Frequency Electronics Inc: Form 10-Q for the period ended Oct 31, 2024

“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, other supply chain related issues, increasing costs for materials, operating related expenses, competitive developments, changes in manufacturing and transportation costs, the availability of capital, the outcome of any litigation and arbitration proceedings, and failure to maintain an effective system of internal controls over financial reporting.. 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, 2024 (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, 2024.

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.

Inventories

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, 2024 and 2023, 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, 2024, revenues from commercial and U.S. Government communication satellite programs accounted for approximately 59% of consolidated revenues compared to approximately 34% of consolidated revenues during this same period in the prior fiscal year. Revenues are recognized primarily over time under the percentage-of-completion (“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 37% of consolidated revenues for the three months ended October, 31, 2024 compared to approximately 60% of consolidated revenue during the same period in the prior fiscal year. Other commercial and industrial revenues for the three months ended October 31, 2024 accounted for approximately 4% of consolidated revenue compared to 5% 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 reflected in the FEI-NY segment and was related an increase of approximately $3.8 million in sales to U.S. Government space customers.

For the six months ended October 31, 2024, revenues from commercial and U.S. Government communication satellite programs accounted for approximately 57% of consolidated revenues compared to approximately 37% of consolidated revenues during this same period in the prior fiscal year. Revenues from non-space U.S. Government/DOD customers accounted for approximately 39% of consolidated revenues for the six months ended October, 31, 2024 compared to approximately 58% of consolidated revenue during the same period in the prior fiscal year. Other commercial and industrial revenues for the six months ended October 31, 2024 accounted for approximately 4% of consolidated revenue compared to 5% in the same period of the prior fiscal year. The significant increase in revenue for this six month period, compared to the same period in the previous fiscal year, was reflected in the satellite segment and primarily related to an increase in contract awards from prior periods that moved into production during the six months ended October 31, 2024.

Gross Margin

(in thousands)

For the three months ended October 31, 2024, both gross margin (“GM”) and GM rate increased compared to the same period in the prior fiscal year. The increase in GM was mainly due to an increase in revenue and the GM rate increase was mainly attributable to a large space program that completed a major milestone in its production. As a result of the completed milestone, risk was mitigated, allowing the release of costs relating to this program, which caused a higher GM for the quarter. For the six months ended October 31, 2024, both GM and GM Rate increased compared to the same period in the prior fiscal year. This is partially due to the program mentioned above that completed a major milestone during the quarter ended October 31, 2024, as well as a significant number of smaller jobs that were completed at higher margins during the six months ended October 31, 2024. As a result, the residual older low margin programs had a smaller impact on results.

Selling, General, and Administrative Expenses

Periods ended October 31,

(in thousands)

For the three months ended October 31, 2024 and 2023, selling, general, and administrative (“SG&A”) expenses were approximately 21% and 19%, respectively, of consolidated revenues. For the six months ended October 31, 2024 and 2023, SG&A expenses were approximately 20% and 19%, respectively, of consolidated revenues. The increase in SG&A expense during the three and six months ended October 31, 2024, was mainly related to an increase in payroll related expenses, costs from the re-alignment of employees from overhead to SG&A, and costs related to Frequency Electronics’ first Quantum Summit in October 2024. The Company believes the costs related to SG&A will remain fairly consistent throughout the remainder of fiscal year 2025.

Research and Development Expenses

Periods ended October 31,

(in thousands)

Research and Development (“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, 2024, as compared to the prior year periods, was primarily due to a focus on advances and modernization of products. The Company plans to continue to invest in R&D in the future to keep its products at the state of the art, however we expect the actual quarterly spend to vary.

Operating Income

Periods ended October 31,

(in thousands)

For the three and six months ended October 31, 2024, operating income increased due to higher revenue and GM percentage, partially offset by higher R&D expenses. The increase is partially due to a large space program that completed a major milestone in its production during the three months ended October 31, 2024, as discussed above, however, the increase is also the result of the successful efforts of the Company to complete complex 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. The Company seeks to continue to implement changes to further improve its performance.

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. The majority of the approximately $0.2 million and $0.4 million of investment income for the three and six months ended October 31, 2024, respectively, was from unrealized gains on assets held in the Frequency Electronics, Inc. Deferred Compensation Trust.

Provision for Income Tax

Periods ended October 31,

(in thousands)

16

The estimated annual effective tax rate for the fiscal year ending April 30, 2025 is 5.15%. 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. It is reasonably possible the existing valuation allowance will be reduced within the next 12 months.

For the three months ended October 31, 2024, the Company recorded an income tax provision of $138,592 which includes a discrete tax income benefit of $9,577. The calculation of the overall income tax provision consists of current U.S. federal and state income taxes. For the three months ended October 31, 2023, the Company recorded an income tax provision of $6,000.

For the six months ended October 31, 2024, the Company recorded an income tax provision of $271,522 which includes a discrete tax benefit of $4,222. The calculation of the overall income tax provision consists of current U.S. federal and state income taxes. For the six months ended October 31, 2023, the Company recorded an income tax provision of $13,000.

