Frequency Electronics, Inc. — Form 10-Q Summary
Reporting period: Second quarter and six months ended October 31, 2011 (fiscal 2012). Comparisons are with the periods ended October 31, 2010, unless otherwise stated. Dollar amounts are in millions except per-share data.
Business context and financial performance
The company develops and manufactures precision time and frequency-control products, serving satellite, U.S. government and defense, and telecommunications markets through its FEI-NY, Gillam-FEI, and FEI-Zyfer segments.
| Metric | Three months ended Oct. 31, 2011 | Three months ended Oct. 31, 2010 | Six months ended Oct. 31, 2011 | Six months ended Oct. 31, 2010 |
|---|---|---|---|---|
| Revenue | $15.055 | $12.528 | $30.994 | $24.652 |
| Gross profit / margin | $6.112 / 40.6% | $4.804 / 38.4% | $12.256 / 39.5% | $9.550 / 38.7% |
| Operating profit / margin | $1.775 / 11.8% | $0.812 / 6.5% | $3.559 / 11.4% | $1.601 / 6.5% |
| Net income | $0.776 | $0.328 | $2.120 | $0.835 |
| Diluted EPS | $0.09 | $0.04 | $0.25 | $0.10 |
Six-month revenue rose 26%, and quarterly revenue rose 20%. Satellite payload programs drove the increase, with commercial and government satellite revenues accounting for about half of six-month revenue, versus about 30% a year earlier. FEI-NY revenue increased 45% for the six months; Gillam-FEI revenue fell 29%, while FEI-Zyfer rose 16%. Six-month operating profit increased 122%; net income increased 154%.
Gross-margin improvement reflected higher volume and a more favorable program mix, particularly in FEI-NY, where volume absorbed more fixed costs. Selling and administrative expense increased 19% for the six months, mainly from higher incentive, stock-based, and deferred compensation expense. R&D expense declined 13%, primarily because resources shifted to customer-funded development, whose costs are included in cost of revenues.
Cash flow, liquidity, and obligations
- Operating cash flow: $0.412 million provided in the six months, versus $1.842 million used in the prior-year period. Working-capital demands included higher inventory and unbilled contract assets.
- Investing cash flow: $4.058 million used, including $0.855 million of capital expenditures and a $0.092 million additional loan to Elcom. The company purchased $8.222 million and redeemed $5.111 million of marketable securities.
- Cash and marketable securities: $19.950 million at October 31, 2011, comprising $1.644 million cash and $18.306 million securities; cash alone declined from $5.275 million at April 30, 2011.
- Working capital and current ratio: $62.9 million and 10.5:1 at October 31, compared with $60.3 million at April 30.
- Debt and liabilities: The filing reports no conventional borrowings. Capital-lease obligations totaled $0.321 million ($0.276 million current and $0.045 million noncurrent). Total liabilities were $17.565 million, including $10.042 million of deferred compensation.
- Other balance-sheet movements: Inventory increased to $30.447 million from $28.172 million; net costs and estimated earnings in excess of billings rose to $7.402 million from $2.409 million. Stockholders’ equity was $73.792 million.
Outlook, risks, and unusual items
- Management expected higher fiscal 2012 revenue and profit than in fiscal 2011, including increased satellite payload revenue, continued U.S. government/defense growth, and growth in wireline telecommunications. It anticipated full-year operating profit and stated that operating margin could exceed 10% at the increased business level.
- Management expected gross-margin rates for the remainder of fiscal 2012 to reach or exceed its approximately 40% target. It anticipated selling and administrative costs to remain near their current rate and possibly exceed its 20%-of-revenue target; internal R&D was expected to remain below 10% of revenue.
- Backlog was approximately $65 million at October 31, with about 60% expected to be filled within 12 months. Approximately $2 million was under cost-plus-fee contracts not yet fully funded. Management believed liquidity would meet operating and investment needs through at least October 31, 2012.
- The company recorded a $0.350 million charge related to Elcom Technologies: a $0.200 million investment impairment and a $0.150 million allowance against notes receivable. It had $1.9 million due from Elcom under notes, including an additional $0.092 million advanced during the period; the notes were due in December 2011 and January 2012.
- Other income included approximately $0.137 million of realized gains on life-insurance policies covering a former employee for the six-month period. The company also reported an approximately $0.411 million negative foreign-currency translation adjustment for the six months.
- Control weakness: Management concluded disclosure controls were not effective at October 31, 2011. Previously identified material weaknesses in internal control over financial reporting continued; remediation work at Gillam-FEI and FEI-Zyfer was ongoing.
- Key stated risks include acceptance of products, competition and technological change, product pricing and raw-material costs, third-party suppliers, manufacturing and transportation costs, contract terms, and capital availability. Revenue and inventory valuation depend on estimates, including contract costs to completion and inventory realizable value.
Important facts for investors to verify
- Whether satellite-program schedules, customer authorizations, and milestone billings support the backlog and forecast, especially the $2 million of not-fully-funded contracts.
- Collection and recoverability of Elcom’s $1.9 million notes and the valuation of the company’s remaining Elcom investment.
- Whether rising inventory and unbilled contract assets convert to shipments, billings, and operating cash flow as expected.
- Progress in remediating the material weaknesses and restoring effective disclosure controls.
- Whether margins, expenses, and full-year growth meet management’s stated expectations; interim results are not necessarily indicative of full-year results.