Frequency Electronics, Inc. — Form 10-Q summary
Reporting period: Fiscal 2014 second quarter and six months ended October 31, 2013, compared with the corresponding 2012 periods. The company develops precision time- and frequency-control products for satellite, government, telecommunications and other markets.
Financial performance
| Metric | Three months ended Oct. 31, 2013 | Three months ended Oct. 31, 2012 | Six months ended Oct. 31, 2013 | Six months ended Oct. 31, 2012 |
|---|---|---|---|---|
| Revenue | $17.0 million | $17.6 million | $33.8 million | $34.3 million |
| Gross margin | $6.2 million (36.6%) | $6.7 million (38.3%) | $12.5 million (36.9%) | $12.7 million (37.1%) |
| Operating profit | $1.3 million | $2.0 million | $2.2 million | $3.1 million |
| Net income | $1.4 million | $1.4 million | $2.1 million | $2.2 million |
| Diluted EPS | $0.16 | $0.17 | $0.24 | $0.26 |
Six-month R&D expense rose 23% to $3.2 million, while selling and administrative expense was nearly flat at $7.0 million. The six-month effective tax rate was 35.7%, versus 33.3% a year earlier.
For the six months, operating cash flow was negative $2.5 million, compared with negative $1.0 million. The company attributed the increased use of cash primarily to higher receivables and inventory. Investing cash flow was negative $1.1 million, including $2.8 million of property and equipment purchases. Financing provided $4.2 million, including $4.1 million of credit-facility borrowings. Cash increased to $5.1 million from $3.5 million at April 30, 2013.
At October 31, 2013, working capital was $77.2 million and the current ratio was 12.3:1. Cash, cash equivalents and marketable securities totaled $20.9 million. Long-term debt was $10.1 million; short-term credit obligations were zero. Total assets were $114.0 million and stockholders’ equity was $85.9 million.
Material changes and operating drivers
- Six-month revenue declined 1%, while operating profit fell 28% and net income fell 6%. In the quarter, revenue declined 3%, operating profit fell 37% and net income fell 3%.
- Satellite-program revenue increased approximately 20% year over year and accounted for more than 55% of revenue in both 2014 periods. Non-space U.S. Government/DOD revenue declined 10% for the six months and 36% for the quarter; network infrastructure revenue declined approximately 20% and 30%, respectively.
- FEI-NY six-month revenue rose 8% to $26.0 million. FEI-Zyfer revenue fell 35% to $4.4 million and recorded a $275,000 operating loss; Gillam-FEI recorded a $36,000 operating loss.
- Gross margin rates were below management’s 40% target. Management cited product mix and unabsorbed overhead; higher R&D spending and lower margins weighed on operating profit.
- Other income included a $736,000 gain on the sale of fully depreciated equipment to Morion, contributing to the period’s reported other income of $734,000 net. The Morion license arrangement also generated $400,000 of revenue for technology transfer, training and parts; further amounts depend on additional deliveries and training and resolution of U.S. Government limitations.
Outlook, liquidity and risks
Management expected fiscal 2014 revenue to remain approximately at the prior-year level, while forecasting full-year operating profit above fiscal 2013 and continued satellite-revenue growth. It expected gross margins to approach the 40% target as satellite volume and mix improve, and positive operating cash flow for the remainder of the year as receivables are collected and inventory purchases slow. These are forward-looking expectations, not guarantees.
Backlog was approximately $57 million at October 31, up from $51 million at April 30; about 70% was expected to be realized within 12 months. Backlog includes approximately $3 million of cost-plus-fee work not fully funded; approximately $20 million of unfunded fixed-price contract amounts is excluded. Management expected liquidity to meet operating and investment needs through at least October 31, 2014. Planned fiscal 2014 capital equipment spending was $3.5–$4.0 million.
The new JPMorgan facility has a maximum commitment of $25 million and matures June 5, 2018. Borrowings bear LIBOR plus 0.75% for Tranche A or 1.75% for Tranche B; outstanding borrowings were under Tranche A. The facility is secured by pledged investments and other company and subsidiary assets and contains financial covenants. The company reported compliance with applicable Tranche A covenants at October 31.
Key risks include dependence on satellite and government programs, contract-estimate and inventory-valuation judgments, product and market competition, technology and raw-material changes, third-party suppliers, foreign-currency exposure, and funding or authorization conditions on contracts. Management identified no material off-balance-sheet arrangements other than operating leases. Disclosure controls were reported effective; the filing identifies no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether satellite growth and the $57 million backlog convert to funded orders, revenue and cash on the expected schedule.
- Whether gross margin improves toward the 40% target and R&D investment translates into new awards and operating profit.
- Whether receivables and inventory normalize enough to deliver management’s expected positive operating cash flow.
- The impact of the Morion agreement’s remaining delivery, training and U.S. Government approval requirements, and the extent to which the reported gain is nonrecurring.
- Facility borrowings, covenant compliance, capital spending and the availability of funding for planned investment or acquisitions.