Frequency Electronics Inc: Form 10-Q for the period ended Oct 31, 2023

“Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995:

The statements in this quarterly report on Form 10-Q regarding future earnings and operations and other statements relating to the future constitute “forward-looking” statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences include but are not limited to, our inability to integrate operations and personnel, actions by significant customers or competitors, general domestic and international economic conditions, reliance on key customers, including the U.S government, continued acceptance of the Company’s products in the marketplace, competitive factors, new products and technological changes, product prices and raw material costs, dependence upon third-party vendors, competitive developments, changes in manufacturing and transportation costs, the availability of capital, and the outcome of any litigation and arbitration proceedings. The factors listed above are not exhaustive. Other sections of this Form 10-Q and in Part I, Item 1A (Risk Factors) of the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2023 (the “Form 10-K”) include additional factors that could materially and adversely impact the Company’s business, financial condition and results of operations. Moreover, the Company operates in a very competitive and rapidly changing environment. New factors emerge from time to time and it is not possible for management to predict the impact of all these factors on the Company’s business, financial condition or results of operations or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not rely on forward-looking statements as a prediction of actual results. Any or all of the forward-looking statements contained in this Form 10-Q and any other public statement made by the Company or its management may turn out to be incorrect. The Company expressly disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Critical Accounting Policies and Estimates

The Company believes its most critical accounting policies to be the recognition of revenue and costs on production contracts and the valuation of inventory. Both of these areas require the Company to make use of reasonable estimates including estimating the cost to complete a contract, the realizable value of its inventory and the market value of its products. Changes in estimates can have a material impact on the Company’s financial position and results of operations. The Company’s significant accounting policies did not change during the three and six months ended October 31, 2023.

Revenue Recognition

Revenues are reported in operating results predominantly over time using the cost-to-cost method. Under this method, revenue is recorded based upon the ratio that incurred costs bear to total estimated contract costs with related cost of revenues recorded as the costs are incurred. Each month management reviews estimated contract costs through a process of aggregating actual costs incurred and estimating additional costs to completion based upon the current available information regarding labor, outside services, materials, overhead costs, and status of the contract. The effect of any change in the estimated gross margin rate (“GM Rate”) for a contract is reflected in revenues in the period in which the change is known. Provisions for the full amount of anticipated losses on contracts are made in the period in which they become determinable.

Significant judgment is used in evaluating the financial information for certain contracts to determine an appropriate budget and estimated cost. The Company evaluates this information continuously and bases its judgments on historical experience, design specifications, and expected costs for material and labor.

Inventory

In accordance with industry practice, inventoried costs contain amounts relating to contracts and programs with long production cycles, a portion of which will not be realized within one year. Inventory write downs are established for slow-moving materials based on percentage of usage over a ten-year period, obsolete items on a gradual basis over five years with no usage and costs incurred on programs for which production-level orders cannot be determined as probable. Such write-downs are based upon management’s experience and estimates for future business. Any changes arising from revised estimates are reflected in cost of revenues in the period the revision is made.

RESULTS OF OPERATIONS

The table below sets forth for the three and six months ended October 31, 2023 and 2022, respectively, the percentage of consolidated revenues represented by certain items in the Company’s condensed consolidated statements of operations or notes to the condensed consolidated financial statements:

Revenues

(in thousands)

For the three months ended October 31, 2023, revenues from commercial and U.S. Government communication satellite programs accounted for approximately 34% of consolidated revenues compared to approximately 48% of consolidated revenues during this same period in the prior fiscal year. Revenues are recognized primarily over time under the POC method. Revenues from the satellite market are recorded in the FEI-NY segment. Revenues from non-space U.S. Government/Department of Defense (“DOD”) customers, which are recorded in both the FEI-NY and FEI-Zyfer segments, accounted for approximately 60% of consolidated revenues for the three months ended October, 31, 2023 compared to approximately 44% of consolidated revenue during the same period in the prior fiscal year. Other commercial and industrial revenues for the three months ended October 31, 2023 accounted for approximately 5% of consolidated revenue compared to 8% in the same period of the prior fiscal year. The significant increase in revenue for this quarter, compared to the same quarter in the previous fiscal year, was in both segments and primarily related to contract awards coming in, resolution of technical problems from the previous fiscal year, and improvements made by management.

