Frequency Electronics Inc Q4 FY2024 Earnings Call

Greetings and welcome to the Frequency Electronics Year-End Fiscal 2024 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. Any statements made by the company during this conference call regarding the future are forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements involve uncertainties that could result in actual outcomes differing significantly from those projected. Factors that could lead to these differences are detailed in the company's press releases and are further discussed in the company's periodic filings with the Securities and Exchange Commission. The company has no obligation to update these forward-looking statements after this conference call. It is now my pleasure to introduce your host, Thomas McClelland, President and Chief Executive Officer.

Good afternoon, everyone. We have a very positive story to tell regarding the fiscal year that ended April 30th. Revenues have grown consistently throughout the year and we expect that to continue in the near term going forward. The backlog of $78 million is a historic high for the company and we anticipate the backlog will remain strong based on a very healthy new business outlook. The company is reporting an operating profit for the year of $5 million with the operating loss in the third quarter being followed by a profitable fourth quarter. We anticipate continued long-term growth in our primary end markets of space, navigation, secure communication and timing. Our proven heritage technical expertise in these disciplines allows us to continue to win new business while maintaining healthy growth margins. This puts us on a very solid footing going forward and gives us some breathing room to develop new technologies and products in these markets as they evolve over the next decade. As we've discussed in the past, there is a growing concern with the vulnerability of satellite assets, and thus a move to lower cost, easily replaceable satellite hardware. The company continues to respond to new business opportunities in this arena. In some cases, these programs involve higher risk and potentially lower gross margins, but are essential for the long-term strength of the company. Our very healthy backlog of traditional satellite programs incorporating our legacy technologies allows us to participate in these more risky programs while maintaining growth and profitability overall. I would like to add a few words about our other press release today. As you have hopefully seen, today, the Board of Directors authorized a $1 per share special dividend and I encourage you to read that press release for the details regarding the record and payment dates coming up in August. This is the second such dividend that the board has authorized in approximately a year and a half. I'm proud of the continued progress we have made on profitability and cash generation, which allows us to reward our shareholders in this fashion. While we're not committing to a certain cadence or amount of such dividends in the future, it's reasonable that should we continue to make progress, the Board will consider similar capital plans in the future. We're able to do this while maintaining a debt-free balance sheet and continuing to invest in next generation programs, which we are winning and are poised to continue to win. As we've seen over just the past two quarters, the path to improved profitability is not always going to be perfectly linear, especially given some of the bleeding-edge technology that we're working on. But as I said earlier, business is booming and we believe it is prudent to return excess cash to shareholders so that future gains and profitability can accrue in a more pronounced manner to equity holders. I'll now turn things over to our CFO, Steve Bernstein, who will fill you in on the financial details.

