FREQUENCY ELECTRONICS INC 10-Q

Item 1. Financial Statements FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Condensed Consolidated Balance Sheets (In thousands except par value) October 31, April 30, 2020 2020 (UNAUDITED) ASSETS: Current assets: Cash and cash equivalents $ 3,654 $ 3,808 Marketable securities 9,948 10,570 Accounts receivable, net of allowance for doubtful accounts of $183 at October 31, 2020 and April 30, 2020 10,298 4,392 Costs and estimated earnings in excess of billings, net 3,201 6,953 Inventories, net 21,028 22,958 Prepaid income taxes 460 849 Prepaid expenses and other 2,333 1,705 Total current assets 50,922 51,235 Property, plant and equipment, at cost, net of accumulated depreciation and amortization 10,511 11,267 Goodwill 617 617 Cash surrender value of life insurance 15,174 14,790 Other assets 2,160 2,503 Right-of-Use assets – operating leases 10,235 10,864 Total assets $ 89,619 $ 91,276 LIABILITIES AND STOCKHOLDERS’ EQUITY: Current liabilities: Line of credit 3,000 - Accounts payable – trade $ 1,188 $ 1,424 Accrued liabilities 5,351 3,982 Loss provision accrual 92 748 Operating lease liability 1,612 1,869 Current debt - 4,965 Total current liabilities 11,243 12,988 Deferred compensation 14,411 14,258 Deferred taxes 8 8 Operating lease liability – non-current 8,937 9,444 Other liabilities 364 342 Total liabilities 34,963 37,040 Commitments and contingencies Stockholders’ equity: Preferred stock - $1.00 par value; authorized 600 shares, no shares issued - - Common stock - $1.00 par value; authorized 20,000 shares, 9,176 shares issued and 9,175 shares outstanding at October 31, 2020; 9,164 shares issued and 9,121 shares outstanding at April 30, 2020 9,176 9,164 Additional paid-in capital 57,071 56,914 Accumulated deficit (12,070 ) (12,137 ) 54,177 53,941 Common stock reacquired and held in treasury - at cost (1 share at October 31, 2020 and 43 shares at April 30, 2020) (6 ) (195 ) Accumulated other comprehensive income 485 490 Total stockholders’ equity 54,656 54,236 Total liabilities and stockholders’ equity $ 89,619 $ 91,276 See accompanying notes to condensed consolidated financial statements. 3 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (In thousands except per share data) (Unaudited) Six Months Ended October 31, Three Months Ended October 31, 2020 2019 2020 2019 Condensed Consolidated Statements of Operations Revenues $ 26,940 $ 21,641 $ 13,990 $ 9,087 Cost of revenues 17,530 18,870 8,668 10,269 Gross margin (loss) 9,410 2,771 5,322 (1,182 ) Selling and administrative expenses 7,352 4,743 4,124 2,290 Research and development expenses 2,177 3,731 979 1,450 Operating (loss) income (119 ) (5,703 ) 219 (4,922 ) Other income (expense): Investment income 157 224 50 45 Interest expense (75 ) (50 ) (36 ) (25 ) Other income (expense), net 129 58 113 2 Income (loss) before provision for income taxes 92 (5,471 ) 346 (4,900 ) Provision for income taxes 25 29 17 9 Net income (loss) $ 67 $ (5,500 ) $ 329 $ (4,909 ) Net income (loss) per common share: Basic and diluted earnings (loss) per share $ 0.01 $ (0.61 ) $ 0.04 $ (0.54 ) Weighted average shares outstanding: Basic 9,154 9,037 9,170 9,072 Diluted 9,206 9,037 9,236 9,072 Condensed Consolidated Statements of Comprehensive Income (Loss) Net income (loss) $ 67 $ (5,500 ) $ 329 $ (4,909 ) Unrealized gain (loss) on marketable securities: Change in market value of marketable securities before reclassification, net of tax 5 207 (176 ) 72 Reclassification adjustment for realized gains included in net income, net of tax (10 ) (1 ) - - Total unrealized (loss) gain on marketable securities, net of tax (5 ) 206 (176 ) 72 Comprehensive income (loss) $ 62 $ (5,294 ) $ 153 $ (4,837 ) See accompanying notes to condensed consolidated financial statements. 4 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (In thousands) (Unaudited) Six Months Ended October 31, 2020 2019 Cash flows from operating activities: Net income (loss) $ 67 $ (5,500 ) Non-cash charges to earnings 2,580 3,939 Net changes in operating assets and liabilities (667 ) 1,741 Net cash provided by operating activities 1,980 180 Cash flows from investing activities: Proceeds on redemption of marketable securities 1,521 2,480 Purchase of marketable securities (909 ) (2,463 ) Purchase of fixed assets and other assets (781 ) (1,274 ) Net cash used in investing activities (169 ) (1,257 ) Net cash used in financing activities: Repayment of PPP Loan (4,965 ) - Proceeds from UBS line of credit 3,000 - Net cash used in financing activities (1,965 ) - Net decrease in cash and cash equivalents (154 ) (1,077 ) Cash and cash equivalents at beginning of period 3,808 3,683 Cash and cash equivalents at end of period $ 3,654 $ 2,606 Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 46 $ 50 Cash refunded during the period for: Income Taxes $ 477 $ 467 See accompanying notes to condensed consolidated financial statements. 