The effective tax rate for the three months ended October 31, 2024 was an income tax provision of 4.96% on pretax income of $2.8 million compared to an income tax provision of .7% on pretax income of $0.8 million in the comparable prior fiscal year period. The effective tax rate for the three months ended October 31, 2024 differs from the U.S. federal statutory rate of 21% primarily due to the valuation allowance, permanent differences, a change in the uncertain tax position liability and state income taxes.

The effective six months ended October 31, 2024 was an income tax provision of 5.07% on pretax income of $5.4 million compared to an income tax provision of 0.5% on pretax income of $2.9 million in the comparable prior fiscal year period. The effective tax rate for the six months ended October 31, 2024 differs from the U.S. federal statutory rate of 21% primarily due to the valuation allowance, permanent differences, a change in the uncertain tax position liability and state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s consolidated balance sheets continue to reflect a strong working capital position of approximately $23.4 million at October 31, 2024 and $27.3 million at April 30, 2024. Included in working capital at October 31, 2024 and April 30, 2024 was $9.7 million and $18.3 million, respectively, of cash and cash equivalents. The Company’s current ratio was 1.8 to 1 at October 31, 2024 compared to 1.9 to 1 as of April 30, 2024.

Net cash provided by operating activities for the six months ended October 31, 2024 was approximately $2.4 million and net cash used in operating activities for the six months ended October 31, 2023 was $2.9 million. The increase in net cash provided by operating activities in the first six months of fiscal 2025 as compared to the prior fiscal year period was mainly due to an increase in operating income partially offset by increases in inventories levels. For the six months ended October 31, 2024 and 2023, the Company incurred approximately $2.5 million and $2.2 million, respectively, of non-cash operating expenses including amortization of ROU assets, 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, 2024 and 2023 was approximately $0.8 million and $0.4 million, respectively. The Company acquired property, plant, and equipment in the amount of approximately $0.8 million and $0.4 million for the six month periods ended October 31, 2024 and 2023, respectively.

Net cash used in financing activities for the six months ended October 31, 2024 was $9.7 million, of which $9.6 million was related to a dividend payout special cash dividend of $1.00 per share of common stock paid on August 29, 2024. There were no financing activities for the six months ended October 31, 2023.

The Company has been authorized by its Board of Directors to repurchase up to $5.0 million worth of shares of its common stock when appropriate opportunities arise. During the six months ended October 31, 2024, the Company repurchased 4,569 shares and 7,893 shares of outstanding common stock at $13.60 per share and $12.62 per share, respectively. As of October 31, 2024, the Company has repurchased approximately $3.6 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, 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, 2024, the Company’s consolidated funded backlog was approximately $81 million compared to approximately $78 million at April 30, 2024. Approximately 65% of the backlog, as of October 31, 2024, 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 16, 2025 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, because of the material weakness in internal control over financial reporting disclosed below, as of October 31, 2024, the Company’s disclosure controls and procedures were not 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.

Material Weakness on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of April 30, 2024. In making this assessment, management used the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, the Company’s management concluded that the Company’s internal control over financial reporting was not effective as of April 30, 2024, because of the material weakness in internal control over financial reporting discussed below.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

In the course of preparing the Company’s consolidated financial statements as of April 30, 2024 and for the year then ended, management identified a material weakness in internal control over the calculation of loss provision accruals in contracts with customers. The Company’s controls over loss provision accruals were not sufficiently designed to capture previously recognized contract losses when calculating the required balance of loss provision accruals as of the end of the reporting period. The errors resulting from this material weakness did not cause material misstatements in previously issued annual or interim financial statements. Such errors were corrected prior to the issuance of the Company’s consolidated financial statements as of April 30, 2024 and for the year then ended. If not remediated timely, the deficiency described above could result in a material misstatement to the future annual or interim consolidated financial statements.

The Company concluded that the item noted above constituted a material weakness in the Company’s internal control over financial reporting as of April 30, 2024.

Notwithstanding the existence of the material weakness described above, management believes that the audited consolidated financial statements included in the Form 10-K fairly presented, in all material respects, our financial position, results of operations and cash flows as of and for the periods presented, in conformity with GAAP.

Plan to Remediate Material Weakness

The Company is currently in the process of remediating the material weakness and has taken actions to address the underlying causes of the material weakness including improving controls over the calculation of loss provision accruals. The Company has updated its method of calculating loss provision accruals by considering previously recognized contract losses. The Company has also started to implement enhanced review, reconciliation, and monitoring controls over loss provision accruals and its underlying calculations. The Company intends to remediate these deficiencies as soon as possible and believes these actions will be sufficient to remediate the identified material weaknesses and strengthen the Company's internal control over financial reporting. As the Company continues to evaluate and improve its internal control over financial reporting, management may determine that additional measures or modifications to the remediation plan are necessary to address the material weakness. Moreover, the Company cannot provide assurance that additional material weaknesses will not arise in the future.

Changes in Internal Control Over Financial Reporting

We are in the process of implementing certain changes to our internal control over financial reporting to remediate the material weaknesses discussed above. Except as noted above, 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, 2024 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.