Frequency Electronics Inc (FEIM) 2023 Q2 法說會逐字稿

Greetings, and welcome to the Frequency Electronics Second Quarter Fiscal 2023 Earnings Release Conference Call. (Operator Instructions) 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's now my pleasure to introduce your host, Thomas McClelland, President and Chief Executive Officer.

Hi, good afternoon, everyone. Although the results for the second quarter are not where we would want them to be, there are significant indicators that we're on the road to recovery. Revenue quarter-over-quarter has increased. Our backlog of approximately $56 million at quarter end is higher than it has been any time in the last 8 years as is the book-to-bill ratio of 2.8. In addition, we've booked $4.4 million of new business already in the third quarter.

At the annual meeting, we discussed the satellite industry move to develop systems which utilized a large number of low-cost satellites, which are by design replaced much more regularly every 3 to 5 years rather than the 15-year lifetime required of today's large satellites. One of our key customers, large government satellite prime contractor, has communicated that they experienced 15% growth in satellite business over the past year, anticipates sustained growth of 10% to 15% annually over the coming years. And as a result, is interested in engaging FEI in development of advanced technology appropriate for what they refer to as proliferated low earth orbit satellite systems, often referred to as large systems of small satellites.

We're experiencing similar overtures from other satellite prime contractors, all of which bodes well for our future space business prospects. All that being said, we still struggle with supply chain issues, persistent inflation. But in both cases, signs of easing are beginning to appear. Continued effort is required to navigate the changing economic and geopolitical environment, but we are confident that we're progressing in a positive direction and look forward to a dramatic improvement in results.

The company is committed to moving towards sustained profitability and cash generation in the near future. We remain debt free and our strong balance sheet allows us to pay the special dividend discussed in a separate press release today, while still maintaining the ability to invest for future growth opportunities.

Okay. I'd now like to turn things over to the Chief Financial Officer, Steve Bernstein. Go ahead, Steve.

Thank you, Tom, and good afternoon. Before I give you the financial report for the second quarter of fiscal '23, I just wanted to give you a brief explanation relating to the delay in filing the 10-Q as well as the restated fiscal '22 10-K.

During the preparation of the current 10-Q for the period ending October 31, '22, we realized there was a formula error in the calculation that split contract assets and contract liabilities from a net presentation to a gross presentation. The net number is correct, however, our formula didn't split the assets and liabilities of related contracts being calculated as one project for revenue purposes. For example, if there were 3 related contracts that made up 1 complete project, 2 with a contract asset of $1.5 million each and 1 with a contract liability of $1 million, our formula would have recorded a contract asset of $2 million instead of a contract asset of $3 million and a contract liability of $1 million. As we put together footnote C in the 10-Q to show the effect of the formula change going back in time, it was determined that it was an immaterial error and that it would be only footnoted to show the effect going back.

It was also determined that when the fiscal year Form 10-K for the period ended April 30, '22, was filed with their stated fiscal year '21 contract assets and contract liabilities, shown gross as opposed to net, as was shown in the fiscal year '21 annual report on Form 10-K, the footnote was deficient in that it did not disclose to the reader that the fiscal year '21 contract assets and contract liabilities will change from net to gross. As a result, we had to amend the fiscal year '22 annual report on Form 10-K to advise the public not to rely upon the financial statements as well as the controls on financial reporting. It is a GAAP requirement to disclose the change that were made with regards to the fiscal year '21 presentation changes in the annual report on Form 10-K for the period ending April 30, '22.

The management wanted to clarify the situation. Despite the omission to disclose to the reader of the financial statements that the contract assets and contract liabilities were changed from net to gross presentation, management feels that the financial statements were accurate and could be relied upon. Other than the formula mentioned above, all of the information a reader of the financial statements needed was in the financials and was completely accurate. The only thing causing this restatement and delay in filing was the correction of a footnote to make the reader aware that the contract assets and contract liabilities, which changed on the face of the FY '21 balance sheet, from net to gross. However, it was shown gross in the supporting footnotes.

I should also mention that this change does not affect the P&L, working capital or any other calculation that would have helped in evaluating the financial statements as presented. It is because of these reasons that management of the company feels that the financials were accurate and could be relied upon.

I believe I have said enough about this subject. However, if you want more details, feel free to contact me after the call. And now I will go into the financials for the second quarter of fiscal '23.

For the 6 months ending October 31, '22, consolidated revenue was $17.2 million compared to $25.9 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 $7.8 million or 46% compared to $13.3 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 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-Zyfer segments were $8 million compared to $10.6 million in the same period of prior fiscal year and accounted for approximately 47% of consolidated revenue compared to 41% for the prior fiscal year. Other commercial and industrial revenues were $1.4 million compared to $2 million in the prior fiscal year. Consolidated revenues increased quarter-over-quarter by approximately $750,000 or 9.1%. Intersegment revenues are eliminated in consolidation.

For the 6 months ending October 31, '22, gross margin and gross margin rate decreased as compared to the same period in fiscal year '22. The decrease in gross margin and gross margin rate was due to increased engineering costs on development phase programs and experienced particularly complex technical challenges that have since been resolved. Minor technical challenges that have been or will be resolved reasonably quickly and the negative cost impacts of some programs due to supply chain delays. Gross margin was also affected by underabsorption of cost due to a decrease in sales during the 6-month period ending October 31, '22.

For the 6 months ending October 31, '22, and '21, SG&A expenses were approximately 23% and 26%, respectively, of consolidated revenue. The decrease in SG&A expense for the 6 months ending October 31, '22, as compared to the prior year, was largely due to a decrease in professional fees as well as onetime reductions to stock option expense related to forfeitures and deferred compensation expense. The company continues to monitor expenses looking for additional cost-effective reductions going forward.

R&D expense for the 6 months ending October 31, '22, decreased to $1.7 million from $2.7 million for 6 months ending October 31, '21, a decrease of $1 million and was approximately 10% and 11%, respectively, of consolidated revenue. The R&D decreases for the first half of the fiscal year '23, are related to focus on projects currently in production phase. The company plans to continue to invest in R&D in the future to keep its products as the state-of-the-art.

For the 6 months ending October 31, '22, the company recorded an operating loss of $5.4 million compared to an operating loss of $1.4 million in the prior year. Operating losses resulted largely from decrease in revenue, coupled with the additional costs made previously regarding gross margin. Operating loss improved quarter-over-quarter by approximately $120,000 or 26.5%.

Other income consisted primarily of investment income derived from the company's holdings of marketable securities, Earnings on these securities made based on fluctuating interest rates, dividend payout levels and the timing of purchase sales redemptions or maturities of securities. This yields a pretax loss of approximately $5.4 million compared to $1.1 million pretax loss for the prior fiscal year. For the 6 months ending October 31, '22, the company recorded a tax provision of $2,200 compared to $2,300 for the same period of the prior fiscal year.

Consolidated net loss for the 6 months ending October 31, '22, was $5.4 million or $0.58 per share compared to $1.1 million net loss or $0.12 per share in the prior fiscal year. Our fully funded backlog at the end of October '22, was approximately $56 million compared to approximately $40 million for the previous fiscal year-end, April 30, '22. The company's balance sheet continues to reflect a strong working capital position of approximately $28 million at October 31, '22, and a current ratio of approximately 3.9:1. Additionally, the company is debt free. The company believes that its liquidity is adequate to meet the operating investing needs for the next 12 months and the foreseeable future.

I will turn the call back to Tom, and we look forward to your questions soon.

We can now take questions.

(Operator Instructions) The first question is coming from Brett Reiss from Janney Montgomery.

Tom, Steven, can you hear me?

Yes.

Yes.

Great. Great. Great. First question is on the dollar a share special dividend. Could you just give me a sense of how the Board decided to do that versus maybe looking on bolt-on accretive acquisitions or retaining the money for organic growth initiatives? And I suppose our share buyback, since the stock is already pretty illiquid, that's why that was ruled out. Could you give us some color on that?

Well, I think you kind of hit the nail on the head with respect to share buyback. I think the general conclusion of the Board was that this was an appropriate way to essentially provide the same benefit as a share buyback for shareholders, but in a more effective fashion.

Okay. The -- it was very encouraging to see the backlog move up so dramatically. Could you -- Tom, could you give us some sense on the timing on working through the backlog? Is it a certain percentage each quarter? Is it more back-end loaded? Could you give us some color on that?

