Frequency Electronics, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended October 31, 2012; fiscal year ends April 30. Financial amounts below are in millions of dollars, except per-share data.
Business context
The company makes precision time- and frequency-control products and systems for satellite, U.S. government and defense, and telecommunications markets. Its three reporting segments are FEI-NY, Gillam-FEI, and FEI-Zyfer. Fiscal 2013 results include FEI-Elcom, acquired in February 2012; the comparable 2011 reported results generally exclude Elcom.
Financial results
| Metric | Three months ended Oct. 31, 2012 | Prior-year quarter | Six months ended Oct. 31, 2012 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $17.569 | $15.055 | $34.254 | $30.994 |
| Gross profit / margin | $6.732 / 38.3% | $6.112 / 40.6% | $12.713 / 37.1% | $12.256 / 39.5% |
| Operating profit / margin | $2.018 / 11.5% | $1.775 / 11.8% | $3.099 / 9.1% | $3.559 / 11.4% |
| Net income | $1.441 | $0.776 | $2.209 | $2.120 |
| Diluted EPS | $0.17 | $0.09 | $0.26 | $0.25 |
- Quarterly revenue rose 17% and net income rose 86%; six-month revenue rose 11% and net income rose 4% year over year.
- Six-month operating profit declined 13%, as gross-margin compression and higher R&D and FEI-Elcom costs more than offset sales growth. R&D expense was $2.618 million for the six months, up 26%.
- Six-month operating cash flow was negative $0.981 million, versus positive $0.412 million in the prior-year period. The filing attributes the use of cash mainly to higher unbilled contract receivables and inventory, payments against trade payables, and FEI-Elcom’s operating loss.
- At October 31, cash and equivalents were $6.978 million and marketable securities were $16.931 million. Working capital was $66.5 million and the current ratio was 4.8:1. Short-term credit obligations were $8.722 million; management described $8.5 million as line-of-credit borrowings.
- Total assets were $110.718 million; total liabilities were $28.590 million. The filing does not provide a separate total-debt figure beyond reported credit and lease obligations.
Material changes and unusual items
- FEI-Elcom contributed approximately $3.1 million of third-party revenue and an operating loss of approximately $0.9 million in the six months; it recorded a $15,000 operating profit in the second quarter. Its low sales volume and higher customer-funded engineering costs weighed on gross margin.
- FEI-NY revenue increased 10% for the six months and Gillam-FEI increased 23%; FEI-Zyfer increased 2%. Satellite programs accounted for just under half of consolidated sales, while U.S. government/defense business exceeded 20%.
- Prior-year results included $0.350 million of Elcom-related investment and receivable impairment charges and $0.117 million of equity losses; neither recurred in the current period. Current-period interest expense increased with line-of-credit borrowings.
- On October 22, 2012, the company agreed to license rubidium oscillator production technology and sell equipment to Morion for approximately $2.7 million, plus 5% royalties on third-party sales for five years. It also committed to purchase approximately $0.4 million of oscillators annually during that period, although Morion is not obligated to supply that amount. Morion paid a $0.925 million deposit in November, recorded as deferred revenue; technology transfer was expected within a year and had State Department approval.
- After quarter-end, the board declared a special cash dividend of $0.20 per share, payable December 31, 2012 to holders of record December 24.
Outlook, risks and controls
- Management expected fiscal 2013 revenue to grow, with satellite payloads remaining the largest business area and U.S. government/defense and network infrastructure revenue also expected to increase. It expected full-year operating profit to exceed fiscal 2012 and anticipated improved gross margins, targeting a rate at or above 40% for the remainder of the year as revenue and FEI-Elcom performance improved.
- Backlog was approximately $63 million at October 31, with about 70% expected to be realized within 12 months. The company reported approximately $1 million of cost-plus-fee backlog not fully funded and more than $5 million of unfunded fixed-price contract amounts excluded from backlog.
- Management expected positive operating cash flow for the balance of fiscal 2013 as contract milestones were billed, planned $2–$3 million of capital equipment spending, and said liquidity was adequate through at least October 31, 2013. These are forward-looking expectations, not guarantees.
- Key risks include contract cost estimates and percentage-of-completion revenue recognition, inventory valuation, customer and market acceptance, competition and technology changes, raw-material and manufacturing costs, third-party vendors, funding availability, and the timing of contract billings.
- Management concluded disclosure controls were not effective as of October 31, 2012. A previously identified material weakness in acquisition accounting controls remained unresolved; management said it planned to add acquisition-accounting expertise if another acquisition occurred.
- The company reported no material off-balance-sheet arrangements other than operating leases. Interim results may not indicate full-year results.
Important facts for investors to verify
- Whether the expected revenue growth, improved margins, and higher full-year operating profit materialize, particularly given FEI-Elcom’s performance and the 40% gross-margin target.
- Whether the $63 million backlog converts to revenue and cash on schedule, including the funding and authorization status of excluded or partially funded contracts.
- Whether unbilled receivables, inventory, and working-capital needs allow operating cash flow to turn positive as management expected.
- The economics, delivery obligations, royalty terms, and deferred-revenue recognition for the Morion agreement.
- Progress in remediating the acquisition-accounting material weakness and the implications of ineffective disclosure controls.
- The capacity to fund the special dividend, planned capital spending, product development, and any acquisitions while managing line-of-credit borrowings.