FREQUENCY ELECTRONICS INC quarterly report, Q3 FY2013

Frequency Electronics, Inc. — Form 10-Q Summary

Reporting period: Fiscal third quarter and nine months ended January 31, 2013. The interim financial statements are unaudited. The company supplies precision time-and-frequency products and systems for satellite, U.S. government and defense, telecommunications, and other markets through its FEI-NY, Gillam-FEI, and FEI-Zyfer segments.

Financial performance

Amounts below are in millions, except per-share data and percentages.

Metric	Three months ended Jan. 31, 2013	Three months ended Jan. 31, 2012	Nine months ended Jan. 31, 2013	Nine months ended Jan. 31, 2012
Revenue	$17.137	$15.448	$51.391	$46.442
Gross profit / margin	$6.750 / 39.4%	$6.215 / 40.2%	$19.463 / 37.9%	$18.472 / 39.8%
Operating profit / margin	$1.750 / 10.2%	$1.943 / 12.6%	$4.849 / 9.4%	$5.501 / 11.9%
Net income	$1.520	$1.074	$3.729	$3.194
Diluted earnings per share	$0.18	$0.13	$0.43	$0.37

Cash flow: Nine-month operating cash flow was $3.225 million, compared with $1.276 million a year earlier. Investing used $0.103 million and financing used $2.975 million. Cash and cash equivalents rose $0.440 million to $5.222 million.
Liquidity and debt: Working capital was $66.0 million, versus $63.3 million at April 30, 2012; the current ratio was 5.5 to 1. Cash, cash equivalents, and marketable securities totaled $21.6 million, partly offset by $5.178 million in short-term credit obligations. The company reported liquidity adequate to meet operating and investment needs through at least January 31, 2014.
Balance sheet: Total assets were $108.280 million and stockholders’ equity was $82.446 million at January 31, 2013. Inventory was $37.756 million and unbilled contract costs and estimated earnings, net, were $8.617 million.

Changes and drivers

Revenue increased 11% in both the quarter and nine-month period. FEI-NY revenue rose 27% in the quarter and 16% year to date; Gillam-FEI revenue declined 43% in the quarter and 9% year to date. FEI-Zyfer revenue rose 3% in both periods.
Fiscal 2013 results include FEI-Elcom, acquired in February 2012; prior-year revenue and operating results do not include it. FEI-Elcom contributed approximately $6.0 million of third-party revenue and an operating loss of about $0.75 million in the nine-month period; in the third quarter it contributed approximately $2.9 million of revenue and $0.13 million of operating profit.
Gross margin dollars grew, but gross margin rate and operating profit declined year over year. Management attributed pressure to product mix, low early-year FEI-Elcom sales, and higher costs on certain customer-funded engineering projects, as well as increased operating expenses.
Nine-month net income rose 17%; third-quarter net income rose 41%. Lower effective tax rates and the absence of the prior-year Elcom equity-loss and impairment charges helped the comparisons. Prior-year periods also included $0.451 million of equity losses and a $0.350 million impairment charge for the nine months.

Outlook, risks, and notable items

Management expected fiscal 2013 revenue and operating profit to exceed fiscal 2012 levels, citing backlog, potential orders, and improved FEI-Elcom performance. It expected gross margin rates for the remainder of fiscal 2013 to reach or exceed its approximately 40% target and selling and administrative costs to approach 20% of revenue.
Backlog was approximately $63 million at January 31, 2013; about 70% was expected to be realized within twelve months. Management said satellite payload business represented three-fourths of backlog. Some unfunded contract amounts are excluded from backlog.
Planned fiscal 2013 capital equipment spending was $2 million to $3 million. The company targeted internal R&D spending below 10% of revenue and said available cash and internally generated funds were sufficient for planned investment and development.
In October 2012, the company agreed to license rubidium-oscillator technology and sell equipment to Morion for approximately $2.7 million, plus royalties on third-party sales for five years. Morion paid a $0.925 million deposit, recorded as deferred revenue. Frequency Electronics committed to purchase at least approximately $0.4 million of oscillators annually during that period; the agreement’s technology transfer was expected to be completed within a year, subject to regulatory approval, which the filing says had been received.
The company paid a special cash dividend of $0.20 per share, totaling approximately $1.684 million. It had repurchased approximately $4 million of the $5 million authorized share-repurchase amount as of January 31, 2013, with no formal plan or commitment for further purchases.
Management identified contract revenue and cost estimates and inventory valuation as critical accounting areas. Contract costs-to-complete and inventory realizability depend on estimates that may change. Forward-looking results are subject to demand, competition, technology changes, product prices, raw-material costs, third-party vendors, contractual terms, manufacturing costs, and capital availability.
Control concern: Management concluded disclosure controls were not effective as of January 31, 2013. A previously identified material weakness in internal control over financial reporting related to acquisition accounting continued; management reported no substantial changes to controls during the period.

Important facts for investors to verify

Whether FEI-Elcom can sustain the third-quarter return to operating profitability and improve margins.
How much of the $63 million backlog converts to revenue on schedule, including the funding status of government and fixed-price contracts.
Whether unbilled contract assets and elevated inventory convert to billings, collections, and operating cash flow as expected.
Progress and accounting for the Morion technology-license and equipment transfer, royalties, and associated purchase commitment.
Remediation of the acquisition-accounting material weakness and restoration of effective disclosure controls.