For the six months ended October 31, 2023, revenues from commercial and U.S. Government communication satellite programs accounted for approximately 37% of consolidated revenues compared to approximately 46% of consolidated revenues during this same period in the prior fiscal year. Revenues are recognized primarily over time under the POC method. Revenunes from the satellite market are recorded in the FEI-NY segment. Revenues from non-space U.S. Government/DOD customers, which are recorded in both the FEI-NY and FEI-Zyfer segments, accounted for approximately 58% of consolidated revenues for the six months ended October, 31, 2023 compared to approximately 47% of consolidated revenue during the same period in the prior fiscal year. Other commercial and industrial revenues for the six months ended October 31, 2023 accounted for approximately 5% of consolidated revenue compared to 8% in the same period of the prior fiscal year. The significant increase in revenue for this period, compared to the same period in the previous fiscal year, was in both segments and primarily related to contract awards coming in, resolution of technical problems from the previous fiscal year, and improvements made by management.

Gross Margin

(in thousands)

For the three and six months ended October 31, 2023, gross margin (“GM”) and GM Rate increased compared to the same period in the prior fiscal year. The gross margin dollars increased as a direct result of the increase in revenue. The GM 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.

Selling, General, and Administrative Expenses

Periods ended October 31,

(in thousands)

For the three months ended October 31, 2023 and 2022, selling, general, and administrative (“SG&A”) expenses were approximately 19% and 23%, respectively, of consolidated revenues. The percentage of consolidated revenue decreased 4% due to an increase in sales for the three months ended October 31, 2023 as compared to the three months ended October 31, 2022. The increase in SG&A expenses for the three months ended October 31, 2023 as compared to the prior year period was largely due to an increase in professional fees and payroll and associated costs.

For the six months ended October 31, 2023 and 2022 SG&A expenses were approximately 19% and 23%, respectively, of consolidated revenues. The percentage of consolidated revenue decreased 5% due to an increase in sales for the six months ended October 31, 2023 as compared to the six months ended October 31, 2022. The increase in SG&A expenses for the six months ended October 31, 2023 as compared to the prior year period was largely due to an increase in professional fees and payroll and associated costs.

Research and Development Expenses

Periods ended October 31,

(in thousands)

R&D expenditures represent investments intended to keep the Company’s products at the leading edge of time and frequency technology and enhance future competitiveness. The change in R&D expenditures for the three and six months ended October 31, 2023, was primarily due to a shift of employees between production and development depending upon availability, scheduling and necessity. The Company plans to continue to invest in R&D in the future to keep its products at the state of the art.

Operating Income (Loss)

Periods ended October 31,

(in thousands)

For the three and six months ended October 31, 2023, operating income increased due to a combination of increased revenue and gross margin, and the effects of certain cost cutting measures instituted by management that began in fiscal year 2023.

Other Income (Expense), net

(in thousands)

Other income (expense), net is derived from various sources. The income can come from reclaiming of metal, refunds, interest on deferred trust assets, or the sale of a fixed asset. Interest expense is related to the deferred compensation payments made to retired employees.

Provision for Income Tax

Periods ended October 31,

(in thousands)

The estimated annual effective tax rate for the fiscal year ending April 30, 2024 is 0%. This calculation reflects estimated income tax expense based on our current year annual pretax income forecast which is offset by the estimated change in the current year valuation allowance. The Company maintains a full valuation allowance against its deferred tax assets.

For the three months ended October 31, 2023, the Company recorded an income tax provision of $6,000 primarily related to state income taxes and discrete income tax provision related to an accrual of interest for unrecognized tax benefits. For the three months ended October 31, 2022, the Company recorded an income tax provision of $1,000.

For the six months ended October 31, 2023, the Company recorded an income tax provision of $13,000 primarily related to state income taxes and discrete income tax provision related to an accrual of interest for unrecognized tax benefits. For the six months ended October 31, 2022, the Company recorded an income tax provision of $2,000.

The effective tax rate for the three months ended October 31, 2023 was an income tax provision of 0.7% on pretax income of $0.8 million compared to an income tax provision of 0.0% on pretax loss of $2.3 million in the comparable prior fiscal year period. The effective tax rate for the three months ended October 31, 2023 differs from the U.S. federal statutory rate of 21% primarily due to domestic losses for which the Company is not recognizing an income tax benefit.

The effective tax rate for the six months ended October 31, 2023 was an income tax provision of 0.5% on pretax income of $2.9 million compared to an income tax provision of 0.0% on pretax loss of $5.4 million in the comparable prior fiscal year period. The effective tax rate for the six months ended October 31, 2023 differs from the U.S. federal statutory rate of 21% primarily due to domestic losses for which the Company is not recognizing an income tax benefit.