5 Table of Contents FREQUENCY ELECTRONICS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Changes in Stockholders’ Equity Three and Six Months Ended October 31, 2020 (In thousands except share data) (Unaudited) Additional Treasury stock Accumulated other Common Stock paid in Accumulated (at cost) comprehensive Shares Amount capital Deficit Shares Amount Income (loss) Total Balance at April 30, 2020 9,163,940 $ 9,164 $ 56,914 $ (12,137 ) 42,696 $ (195 ) $ 490 $ 54,236 Contribution of stock to 401(k) plan 68 (14,926 ) 68 136 Stock-based compensation expense 54 54 Exercise of stock options and stock appreciation rights - net of shares tendered for exercise price (109 ) (23,808 ) 109 - Other comprehensive income, net of tax 171 171 Net income (loss) (262 ) (262 ) Balance at July 31, 2020 9,163,940 $ 9,164 $ 56,927 $ (12,399 ) 3,962 $ (18 ) $ 661 $ 54,335 Contribution of stock to 401(k) plan 9,496 9 86 95 Stock-based compensation expense 73 73 Exercise of stock options and stock appreciation rights - net of shares tendered for exercise price 2,654 3 (15 ) (2,586 ) 12 (0 ) Other comprehensive income, net of tax (176 ) (176 ) Net income (loss) 329 329 Balance at October 31, 2020 9,176,090 $ 9,176 $ 57,071 $ (12,070 ) 1,376 $ (6 ) $ 485 $ 54,656 See accompanying notes to condensed consolidated financial statements. 6 Table of Contents FREQUENCY ELECTRONICS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Changes in Stockholders’ Equity Three and Six Months Ended October 31, 2019 (In thousands except share data) (Unaudited) Additional Treasury stock Accumulated other Common Stock paid in Accumulated (at cost) comprehensive Shares Amount capital Deficit Shares Amount Income (loss) Total Balance at April 30, 2019 9,163,940 $ 9,164 $ 56,831 $ (2,111 ) 183,661 $ (841 ) $ 46 $ 63,089 Contribution of stock to 401(k) plan 74 (10,906 ) 50 124 Stock-based compensation expense 80 80 Exercise of stock options and stock appreciation rights - net of shares tendered for exercise price (189 ) (41,325 ) 189 - Other comprehensive income, net of tax 134 134 Net loss (591 ) (591 ) Balance at July 31, 2019 9,163,940 $ 9,164 $ 56,796 $ (2,702 ) 131,430 $ (602 ) $ 180 $ 62,836 Contribution of stock to 401(k) plan 66 (8,703 ) 39 105 Stock-based compensation expense 64 64 Exercise of stock options and stock appreciation rights - net of shares tendered for exercise price (268 ) (58,387 ) 268 - Other comprehensive income, net of tax 72 72 Net loss (4,909 ) (4,909 ) Balance at October 31, 2019 9,163,940 $ 9,164 $ 56,658 $ (7,611 ) 64,340 $ (295 ) $ 252 $ 58,168 See accompanying notes to condensed consolidated financial statements. 7 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) NOTE A – CONDENSED CONSOLIDATED FINANCIAL STATEMENTS In the opinion of management of Frequency Electronics, Inc. (the “Company”), the accompanying unaudited condensed consolidated interim financial statements reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly, in all material respects, the consolidated financial position of the Company as of October 31, 2020 and the results of its operations, changes in Stockholders’ Equity for the three and six months ended October 31, 2020 and 2019, and cash flows for the six months ended October 31, 2020 and 2019. The April 30, 2020 condensed consolidated balance sheet was derived from audited financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the annual consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2020, filed on July 29, 2020 with the Securities and Exchange Commission. The results of operations for such interim periods are not necessarily indicative of the operating results for the full fiscal year. COVID-19 Pandemic and the CARES Act On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus originating in Wuhan, China (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally beyond its point of origin. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. As such, it is uncertain as to the full magnitude that the pandemic may have on the Company’s financial condition, liquidity, and future results of operations. Management is actively monitoring the impact of the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is not able to estimate the potential adverse effects of the COVID-19 outbreak on its results of operations, financial condition, or liquidity for fiscal year 2021. The Company faces various risks related to COVID-19 outbreak. The Company is dependent on its workforce to deliver its products primarily to the U.S. Government. If significant portions of the Company’s workforce are unable to work effectively, or if the U.S. Government, state and/or other customers or supplier operations are curtailed due to illness, quarantines, government actions, facility closures, or other