Thank you, Tom, and Good afternoon. Before we jump into the details of the company's results for the fiscal year ended April 30th, 2024, I would like to remind everyone that as mentioned on previous calls, there will be times the company's results will fluctuate quarter-over-quarter and that a single quarter is not indicative of future results. As an example, sometimes the effect of changes taken in one quarter can reverse in another quarter as engineering problems are solved and revenue and profitability flow through. For an accurate view of the company's performance, it's important to review the entire year and other significant items. For the fiscal year ended April 30, 2024, consolidated revenue was $55.3 million compared to $40.7 million for the same period of the prior fiscal year. The components of revenue are as follows. Revenue from commercial and US Government satellite programs was approximately $23.2 million or 42% compared to $17.9 million or 44% 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. Revenue from non-space US Government and DOD customers, which are recorded in both the FEI New York and FEI Zyfer segments, were $29 million compared to $20.3 million in the same period of the prior fiscal year and accounted for approximately 52% of consolidated revenue compared to 50% for the prior fiscal year. Other commercial industrial revenue was $3.1 million and $2.6 million for the fiscal years ended April 30, 2024, and 2023 respectively. The significant increase in revenue for the period was primarily related to an increase in US Government orders. For the fiscal year ended April 30, 2024, gross margin and gross margin rate as compared to the same period in fiscal year 2023, the gross margin dollars increased as a direct result of the increase in revenue. The gross margin rate increased significantly due to the fact that many of the technical challenges faced in the prior fiscal year have been resolved, and as a result, the related programs are now moving forward and running more efficiently. Previous programs that sustained lower margins due to technical issues are near completion or have been completed. For the fiscal year ending April 30, 2024, and 2023, SG&A expenses were approximately 18% and 23% respectively of consolidated revenue. While total SG&A expenses increased in fiscal year 2024 as compared to the prior fiscal year, SG&A expenses decreased as a percentage of revenue in fiscal year 2024 due to increased revenue as well as the company successfully moderating costs given the current economic conditions. R&D expense for the fiscal year ended April 30, 2024 increased to $3.4 million from $3.1 million for the fiscal year ended April 30, 2023, an increase of $300,000 and were approximately 6% and 8% respectively of consolidated revenue. The company's funded R&D amount was slightly higher in fiscal year 2024 as compared to the previous fiscal year, reflecting the company's commitment to maintaining its technical excellence. The company expects future R&D investment to be in line with or even potentially above historic commitments. For the fiscal year ending April 30, 2024, the company recorded operating income of $5 million compared to an operating loss of $4.7 million in the prior fiscal year. The change from an operating loss to operating income year over year is a tribute to the company's significant increase in revenue and margin during the fiscal year 2024, along with the positive effects of cost-cutting measures instituted by management. Other income can be derived from reclaiming metals, refunds, interest on deferred trust assets, or the sale of fixed assets, interest expenses related to the deferred compensation payments made to retired employees. This yields pre-tax income of approximately $5.5 million compared to a $5.4 million pre-tax loss for the prior fiscal year. For the fiscal year ended April 30, 2024, the company recorded a tax benefit of $130,000 compared to a tax provision of $74,000 for the same period of the prior fiscal year. Consolidated net income for the fiscal year ended April 30, 2024 was $5.6 million or $0.59 per share compared to a $5.5 million net loss or a negative $0.59 per share in the previous fiscal year. Our fully funded backlog at the end of April 2024 was approximately $78 million compared to approximately $56 million for the previous fiscal year ended April 30, 2023. The company's balance sheet continues to reflect strong working capital position of approximately $27 million at April 30th, 2024, 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 and 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.

Okay. Thank you Steve. And we're now prepared to take questions.

Your first question is from Brett Reiss at Janney Montgomery Scott. Your line is open.

Gentlemen, can you hear me because I'm calling from home?

Yes, we can hear you.

Great, great. Congrats on a spectacular quarter to both of you and the team. The dollar special dividend, fantastic. And I'm not going to give it back, but, despite that business is booming and there were so many secular tailwinds in the satellite business, how did you arrive at the dollar? Why not $0.50 and retain $0.50 and to reinvest in the growth opportunities in the business? If you could give me your thoughts on that, I'd appreciate it.

I believe that this decision primarily rests with the Board. There are many arguments for different levels of dividends. Right now, we consider this to be a one-time dividend and feel that we can afford it at this moment. We will assess in the future whether there will be additional dividends. If some of the favorable trends you mentioned materialize or become more significant, we can always reconsider. However, at this time, we feel confident that we can manage this dividend.

Great, great. One more if I may and then I'll drop back in queue because I'm sure there's a line. This tremendous momentum and business opportunity going forward, what keeps you up at night that could derail the continued taking advantage of the opportunity that lays before us?

Well, there's certainly plenty to keep me awake at night. I think a couple of things that stand out, and in my earlier words, I tried to hit on it, we do see changes in the satellite industry and exactly how best to deal with those changes and how best to position ourselves relative to those changes is something that we give an awful lot of thought to, certainly. Particularly with government customers, we see there's kind of a desire to have the best of all worlds. They want smaller, cheaper, faster satellite hardware and they don't want to invest anything in order to get there. So how exactly to be able to do that is certainly a challenge. And I think it's something that we're working on. The trick is to do that. On the one hand, we absolutely have to participate. On the other hand, we don't want to start giving things away for nothing and go back into a situation where we're potentially losing money on these programs. So this is certainly perhaps the biggest challenge that keeps us awake at night at this point.

Thank you for taking my questions. I appreciate it.

