Frequency Electronics, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Quarter and six months ended October 31, 2017; fiscal year ends April 30. Amounts below are in millions of dollars unless noted.
Business context and financial results
The company supplies precision time and frequency products for satellite, telecommunications, and government markets. Its reportable segments are FEI-NY and FEI-Zyfer. Gillam, its Belgian subsidiary, is presented as discontinued operations pending sale.
- Quarter: Revenue was $9.34 million, down 18.6% year over year. Gross margin was $2.20 million (23.6% of revenue), versus $3.73 million (32.5%). Operating loss was $1.87 million versus $1.18 million; continuing-operations loss was $1.29 million versus $0.86 million. Net loss was $1.48 million, or $0.17 per diluted share, versus $1.02 million, or $0.12 per share.
- Six months: Revenue was $21.36 million, down 7.2%. Gross margin was $6.72 million (31.5%) versus $7.55 million (32.8%). Operating loss was $1.69 million versus $1.59 million; continuing-operations loss was $0.46 million versus $1.17 million. Net loss was $0.87 million, or $0.10 per diluted share, versus $1.73 million, or $0.20 per share.
- Cash flow: Six-month cash provided by continuing operations was $2.22 million, compared with $3.21 million used in the prior-year period. Including discontinued operations, operating cash flow was $2.83 million versus $2.48 million used. Investing activities provided $5.57 million, principally from $6.48 million of securities redemptions; capital expenditures and other asset purchases were $0.88 million. Continuing-operations cash was $11.02 million at October 31.
- Liquidity and debt: Working capital was $61.9 million and the current ratio was 9.2 to 1. Cash, cash equivalents, and marketable securities totaled $12.4 million. The company had repaid and terminated its bank credit facility and reported no borrowings; it had access to borrowing based on securities holdings but had not drawn on it.
- Balance sheet: Total assets were $112.7 million, total liabilities $23.8 million, and stockholders’ equity $88.9 million at October 31. Inventory was $31.2 million, up from $29.1 million at April 30.
Changes, outlook, and risks
- Quarterly revenue fell in both FEI-NY (down 14.9%) and FEI-Zyfer (down 15.4%). For the six months, FEI-NY revenue fell 11.2%, while FEI-Zyfer revenue rose 19.2%. Management attributed weaker gross margin and margin rate mainly to lower revenue and underabsorbed manufacturing overhead.
- For the six months, investment income rose to $1.17 million from $0.28 million, primarily reflecting approximately $1.0 million in gains on securities sold or redeemed. The company sold or redeemed $6.5 million of securities and divested its equity holdings during the July quarter.
- Management expects FY2018 satellite payload revenue to be lower than the prior year, while satellite payloads remain the dominant business. It expects non-space U.S. Government/DoD revenue to increase if funding is received for programs bid or being bid; additional funding was expected in the upcoming fiscal year. R&D activity is expected to continue, and management anticipates seeking further customer funding for some R&D.
- Funded backlog was approximately $21 million, down from $28 million at April 30; about 80% was expected to be realized within twelve months. Approximately $8.8 million was under cost-plus-fee contracts that management said were firm commitments but not yet fully funded. Management said liquidity was adequate through at least December 15, 2018.
- The planned Gillam sale remained uncertain: the original foreign counterparties had not performed under the purchase agreement, and the company was also negotiating with other potential buyers. Management was actively negotiating with a potential foreign buyer and sought completion before April 30, 2018; it expected a positive cash effect upon closing. Gillam recorded a six-month loss of $0.41 million.
- Management identified contract-cost estimates and inventory valuation as critical estimates. Other risks cited include customer acceptance and funding, competition and technology changes, third-party vendors, costs, and foreign-exchange movements. A possible U.S. tax-rate reduction could require remeasurement of deferred tax assets and a tax charge; the filing did not include any tax-reform effect in reported results. A $6.4 million valuation allowance covered uncertainty over certain state and foreign tax attributes.
- Management reported disclosure controls were effective at October 31, 2017, with no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether satellite-program revenue weakness and lower manufacturing utilization persist, and whether anticipated government program funding is received.
- Backlog quality, timing, and conversion to revenue, including the unfunded portion of cost-plus-fee commitments.
- Progress, terms, and timing of a Gillam sale, given the prior buyer’s failure to perform.
- Inventory realizability and contract cost-to-complete estimates, as well as the potential effect of tax-law changes on deferred tax assets.
- Cash generation excluding securities sales and realized gains, and the company’s cash-management and investment plans.