restrictions in connection with the COVID-19 pandemic, the Company’s operations may be impacted. The Company may be unable to perform fully on its contracts and costs may increase as a result of the COVID-19 outbreak. These cost increases may not be fully recoverable or adequately covered by insurance. Since the COVID-19 outbreak began, no facilities have been fully shut down (other than temporarily for disinfecting) and such measures to disinfect facilities have not had a significant impact on production. Certain of the Company’s vendors have been unable to deliver materials on time due to the COVID-19 outbreak. Such delays have had a minor impact on the Company’s production schedules to date, but vendor delivery performance is being closely monitored and alternate sources of supply are generally available if necessary. On March 27, 2020, President Trump signed into law the “Coronavirus Aid, Relief, and Economic Security (CARES) Act.” The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, increased limitations on qualified charitable contributions, and technical corrections to tax depreciation methods for qualified improvement property. The CARES Act also appropriated funds for the Small Business Administration (SBA) Paycheck Protection Program loans that are forgivable in certain situations to promote continued employment, as well as Economic Injury Disaster Loans to provide liquidity to small businesses harmed by the COVID-19 outbreak. The Company received a loan under the Paycheck Protection Program (“PPP”) in April 2020, which it repaid in full in May 2020. For more detail regarding the Company’s PPP Loan, see Note K below. 8 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) NOTE B – EARNINGS PER SHARE Reconciliation of the weighted average shares outstanding for basic and diluted loss per share for the six and three months ended October 31, 2020 and 2019, respectively, were as follows: Periods ended October 31, Six months Three months 2020 2019 2020 2019 Weighted average shares outstanding: Basic EPS Shares outstanding (weighted average) 9,154,434 9,036,732 9,169,758 9,072,141 Effect of Dilutive Securities 51,389 ** 66,019 ** Diluted EPS Shares outstanding 9,205,823 9,036,732 9,235,777 9,072,141 **For the six and three-month periods ended October 31, 2019 dilutive securities are excluded from the calculation of earnings per share since the inclusion of such shares would be antidilutive due to the net loss for those periods. The exercisable shares excluded for the three and six months ended October 31, 2020 are 303,000 and 436,000 options, respectively. The exercisable shares excluded as of October 31, 2019 are 178,000 options for both periods. The effect of dilutive securities would have been 239,866 options and 230,670 options for the six and three-month periods ended October 31, 2019, respectively. NOTE C – COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS, NET At October 31, 2020 and April 30, 2020, costs and estimated earnings in excess of billings, net, consisted of the following: October 31, 2020 April 30, 2020 (In thousands) Costs and estimated earnings in excess of billings $ 13,858 $ 10,460 Billings in excess of costs and estimated earnings (10,657 ) (3,507 ) Net asset $ 3,201 $ 6,953 Such amounts represent revenue recognized on long-term contracts that had not been billed at the balance sheet dates or represent a liability for amounts billed in excess of the revenue earned. Amounts are billed to customers pursuant to contract terms. In general, the recorded amounts will be billed and collected or revenue recognized within twelve months of the balance sheet date. Revenue on these long-term contracts is accounted for on the percentage of completion (“POC”) basis. During the six and three months ended October 31, 2020, revenue recognized under POC contracts was approximately $24.6 million and $12.9 million, respectively. During the six and three months ended October 31, 2019, revenue recognized under POC contracts was approximately $19.1 million and $7.7 million, respectively. If contract losses are anticipated, costs and estimated earnings in excess of billings are reduced for the full amount of such losses when they are determinable. Contract losses of approximately $731,000 and $121,000 were recorded for the six and three months ended October 31, 2020, respectively. Contract losses recognized for the six and three months ended October 31, 2019 were approximately $1.9 million and $1.6 million, respectively. NOTE D – TREASURY STOCK TRANSACTIONS During the six month period ended October 31, 2020, the Company made contributions of 24,422 shares of its common stock and common stock held in treasury to the Company’s profit-sharing plan and trust under Section 401(k) of the Internal Revenue Code. Such contributions are in accordance with the Company’s