Frequency Electronics, Inc. — Form 10-Q Summary
Business context and reporting period. The filing covers the fiscal third quarter and nine months ended January 31, 2014; comparisons are with the periods ended January 31, 2013. The company supplies precision time-and-frequency products and systems through three geographic segments: FEI-NY, Gillam-FEI and FEI-Zyfer. Interim results are unaudited and are not necessarily indicative of full-year results.
Financial performance
| Metric | Three months ended Jan. 31, 2014 | Three months ended Jan. 31, 2013 | Nine months ended Jan. 31, 2014 | Nine months ended Jan. 31, 2013 |
|---|---|---|---|---|
| Revenue | $18.218 million | $17.137 million | $52.052 million | $51.391 million |
| Gross margin | $6.111 million (33.5%) | $6.750 million (39.4%) | $18.609 million (35.8%) | $19.463 million (37.9%) |
| Operating profit | $1.260 million | $1.750 million | $3.486 million | $4.849 million |
| Net income | $1.218 million | $1.520 million | $3.285 million | $3.729 million |
| Diluted EPS | $0.14 | $0.18 | $0.37 | $0.43 |
| Operating cash flow | Not provided separately for the quarter | Not provided separately for the quarter | $0.694 million | $3.225 million |
For the nine months, revenue increased 1%, while gross profit declined 4%, operating profit declined 28% and net income declined 12%. In the quarter, revenue rose 6%, but gross profit fell 9%, operating profit fell 28% and net income fell 20%. Gross margin pressure and higher R&D spending weighed on earnings.
Liquidity, debt and cash flow
- At January 31, 2014, cash and cash equivalents were $8.561 million and marketable securities were $14.071 million, totaling $22.632 million. Working capital was $78.5 million and the current ratio was 11.4:1.
- Total assets were $116.375 million and total liabilities were $28.953 million. Long-term debt was $10.1 million, compared with $6.0 million at April 30, 2013; short-term credit obligations were zero. The company reported compliance with its Tranche A debt covenants.
- Nine-month operating cash flow fell to $0.694 million from $3.225 million, mainly due to increased inventory purchases ahead of long-term contract production. Cash and cash equivalents increased by $5.101 million to $8.561 million.
- Capital expenditures were $3.560 million versus $1.608 million a year earlier. The company expected fiscal 2014 capital equipment spending of $4.0–$4.5 million.
Material changes and operating drivers
- Satellite program revenue, about 60% of consolidated revenue, increased approximately 20% for the nine months and 25% for the quarter. Non-space U.S. Government/DOD revenue declined approximately 20% and 30%, respectively; network infrastructure revenue declined approximately 25% and 5%.
- FEI-NY revenue increased 5% for the nine months; Gillam-FEI increased 9%; FEI-Zyfer declined 32% and reported an operating loss of $0.652 million. Consolidated operating profit was also affected by operating losses at Gillam-FEI and corporate costs.
- Gross margin was reduced by snow-related costs at FEI-NY, higher-than-anticipated engineering and production costs at Gillam-FEI, and lower FEI-Zyfer volume and overhead absorption. R&D expense rose 23% for the nine months, to $4.589 million.
- Inventory increased to $42.076 million from $37.521 million at April 30, 2013; accounts receivable rose to $12.124 million from $7.781 million. Costs and estimated earnings in excess of billings, net, declined to $3.857 million from $8.617 million.
Outlook, risks and unusual items
- Management expected fiscal 2014 revenue to remain approximately level with the prior year, while full-year operating profit was expected to exceed fiscal 2013. Based on bookings and backlog, management also anticipated satellite revenue growth and increased profitability.
- Management expected fourth-quarter gross margins to improve, but remain below its 40% target. The expected fiscal 2014 effective tax rate was 30%–35%. The company targeted internal R&D spending below 10% of revenue.
- Backlog was approximately $55 million, up from $51 million at April 30, 2013; about 70% was expected to be realized within 12 months. Backlog included approximately $3 million of cost-plus-fee commitments not fully funded, and approximately $12 million of unfunded fixed-price contract amounts was excluded.
- Management believed liquidity was adequate through at least January 31, 2015, and expected positive operating cash flow for the remainder of fiscal 2014 as receivables were collected and inventory purchasing slowed.
- A Morion technology-licensing arrangement generated $0.400 million of revenue and a $0.736 million gain on sale of fully depreciated equipment during the nine months. Further agreement revenue depends on additional training and parts delivery and relief from certain U.S. Government restrictions; the company said additional amounts would be recognized after those conditions are met.
- Key risks identified include customer acceptance and competition, technology and product changes, raw-material and manufacturing costs, third-party supplier dependence, foreign-currency exposure, and contract-cost and inventory valuation estimates. The company noted that contract revenue recognition relies on estimates of costs to complete.
Important facts for investors to verify
- Whether satellite demand and the reported backlog convert to funded orders and revenue on the expected schedule.
- Whether inventory and receivables convert to cash as management expected, given the decline in operating cash flow.
- Whether gross margins recover from the reported levels and whether FEI-Zyfer and Gillam-FEI improve their operating results.
- Remaining conditions, timing and potential additional revenue under the Morion license agreement, including U.S. Government restrictions.
- Debt-facility capacity, covenant compliance and the funding required for planned capital spending and potential acquisitions.