Frequency Electronics' 2026 Q1 Earnings Call: Contradictions Emerge on Quantum Sensing, Contract Growth, and Margins

Date of Call: None provided

Financials Results

• Revenue: $25.9M for six months ended Oct 31, 2023, vs $17.2M for same prior-year period (up YOY); management said revenue holding steady vs Q1
• EPS: $0.30 per share for six months ended Oct 31, 2023, vs a $0.58 per-share loss in the prior-year six-month period
• Gross Margin: Gross margin dollars and rate increased vs prior fiscal year (management said the rate increased significantly due to resolution of prior technical issues); holding steady vs Q1
• Operating Margin: Operating income $3.0M for six months ended Oct 31, 2023 vs an operating loss of $5.4M in the prior-year period (improved YOY); management attributes improvement to higher revenue, better gross margins and cost-cutting

Business Commentary:

• Revenue Growth and New Contracts:
• Frequency Electronics reported consolidated revenue of $25.9 million for the six months ended October 31, up 107% year-on-year.

• The significant revenue increase was due to new contract awards and the resolution of technical challenges from the previous fiscal year.

• Improved Gross Margin and Operating Income:

• The gross margin dollar increased as a result of a 57% year-on-year increase in revenue, leading to improved gross margin rate.
• Frequency Electronics reported operating income of $3 million, reflecting a $5.4 million improvement from the prior fiscal year.
• The improvement in gross margin and operating income was attributed to the resolution of technical issues and cost-cutting measures.

• Backlog and Future Expectations:
• The company's fully funded backlog was approximately $50 million at the end of October 2023, anticipated to grow significantly due to new contract awards.

• The backlog growth is expected as several large contracts, valued at around $80 million combined, were recently secured.

• Research & Development and Cost Management:

• R&D expenses decreased to $1.3 million, a $400,000 reduction from the previous year, resulting in an R&D expense ratio of 5% of consolidated revenue.
• The reduction in R&D expenses was due to a shift of employees between production and development based on availability, scheduling, and necessity.

Sentiment Analysis:

Overall Tone: Positive

• CEO: “we have encouraging numbers… confident that we're on a sustainable path of growth and profitability.” CFO: consolidated revenue $25.9M vs $17.2M prior-year and operating income $3.0M vs a $5.4M loss prior-year. CEO noted three large contract awards in November and said backlog is expected to grow significantly; repeated emphasis on being well positioned to execute and targeting ~50% gross margin.

Q&A:

• Question from Brett Reiss (Janney): Tom, the Starlink satellite program... Is the satellite size of those satellites the size where our atomic clocks and our frequency generators, are these potential sales opportunities?
  Response: FEI has no products on Starlink and does not expect to; the company sees better opportunities in other LEO communications systems that add navigation payloads and already has relationships with several such programs.

• Question from Chris Vachovsky (Private Investor): Did the margins go down slightly sequentially? You had slightly larger revenues but operating income was a bit under $1M vs a little over $1M last quarter?
  Response: Yes, margins were slightly down quarter-to-quarter largely because prior quarter included one-time positive items; management views margins as essentially holding steady despite small QoQ fluctuation.

• Question from Tim Hasara (Sinnet Capital): You said 50% gross margins in the next 6 months to a year—correct? And are the three new contracts higher gross margin and how will they be booked (timing/linear vs front/back-loaded)?
  Response: Yes, 50% gross margin is the target within ~6–12 months; the November contracts are generally higher margin, will be recognized on percentage-of-completion (durations ~18 months to 3 years) and revenue is expected to be approximately linear but slightly front-loaded.

• Question from Frank Wysenski (Private Investor): Given the new orders in November, is your current backlog close to $100M and do you have enough engineers to execute; inventory is high—how do you view that?
  Response: Funded backlog is not $100M—reported funded backlog was about $50M and will grow as programs are funded; inventory is intentionally elevated from supply-chain buffering but management plans to reduce and they've been hiring engineers to be prepared to execute.

• Question from Frank Wysenski (Private Investor): You have contract awards, say a $25M award—why don't you take the whole $25M into backlog?
  Response: We report only fully funded backlog; if a $25M contract initially provides $5M in funding, we include the funded $5M in backlog and add further funding as it is provided.

• Question from Frank Wysenski (Private Investor): The atomic clock order with potential options up to $70M—when is the demonstration satellite launch and when would you expect confirmation of effectiveness?
  Response: The demonstration is currently scheduled for 2027; determination of options would follow the demo, and FEI expects low new-development risk on that program (it's largely production) though final exercise of options depends on factors sometimes outside FEI's control.

• Question from George Marema (Pareto Ventures): If you reach a 50% gross margin, what would operating/net margins look like and how will SG&A and R&D scale as revenue grows?
  Response: SG&A dollars should remain relatively consistent (percent of revenue will decline as revenue grows); operating/net margins would improve if gross margin reaches 50%, but management did not provide a precise net margin target.

• Question from Michael Eisner (Private Investor): How many employees do you have now; are the technologies on the $25M and $19M contracts already proven; have you started work on the three contracts?
  Response: About 200 full-time employees plus some part-time/consultants; the technologies on the first two contracts are proven, FEI owns the IP on all three contracts, and work has already started and is being pursued aggressively.