discretionary match of employee voluntary contributions to this plan. 9 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) NOTE E – INVENTORIES Inventories, which are reported at the lower of cost and net realizable value, consisted of the following: October 31, 2020 April 30, 2020 (In thousands) Raw Materials and Component Parts $ 12,822 $ 15,470 Work in Progress 6,799 6,104 Finished Goods 1,407 1,384 $ 21,028 $ 22,958 The amounts above are net of reserves of $7.0 million and $6.6 million as of October 31, 2020 and April 30, 2020, respectively. NOTE F – RIGHT-OF-USE ASSETS AND LEASE LIABILITIES The Company’s leases primarily represent offices, warehouses, vehicles, and manufacturing and research and development facilities which expire at various times through 2029 and are generally operating leases. Contractual arrangements are evaluated at inception to determine if the agreement contains a lease. Certain lease agreements contain renewal options, rent abatement, and escalation clauses that are factored into our determination of lease payments when appropriate. Right-of-use (“ROU”) assets and lease liabilities are recorded based on the present value of future lease payments which factor in certain qualifying initial direct costs incurred as well as any lease incentives that may have been received. Lease expenses for operating lease payments are recognized on a straight-line basis over the lease term. Lease terms may factor in options to extend or terminate the lease. The Company elected the practical expedient for short-term leases which allows leases with terms of twelve months or less to be recorded on a straight-line basis over the lease term without being recognized on the balance sheet. Effective May 1, 2019, the Company adopted ASU 2016-02. The table below presents ROU assets and liabilities recorded on the respective consolidated balance sheets, related to ASU 2016-02 (in thousands): Classification October 31, 2020 April 30, 2020 (unaudited) Assets Operating lease ROU assets Right-of-Use assets leases $ 10,235 $ 10,864 Liabilities Operating lease liabilities (short-term) Lease liability, current 1,612 1,869 Operating lease liabilities (long-term) Lease liability, non-current 8,937 9,444 Total lease liabilities $ 10,549 $ 11,313 Total operating lease expense was $1.2 million and $500,000 for the six and three months ended October 31, 2020, respectively, the majority of which is included in cost of revenues and the remaining amount in selling and administrative expenses on the unaudited condensed consolidated statements of operations. Total operating lease expense was approximately $1.0 million and $504,000 for the six and three months, respectively, ended October 31, 2019, respectively, the majority of which is included in cost of revenues and the remaining amount in selling and administrative expenses on the unaudited condensed consolidated statements of operations. 10 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) The table below reconciles the undiscounted cash flows for each of the first five years and total of the remaining years to the operating lease liabilities recorded on the unaudited consolidated balance sheet as of October 31, 2020: Fiscal Year Ending April 30, ( in thousands ) Remainder of 2021 $ 756 2022 1,809 2023 1,829 2024 1,834 2025 1,723 Thereafter 5,492 Total lease payments 13,443 Less imputed interest (2,894 ) Present value of future lease payments 10,549 Less current obligations under leases (1,612 ) Long-term lease obligations 8,937 As of October 31, 2020, the weighted-average remaining lease term for all operating leases was 7.9 years. The Company does not generally have access to the rate implicit in the leases and therefore utilized the Company’s borrowing rate as the discount rate. The weighted average discount rate for operating leases as of October 31, 2020 was 6.20%. NOTE G – SEGMENT INFORMATION The Company operates under two reportable segments based on the geographic locations of its subsidiaries: (1) FEI-NY – operates out of New York and its operations consist principally of precision time and frequency control products used in three principal markets: satellites (both commercial and U.S. Government-funded); terrestrial cellular telephone or other ground-based telecommunication stations; and other components and systems for the U.S. military. The FEI-NY segment also includes the operations of the Company’s wholly-owned subsidiary, FEI-Elcom. FEI-Elcom, in addition to its own product line, provides design and technical support for the FEI-NY segment’s satellite business. (2) FEI-Zyfer – operates out of California and its products incorporate Global Positioning System (GPS) technologies into systems and subsystems for secure communications, both government and commercial, and other locator applications. FEI-Zyfer’s products also