Thank you. Your next question is coming from Richard Johns. Your line is live.

Good afternoon and thanks very much for the dollar and the great job you're doing. I just have one question. I'm wondering what the size of the tax loss carry forward is as of the end of April?

I believe the NOLs were roughly in the low $20 million range. They're not all 100%. Some will be used obviously this year and then it will be recalculated after we file our tax return.

Okay, thank you.

Thank you. Your next question is coming from George Marema from Pareto Ventures. Your line is live.

Hey, good afternoon, Tom.

Hi.

So this quarter, your gross margin was about 40%. Your backlog increased substantially. I have a couple of questions regarding this. Is there any change to your long-term gross margin outlook? Looking ahead to fiscal '25, how should we approach gross margin and its progression? I also want to discuss the seasonality of this.

Okay. It's actually a really good question. I think, and we've talked about it on the last few calls a little bit, I think, I divide things into two categories. We have the traditional programs that we've dealt with, particularly in the satellite industry. And I think there we really can push to keep the gross margins high. As we've said previously, we target 50% gross margin on those kinds of programs. But then we have what we were just discussing a little bit earlier, these new programs where there's tremendous pressure on costs. And, of course, we have a concern that if we don't get involved in some of those programs we may lose out in the long run. So in some cases, we have to take on some additional risk. And effectively, that means that the gross margins we can expect from those programs is a little bit lower. So I think that realistically, I think we can expect the gross margins to stay where they are. Stay where they are, we may be able to push them higher in some cases, but I think on an overall basis, I don't see them going a lot higher in the near future.

Okay. In terms of backlog, it seems there is some seasonality where larger contracts are typically won in the fall, which I assume is linked to the government's fiscal year. Therefore, I was somewhat surprised to see such a significant increase in backlog during the spring. Is there any seasonality to this?

I don't really think there is. There may have been at one time, but the government's fiscal year is currently a bit distorted since it starts on October 1st, and last year we went six months without a budget. I believe we are not very closely linked to the government fiscal year. While some parts of our business are affected, most of our work consists of subcontracts with major prime contractors to the government, rather than direct government contracts. This typically means there is a delay between when they secure their contracts and when we receive ours. Any perceived seasonality over the past year or so seems more coincidental than anything else.

Did you win any contracts? I mean, your backlog increased from $67 million last quarter to $78 million now, and you reported about $16 million in revenue, so that's roughly a net increase of $27 million to $28 million. Were there any large contracts that contributed to this, or was it a collection of smaller ones? What was the breakdown?

We haven't had any excessively large contracts during that time, but there have been a number of medium-sized contracts.

Okay, thank you. I'll get back in the queue.

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

Hey, great job.

Thank you.

When you said 40% gross margins, was that going forward for the year?

Yeah, I think so.

Roughly, roughly.

Yes.

The contracts we received in November of last year.

Yeah.

How is that progressing? Are there any issues?

Well, there's never a case where we have no problems, but I would say everything is very positive at this point in time. If it was a no problem kind of contract, they wouldn't be coming to Frequency Electronics. But we don't have the kind of technical problems that caused difficulties in the past, not yet on these contracts. And yeah, so I think things are looking pretty good in that respect.

And, is Zyfer back on schedule?

Zyfer is back on schedule, and we're making a significant effort to stay disciplined in that area to ensure it continues to be the case moving forward.

All right. In the first quarter of last year, you did like $12.5 million. Second quarter, $13.5 million. Third quarter, like $13.7 million. This quarter, $15.5 million. But your backlog actually went up by $26 million during this period. So I guess how much of this backlog do you expect to see in 2025 fiscal year?

Steve, why don't you tackle that one?

So you're talking about how much of the backlog we expect to use to turn it?

Yeah, I think years ago it was around 60% to 75%, but I can't remember the exact figure.

That's approximately where it will be. It's based on the length of the programs and backlog and everything else.

It seems like backlog is going up a lot more than revenues. That's what basically I'm getting at. All right, that's it for me. Great job.

Thank you.

Thank you. Your next question is coming from Jason Ursaner from Bumbershoot Holdings. Your line is live.