• Question from Frank Gasser (Private Investor): Are you working on the advanced atomic clock (game changer) and any update on tests or capability improvements?
  Response: Yes—FEI is testing an advanced post-optically pumped rubidium clock (terrestrial demo scheduled for tomorrow) expected to show ~10x improvement versus current products; company is pursuing external funding to advance even more advanced clock technologies and is developing smaller, low-power space-capable clocks.

• Question from Richard Johns (Private Investor): Would you characterize the large and small contracts you're winning as fixed-price contracts and can you expand on changes to your bidding process?
  Response: Most bids are fixed-price (some cost-plus); management is bidding more conservatively—pushing back on risk, avoiding low-margin/high-risk NRE work, and aiming to protect margins especially where FEI is near sole source.

• Question from Jeffrey Cohen (Mulholland Capital Management): If 50% gross margin is your target, what sort of quarterly revenue run rate would that contemplate (i.e., what revenue is needed to get to that margin in reported results)?
  Response: Management declined to tie the 50% target to a specific revenue run rate—50% is a bidding target for new business rather than a projection tied to a particular revenue figure.

• Question from Jeffrey Cohen (Mulholland Capital Management): You mentioned lots of NOLs—can you quantify cumulative NOLs roughly?
  Response: Steven Bernstein estimated cumulative NOLs at approximately $20 million (give or take).

Contradiction Point 1

Quantum Sensing and Space Applications

It involves the company's focus and potential future contributions in the field of quantum sensing, impacting strategic directions and potential growth areas.

What's the current status of quantum sensing in space applications, and are there other areas like quantum computing where this technology could be applied? - George Marema (Pareto Ventures)

2024Q2: Quantum computing doesn't exclude space applications. Frequency Electronics is focusing on quantum sensing contributions for near-term impact. While not directly investing in quantum computing, the company is aware of the field and is building an engineering team with expertise in potential future contributions. - Thomas McClelland(CEO, President & Director)

Can you comment on future technology, particularly advanced atomic clocks? - Unknown Attendee (Private Investor)

2026Q1: We are working on an advanced atomic clock with a demonstration tomorrow, showing significant improvement. We seek external funding for further development. - Thomas McClelland(CEO, President & Director)

Contradiction Point 2

Future Contract Options and Business Expansion

It involves the company's ability to secure additional business from existing contracts and its plans for expansion, which are crucial for revenue growth and market positioning.

Can these companies generate more business from these two contracts? - Michael Eisner (Private Investor)

2024Q2: Yes, there are future contract options. Our goal is to leverage past performance to secure more business. - Thomas McClelland(CEO, President & Director)

Do you know who the companies developing similar systems are, and whether you already have established relationships with them, or does your sales team need to establish contact first? - Brett Reiss (Janney)

2026Q1: We know who the organizations are and have made significant inroads. The competition is strong, but we are well-positioned. - Thomas McClelland(CEO, President & Director)

Contradiction Point 3

Government Business and Contract Growth

It involves expectations and actual performance regarding government business and contract growth, which are crucial for the company's revenue projections and strategic planning.

Are you considering significantly entering civilian markets? - Private Investor (Unknown Attendee)

2024Q2: We anticipate significant civilian market opportunities. Our $9 million contract was a non-U.S. government deal. - Thomas McClelland(CEO)

Will non-space DoD and government sales continue to improve? - Unknown Analyst (Private Investor)

2025Q3: Yes, we anticipate that trend to continue for at least the next year and potentially longer. - Thomas McClelland(CEO)

Contradiction Point 4

Product Developments and Revenue Expectations

It involves the company's product development pipeline and revenue expectations, which are critical for investor assessments of the company's growth prospects.

Can you discuss future technology, particularly the advanced atomic clock? - Unknown Attendee (Private Investor)

2024Q2: We are working on an advanced atomic clock with a demonstration tomorrow, showing significant improvement. We seek external funding for further development. - Thomas McClelland(CEO)

Can you elaborate on Quantum sensing and whether there is a product ready or revenue expected in 2025? - George Marema (Pareto Ventures)

2025Q3: We do not have any products at this point, but we anticipate several development contracts over the next year or two. We're excited about products like a magnetometer for GPS-denied environments and MAD, and a Rubidium sensor for small, compact antennas. - Thomas McClelland(CEO)

Contradiction Point 5

Gross Margin Expectations

It involves changes in financial forecasts, specifically regarding gross margin expectations, which are critical indicators for investors.

Did margins decline sequentially, and if so, how do economies of scale apply to the government business? - Private Investor (Unknown Attendee)

2024Q2: Margins may appear down slightly due to onetime events, but we anticipate steady performance. Government scrutiny is strong, but our target is a gross margin of 50%. - Thomas McClelland(CEO)

Will Blackwell's Q4 revenue be additive, and what's the expected gross margin exit rate? - Stacy Rasgon (Bernstein Research)

2025Q3: Gross margins for Q3 are expected around 75%, with full-year guidance in the mid-70s. - Steven Bernstein(CFO)