Frequency Electronics, Inc. — Form 10-Q Summary
Business context and period: This report covers the first quarter of fiscal 2013, the three months ended July 31, 2012, compared with the three months ended July 31, 2011. Frequency Electronics develops precision time and frequency products for satellite, government, telecommunications, and GPS-related markets. Unless otherwise noted, financial amounts below are in millions of dollars.
Financial performance and position
| Metric | Q1 FY2013 | Q1 FY2012 |
|---|---|---|
| Revenue | $16.685 | $15.939 |
| Gross profit / margin | $5.981 / 35.8% | $6.144 / 38.5% |
| Operating profit / margin | $1.081 / 6.5% | $1.784 / 11.2% |
| Income before taxes | $1.198 | $1.984 |
| Net income / diluted EPS | $0.768 / $0.09 | $1.344 / $0.16 |
| Operating cash flow | $(0.402) | $2.662 |
| Capital expenditures | $0.332 | $0.520 |
- Selling and administrative expenses rose 10% to $3.485 million; research and development expense rose 18% to $1.415 million. Interest expense was $56,000, versus $24,000.
- At July 31, 2012, cash and cash equivalents were $5.461 million and marketable securities were $16.678 million. Working capital was $64.2 million and the current ratio was 5.2 to 1.
- Short-term credit obligations were $6.317 million. The company said it had borrowed $6 million during fiscal 2012 to help finance the FEI-Elcom acquisition. Total liabilities were $26.216 million; total assets were $106.090 million.
- Inventory was $34.532 million. Costs and estimated earnings in excess of billings, net, were $8.649 million, up from $7.207 million at April 30, 2012.
- Comprehensive income was $0.382 million, including a $0.386 million other comprehensive loss, mainly reflecting foreign-currency translation.
Material changes and operating drivers
- Revenue increased 5%, while gross profit fell 3%, operating profit fell 39%, and net income fell 43% year over year. Gross margin declined 2.7 percentage points.
- FEI-NY revenue rose 12% to $11.848 million; Gillam-FEI revenue fell 4% to $1.908 million; FEI-Zyfer revenue fell 11% to $3.357 million.
- The quarter included FEI-Elcom, acquired in February 2012. FEI-Elcom had less than $1 million of third-party revenue and an approximately $0.9 million operating loss in the quarter. Management attributed lower margins and profits partly to the subsidiary’s costs preceding deliveries on new orders.
- Satellite programs accounted for approximately 50% of revenue, compared with 40% in the prior-year quarter. U.S. Government/DOD non-space business was approximately 15% of revenue, versus 20%; network infrastructure was approximately 25%, versus less than 30%.
- Operating cash flow turned negative, primarily due to FEI-Elcom’s operating loss, increased unbilled receivables and inventory, and payments against trade payables. Cash and cash equivalents nevertheless increased $0.679 million during the quarter, including the effect of exchange-rate changes.
Outlook, risks, and other notable items
- Management expected fiscal 2013 revenue to grow and full-year operating profit to exceed fiscal 2012. It expected FEI-Elcom to become accretive during fiscal 2013, while noting the acquisition could reduce near-term operating profit. Management also expected improving FEI-Elcom deliveries and gross margins during the rest of the year.
- The company expected positive operating cash flow for the balance of fiscal 2013, planned $2 million to $3 million of capital-equipment spending, and targeted internal R&D spending below 10% of revenue. It stated liquidity was adequate to meet operating and investment needs through at least July 31, 2013.
- Backlog was approximately $58 million at July 31, 2012, with about 70% expected to be realized within 12 months. It included approximately $1 million of cost-plus-fee commitments not fully funded; more than $5 million of unfunded fixed-price contract amounts were excluded from backlog.
- Key risks cited include market acceptance, competition and technology changes, product pricing and raw-material costs, third-party vendor dependence, manufacturing and transportation costs, contract terms, and capital availability. Contract revenue depends in part on percentage-of-completion estimates; changes in estimated costs or inventory realizability could affect results.
- Management reported that disclosure controls were not effective as of July 31, 2012. A previously identified material weakness in internal control over financial reporting related to acquisition accounting remained; management planned to add accounting expertise if another acquisition occurs.
- The company reported no material off-balance-sheet arrangements other than operating leases. Quantitative and qualitative market-risk disclosure was marked not applicable. Marketable securities had $88,000 of gross unrealized losses, which management did not consider other-than-temporary.
Important facts for investors to verify
- Whether FEI-Elcom converts its new orders and backlog into timely shipments, revenue, and improved operating performance.
- Whether gross margin and operating profit recover as management projected, and whether fiscal 2013 operating profit exceeds the prior year.
- Whether unbilled receivables, inventory, and working-capital movements support a return to positive operating cash flow.
- The status and remediation of the acquisition-accounting material weakness and ineffective disclosure controls.
- Backlog funding, timing of conversion to revenue, and the company’s ability to service its credit obligations while funding planned capital spending and development.