Frequency Electronics, Inc. — Form 10-Q Summary
Reporting period: Third quarter and nine months ended January 31, 2015 (fiscal 2015). Comparative periods are the three and nine months ended January 31, 2014. Amounts are in millions, except per-share data.
Business context
The company develops and manufactures precision time and frequency control products, including products for satellite, U.S. Government and defense, telecommunications, and industrial markets. It reports three segments: FEI-NY, Gillam-FEI, and FEI-Zyfer. Satellite programs accounted for about 60% of revenue in both fiscal 2015 periods.
Financial results
| Metric | Three months 2015 | Three months 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $18.381 | $18.218 | $57.364 | $52.052 |
| Gross profit / margin | $5.896 / 32.1% | $6.111 / 33.5% | $18.235 / 31.8% | $18.609 / 35.8% |
| Operating profit | $0.997 | $1.260 | $3.722 | $3.486 |
| Net income | $0.878 | $1.218 | $2.885 | $3.285 |
| Diluted EPS | $0.10 | $0.14 | $0.33 | $0.37 |
| Operating cash flow | Not separately presented | $(0.791) | $0.694 |
For the nine months, revenue rose 10%, while gross profit declined 2%; operating profit increased 7%, but net income fell 12%. For the quarter, revenue increased 1%, while operating profit declined 21% and net income declined 28%. Lower gross margin affected both periods. The filing attributes the nine-month net-income decline in part to the prior-year Morion equipment-sale gain and higher other income in 2014.
Balance sheet, liquidity, and debt
- At January 31, 2015, cash and cash equivalents were $6.070 million and marketable securities were $12.218 million, totaling $18.288 million.
- Working capital was $78.2 million, unchanged from April 30, 2014; the current ratio was 9.6:1.
- Long-term debt was $8.4 million, all under Tranche A of a credit facility with a $25 million maximum. The facility matures June 5, 2018; the company reported compliance with its covenants at quarter-end.
- Operating cash flow was negative $0.791 million, primarily reflecting increased receivables, according to management. Investing activities provided $0.608 million; financing activities used $1.662 million. Cash declined $1.628 million from the fiscal-year opening balance.
- Capital expenditures were approximately $3.6 million for the nine months; management expected approximately $4.0 million for fiscal 2015. Management said liquidity was adequate through at least January 31, 2016.
Material changes and management outlook
- FEI-NY nine-month revenue increased 14% to $45.962 million, while Gillam-FEI revenue declined 7% to $6.511 million and FEI-Zyfer revenue increased 19% to $7.110 million. Gillam-FEI reported a nine-month operating loss of $0.707 million.
- Management attributed lower gross margin rates to contract and product mix, lower early-year non-space government and Gillam-FEI revenue, and higher FEI-NY overhead and production costs. It expected elevated costs to continue through the rest of fiscal 2015.
- Satellite revenue increased 16% for the nine months but fell 2% in the quarter. A delay in additional funding on a cost-plus-fee contract held back quarterly revenue; management expected the funding-related revenue to be recognized in the fourth quarter.
- Non-space government revenue rose 25% in the quarter, mainly due to additional FEI-Zyfer funding for GPS secure-communications protection. Third-party contract manufacturing at FEI-Asia also contributed to commercial revenue growth.
- Management expected fiscal 2015 revenue and operating profit to exceed fiscal 2014 levels. It also cautioned that net income could be lower because fiscal 2014 included a one-time Morion equipment-sale gain. The company forecast a 30%–36% effective tax rate for fiscal 2015 and internal R&D spending below 10% of revenue.
- Funded backlog was approximately $41 million at January 31, 2015, versus $48 million at April 30, 2014; about 70% was expected to be realized within 12 months. Approximately $2 million was under cost-plus-fee contracts not yet fully funded.
Risks, contingencies, and unusual items
- Results depend on long-term contract estimates, including cost-to-complete assumptions, and on inventory valuation; changes in estimates can materially affect reported results. Long-term contract revenue is recognized principally using percentage of completion.
- The company cites risks including product acceptance, competition and technological change, raw-material and manufacturing costs, third-party vendors, contractual terms, capital availability, and foreign-currency movements.
- Further revenue under the Morion rubidium-oscillator license agreement depends on additional training and component deliveries and relief from certain U.S. Government restrictions. The filing describes a five-year minimum purchase commitment by the company, although Morion is not obligated to sell that amount.
- Marketable securities had $0.224 million of gross unrealized losses at January 31, 2015; management did not consider them other-than-temporary. The filing states that there were no material off-balance-sheet arrangements other than operating leases. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether delayed satellite-contract funding was received and the related revenue recognized in the fourth quarter as anticipated.
- Whether the $41 million backlog converts to revenue on schedule, and how much of the approximately $2 million of not-fully-funded cost-plus-fee work becomes funded.
- Whether gross margin recovers, given management’s expectation of continued elevated costs through fiscal 2015.
- Whether receivables convert to cash and operating cash flow turns positive as management expected.
- Progress on Morion agreement deliveries and U.S. Government restrictions, and the effect of foreign operations, contract estimates, and the credit facility’s covenants on results and liquidity.