Well, it's -- yes. The -- it's not like the backlog is represented by 1 or 2 contracts, so I think it's hard to make a general statement in that regard. I think -- in general, I think the backlog is converted to revenue for a period of roughly 2 years. But there are going to be some cases where it's significantly longer than that and somewhere it's a little bit shorter.

Okay. And what is the composition of the backlog? Is it mainly with your expertise with the quartz clocks? Is it the atomic clocks? Or is it another area of your business that gave rise to this increase in the backlog?

Well, I think there are really 3 things. There's quartz oscillators, atomic clocks and microwave systems. And I actually don't have a quantitative breakout available at this time, but those are the primary things. I think it's reasonably well balanced between those 3 areas.

Okay. And a couple of quarters ago, the company was devoting a lot of R&D to reduce the size, weight, power needs and cost on your clock offerings. Have -- could you describe the progress you've been able to make in that area?

Well, I think we've made considerable progress, but it's something that we still work on. In fact, we -- I just noticed that -- made note of the fact that we got a little over $4 million of new business in the third quarter. And a significant chunk of that is a contract, which we will utilize the results of some of that R&D to develop smaller devices. And so I think that's pretty encouraging. But there's very much an ongoing effort. We do see this as the direction of the industry at this point, moving to smaller, lower-cost systems and we have every intention of being a strong competitor in that environment.

Last question for me and I'll drop back in queue is your employee headcount, where you want it to be, based on what you see the -- your level of business over the next few quarters are going to be?

Yes, I think we're pretty close to where we need to be. I certainly don't anticipate any further reductions at this point in time.

Okay. Up next, we have [Richard Johns], private investor.

First, thank you for the dividend. And my first question has to do with your supply chain problems. You've had this difficulty getting parts, and that continued in the second quarter. My question is can you see an end of that? Can you see getting back to normal in that regard at some point in the foreseeable future?

Yes, I think we can. What we continue to see, we place orders and we get extremely long lead times on electronic parts that ordinarily would have lead times of a couple of weeks, maybe a month, we now are quoted to lead times of more than a year. In some cases, we've had lead times of 80 weeks.

But what we're starting to see is that we get promised deliveries 80 weeks out in the future, and then we actually receive the parts in 10 weeks or 15 weeks. And we've seen that in a number of cases. And so I think what I start to see is that people are being very conservative in making promises, but things are turning around and they're able to do much better than those original conservative estimates. And that's really encouraging.

But nonetheless, we have to plan based on the promises made by our suppliers. And so -- and then we don't see these kind of improvements to deliveries in all cases. So it's kind of a mixed bag, but I think it is indicative of the direction that things are going.

Okay. That's great. And the additional costs that come as a result of difficulty in getting parts or taking more time to engineer products. Do you ever get compensated for that? That is -- in your ultimate development or production programs, do your customers give you some wiggle room and help you pay for that?

Well, we -- that's something that we're actively pursuing at this point in time with some of our customers. In one particular case, we have gotten some benefit in that regard. But in general, that hasn't happened. But I think that it is something that we are going to be pursuing over the next year or so because, yes, it's -- we've -- we have suffered tremendously in this regard.

Okay. And you said on 1 of the 2 calls that you led Tom that you were hoping to get back to breakeven by the end of this fiscal year, and I'm wondering if you still think that's likely.

Well, I wouldn't say as likely as it -- this fiscal year will be breakeven. But I think the last quarter and going forward after that, we do anticipate being breakeven or perhaps a little bit better.

Okay. Next, we have Robert Smith with the Center for Performance Investing.

Tom, the presentation you made at the annual meeting, is that on the website?

It should be. If not, we'll check, but it should be there.

Okay. Yes, I'm really interested in listening to it. So Tom, what kind of time period do you think you'd need to make your own personal imprint on leadership at the company? I mean you've been at the helm for a relatively short while. You have a wealth of experience with the company. And I assume you're attempting to reposition the company into stronger growth markets. So I'm wondering how you feel about this.

Well, I think in some ways, I'm leaving an imprint already, they're not very visible in the financial results at this point, but there are a lot of things going on, a lot of changes that have been made. And so I think it's kind of a mixed answer. There are some things that are evident already, and there are some things that are going to take a couple of years. We have -- we're pursuing new products and things. And those are things that aren't going to develop instantaneously. There are some things we're working on, and we think we're going to have some prototype products in the 2025 time frame to 2026 time frame. So I guess really a summary answer is there's imprints happening continuously between the present and a couple of years out.

Yes. I mean the burgeoning small satellite business is really coming to the fore. I assume -- I'm not saying you're asleep, but in the past, you've certainly not been trying to participate more, so I assume that this is a really important shift that you're trying to take the company or direction.

Yes, it is, in some sense. But I will say, we don't believe that the large satellites are going to completely disappear anytime soon, and so we don't want to abandon that business. In fact, there are signs of growth in that business also looking to the near future. But yes, we do feel that the small satellite business is where the future will go.

But I think the thing -- and I've said this before, the question is what does small satellite really mean? And there are satellites the size of a basketball and even smaller that have been launched recently. And then there people that call satellites that are 100x bigger than that, which are also considered small satellites. And so that's really -- the challenge for us is to find where the sweet spot is and where things really end up.

I think there are an awful lot of these small satellites, many of which get launched up into space and never operated even for a minute or 2. In fact, as part of the ARMAS launch, there were some satellites launched at the same time that never functioned properly. So there's evidence that you can't just make things cheaper and cheaper and smaller and smaller and get away with it. There are challenges in space. There's radiation. There is -- all kind of environmental things that need to be taken into account. So that's what we're really trying to do is make sure that we steer towards the sweet spot in the future. And I think we have some pretty good ideas of where that will be, but...

Makes sense. So looking at the revenue model, do you have a guesstimate as to what kind of volume we have to generate to reach breakeven considering gross margins?

Well, you want to answer that one, Steve?

We have a model. We -- I don't want to really forecast the future yet. But based on what we see, what we have in-house and our backlog and everything else, we believe, based on product mix and everything else going, like Tom said, in the second -- or the fourth quarter, we should be heading in that direction now.

(Operator Instructions) Up next, we have [Michael Eisner], private investor.

The $56 million in backlog, was some of that classified because there wasn't many news releases recently about contracts?

We don't have any classified contracts. None of that's classified.

And then the -- right now technically up to $60 million in backlog because that $4.4 billion came in after October 31?

Yes, yes.

All right. That's good. How many employees do you have all over?

We have about 180 employees considering all of the...

California and New Jersey also, total 180?

That's 180 between Long Island, New Jersey and California.

I see. Went down a drop, I think you did. Did you move more people to -- from California to New York?

No, no, we did not.

All right. And where are we with GPS IIIF?

We've -- we have actually just completed qualification testing of an engineering model. And in fact, we have also completed -- as part of that, we needed to do a 140-day stability test, and we have successfully completed that also. We have also delivered an engineering model, which is slated to fly on one of the GPS III satellites in -- they have an extra slot on the satellite for extra atomic clock, and our clock will be flying in that slot. I don't remember the exact schedule for that satellite at this point in time, but we have heard word that everything is good. And I believe that the satellite is all bundled up and ready to go, it's just a question of when it will actually launch.

That would be on GPS III, not the GPS IIIF?

That's correct. That's correct. Yes. And that -- there's a goal for everybody on the program, this is seen as an important step in everybody having confidence in our clock as a primary clock on the satellites. And so there's an effort to get this inserted as early as possible.

The IIIF is like the longest, biggest contract, right? That would take years.

Yes. The -- yes, it will take a few years to -- I think there are 22 GPS IIIF satellites. But I don't believe all of them have been released at this point in time.

Plus, the GPS III, there was like 10, right?

Yes.

So it's a total of like 32?

Yes.

And you're getting on the final of the GPS III?

Yes.

All right. And one more question. I think you mentioned last quarter some of the companies were buying more parts upfront or something to that effect. Are they continuing to do that?

Well, we -- I don't want to speak for other companies, but we're doing that.

That's what I mean. So this way, you won't be short parts?

Yes. Well, you know the -- it's a challenge because we don't want to just build up a huge inventory of parts. On the other hand, it makes sense given the long lead times to judiciously build up some inventory of parts that we commonly use. So we're definitely pursuing that.

Yes, I think this you commented like if they can give you the right part, it would take like a year to get the new part or something. I think that's what you mentioned last time. That's...

Yes, yes.

