tom and all. First, I was glad to see you were appointed to the board. Very well deserved. My question is on the non-space U.S. government policy. and DOD business, the Cipher and some of the West Coast operations. They continue to be weak, and I assume when you were talking about the funding difficulties, the continuing resolutions and such, it referred mainly to this area of your business. Could you give us a little feel for whether you expect any recovery in the revenues from those operations in the next six months?

Yeah, I think it's certainly true that the non-space government stuff, we, you know, definitely programs get pushed out and there are challenges there. I think that I do anticipate some progress. What we've seen is that there's a fair amount of variability quarter to quarter. So I don't think we're on a downward trend in any sense with that business. I think it's solid, it's profitable, and we anticipate some significant growth. The timing is just very, very challenging to predict at this point in time.

Thank you. And would your backlog be primarily space business?

Well, certainly a big chunk of it is space business. I don't have the exact breakdown at this point. Okay.

Thank you.

Okay.

The next question comes from Tim Hasara with Sunet Capital. Please proceed.

Just curious, what's the prospects for more geo contracts with upgrades to some of your existing programs that have been out there for a while and just over the next six to nine months here?

Oh, we, you know... We do anticipate a significant amount of work in that area, definitely within the next six to nine months. We have proposals out to multiple primes on several different programs. Again, we have a new administration, and exactly how things play out is a little bit hard to say But we definitely anticipate continued business there. And I feel that that's quite important for us because those are the programs where I think we, you know, when we do things right, and I think we've bid those programs properly, we should be able to get customers good margins on those programs give us a little bit of leeway to try to do some of what we need to do to get positioned properly for the small satellite stuff. Great. Thank you. Appreciate it.

We have a follow-up coming from Michael Eisner, private investor. Please proceed.

Tom, I meant to congratulate you on joining the board. Thank you.

Oh, thanks.

Okay, the next question is from George Maroma with Pareto Ventures. Please proceed.

Yeah, hi. I didn't want to leave Zypher as the odd man out. How is the Zypher unit performing? They're doing pretty good, actually.

Yeah. Thanks. I think you'll see some specifics on that, but I think we're pretty happy with their performance at this point.

Are there any R&D priorities for Zypher or any new areas or new things going on there?

Yeah, we definitely have some R&D activity going on at Zypher. I think the main area there is a variant of the theme we see in the satellite business. smaller, cheaper. So we have some development to do some of the same things that they've been doing for years, but in smaller packages. And then I think the other thing is to take some of their products, which traditionally they take... to incorporate a GPS receiver and perform timing and synchronization functions utilizing a GPS receiver and precision clocks locked to the GPS receiver. I think one of the things going forward is to add to that some capability for navigation in the absence of GPS. So inertial navigation and potentially alternate means of navigation. So, yeah, and that kind of leads to some of the quantum sensors that we've been looking at. And so we're looking to potentially incorporate some of that technology into Zypher products in the future.

Any cybersecurity connections, any of this with them?

Well, cybersecurity is a huge thing with everything that we do. It's a means to an end. It's not really an end in itself, but it's very important. Okay. Thank you, Tom. Yeah.

As we have no further questions in queue, I'd like to turn the floor back over to management for any closing remarks.

Okay. I'd like to thank everybody for participating in this call, and I'd like to wish everyone a happy and healthy weekend. holiday season. Thank you very much.

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.