Frequency Electronics, Inc. — Form 10-Q Summary
Business context and reporting period. This filing covers the three months ended July 31, 2018, the first quarter of the company’s fiscal 2019, with comparative results for the three months ended July 31, 2017. Frequency Electronics develops precision time and frequency products and systems for satellite, telecommunications, and government markets. Its reportable segments are FEI-NY and FEI-Zyfer. The statements are unaudited.
Key financial results
| Metric | Quarter ended July 31, 2018 | Prior-year quarter |
|---|---|---|
| Revenue | $11.011 million | $12.023 million |
| Gross profit / margin | $4.274 million / 38.8% | $4.521 million / 37.6% |
| Operating income | $85,000 | $180,000 |
| Income from continuing operations | $31,000 | $830,000 |
| Net income | $31,000 | $614,000 |
| Basic and diluted EPS | $0.00 | $0.07 |
| Operating cash flow | $(3.561) million | $3.159 million provided |
- Revenue declined 8%. FEI-NY revenue fell 6% to $8.577 million; FEI-Zyfer fell 40% to $2.561 million. Management attributed the overall decline mainly to lower other commercial revenue, down approximately $1.6 million. Satellite and non-space U.S. Government/Defense revenue increased approximately $335,000 and $230,000, respectively.
- Gross margin dollars declined 6% with lower sales, while the margin rate improved 1.2 percentage points to 38.8%, attributed to product mix and cost management. Selling and administrative expense declined 6% to $2.540 million; R&D rose 1% to $1.649 million.
- Other income/expense was a net expense of $47,000, versus net income of $1.135 million in the prior-year quarter. Prior-year investment income included approximately $1.0 million in realized gains from equity securities sales. Interest expense was $18,000.
- Cash and cash equivalents were $2.621 million and marketable securities were $7.178 million at July 31, 2018. Working capital was $47.6 million and the current ratio was 11.7:1. Operating cash use was primarily associated with increased receivables. Cash decreased by $5.248 million during the quarter.
- Total liabilities were $19.564 million; the filing reports no outstanding borrowings. The former bank credit facility was terminated, though the company said credit may be available against securities holdings.
Material changes, outlook, and risks
- The company adopted ASC 606 and related contract-cost guidance on May 1, 2018 using the modified retrospective method. Adoption increased opening retained earnings by a net $484,000. For this quarter, the company reported revenue $811,000 higher and net income $575,000 higher than it would have without adoption; without adoption, it would have reported a $544,000 net loss. The change also moved certain U.S. Government production-type contract revenue from shipment-based recognition to percentage-of-completion recognition.
- Satellite revenue was approximately 50% of consolidated revenue, versus 43% in the prior-year quarter. Management expects fiscal 2019 satellite payload revenue to exceed fiscal 2018, citing significant bookings in the prior two quarters and current backlog. The company also expects significantly higher customer-funded R&D for the balance of fiscal 2019.
- Funded backlog was approximately $37 million at July 31, up from $30 million at April 30; approximately 80% was expected to be realized within 12 months. About $10.4 million was under cost-plus-fee contracts that management viewed as firm commitments, but for which full funding had not yet been received.
- Management stated that liquidity should cover operating and investment needs through at least September 14, 2019 and the foreseeable future. The company plans continued investment in product development and may pursue acquisitions, potentially using external funding.
- Estimates of contract costs and completion, inventory valuation, revenue timing, and deferred tax assets are important judgment areas. The company had a full valuation allowance against U.S. deferred tax assets due notably to cumulative losses over three years. TCJA accounting remained incomplete, with no estimate changes in this quarter.
- Other risks cited include market acceptance, competition and technology changes, raw-material and manufacturing costs, third-party vendors, contractual changes, capital availability, and currency movements, particularly the Chinese renminbi. Management reported effective disclosure controls and no material change in internal control over financial reporting.
- The company sold Gillam-FEI in April 2018 for $1.0 million cash and a $1.0 million note due in three years, recording an approximately $359,000 loss. Gillam’s prior-year quarterly loss of $216,000 was reported as discontinued operations.
Important facts for investors to verify
- How much of reported revenue and earnings reflects the ASC 606 transition, and how the new recognition timing compares with cash collection and contract milestones.
- Progress in converting the $37 million backlog into revenue, including receipt of full funding for the $10.4 million of cost-plus-fee commitments.
- Receivables, contract assets, and operating cash flow trends, given the quarter’s significant cash use and increase in receivables.
- Whether the satellite revenue outlook and customer-funded R&D expectations are supported by subsequent bookings and funded contracts.
- Recovery prospects for U.S. deferred tax assets and final accounting for the Tax Cuts and Jobs Act; also monitor investment-security values and the Gillam note receivable.