Frequency Electronics, Inc. — Form 10-Q Summary
Business context and period: The unaudited report covers the three months ended July 31, 2013, the first quarter of fiscal 2014, with comparison to the three months ended July 31, 2012. The company develops and manufactures precision time and frequency products and systems for satellite, government/defense, and telecommunications markets.
Financial performance
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Revenue | $16.827 million | $16.685 million |
| Gross profit / margin | $6.266 million / 37.2% | $5.981 million / 35.8% |
| Operating profit / margin | $0.963 million / 5.7% | $1.081 million / 6.5% |
| Net income | $0.676 million | $0.768 million |
| Diluted EPS | $0.08 | $0.09 |
| Operating cash flow | $(2.169) million | $(0.402) million |
Revenue increased 1%, while net income fell 12%. Gross margin improved, but higher R&D spending—up 23% to $1.743 million—more than offset the gross-profit increase and reduced operating profit. Management attributed the improved gross margin mainly to higher FEI-NY revenue; the rate remained below its 40% target, partly due to unabsorbed overhead and product mix.
Cash and cash equivalents were $4.149 million and marketable securities were $16.823 million at July 31, for combined cash and securities of about $21.0 million. Working capital was $74.7 million and the current ratio was 8.9 to 1. Operating cash use reflected higher accounts receivable and inventory. Investing activities used $0.495 million, including $1.456 million for fixed assets; financing provided $3.324 million, including $3.2 million of net facility borrowing. Cash ended at $4.149 million, up from $3.460 million at April 30.
Total debt was $9.206 million at July 31, including $9.2 million of noncurrent debt and $6,000 of short-term credit obligations. The new JPMorgan facility has a maximum commitment of $25 million, matures June 5, 2018, and bears interest at LIBOR plus 0.75% on Tranche A or 1.75% on Tranche B. The company reported compliance with its financial covenants at quarter-end. Total liabilities were $29.778 million and stockholders’ equity was $83.205 million.
Material changes and business drivers
- FEI-NY revenue increased 11% to $13.174 million; Gillam-FEI increased 41% to $2.695 million, largely due to intersegment sales; FEI-Zyfer declined 41% to $1.988 million.
- Satellite-program revenue, over 55% of consolidated revenue, increased 16%. Non-space U.S. Government/DoD revenue increased 40%; network-infrastructure revenue declined about 40%.
- R&D investment accelerated for satellite payload microwave receivers/converters and also includes rubidium clock and GPS synchronization products.
- Inventory rose to $39.221 million from $37.521 million; accounts receivable rose to $12.616 million from $7.781 million.
- Unrealized losses on available-for-sale securities were $191,000 at July 31. Management did not consider them other-than-temporary.
Outlook, risks and unusual items
Management expected fiscal 2014 revenue to grow, and expected full-year operating profit to exceed fiscal 2013. It anticipated improved revenue and margins over the remainder of the year, with gross margin reaching or exceeding the 40% target as satellite volume and product mix improved. It expected positive operating cash flow for the balance of fiscal 2014, targeted internal R&D spending below 10% of revenue, and planned $2.5–$3.0 million of capital equipment spending.
Backlog was approximately $56 million at July 31, versus $51 million at April 30; about 70% was expected to be realized within 12 months. More than three-fourths of backlog represented satellite payload business. About $2 million consisted of cost-plus-fee commitments not yet fully funded. Management stated liquidity was adequate through at least July 31, 2014.
Risks include reliance on product and market acceptance, competition and technology change, raw-material and manufacturing costs, third-party suppliers, availability of capital, and estimation uncertainty in percentage-of-completion contract revenue and inventory valuation. The new credit agreement includes collateral, restrictions, and financial covenants. The company also disclosed a Morion technology-license and equipment-sale agreement for about $2.7 million plus 5% royalties on third-party sales for five years; Morion had paid a $925,000 deposit recorded as deferred revenue. The company committed to purchasing at least about $400,000 of oscillators annually for five years, although Morion is not obligated to supply that amount. Management expected the approved technology transfer to be completed within a year of the October 2012 agreement.
Management reported disclosure controls and internal control over financial reporting were effective as of July 31, 2013, with no material control changes during the quarter. Interim results are not necessarily indicative of full-year results, and the filing provides no quantified formal revenue or EPS guidance.
Important facts for investors to verify
- Whether the satellite backlog converts to funded orders and revenue on the expected timetable, including the unfunded contract amounts.
- Whether higher sales volume and product mix lift gross margin to management’s 40% target, and whether full-year operating profit exceeds fiscal 2013.
- Whether receivables and inventory convert to cash and operating cash flow turns positive as expected.
- Facility balances, borrowing costs, collateral and covenant headroom as capital spending and working-capital needs evolve.
- Progress and financial effects of the Morion technology transfer, license payment, royalties, and purchase commitment.