Business context and reporting period
Frequency Electronics, Inc. designs and manufactures precision time-and-frequency control products and systems for satellite, government/defense, telecommunications, and other commercial markets. This Form 10-Q covers the quarter and nine months ended January 31, 2019, the company’s fiscal 2019 third quarter; comparisons are with the corresponding periods ended January 31, 2018. Amounts below are in U.S. dollars.
Financial results and liquidity
| Metric | Three months ended Jan. 31, 2019 | Three months ended Jan. 31, 2018 | Nine months ended Jan. 31, 2019 | Nine months ended Jan. 31, 2018 |
|---|---|---|---|---|
| Revenue | $13.193 million | $10.572 million | $36.345 million | $31.932 million |
| Gross profit (loss); margin | $4.100 million; 31.1% | $(2.852) million; (27.0)% | $12.392 million; 34.1% | $3.872 million; 12.1% |
| Operating loss | $(0.394) million | $(7.309) million | $(0.540) million | $(8.995) million |
| Net loss | $(0.321) million | $(10.396) million | $(0.168) million | $(11.263) million |
| Net loss per share | $(0.04) | $(1.18) | $(0.02) | $(1.27) |
| Cash from operations | Not provided separately for the quarter | Not provided separately for the quarter | $(1.285) million | $4.010 million, including discontinued operations |
For the nine months, cash used by continuing operations was $1.285 million, versus $2.793 million provided in the prior-year period. Investing activities used $4.388 million, including $2.175 million of purchases of property and other assets; financing activities provided no cash. Cash and cash equivalents declined $5.451 million to $2.418 million. Marketable securities were $8.442 million, bringing cash and securities to $10.860 million.
At January 31, 2019, working capital was $47.2 million and the current ratio was 11.4 to 1. Total assets were $84.248 million and total liabilities $19.657 million. The filing reports no borrowings under its securities-backed credit facility; available credit was based on securities holdings. Interest expense for the nine months was $57,000.
Material changes versus the prior comparable periods
- Revenue rose 24.8% in the quarter and 13.8% over nine months. Satellite revenue increased to $5.987 million for the quarter and $17.289 million for the nine months. FEI-NY revenue grew, while FEI-Zyfer revenue declined year over year.
- Gross margin and operating results improved substantially. Management attributed the prior-year weakness in part to a $5.0 million inventory write-down, lower revenue, repair costs, and under-absorbed manufacturing overhead. The prior-year period also included approximately $8.3 million in non-cash charges for the nine months.
- Reported revenue comparisons are affected by adoption of ASC 606 (ASU 2014-09), which shifted certain U.S. Government production-type contracts from point-in-time recognition to percentage-of-completion recognition. The filing’s pro forma comparison without adoption shows nine-month revenue $2.861 million lower and gross profit $0.677 million lower; for the quarter, revenue would have been $0.809 million lower and gross profit $0.312 million higher.
- Gillam was sold in April 2018 for $1.0 million cash and a $1.0 million note due in three years. Its prior-year results are reported as discontinued operations, including a $0.697 million nine-month net loss; there was no discontinued-operations loss in fiscal 2019.
Outlook, commentary, and risks
- Funded backlog was approximately $39 million at January 31, 2019, up from $30 million at April 30, 2018; about 75% was expected to be realized within 12 months. Backlog included $3.1 million of cost-plus-fee contract commitments not yet fully funded.
- Management expects research and development activity to continue at a similar rate and says significant additional customer funding for R&D has been secured. Management believes internally generated cash will be adequate for development efforts and liquidity sufficient for operating and investment needs through at least March 16, 2020. No specific earnings or revenue forecast is provided.
- Key estimation risks include contract cost-to-complete and percentage-of-completion judgments, inventory valuation, and income-tax estimates. A full valuation allowance remains against U.S. deferred tax assets, based notably on three-year cumulative losses. The company also cites competitive and technology changes, customer acceptance, supplier dependence, cost and contract changes, capital availability, and Chinese renminbi exchange-rate exposure.
- The company expects lease accounting adoption on May 1, 2019 to materially affect the balance sheet through recognition of right-of-use assets and lease liabilities. It holds a 4.6% cost-basis investment in Russian company Morion, which is a subsidiary of Gazprombank, subject to U.S. financing restrictions; the filing reports no Morion-related receivable or payable at period end.
- Management reported effective disclosure controls as of January 31, 2019 and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported revenue and margin improvement reflects underlying delivery and execution versus the timing change from ASC 606, and how comparable the prior-year figures are.
- Whether the $39 million backlog converts to revenue as expected, including timing and funding of the $3.1 million cost-plus-fee commitments.
- Cash conversion and working-capital trends: cash from continuing operations was negative for the nine-month period, while receivables and unbilled contract assets increased.
- Whether improved gross margins persist and whether contract estimates, inventory reserves, or deferred-tax valuation assumptions require revisions.
- Collection of the $1.0 million Gillam note, the impact of lease adoption, and any material developments affecting Morion or foreign-exchange exposure.