incorporate precision time references for terrestrial secure communications and command and control, and frequency products that incorporate GPS. FEI-Zyfer’s GPS capability complements the Company’s existing technologies and permits the combined entities to provide a broader range of embedded systems for a variety of timing functions and anti-spoofing (“SAASM”) applications. The Company measures segment performance based on total revenues and profits generated by each geographic location rather than on the specific types of customers or end-users. Consequently, the Company determined that the segments indicated above most appropriately reflect the way the Company’s management views the business. The accounting policies of the two segments are the same as those described in the “Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2020, filed on July 29, 2020 with the Securities and Exchange Commission. The Company evaluates the performance of its segments and allocates resources to them based on operating profit which is defined as income before investment income, interest expense and taxes. All acquired assets, including intangible assets, are included in the assets of both reporting segments. 11 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) The tables below present information about reported segments with reconciliation of segment amounts to consolidated amounts as reported in the condensed consolidated statements of operations or the condensed consolidated balance sheets for each of the periods (in thousands): Periods ended October 31, Six months Three months 2020 2019 2020 2019 Revenues: FEI-NY $ 20,996 $ 16,794 $ 11,156 $ 7,784 FEI-Zyfer 7,353 5,701 3,430 2,000 less intersegment revenues (1,409 ) (854 ) (596 ) (697 ) Consolidated revenues $ 26,940 $ 21,641 $ 13,990 $ 9,087 Operating profit (loss): FEI-NY $ (582 ) $ (5,475 ) $ 41 $ (4,296 ) FEI-Zyfer 667 (44 ) 306 (561 ) Corporate (204 ) (184 ) (128 ) (65 ) Consolidated operating (loss) income $ (119 ) $ (5,703 ) $ 219 $ (4,922 ) October 31, 2020 April 30, 2020 Identifiable assets: FEI-NY $ 42,472 $ 44,599 FEI-Zyfer 14,089 13,344 less intersegment balances - (8,586 ) Corporate 33,058 41,919 Consolidated identifiable assets $ 89,619 $ 91,276 Total revenue recognized over time as POC and Passage of Title (“POT”) were approximately $24.6 million and $2.3 million, respectively, for the six months ended October 31, 2020. The amounts recognized over time as POC and POT were approximately $19.1 million and $2.5 million, respectively, for the six months ended October 31, 2019. The amounts by segment and product line were as follows: Six Months Ended October 31, 2020 2019 (In thousands) (In thousands) POC Revenue POT Revenue Total Revenue POC Revenue POT Revenue Total Revenue FEI-NY $ 18,857 $ 2,139 $ 20,996 $ 14,297 $ 2,497 $ 16,794 FEI-Zyfer 5,744 1,609 7,353 4,925 776 5,701 Intersegment (10 ) (1,399 ) (1,409 ) (76 ) (778 ) (854 ) Revenue $ 24,591 $ 2,349 $ 26,940 $ 19,146 $ 2,495 $ 21,641 12 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) Three Months Ended October 31, 2020 2019 (In thousands) (In thousands) POC Revenue POT Revenue Total Revenue POC Revenue POT Revenue Total Revenue FEI-NY $ 10,235 $ 921 $ 11,156 $ 6,139 $ 1,645 $ 7,784 FEI-Zyfer 2,706 724 3,430 1,602 398 2,000 Intersegment (1 ) (595 ) (596 ) (50 ) (647 ) (697 ) Revenue $ 12,940 $ 1,050 $ 13,990 $ 7,691 $ 1,396 $ 9,087 Periods ended October 31, (in thousands) Six months Three months 2020 2019 2020 2019 Revenues by Product Line: Satellite Revenue $ 14,228 $ 9,431 $ 7,576 $ 5,537 Government Non-Space Revenue 10,855 9,005 5,520 2,261 Other Commercial & Industrial Revenue 1,857 3,205 894 1,289 Consolidated revenues $ 26,940 $ 21,641 $ 13,990 $ 9,087 NOTE H – INVESTMENT IN MORION, INC. The Company has an investment in Morion, Inc. (“Morion”), a privately-held Russian company, which manufactures high precision quartz resonators and crystal oscillators. The Company has also licensed certain technology to Morion. The Company’s investment consists of 4.6% of Morion’s outstanding shares, accordingly, the Company accounts for its investment in Morion on the cost basis. This investment of approximately $800,000 is included in other assets in the accompanying condensed consolidated balance sheets. During the six months ended October 31, 2020 and 2019, the Company acquired product from Morion in the aggregate amount of approximately $268,000 and $380,000, respectively, and during the six months ended October 31, 2019 the Company sold product and training services to Morion in the aggregate amount of approximately $49,000, included in revenues in the condensed consolidated statements of operations as part of the FEI-NY segment. During the three months ended October 31, 2020 and 2019, the Company acquired product from Morion in the aggregate amount of approximately $118,000 and $135,000, respectively, and during three months ended October 31, 2019 the Company sold product and training services to Morion in the aggregate amount of approximately $2,000, included in revenues in the condensed consolidated statements of operations as part of the FEI-NY segment. During the six months ended October 31, 2020 and 2019, the Company received dividends from Morion in the amount of approximately $105,000 and $125,000, respectively, which is included in other income, net in the condensed consolidated statements of operations as part of the FEI-NY segment. Morion is a less than wholly-owned subsidiary of Gazprombank, a state-owned Russian bank. The U.S. Ukraine-related sanctions regime has since 2014 included a list of sectoral sanctions identifications (“SSI”) pursuant to Executive Order 13662, which prohibits certain transactions, including certain extensions of credit, with an entity designated as an SSI or certain affiliates of an entity designated as an SSI. On July 16, 2014, after the Company’s investment in Morion, Gazprombank was designated as an SSI. 13 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) In light of Morion’s relationship with Gazprombank, the Company recently evaluated, with the assistance of external legal counsel, certain sales to Morion and the timing of payments by Morion to the Company in connection with those sales to determine whether payments by Morion may have inadvertently constituted extensions of credit in violation of Directive 1 under Executive Order 13662. The Company determined that certain payments by Morion – the majority of which occurred more than five years ago – were not timely. Following the evaluation, on May 7, 2020, the Company voluntarily disclosed its findings to the Office of Foreign Assets Control (“OFAC”). The Company’s voluntary disclosure to OFAC relates solely to delays in collection of accounts receivable that exceeded then-applicable payment windows set forth in sanctions regulations and do not relate to any other type of payment or transaction. On July 22, 2020, OFAC informed the Company that it is conducting a civil investigation of the matter. The ongoing OFAC civil investigation subjects the Company to a number of financial and business risks. OFAC has broad enforcement discretion, and the imposition of sanctions, fines or remedial measures could have a material adverse effect on the Company’s business, prospects, reputation, financial condition, liquidity, results of operations or cash flows. Given the matter is in an early stage, however, the Company does not have sufficient information to (i) determine whether any liability (including penalties, sanctions, or remedial actions) as a result of the voluntary disclosure is probable or (ii) estimate the magnitude of any liability. While we are currently unable to predict what if any actions OFAC might take, or what the likely outcome of any such actions might be, or estimate the range of reasonably possible fines or penalties, such outcome may be material. Also, the Company is unable to predict the duration, scope, result or related costs of the investigation, including legal fees. NOTE I – FAIR VALUE OF FINANCIAL INSTRUMENTS The cost, gross unrealized gains, gross unrealized losses, and fair market value of available-for-sale securities at October 31, 2020 and April 30, 2020, respectively, were as follows (in thousands): October 31, 2020 Cost Gross Unrealized Gains Gross Unrealized Losses Fair Market Value Fixed income securities $ 9,463 $ 530 $ (45 ) $ 9,948 April 30, 2020 Cost Gross Unrealized Gains Gross Unrealized Losses Fair Market Value Fixed income securities $ 10,081 $ 495 $ (6 ) $ 10,570 The following table presents the fair value and unrealized losses, aggregated by investment type and length of time that individual securities have been in a continuous unrealized loss position (in thousands): Less than 12 months 12 Months or more Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses October 31, 2020 Fixed Income Securities $ 380 $ (5 ) $ 983 $ (40 ) $ 1,363 $ (45 ) April 30, 2020 Fixed Income Securities $ 380 $ (6 ) $ - $ - $ 380 $ (6 ) 14 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) During the six and three months ended October 31, 2020, the Company sold or redeemed available-for-sale securities of approximately $1.5 million and $796,000, respectively, realizing gains of approximately $12,000 and $9,000, respectively. Maturities of fixed income securities classified as available-for-sale at October 31, 2020 were as follows, at cost (in thousands): Current $ 3,267 Due after one year through five years 3,257 Due after five years 2,939 $ 9,463 The fair value accounting framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The levels of the fair value hierarchy are described below: Level 1 Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access. Level 2 Inputs to the valuation methodology include: -Quoted prices for similar assets or liabilities in active markets; -Quoted prices for identical or similar assets or liabilities in inactive markets; -Inputs other than quoted prices that are observable for the asset or liability; and -Inputs that are derived principally from or corroborated by observable market data by correlation or other means. Level 3 Inputs to the valuation methodology are unobservable and significant to the fair value measurement. The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. The Company’s money market, business account, and U.S. securities are valued on a Level 1 basis. The Company’s fixed income corporate debt securities and certificates of deposit are valued on a Level 2 basis. NOTE J – RECENT ACCOUNTING PRONOUNCEMENTS In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Under ASU 2017-04 goodwill impairment will be tested by comparing the fair value of a reporting unit with its carrying amount, and recognizing an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The new guidance must be applied on a prospective basis and is effective for periods beginning after December 15, 2022, with early adoption permitted. The Company will not be adopting ASU 2017-04 early, and is in the process of determining the effect that ASU 2017-04 may have. However, the Company expects the new standard to have an immaterial effect on its consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) which replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance is effective for fiscal years beginning after December 15, 2022. The Company is evaluating the effect, if any, the update will have on its consolidated financial statements when adopted in fiscal year 2023. 15 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) NOTE K – CREDIT FACILITY As of October 31, 2020, the Company had available credit with UBS Bank USA at variable terms based on its securities holdings under an advisory arrangement, under which the Company has borrowed $3 million. On April 12, 2020, the Company received proceeds from a PPP Loan in the amount of $4,964,810 from JPMorgan Chase Bank, N.A. as the Lender, pursuant to the SBA Paycheck Protection Program under the CARES Act. The PPP Loan was repaid in full on May 6, 2020. NOTE L – VALUATION ALLOWANCE ON DEFERRED TAX ASSETS Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. As required by the authoritative guidance on accounting for income taxes, we evaluate the realization of deferred tax assets on a jurisdictional basis at each reporting date. We consider all positive and negative evidence, including the reversal of deferred tax liabilities, projected future taxable income, tax planning strategies, and results of recent operations. Accounting for income taxes requires that a valuation allowance be established when it is more likely than not that all or a portion of the deferred tax assets will not be realized. In circumstances where there is sufficient negative evidence indicating that the deferred tax assets will not be realizable, we establish a valuation allowance. As of October 31, 2020, and April 30, 2020, the Company maintained a full valuation allowance against its deferred tax assets. If these estimates and assumptions change in the future, the Company may be required to adjust its existing valuation allowance resulting in changes to deferred income tax expense. NOTE M – COMMITMENTS AND CONTINGENCIES On January 28, 2020, Martin B. Bloch, the former Chief Scientist of the Company and a former member of the Company’s Board of Directors (the “Board”), filed a complaint against the Company and Jonathan Brolin, Lance W. Lord, Russell M. Sarachek, Richard Schwartz and Stanton D. Sloane, each in their capacity as members of the Board (collectively, the “Director Defendants”), in the Supreme Court of the State of New York, County of Nassau ( Bloch v. Frequency Electronics, Inc., et al ., Index No. 601369/2020 (N.Y. Sup. Ct. filed Jan. 28, 2020)). Mr. Bloch seeks compensatory damages and costs and attorney’s fees, among other things, based on allegations that he was wrongfully terminated “for cause” pursuant to his employment agreement, dated March 17, 2008, and that the Company and the Director Defendants discriminated against him based on his age. Mr. Bloch had originally also sought a declaratory judgment and claims for damage to his reputation and a derivative claim on behalf of the Company alleging that the Director Defendants breached their fiduciary duty in rendering their decision to terminate Mr. Bloch’s employment with the Company. However, Mr. Bloch removed those claims from a subsequently filed amended complaint after the Company and the Director Defendants moved to dismiss them. On June 11, 2020, the Company and