Frequency Electronics, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended July 31, 2017 (the company’s fiscal 2018 first quarter); comparative period is the three months ended July 31, 2016. Frequency Electronics develops precision time-and-frequency products and systems for satellite, telecommunications, secure communications, and defense markets. Gillam, its Belgian business, is reported as discontinued operations.
Financial performance and liquidity
- Revenue: Continuing-operations revenue was $12.0 million, up 4% from $11.6 million. Gross profit increased to $4.5 million from $3.8 million; gross margin expanded to 37.6% from 33.1%.
- Operating results: Operating profit was $180,000 versus an operating loss of $408,000. Continuing-operations net income was $830,000 versus a $317,000 loss. Including discontinued operations, net income was $614,000, or $0.07 per diluted share, compared with a $706,000 loss, or $0.08 per share.
- Cash flow: Operating cash flow was $3.2 million, compared with a $571,000 use of cash. Investing activities provided $5.8 million, primarily from $6.3 million of securities redemptions; capital expenditures were $450,000. Cash and cash equivalents of continuing operations were $10.9 million at July 31.
- Liquidity and debt: Working capital was $62.4 million and the current ratio was 8.7:1. Cash, cash equivalents, and marketable securities totaled $12.5 million. The company had no credit-line borrowings during the quarter and had repaid and terminated its bank facility in January 2017. Management said liquidity should meet operating and investment needs through at least September 14, 2018.
- Balance sheet: Total assets were $114.1 million, total liabilities $24.2 million, and stockholders’ equity $89.9 million. Inventory was $30.5 million, up from $29.1 million at April 30, 2017.
Material changes and management commentary
- FEI-Zyfer revenue rose 82% to $4.3 million, while FEI-NY revenue fell 8% to $9.2 million; consolidated revenue includes eliminations of intersegment sales. Non-space U.S. Government/DoD revenue increased, while satellite-program revenue declined about $1.1 million year over year.
- Management attributed improved gross margin to higher secure-communications product sales, favorable mix, and cost management. SG&A decreased 4% to $2.7 million; R&D increased 16% to $1.6 million, reflecting accelerated development for secure communications and next-generation satellite payloads.
- Investment income rose to $1.2 million, including approximately $1.0 million of realized gains from securities sales. The company sold or redeemed its equity securities during the quarter. This gain materially supported reported pretax income.
- Funded backlog was approximately $23 million, down from $28 million at April 30, 2017; about 80% was expected to be realized within 12 months. Approximately $9.4 million was under cost-plus-fee contracts that management described as firm commitments but not yet fully funded.
- Management expected fiscal 2018 satellite-payload revenue to be lower than the prior year, while remaining the dominant business, with growth anticipated when delayed and new programs are released. Non-space DoD revenue was expected to increase as additional program funding is received.
Outlook, risks, and unusual items
- The company continued to pursue a sale of Gillam, targeting completion by the end of fiscal 2018. The original prospective buyers had not performed under the share purchase agreement; the company was also discussing a sale with other potential buyers. Gillam recorded a $216,000 quarterly net loss, an improvement from $389,000.
- Management cited risks including customer acceptance and funding, competition and technology changes, raw-material and manufacturing costs, third-party vendors, contract estimates, and foreign-exchange movements, particularly the euro and Chinese renminbi versus the U.S. dollar.
- Revenue on many long-term contracts uses percentage-of-completion estimates. Changes in estimated costs to complete can affect reported revenue and profit. Inventory valuation also depends on estimates of future demand and realizable value.
- The quarter’s 36.9% effective tax rate included a discrete provision primarily related to stock compensation under newly adopted accounting guidance. The filing reported a $3.3 million valuation allowance against deferred tax assets, principally for certain state credits and foreign tax-loss and credit carryovers.
- The company said expected cash flow from the Gillam sale would be neutral before closing and positive upon completion. It also noted that customer funding and future acquisition plans could affect capital needs.
Important facts for investors to verify
- Whether Gillam’s sale process advances and on what terms, given the initial buyer’s failure to perform.
- Whether the $23 million backlog converts to revenue as expected, especially the unfunded portion of cost-plus-fee commitments.
- Whether delayed or new satellite programs and anticipated DoD funding support management’s revenue outlook.
- How much earnings are attributable to recurring operations versus the approximately $1.0 million realized securities gain.
- Whether inventory levels, contract-cost estimates, and deferred tax asset assumptions remain supportable as demand and program funding evolve.