And are the overruns over with? You're in good shape there?

We're definitely finishing up the development on a couple of programs. And yes, we anticipate that the overruns are over or nearly over those, so yes.

All right. I will assume you think everything is going good if you paid the dividend.

Well, we're certainly pretty bullish about the future.

That's right. I'm glad to hear that. And I think you said this is the -- something like in -- first time in 8 years that you had this kind of backlog in the release.

Yes.

The next question is coming from [Frank Wesneski], private investor.

Follow-up on the inventory question. Well, it was pretty clear this -- the supply chain issues and then other issues contributed to that. What do you see as you're -- but it's still a very large number, almost $20 million in inventories, so the turns are pretty poor. But on an ongoing basis, without any supply chain uncertainties, what do you think your inventory turn should be? Because you have a lot of cash obviously tied up in that.

Steve?

We look and manage inventory. The problem is sometimes we use it later on as we get repeat programs. So you can't -- you have minimum buys and various other things that affect the growth of the inventory. So yes, it stays a little bit higher, but the end result is a lot of it gets reused on the next generation of things and things of that nature.

Okay. So you haven't seen any particular change in the inventory turn ratio?

Because of the length of the programs and stuff, probably not or not significant.

Okay. Could you update us a little bit on Zyfer? What's happening out there as far as their outlook for business?

I think their outlook is quite good at this point. We've recently received a large contract. And we have a couple more in the pipeline that look very promising. So I think we've gone through a challenging period with Zyfer, but I think things look really -- pretty good right now.

Good. One more. In the past, there have been some classified work out there, hadn't it?

Classified work at Zyfer?

At Zyfer, yes.

Yes. Well, I think the -- Zyfer, they manufacture hardware that takes advantage of -- that utilizes GPS receivers. And so there are GPS receivers that are able to utilize the encrypted messages, military messages. And so there's some classified activity that goes on related to that, but it's not that Zyfer is working on overall classified programs.

Okay. And one final question. One, I think the moves you've made since you've become interim has been very favorable. Could you update us on what the status is of a noninterim, either you or someone else, CEO?

Well, I don't know that, that's really for me to say. I think that -- it's my understanding that the Board is not actively looking for a replacement for me. But I don't have any intentions of going anywhere or doing anything different at this point in time. So I think that I have every intention of being here certainly for the next 3 to 5 years.

Well -- and those in the interim designation that you had (inaudible).

Yes. Well, perhaps, we'll see.

The next question is coming from [Bert Cole], private investor.

The question that I have really relates to our Board and the dividend that we're giving. While I certainly appreciate it, I have some questions as relating to how our Board is performing and that no one on this call seems to really be concerned. Our backlog is $56 million, up from $40 million. Additionally, we shipped [SCADA $8 million] over the 6 months. All of the press releases that go through the Board's approval and so on, I haven't seen any telling an industry and the public at large that the corporation is, in fact, having increased bookings. We took this SCADA $8 million contract and that one and so on and so forth to promote our corporation as it relates to the stock price and the value of our corporation. That's a Board responsibility, which to me and maybe others, they've certainly failed.

The next thing that concerns me and it only occurs an hour ago is a release of $1 a share dividend. While I certainly appreciate it, the corporation is losing tons of money. And it includes Board members that probably own 20% or 25% or control 20% or 25% of the company's stock. Look at the reward they're getting for a corporation that's lost half its value in the last couple of years.

I'm really upset of the performance of an overseeing Board that determines a temporary CEO or not-a-temporary CEO or whatever is going on, and no one on this call seems to be concerned that our Board of Directors is rewarding itself in certain instances or the shareholders that they represent, and the corporation is just giving up and losing money, certainly, perhaps for the next balance of this fiscal year and hopefully, it will turn around next year.

And while I'm an extremely small shareholder, I guess you can tell why my anger and my conversations today that I'm more than upset over the performance of individuals that control and run the management, so to speak, of our business. Gentlemen, I only wish you a healthy, healthy new year. And next year, fiscal and calendar should be better for all of us. And thank you for accepting my call.

Okay. No comment at this time.

Okay. We have no further questions in queue. I'd like to turn the floor back to Tom for any closing remarks.

Okay. I'd just like to wish everyone a very happy holidays and good health. And yes, that's it. Thank you.

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.