Frequency Electronics, Inc. — Q1 FY2012 Form 10-Q
Reporting period: Three months ended July 31, 2011; balance-sheet figures are compared with April 30, 2011. The company develops and manufactures precision time and frequency control products, serving satellite, government/defense, and telecommunications markets. Interim results are unaudited and may not indicate full-year performance.
Financial performance
| Metric | Q1 FY2012 | Q1 FY2011 |
|---|---|---|
| Revenue | $15.939 million | $12.124 million |
| Gross profit / margin | $6.144 million / 38.5% | $4.746 million / 39.1% |
| Operating profit / margin | $1.784 million / 11.2% | $0.789 million / 6.5% |
| Net income | $1.344 million | $0.507 million |
| Diluted EPS | $0.16 | $0.06 |
| Operating cash flow | $2.662 million | $0.492 million |
Revenue increased 31%; net income rose 165%. Gross margin dollars increased 29%, while the margin rate declined 0.6 percentage point, reflecting program mix. Selling and administrative expense rose 13% to $3.162 million, but fell to 19.8% of revenue from 23.0%. R&D expense was $1.198 million, or 7.5% of revenue, versus 9.6% a year earlier.
Cash, liquidity, and obligations: At July 31, cash and equivalents were $7.659 million and marketable securities were $14.999 million, together $22.658 million. Working capital was $61.9 million, with a current ratio of 8.9:1. Total assets were $92.116 million and total liabilities $18.742 million. The balance sheet reports capital lease obligations of $389,000 ($276,000 current and $113,000 noncurrent); no other borrowings are shown. Operating cash flow was positive; investing activities used $333,000, including $520,000 of fixed-asset purchases, and financing activities used $53,000. Cash ended the quarter at $7.659 million.
Material changes and business drivers
- FEI-NY revenue increased 39% to approximately $10.6 million, driven primarily by satellite payload programs. FEI-Zyfer revenue rose 51% to approximately $3.8 million. Gillam-FEI revenue declined 33% to approximately $2.0 million and reported a $230,000 operating loss, versus $117,000 operating profit a year earlier.
- Satellite programs contributed approximately 40% of revenue, up from 30%. U.S. Government/DoD revenue was approximately unchanged in dollars and represented 20% of revenue, compared with 25% a year earlier. Network infrastructure gains at FEI-Zyfer were partly offset by declines at Gillam-FEI.
- Inventory rose to $30.247 million from $28.172 million; accounts receivable declined to $8.738 million from $11.663 million. The net contract asset for costs and estimated earnings in excess of billings increased to $3.315 million from $2.409 million.
- Other income included an approximately $90,000 gain on life insurance policies covering a former employee. The tax provision was $640,000; the company attributed the changed tax treatment to the reduction of its U.S. deferred-tax-asset valuation allowance in the prior fiscal-year fourth quarter. A remaining valuation allowance of approximately $4.6 million was reported.
Outlook, risks, and contingencies
Management expected higher revenue and improved gross and operating margins through FY2012, and anticipated higher full-year profits than in FY2011. It expected gross margin rates to reach or exceed its approximately 40% target, operating profit to exceed 10% of revenue at the increased business level, positive operating cash flow, and capital expenditures below $2 million for the full year. Management said internally generated cash and reserves were adequate for planned product development and capital investment, and liquidity was expected to meet operating and investment needs through at least July 31, 2012.
Backlog was approximately $67 million, with about 60% expected to be filled within 12 months. Approximately $3.7 million of cost-plus-fee commitments was not fully funded; a further approximately $3.7 million of fixed-price contract work was unfunded and excluded from backlog. Management expected funding over time, but timing and realization are uncertain.
Key risks include customer acceptance and contract funding, competition and technology changes, product pricing and raw-material costs, reliance on third-party vendors, manufacturing and transportation costs, and estimates used for percentage-of-completion revenue and inventory valuation. The company identified its disclosure controls as ineffective at July 31, 2011. Previously reported material weaknesses in internal control over financial reporting remained; remediation work at Gillam-FEI and FEI-Zyfer was planned during FY2012.
Important facts for investors to verify
- Whether satellite-program growth and the $67 million backlog convert to revenue on the expected schedule, including funding of excluded contract amounts.
- Whether margins and operating profitability meet management’s FY2012 targets, given the lower year-over-year gross-margin rate and differing segment trends.
- Whether inventory, contract estimates, and unbilled contract assets are recoverable and convert to cash as expected.
- Progress in remediating the disclosed material weaknesses and restoring effective disclosure controls.
- The sustainability of earnings after considering the approximately $90,000 unusual insurance gain and the changed deferred-tax accounting.