The Inflation Reduction Act of 2022 (the “Act”) was signed into U.S. law on August 16, 2022. The Act includes various tax provisions,

including an excise tax on stock repurchases, expanded tax credits for clean energy incentives, and a corporate alternative minimum tax that generally applies to U.S. corporations with average adjusted annual financial statement income over a three-year period in excess of $1 billion. The Company does not expect the Act to materially impact its consolidated financial statements.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s consolidated balance sheets continue to reflect a strong working capital position of approximately $24.7 million at October 31, 2023 and $21.0 million at April 30, 2023. Included in working capital at October 31, 2023 and April 30, 2023 was $8.7 million and $12.0 million, respectively, of cash and cash equivalents. The Company’s current ratio was 2.0 to 1 at October 31, 2023 compared to 1.8 to 1 as of April 30, 2023.

Net cash used in operating activities for the six months ended October 31, 2023 and 2022 was approximately $2.9 million and $0.5 million, respectively. The increase in net cash used in operating activities in the first six months of fiscal 2024 as compared to the prior fiscal year period was mainly due to operating income, offset by an increase in inventory and a decrease in contract liabilities. For the six months ended October 31, 2023 and 2022, the Company incurred approximately $2.2 million and $1.2 million, respectively, of non-cash operating expenses including amortization of ROU assets, loss provision accrual, depreciation and amortization, inventory net realizable value adjustments, deferred compensation, and accruals for employee benefit programs.

Net cash used in investing activities for the six months ended October 31, 2023 and 2022 was approximately $360,000 and $975,000, respectively. During the six months ended October 31, 2023, no marketable securities were sold or redeemed compared to $1.1 million for the same period of fiscal year 2023. During the six months ended October 31, 2023, no marketable securities were purchased compared to $1.4 million for the same period of fiscal year 2023. The Company acquired property, plant, and equipment in the amount of approximately $360,000 and $729,000 for the six month periods ended October 31, 2023 and 2022, respectively.

There were no financing activities for the six months ended October 31, 2023 or the six months ended October 31, 2022.

The Company has been authorized by its Board of Directors to repurchase up to $5 million worth of shares of its common stock when appropriate opportunities arise. As of October 31, 2023, the Company has repurchased approximately $4 million of its common stock out of the $5 million authorization, the majority of which has since been reissued. For the six months ended October 31, 2023 and 2022, there were no repurchases of shares.

The Company will continue to expend resources for R&D to develop, improve and acquire products for space applications, guidance and targeting systems, and communication systems that management believes will result in future growth and profitability. The Company anticipates securing additional customer funding for a portion of its R&D activities and will allocate internal funds depending on market conditions and identification of new opportunities. The Company expects internally generated cash will be adequate to fund these R&D efforts. The Company may also pursue acquisitions to expand its range of products and may use internally generated cash and external funding in connection with such acquisitions.

As of October 31, 2023, the Company’s consolidated funded backlog was approximately $50 million compared to $57 million at April 30, 2023, the end of fiscal year 2023. Approximately 75% of this backlog is expected to be realized in the next twelve months. The Company excludes from backlog any contracts or awards for which it has not received authorization to proceed. On fixed price contracts, the Company excludes any unfunded portion. Over time, as partially funded contracts become fully funded, the Company will add the additional funding to its backlog. The backlog is subject to change for various reasons, including possible cancellation of orders, change orders, terms of the contracts and other factors beyond the Company’s control. Accordingly, the backlog is not necessarily indicative of future revenues or profits (losses) which may be realized when the results of such contracts are reported.

The Company believes that its liquidity is adequate to meet its short-term operating and investment needs through at least December 15, 2024 and its long-term operation and investment needs for the foreseeable future thereafter.

The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors.

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on their evaluation, the Company’s chief executive officer and chief financial officer have concluded that, as of October 31, 2023, the Company’s disclosure controls and procedures were effective at a reasonable assurance level.

There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended October 31, 2023 that has materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

As disclosed in “Item 1A. Risk Factors” in the Form 10-K, there are a number of risks and uncertainties that could have a material adverse effect on the Company’s business, financial position, results of operations and/or cash flows. There are no material updates or changes to the Company’s risk factors since the filing of the Form 10-K.