the Director Defendants filed their answer to the amended complaint. Mr. Bloch filed a motion for summary judgment on June 23, 2020, which the Company and the Director Defendants opposed on July 10, 2020. Mr. Bloch’s motion seeks an order that the Company is liable for breach of his employment agreement because he purportedly resigned from the Company before he was terminated. On July 10, 2020, the Company and the Director Defendants opposed Mr. Bloch’s motion and also filed a motion for summary judgment seeking the dismissal of all claims in Mr. Bloch’s amended complaint. On September 23, 2020, the Court denied Mr. Bloch’s motion for summary judgment. It also granted the Company and the Director Defendants’ motion for summary judgment as to all claims, except for one claim for breach of contract against the Company. On October 23, 2020, the Company filed a brief with the Appellate Division, Second Department, seeking a reversal of the lower court’s order to the extent that it denied the Company’s summary judgment motion on the breach of contract claim. Mr. Bloch filed its responsive brief on November 20, 2020. The appeal is currently pending. The Company believes that the Board was justified in its decision to terminate Mr. Bloch “for cause” and that Mr. Bloch’s single surviving claim is entirely without merit. The Company intends to vigorously defend against all of Mr. Bloch’s allegations. At this time, the Company does not have sufficient information to determine whether liability, if any, arising out of these matters is probable or the possible loss, if any, which could result from an unfavorable outcome arising out of these matters. In addition, Mr. Bloch sought to initiate two arbitration proceedings under the AAA Rules ( Bloch v. Frequency Electronics, Inc., the Compensation Committee of the Board of Directors of Frequency Electronics, Inc., and the Deferred Compensation Plan Agreement Dated March 7, 2008 ). One arbitration is brought under a deferred compensation agreement dated March 27, 1980 and the other under a second amended and restated deferred compensation agreement, dated March 7, 2008. Bloch submitted his Statements of Claim in both arbitrations on May 4, 2020. In both proceedings, Mr. Bloch claims that defendants violated ERISA rules by denying him deferred compensation benefits. He seeks an award for allegedly past due deferred compensation benefits plus interest, clarification as to his future rights to deferred compensation benefits, and attorneys’ fees and costs. 16 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) On June 2, 2020, the Company filed a petition for a stay of arbitration and related declaratory relief against Mr. Bloch, in the Supreme Court of the State of New York, New York County ( Frequency Electronics, Inc. v. Martin B. Bloch , Index No. 652191/2020 (N.Y. Sup. Ct. filed June 2, 2020)). The Company claims that Mr. Bloch may not arbitrate his claims for deferred compensation because he did not timely appeal the Company’s denial of those claims, and because he failed to comply with the arbitration procedures in the applicable deferred compensation agreement. Mr. Bloch filed a motion on June 16, 2020 seeking a change of venue to the County of Nassau, which the Company opposed on July 7, 2020. The Court granted Mr. Bloch’s motion on September 8, 2020. The case was therefore transferred to the County of Nassau, and assigned to the same Judge hearing the other cases between the parties. At this time, the Company does not have sufficient information to determine the likelihood of success of this petition. On June 5, 2020, Mr. Bloch filed a petition against the Company, the Compensation Committee of the Company’s Board of Directors, and the Deferred Compensation Plan Agreement Dated March 7, 2008, as amended (“Respondents”), for the appointment of an arbitrator in one of the arbitration proceedings that Mr. Bloch sought to initiate. The petition was filed in the Supreme Court of the State of New York, County of Nassau (Bloch v. Frequency Electronics, Inc. et al., Index No. 605380/2020 (N.Y. Sup. Ct. filed June 5, 2020)). On June 22, 2020, Respondents moved to dismiss Mr. Bloch’s petition, and he opposed the motion on July 2, 2020. The motion is currently pending. On September 11, 2020, the Court granted Respondents’ application for an interim stay of the arbitration pending the Court’s determination of the Company’s petition for a stay of arbitration (described above), Mr. Bloch’s petition for the appointment of an arbitrator, and other outstanding motions. Respondents dispute all of Bloch’s claims and intend to continue to vigorously defend the Company in this special proceeding. The likelihood of any outcome of this proceeding cannot be determined at this time. 17 Table of Contents FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES