Frequency Electronics, Inc. — Fiscal 2015 First Quarter 10-Q
Reporting period: Three months ended July 31, 2014, compared with the three months ended July 31, 2013. Financial statements are unaudited. Dollar amounts below are in millions unless otherwise noted.
Financial performance
- Revenue: $19.74 million, up 17% from $16.83 million. FEI-NY revenue rose 31% to $17.26 million; Gillam-FEI fell 45% to $1.49 million; FEI-Zyfer fell 44% to $1.12 million.
- Profit and margins: Gross margin was $5.67 million, down 10%; gross margin rate contracted to 28.7% from 37.2%. Operating profit was $0.93 million, down 4%, with operating margin of 4.7% versus 5.7%. Net income increased 6% to $0.72 million; diluted earnings per share were $0.08 in both periods.
- Drivers: Lower gross margin reflected reduced non-space U.S. government and Gillam-FEI sales, low subsidiary volumes and product mix. Lower SG&A and R&D partially offset the decline. Investment income increased to $0.41 million, including an approximately $0.28 million realized gain on securities sales.
- Cash flow: Operating activities used $5.64 million, versus $2.17 million used in the prior-year quarter. Management attributed the outflow mainly to nearly doubled accounts receivable and higher inventory. Capital expenditures were $1.15 million. Cash and equivalents declined to $4.54 million from $7.70 million at April 30, 2014.
- Liquidity and debt: Working capital was $81.1 million; current ratio was 8.3 to 1. Cash, equivalents and marketable securities totaled $19.8 million. Long-term debt was $12.4 million, all under Tranche A of a credit facility with a $25 million maximum. The company borrowed $2.3 million during the quarter and reported compliance with facility covenants.
- Balance sheet: Total assets were $124.5 million, up from $119.5 million at April 30, 2014. Inventory was $42.8 million, up from $41.2 million; accounts receivable was $14.7 million, up from $7.7 million.
Business changes and outlook
- Commercial and U.S. Government satellite programs accounted for more than 60% of quarterly revenue, versus 55% in the comparable period. Non-space U.S. Government/DOD revenue was less than 10%, with bookings affected by uncertainty in the federal budget process. Network infrastructure and other industrial revenue represented about one-fourth of revenue, including growth in third-party manufacturing at FEI-Asia.
- Management expected fiscal 2015 revenue to grow, citing backlog and potential new orders; satellite payloads remain the largest business and principal growth opportunity. It also anticipated stronger non-space government revenue, including FEI-Zyfer activity on a GPS anti-jamming and anti-spoofing initiative.
- Management expected improved gross margin rates and operating profit for the remainder of fiscal 2015, and full-year operating profit above fiscal 2014. It cited anticipated volume increases at Gillam-FEI and FEI-Zyfer and product mix. Fiscal 2015 gross margin rates to date were below the company’s 40% target at current revenue levels.
- Backlog was approximately $57 million at July 31, 2014, versus $48 million at April 30; about 70% was expected to be realized within 12 months. More than three-fourths of backlog represented satellite payload business. Approximately $2 million was under cost-plus-fee contracts not yet fully funded.
- Management forecast positive operating cash flow in the second fiscal quarter and for the balance of fiscal 2015, expecting to collect a high percentage of billed receivables. It planned $3–$4 million of fiscal-year capital spending and internal R&D spending below 10% of revenue. Management said liquidity was adequate through at least July 31, 2015.
Risks, contingencies and notable items
- Revenue and cost recognition on long-term contracts depends on percentage-of-completion estimates, including estimated costs to complete; inventory valuation also requires estimates. Changes in assumptions could affect reported results.
- Results depend substantially on satellite programs, while non-space U.S. government bookings face federal budget delays. Other disclosed risks include competition, technology changes, product pricing and raw-material costs, third-party vendors, manufacturing and transportation costs, and availability of capital.
- The credit facility is secured by a pledge of substantially all personal property of the company and certain subsidiaries and includes financial covenants and restrictions on debt, liens, acquisitions and other actions.
- Further revenue under the Morion technology-license arrangement depends on additional training and component deliveries and relief from certain U.S. Government limitations. The filing reports State Department approval of the technology transfer but does not state that all remaining conditions were satisfied.
- The effective tax rate was 45.1%, compared with 36.0%; management expected a mid-30% rate for fiscal 2015, dependent in part on foreign-subsidiary results. The U.S. R&D tax credit had expired and had not been reinstated as of the filing.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter. No material off-balance-sheet arrangements were reported apart from operating leases.
Important facts for investors to verify
- Whether receivables convert to cash as expected and operating cash flow turns positive.
- Whether backlog converts to funded orders and revenue on schedule, particularly the unfunded cost-plus-fee amounts and satellite programs.
- Whether lower-volume segments recover and gross margins improve toward management’s stated expectations.
- Whether inventory levels, contract cost estimates and long-term contract margins remain supportable.
- Whether the company maintains credit-facility covenant compliance and achieves its capital-spending and full-year outlook.
- How the Morion agreement’s remaining conditions and the expired R&D tax credit affect future revenue and taxes.