Frequency Electronics, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended October 31, 2014. Results are unaudited; dollar amounts below are in millions unless noted.
Business context and financial performance
The company develops and manufactures precision time- and frequency-control products and systems for satellite, U.S. government, telecommunications, and industrial markets. Its reportable segments are FEI-NY, Gillam-FEI, and FEI-Zyfer.
| Metric | Three months ended Oct. 31, 2014 | Year-over-year | Six months ended Oct. 31, 2014 | Year-over-year |
|---|---|---|---|---|
| Revenue | $19.24 | +13% | $38.98 | +15% |
| Gross margin | $6.67; 34.7% | +$0.44; rate down 1.9 percentage points | $12.34; 31.7% | -$0.16; rate down 5.2 percentage points |
| Operating profit | $1.80 | +42% | $2.72 | +22% |
| Net income | $1.29 | -$0.10; -7% | $2.01 | -$0.06; -3% |
| Diluted EPS | $0.15 | vs. $0.16 | $0.23 | vs. $0.24 |
For the six-month period, selling and administrative expense was $6.97 million, down 1%, and research and development expense was $2.65 million, down 18%. Operating margin improved to 7.0% from 6.6% for the six months and to 9.4% from 7.4% for the quarter. Investment income was $0.63 million for the six months; interest expense was $0.08 million.
Cash flow, liquidity, and debt
- Operating cash flow was negative $2.51 million for the six months, essentially unchanged from the prior-year period; management attributed the outflow mainly to higher receivables and inventory.
- Investing cash outflow was $0.41 million, including $3.12 million of purchases of fixed and other assets. Financing provided $1.33 million, including $2.30 million of credit-line borrowings and $1.00 million of repayments.
- At October 31, cash and cash equivalents were $6.42 million and marketable securities were $13.83 million. Working capital was $79.8 million and the current ratio was 8.7:1.
- Long-term debt was $11.4 million, all under Tranche A of a credit facility permitting up to $25 million in total borrowings. The facility matures June 5, 2018; the company reported compliance with its borrowing covenants.
- Management said liquidity was adequate through at least October 31, 2015. Planned fiscal 2015 capital-equipment spending was $4.0–$4.5 million.
Material changes and management outlook
FEI-NY revenue increased 23% for the six months, driven in part by satellite programs; Gillam-FEI revenue was essentially flat and FEI-Zyfer revenue declined 4%. Quarterly revenue rose across all three segments. Satellite programs represented about 60% of six-month revenue and increased 27%; non-space U.S. government revenue was about 15% of six-month revenue. FEI-Asia’s increased third-party contract manufacturing contributed to commercial revenue growth.
Six-month gross margin declined despite higher revenue, primarily reflecting weak first-quarter non-space government and Gillam-FEI sales, product mix, and lower volume. Management expected improved gross margins as satellite payload sales increased, while noting the reported rates remained below its 40% target. The prior-year comparison included a $0.736 million gain on the sale of fully depreciated equipment to Morion under a technology-licensing arrangement; this gain contributed to higher prior-year other income and helps explain why current-period net income was slightly lower despite stronger operating profit.
Management expected fiscal 2015 revenue to grow and full-year operating profit to exceed fiscal 2014, citing backlog and bookings. It expected positive operating cash flow in the remainder of the year as receivables were collected, SG&A below 20% of revenue, internal R&D below 10% of revenue, and a full-year effective tax rate of 30%–36%. Funded backlog was approximately $52 million at October 31, up from $48 million at April 30; over three-fourths was satellite payload business and about 70% was expected to be realized within 12 months.
Risks, contingencies, and other notable items
- Revenue recognition on long-term contracts uses percentage-of-completion estimates, including estimated costs to complete; inventory valuation also depends on management estimates. Revisions may affect results.
- The company cited market acceptance, competition and technology changes, product pricing and raw-material costs, third-party suppliers, manufacturing and transportation costs, contract terms, capital availability, and foreign-currency movements as risks.
- Approximately $2 million of backlog was under cost-plus-fee contracts not yet fully funded. The company excludes unauthorized or unfunded contract amounts from backlog.
- The Morion agreement includes further potential revenue subject to additional training and parts deliveries and relief from certain U.S. Government restrictions. The filing says the technology transfer received State Department approval.
- The company reported no material off-balance-sheet arrangements other than operating leases. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether satellite and secure-GPS program orders convert into funded backlog and recognized revenue on schedule.
- Whether gross margins recover from the six-month 31.7% level toward management’s 40% target, and whether the full-year operating-profit outlook is achieved.
- Whether receivables and inventory convert to cash as expected after six-month operating cash outflow of $2.51 million.
- Credit-facility availability, borrowing levels, covenant compliance, and the funding of planned capital spending.
- Contract cost estimates, inventory realizability, Morion agreement conditions, and foreign-exchange exposure.