Frequency Electronics, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended April 30, 2018, compared with the year ended April 30, 2017. Although the request metadata says “2017 Q4,” this filing reports FY2018 annual results, not a standalone quarter.
Business context
Frequency Electronics designs and manufactures precision time- and frequency-control products for satellite payloads, U.S. Government and defense programs, secure communications, and electronic warfare. Its reportable segments are FEI-NY and FEI-Zyfer. The company sold its Belgian Gillam subsidiary in April 2018 and reported it as discontinued operations.
Financial performance and liquidity
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $39.4 million | $50.4 million |
| Gross profit / margin | $5.2 million / 13.1% | $11.2 million / 22.3% |
| Operating loss | $12.4 million | $7.5 million |
| Net loss | $23.8 million | $4.8 million |
| Basic and diluted loss per share | $2.69 | $0.55 |
| Operating cash flow, continuing operations | $3.3 million | $3.5 million |
- Revenue fell 22%. FEI-NY revenue declined 32% to $26.9 million, while FEI-Zyfer revenue increased 3% to $15.3 million; segment amounts include intersegment sales.
- Gross margin contracted amid lower sales, repair costs, under-absorbed manufacturing overhead and a $5.6 million inventory write-down. Management also cited about $3.0 million of unabsorbed overhead in the operating loss.
- SG&A was $10.6 million, down 11%; R&D was $7.0 million, roughly flat. R&D increased to about 18% of revenue from 14%.
- The $11.2 million income-tax provision was recorded despite a pretax loss. It included a provisional $5.3 million charge related to the Tax Cuts and Jobs Act and a non-cash charge of approximately $9.6 million for a full valuation allowance against U.S. net deferred tax assets.
- Cash and cash equivalents were $7.9 million and short-term marketable securities were $6.1 million at year-end. Working capital was $46.8 million and the current ratio was 9.9, versus 8.6 a year earlier.
- Total cash provided by operations, including discontinued operations, was $4.5 million. Cash provided by investing activities was $0.3 million; financing cash flow was zero. The company had no outstanding borrowings and had terminated its JPMorgan credit facility after repaying $6.0 million in January 2017. It reported available credit under a securities-based advisory arrangement, with no borrowings.
- Total liabilities were $20.3 million, including $13.5 million of deferred compensation. The company paid no dividends and made no treasury-stock purchases in either year.
Changes, outlook and notable matters
- Satellite-program revenue, the largest business area in FY2017, declined $8.3 million, or 37%, amid a prolonged slowdown in commercial communications satellite procurement. Non-space U.S. Government/DoD sales also declined about 9%.
- The inventory write-down reflected satellite manufacturers’ policies restricting use of components more than ten years old and technology changes reducing demand for some frequency-conversion components. FY2017 also included substantial inventory adjustments.
- Backlog rose to approximately $30 million from $28 million; about 37% was expected to be filled in FY2019. The filing cautions backlog can change and is not necessarily indicative of future revenue or profit.
- Management said liquidity was adequate for operating and investment needs through at least July 30, 2019. It planned continued product development and expected internally generated cash to fund R&D; no specific revenue or earnings guidance was provided.
- In April 2018, the Air Force Research Laboratory selected the company to develop an Advanced Rubidium Atomic Frequency Standard. Management views this as a potential next-generation technology opportunity, not a guaranteed commercial outcome.
- Gillam was sold for $1.0 million in cash and a $1.0 million note due in three years; the company recorded a $0.36 million loss on sale. The divested unit reported a $1.33 million FY2018 loss, including that sale loss.
- Sales to U.S. Government contracts or subcontracts represented 74% of revenue, up from 59%. Several customers each exceeded 10% of segment revenue, and Lockheed Martin and Raytheon each exceeded 10% of consolidated revenue. Management warns that losing a major customer could materially harm the business.
- Management cited headcount reductions, manufacturing consolidation and operational improvements as responses to weak end markets. The CEO transition became effective May 1, 2018, with Stanton Sloane succeeding Martin Bloch as CEO; Bloch became Executive Chairman and remained Chief Scientist.
- Management identified contract cost estimates, inventory valuation and income taxes as critical estimation areas. The company also noted government funding and program delays, competition, customer concentration, and dependence on successful product and technology development as risks.
Important facts for investors to verify
- Whether satellite demand and FEI-NY performance recover, and whether the inventory and overhead charges recur.
- Whether backlog converts to funded orders, revenue and positive margins, including the expected FY2019 deliveries.
- The realization and future accounting treatment of deferred tax assets and the full valuation allowance; the tax assessment was described as incomplete.
- Collection of the $1.0 million Gillam note and the financial impact of the divestiture and any remaining obligations.
- Exposure to major customers and U.S. Government procurement timing, including the funding and commercial prospects for the new atomic-frequency-standard development program.
The independent auditor issued an unqualified opinion on the financial statements. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation.