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FEIM > SEC Filings for FEIM > Form 10-Q on 16-Sep-2013All Recent SEC Filings

Show all filings for FREQUENCY ELECTRONICS INC

Form 10-Q for FREQUENCY ELECTRONICS INC


16-Sep-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995:

The statements in this quarterly report on Form 10-Q regarding future earnings and operations and other statements relating to the future constitute "forward-looking" statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words "believe," "may," "will," "could," "should," "would," "anticipate," "estimate," "expect," "project," "intend," "objective," "seek," "strive," "might," "likely result," "build," "grow," "plan," "goal," "expand," "position," or similar words, or the negatives of these words, or similar terminology, identify forward-looking statements. These statements are based on assumptions that the Company believes are reasonable, but are subject to a wide range of risks and uncertainties, and a number of factors could cause the Company's actual results to differ materially from those expressed in the forward-looking statements referred to above. Factors that would cause or contribute to such differences include, but are not limited to, continued acceptance of the Company's products in the marketplace, competitive factors, new products and technological changes, product prices and raw material costs, dependence upon third-party vendors, competitive developments, changes in manufacturing and transportation costs, changes in contractual terms, the availability of capital, and other risks detailed in the Company's periodic report filings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which relate only to events as of the date on which the statements are made and which reflect management's analysis, judgments, belief, or expectation only as of such date. By making these forward-looking statements, the Company undertakes no obligation to update these statements for revisions or changes after the date of this report.

Critical Accounting Policies and Estimates

The Company's significant accounting policies are described in Note 1 to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended April 30, 2013. The Company believes its most critical accounting policies to be the recognition of revenue and costs on production contracts and the valuation of inventory. Each of these areas requires the Company to make use of reasoned estimates including estimating the cost to complete a contract, the realizable value of its inventory or the market value of its products. Changes in estimates can have a material impact on the Company's financial position and results of operations.

Revenue Recognition

Revenues under larger, long-term contracts which generally require billings based on achievement of milestones rather than delivery of product, are reported in operating results using the percentage of completion method. On fixed-price contracts, which are typical for commercial and U.S. Government satellite programs and other long-term U.S. Government projects, and which require initial design and development of the product, revenue is recognized on the cost-to-cost method. Under this method, revenue is recorded based upon the ratio that incurred costs bear to total estimated contract costs with related cost of sales recorded as the costs are incurred. Each month management reviews estimated contract costs through a process of aggregating actual costs incurred and estimating additional costs to completion based upon the current available information and status of the contract. The effect of any change in the estimated gross margin percentage for a contract is reflected in revenues in the period in which the change is known. Provisions for anticipated losses on contracts are made in the period in which they become determinable.

On production-type orders, revenue is recorded as units are delivered with the related cost of sales recognized on each shipment based upon a percentage of estimated final program costs.

Changes in job performance on long-term contracts and production-type orders may result in revisions to costs and income and are recognized in the period in which revisions are determined to be required. Provisions for anticipated losses on customer orders are made in the period in which they become determinable.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

For customer orders in the Company's Gillam-FEI and FEI-Zyfer segments or smaller contracts or orders in the FEI-NY segment, sales of products and services to customers are reported in operating results based upon (i) shipment of the product or (ii) performance of the services pursuant to terms of the customer order. When payment is contingent upon customer acceptance of the installed system, revenue is deferred until such acceptance is received and installation completed.

Costs and Expenses

Contract costs include all direct material, direct labor costs, manufacturing overhead and other direct costs related to contract performance. Selling, general and administrative costs are charged to expense as incurred.

Inventory

In accordance with industry practice, inventoried costs contain amounts relating to contracts and programs with long production cycles, a portion of which will not be realized within one year. Inventory write downs are established for slow-moving, obsolete items and costs incurred on programs for which production-level orders cannot be determined as probable. Such write downs are based upon management's experience and expectations for future business. Any changes arising from revised expectations are reflected in cost of sales in the period the revision is made.

Marketable Securities

All of the Company's investments in marketable securities are Level 1 securities which trade on public markets and have current prices that are readily available. In general, investments in fixed price securities are only in the commercial paper of financially sound corporations or the bonds of U.S. Government agencies. Although the value of such investments may fluctuate significantly based on economic factors, the Company's own financial strength enables it to wait for the securities to either recover their value or to mature such that any interim unrealized gains or losses are deemed to be temporary.

RESULTS OF OPERATIONS

The table below sets forth for the respective periods of fiscal years 2014 and
2013 (which end on April 30, 2014 and 2013, respectively) the percentage of
consolidated revenues represented by certain items in the Company's consolidated
statements of operations:

                                                Three months ended July 31,
                                                 2013                2012
       Net Revenues
       FEI-NY                                         78.3 %              71.0 %
       Gillam-FEI                                     16.0                11.4
       FEI-Zyfer                                      11.8                20.1
       Less intersegment revenues                     (6.1 )              (2.5 )
                                                     100.0               100.0
       Cost of revenues                               62.8                64.2
       Gross margin                                   37.2                35.8
       Selling and administrative expenses            21.1                20.9
       Research and development expenses              10.4                 8.4
       Operating profit                                5.7                 6.5
       Other income, net                               0.6                 0.7
       Pretax income                                   6.3                 7.2
       Provision for income taxes                      2.3                 2.6
       Net income                                      4.0 %               4.6 %

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                  FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
                                  (Continued)

Revenues

                                           Three months ended July 31,
                                                  (in thousands)
                                                                   Change
                Segment              2013         2012          $           %
              FEI-NY               $ 13,174     $ 11,848     $  1,326        11 %
              Gillam-FEI              2,695        1,908          787        41 %
              FEI-Zyfer               1,988        3,357       (1,369 )     (41 %)
              Intersegment sales     (1,030 )       (428 )       (602 )
                                   $ 16,827     $ 16,685     $    142         1 %

For the three months ended July 31, 2013, revenues from commercial and U.S. Government satellite programs accounted for more than 55% of consolidated revenues and increased by 16% over the same period of fiscal year 2013. Revenues on these contracts are recognized primarily under the percentage of completion method. Revenues from the satellite market are recorded in the FEI-NY segment. Revenues from non-space U.S. Government/DOD customers, which are recorded in both the FEI-NY and FEI-Zyfer segments, also increased by 40% over the prior year and accounted for approximately one-fourth of consolidated fiscal year 2014 revenues. Network infrastructure revenues in the fiscal year 2014 period, declined by approximately 40% from the same period of fiscal year 2013 and accounted for approximately 15% of consolidated revenues. Such revenues are recorded in all three segments although the largest sales are recorded in the Gillam-FEI and FEI-Zyfer segments. Gillam-FEI total revenues increased over the prior year primarily due to intersegment sales which are eliminated in consolidation.

For the three months ended July 31, 2012, revenues from commercial and U.S. Government satellite programs accounted for approximately 50% of consolidated revenues compared to approximately 40% for the same period of fiscal year 2012. Revenues on these contracts are recognized primarily under the percentage of completion method. Revenues in the U.S. Government/DOD non-space business area which are recorded in the FEI-NY (including FEI-Elcom sales) and FEI-Zyfer segments were lower in fiscal year 2013 and accounted for approximately 15% of consolidated revenues compared to 20% of revenues in the fiscal year 2012 period. Network infrastructure revenues were lower in the FEI-NY and Gillam-FEI segments and accounted for approximately 25% of consolidated revenues in the three-month period ended July 31, 2012 compared to less than 30% in the fiscal year 2012 period.

Based on the Company's current backlog, over three-fourths of which represent satellite payload business, and the potential for additional new orders, revenues for fiscal year 2014 are expected to grow. Satellite payload revenues will remain the dominant portion of the Company's business and represents the Company's best growth opportunity.

Gross margin

                                       Three months ended July 31,
                                              (in thousands)
                                                               Change
                                   2013          2012                 $   %
                                 $   6,266      $ 5,981     $ 285       5 %
                       GM Rate        37.2 %       35.8 %

Gross margin for the three month period ended July 31, 2013, increased as a result of higher revenues particularly in the FEI-NY segment. The gross margin rate in fiscal year 2014, while improved over the prior year, was reduced by unabsorbed overhead costs. The gross margin rate is also impacted by product mix.

Fiscal year 2013 gross margin was impacted by lower revenues at both Gillam-FEI and FEI-Zyfer. The gross margin rate was reduced by the effect of FEI-Elcom as well as a higher percentage of lower margin network infrastructure product sales. The fiscal year 2013 first quarter revenues recognized by FEI-Elcom were insufficient to fully cover its production costs such that the consolidated gross margin rate was reduced by approximately 2%.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

The gross margin rates recorded in the fiscal year 2014 and 2013 periods were less than the Company's targeted rate of 40%. As satellite payload sales volume increases and as the product mix changes, the Company anticipates that its gross margin rates for the remainder of fiscal year 2014 will reach or exceed its target rate.

Selling and administrative expenses

                                Three months ended July 31,
                                       (in thousands)
                                                         Change
                            2013           2012        $        %
                          $   3,560       $ 3,485     $ 75       2 %

For both of the three-month periods ended July 31, 2013 and 2012, selling and administrative expenses were approximately 21% of consolidated revenues. The increase in expenses in the fiscal year 2014 quarter compared to the same period of fiscal year 2013 is due to increased stock-based compensation and deferred compensation expenses as well as greater professional fees. For the remainder of fiscal year 2014, the Company expects selling and administrative expenses to be incurred at approximately the same rate and approximate the Company's target of 20% of revenues or less.

Research and development expense

                                Three months ended July 31,
                                       (in thousands)
                                                        Change
                            2013         2012         $        %
                          $   1,743     $ 1,415     $ 328       23 %

Research and development ("R&D") expenditures represent investments intended to keep the Company's products at the leading edge of time and frequency technology and enhance competitiveness for future revenues. R&D spending for the three-month periods ended July 31, 2013 and 2012, was approximately 10% and 8% of revenues, respectively. In the fiscal year 2014 period, the Company accelerated its development of new satellite payload microwave receivers/converters from DC to Ka band. Such products are anticipated to be ready for customer evaluation and new contract awards by the third quarter of fiscal year 2014. In the fiscal year 2013 period, the quarter-to-quarter increase in spending is due primarily to product development expenditures at FEI-Elcom of approximately $300,000. R&D spending in fiscal year 2014, in addition to the development of new satellite payload products, will also include development and improvement of miniaturized rubidium atomic clocks, development of new GPS-based synchronization products and further enhancement of the capabilities of the Company's line of low g-sensitivity and ruggedized rubidium oscillators. Included in these efforts are product redesign and process improvements to enhance product manufacturability and reduce production costs.

In addition to internal research and development efforts, the Company continues to conduct development activities on customer-funded programs the cost of which appears in cost of revenues. The Company will continue to devote significant resources to develop new products, enhance existing products and implement efficient manufacturing processes. For fiscal year 2014, the Company is targeting to spend under 10% of revenues on internal research and development projects. Internally generated cash and cash reserves are adequate to fund these development efforts.

Operating profit

Three months ended July 31,

(in thousands)

Change
2013 2012 $ %
$ 963 $ 1,081 $ (118 ) (11 %)

Higher revenues and increased gross margin in fiscal year 2014 compared to the same period of fiscal year 2013 was offset primarily by increased spending on internal research and development activities. This led to the 11% reduction in operating profit for the period ended July 31, 2013. As a percentage of revenue, fiscal year 2014 operating profit was 5.7% of revenues compared to 6.5% of revenues last year.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

The late fiscal year 2012 addition of FEI-Elcom reduced consolidated operating results for the first quarter of fiscal year 2013. Revenues increased but were offset by higher operating expenses resulting in lower consolidated operating profit in fiscal year 2013 than in fiscal year 2012.

The Company anticipates that for the full fiscal year 2014, it will generate an operating profit that exceeds that of fiscal year 2013.

Other income (expense)

                                                Three months ended July 31,
                                                       (in thousands)
                                                                       Change
                                           2013          2012        $         %
           Investment income              $   143       $  167     $ (24 )     (14 %)
           Interest expense                   (59 )        (56 )      (3 )      (5 %)
           Other income (expenses), net         9            6         3        50 %
                                          $    93       $  117     $ (24 )     (21 %)

Investment income is derived primarily from the Company's holdings of marketable securities. Earnings on these securities may vary based on fluctuating interest rates and dividend payout levels and the timing of purchases or sales of securities. During the three months ended July 31, 2013, as a result of certain bond redemptions over the preceding quarters, the Company held more low earning cash equivalents than investments earning a higher return in the year-ago period. During the three months ended July 31, 2012, investments were held in higher yielding marketable securities than those held in the prior fiscal year. No investment gains or losses were recorded in either the fiscal year 2014 or 2013 periods.

The increase in interest expense for the three months ended July 31, 2013 compared to the same period of fiscal year 2013 is due to increased borrowings under the Company's new credit facility from a bank. During the fiscal year 2014 quarter, the Company refinanced the $6 million used to acquire FEI-Elcom during fiscal year 2012 and increased its borrowings by an additional $3.2 million for working capital and capital equipment acquisitions.

Other income in the fiscal year 2014 and 2013 periods consisted of insignificant non-operating expenses.

Income tax provision

Three months ended July 31,

(in thousands)

Change
2013 2012 $ %
$ 380 $ 430 $ (50 ) (12 %)

The provision for income taxes for the three months ended July 31, 2013 decreased from the same period of fiscal year 2013 due to the 12% decrease in pretax income as well as a reduced effective tax rate. The effective tax rate in fiscal year 2014 is expected to be in the range of 30% to 36% depending on the level of pretax income or loss recorded at the Company's foreign subsidiaries.

The provision for income taxes for the three months ended July 31, 2012 decreased from the same period of fiscal year 2012 due to the 40% decrease in pretax income. As of July 31, 2013 and April 30, 2013, the remaining deferred tax asset valuation allowance is approximately $1.9 million.

The Company is subject to taxation in several countries as well as the states of New York, New Jersey and California. The statutory federal rates are 34% in the United States and Belgium. The effective rate is impacted by the income or loss of certain of the Company's European and Asian subsidiaries that are currently not taxed. In addition, the Company utilizes the availability of research and development tax credits and the Domestic Production Activity credit in the United States to lower its tax rate. As of April 30, 2013, the Company's European subsidiaries had available net operating loss carryforwards of approximately $2.7 million, which will offset future taxable income. As a result of the FEI-Elcom acquisition, the Company has a federal net operating loss carryforward of $6.6 million that may be applied in annually limited amounts to offset future U.S.-sourced taxable income over the next 19 years.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

Net income

Three months ended July 31,

(in thousands)

Change
2013 2012 $ %
$ 676 $ 768 $ (92 ) (12 %)

As detailed above, for the three months ended July 31, 2013, higher revenues and increased gross margin were offset by higher research and development expenses, reducing net income for the quarter as compared to the prior year period. Based on recent bookings and its backlog, the Company expects to record higher consolidated revenue and to realize improved gross margins and operating profits over the remainder of fiscal year 2014.

LIQUIDITY AND CAPITAL RESOURCES

The Company's balance sheet continues to reflect a strong working capital position of $74.7 million at July 31, 2013, compared to working capital of $71.7 million at April 30, 2013. Included in working capital at July 31, 2013 is $21.0 million consisting of cash, cash equivalents and marketable securities. The Company's current ratio at July 31, 2013 is 8.9 to 1.

For the three months ended July 31, 2013, the Company used cash from operations in the amount of $2.2 million compared to the use of cash from operating activities of $402,000 in the comparable fiscal year 2013 period. The reduced cash flow in the fiscal year 2014 period resulted primarily from increased accounts receivables and increased inventory. For both of the three-month periods ended July 31, 2013 and 2012, the Company incurred approximately $1.3 million of non-cash operating expenses, such as depreciation and amortization and accruals for employee benefit programs. For the balance of fiscal year 2014, the Company expects to generate positive cash flow from operating activities.

Net cash use in investing activities for the three months ended July 31, 2013, was $495,000 compared to $951,000 provided by such activity for the same period of fiscal year 2013. During the fiscal year 2014 period, marketable securities were redeemed in the amount of $1.0 million compared to $2.0 million of such redemptions during the fiscal year 2013 period. Some of these proceeds and other cash were reinvested in additional marketable securities for the periods ended July 31, 2013 and 2012 in the amount of $39,000 and $717,000, respectively. In the fiscal quarters ended July 31, 2013 and 2012, the Company acquired property, plant and equipment in the amount of approximately $1.5 million and $332,000, respectively. The Company may continue to invest cash equivalents in longer-term securities or to convert short-term investments to cash equivalents as dictated by its investment and acquisition strategies. The Company will continue to acquire more efficient equipment to automate its production process. The Company intends to spend between $2.5 million and $3.0 million on capital equipment during fiscal year 2014. Internally generated cash or additional borrowings under the Company's credit facility will be used to acquire this level of capital equipment.

Net cash provided by financing activities for the three months ended July 31, 2013 was $3.3 million compared to $87,000 used in financing during the fiscal year 2013 period. During the fiscal year 2014 period, the Company borrowed $3.2 million under its new credit facility with a bank. Such funds were used for working capital and to finance the acquisition of certain fixed assets. During the fiscal year 2014 and 2013 periods, the Company made payments of $10,000 and $107,000, respectively, against capital lease obligations. In addition, during the three months ended July 31, 2012, cash of $20,000 was received upon exercise of employee stock options.

The Company has been authorized by its Board of Directors to repurchase up to $5 million worth of shares of its common stock for treasury whenever appropriate opportunities arise but it has neither a formal repurchase plan nor commitments to purchase additional shares in the future. As of July 31, 2013, the Company has repurchased approximately $4 million of its common stock out of the $5 million authorization.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

The Company will continue to expend resources to develop, improve and acquire products for space applications, guidance and targeting systems, and communication systems which management believes will result in future growth and continued profitability. During fiscal year 2014, the Company intends to make a substantial investment of capital and technical resources to develop and acquire new products to meet the needs of the U.S. Government, commercial space and network infrastructure marketplaces and to invest in more efficient product designs and manufacturing procedures. Where possible, the Company will secure partial customer funding for such development efforts but is targeting to spend its own funds at a rate of less than 10% of revenues to achieve its development goals. Internally generated cash will be adequate to fund these development efforts. The Company may also pursue acquisitions to expand its range of products and may use internally generated cash and external funding in connection with such acquisitions.

As of July 31, 2013, the Company's consolidated backlog is approximately $56 million compared to $51 million at April 30, 2013, the end of fiscal year 2013. Approximately 70% of this backlog is expected to be realized in the next twelve months. Included in the backlog at July 31, 2013 is approximately $2 million under cost-plus-fee contracts which the Company believes represent firm commitments from its customers for which the Company has not received full funding to-date. The Company excludes from backlog any contracts or awards for which it has not received authorization to proceed and on fixed price contracts . . .

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