Hello, good afternoon. Thank you for the questions and congratulations on a great quarter. I have a couple of additional questions regarding the margin. In the press release after the last quarter, the $1.2 million revenue, was that recovered in fiscal Q4? If so, what kind of margin did that have?

Go ahead, Steve.

Some of it was recognized back in this quarter. Not all of it, just some of it.

Okay. And then maybe just try to explain it again. So there's one dynamic where you're kind of chasing business that, I would say, kind of significantly above corporate average margin. That's the 50%-ish gross margin. If you could maybe explain that piece more and then the part where it sounds like there's some pushback on price. I think you're saying everybody wants it smaller, cheaper, wants things for free. Kind of that piece sounds like it's maybe below the corporate average of this 40% level for next year. Kind of just maybe a little more detail on what the dynamic is between those two kind of lines of business and where those are at looking ahead to next year.

I appreciate your question. One of the key strengths we have is our ability to offer high precision products that are unmatched in the market, which means we face minimal competition in those areas. For many traditional satellite programs requiring top-tier phase noise and performance, Frequency Electronics is the go-to choice. In these situations, we maintain healthy gross margins without needing to compromise on pricing. However, we recognize that the landscape is evolving, particularly in the space sector, where there's a shift towards smaller and more cost-effective satellites. This shift often involves using hardware that may not meet the traditional performance standards but is less expensive. We notice a trend where satellites are being designed to function effectively for shorter periods, sometimes only three years, rather than the usual 15. This presents a new business dynamic for us, introducing various risks since the requirements are changing rapidly. Over the next decade, we anticipate that these standards will solidify, but currently, companies are experimenting with different approaches to satellite design. The "fail fast" mentality popularized by innovators like Elon Musk means that when issues arise, there are financial impacts to consider. We are committed to engaging in this evolving market, as we cannot ignore it. However, we also recognize that the traditional market may dwindle if these new methods prove successful long-term. Thus, we must take strategic risks while remaining cautious. Thankfully, we have a robust business in the traditional satellite sector that enables us to explore these newer opportunities, provided we approach them prudently. This is our current strategy moving forward.

Got you. And to the extent some of those kind of more novel approaches work, the idea is that those would also be potentially higher volume down the road. Is it mostly the low earth orbit stuff when you're talking about space and some of these approaches or is it more broad?

Well, it's mostly low earth orbit but not exclusively. The GPS program is looking at medium earth orbit satellites along this same sort of mindset. They're looking at some procuring small numbers at this point of satellites that would still be in medium earth orbit but would fit into this model of low-cost satellites that would be replaced every three to five years. So it's mostly the low earth orbit, but not exclusively the low earth orbit. I think it's a model that just looks very attractive to everybody. It really starts with the fact that the reality is satellites are vulnerable. It doesn't really cost very much to destroy a satellite. And if it takes 10 plus years to replace a satellite, that makes the country very vulnerable. And so it really puts a lot of pressure to come up with an approach that allows those satellites to be replaced much more quickly than 10 years. And going along with that, it needs to be able to be done for a lot less than $1 billion every time that happens. So yeah, that's kind of the name of the game all the way around. And the question really just becomes where's the sweet spot? If you make a million dollar satellite and launch it but it fails before you can get it operational, that doesn't buy anybody anything. So, if it's too cheap, it's not good. On the other hand, if it's too expensive, it's not good either. So there's a lot of work in where that ends up in the end is still an open question.

And the couple of thousand satellites that are already in orbit for low earth, are they using either your technology similar to frequency for timing and just not happy about the cost or have they just not addressed the timing issues and maybe that's why it's becoming more of an issue in terms of failure rate?

Well, some of those applications don't require the kind of precision timing that we provide in our devices. So I think that's the case for the Starlink satellites. They utilize their requirements in terms of performance in this regard is significantly less than what we typically provide. But there are other cases where particular applications that need some of our technologies and I think there's a lot of work to trying to figure out how to provide those technologies at lower cost. We're, of course, participating in that process, but we're not alone. We do have competition.

Okay. Awesome. I appreciate all the details. Thanks a lot, Tom.

Thank you. That completes our Q&A session. Everyone, this concludes today's event. You may disconnect at this time and have a wonderful day. Thank you for your participation.