FEIM

Business Context and Reporting Period

Company: Frequency Electronics, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: January 31, 2010 (Nine and Three Months)
Business Overview: The Company operates in three segments: FEI-NY (precision time/frequency control for satellites and military), Gillam-FEI (wireline synchronization in Belgium), and FEI-Zyfer (GPS technologies for secure communications). The Company is a smaller reporting company.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenues decreased 10% for the nine months ended Jan 31, 2010, primarily due to lower sales in the FEI-NY segment (wireless infrastructure and commercial products). This was partially offset by growth in the FEI-Zyfer segment (US5G product line) and increased U.S. Government/DOD non-space program revenues.
• Margin Expansion: Gross margin improved significantly from 23.2% to 36.1% (nine months). This was driven by higher margin rates on current contracts compared to the prior year, which included high-cost satellite payload programs. Inventory write-downs also decreased to $950,000 from $1.45 million.
• Profitability Turnaround: The Company returned to profitability, recording operating income of $1.2 million compared to a loss of $2.5 million in the prior year. Net income turned positive ($2.6 million) from a loss ($1.6 million), largely due to a significant tax benefit.
• Impairment Charges: The Company recorded a $550,000 impairment charge related to its investment in Elcom Technologies, Inc., compared to none in the prior year.

Guidance, Outlook, and Risks

• Tax Benefit: Net income was significantly boosted by a $1.97 million tax benefit resulting from new U.S. legislation allowing a 5-year carryback of net operating losses. Approximately $2.1 million of this benefit is attributable to the new law.
• Outlook: Management expects revenues from wireless and satellite programs to remain stable for the remainder of fiscal 2010, with increased revenues from wireline and U.S. Government programs. The Company anticipates generating operating income for the full fiscal year.
• Backlog: Consolidated backlog was approximately $32 million as of January 31, 2010, with 70% expected to be realized in the next 12 months. Approximately $9 million of this is under cost-plus-fee contracts pending full funding.
• Risks & Controls: Management concluded that disclosure controls and procedures were not effective as of January 31, 2010, due to material weaknesses in internal control over financial reporting identified in the prior year that have not yet been remediated.
• Capital Allocation: The Company plans to spend approximately 10% of revenues on R&D. It has repurchased approximately $4 million of its $5 million authorized treasury stock.

Investor Verification Checklist

• Tax Benefit Sustainability: Verify the one-time nature of the $1.97 million tax benefit and its impact on future effective tax rates.
• Internal Controls: Review the specific material weaknesses in internal controls disclosed in the prior 10-K and assess the remediation plan.
• Investment Impairment: Investigate the valuation methodology and future outlook for the Elcom Technologies investment following the $550,000 impairment charge.
• Backlog Funding: Confirm the status of the $9 million in cost-plus-fee contracts pending full customer funding.
• Revenue Mix: Monitor the shift in revenue mix from commercial wireless/satellite to U.S. Government and wireline segments.