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

Show all filings for FREQUENCY ELECTRONICS INC

Form 10-Q for FREQUENCY ELECTRONICS INC


16-Dec-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.

Foreign Operations and Foreign Currency Adjustments

The Company maintains manufacturing operations in Belgium and the People's Republic of China. The Company is vulnerable to currency risks in these countries. The local currency is the functional currency of each of the Company's non-U.S. subsidiaries. No foreign currency gains or losses are recorded on intercompany transactions since they are effected at current rates of exchange. The results of operations of foreign subsidiaries, when translated into U.S. dollars, reflect the average rates of exchange for the periods presented. The balance sheets of foreign subsidiaries, except for equity accounts which are translated at historical rates, are translated into U.S. dollars at the rates of exchange in effect on the date of the balance sheet. As a result, similar results in local currency can vary upon translation into U.S. dollars if exchange rates fluctuate significantly from one period to the next.

15 of 24

                  FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
                                  (Continued)

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:


                                          Six months             Three months
                                               Periods ended October 31,
                                       2013        2012        2013        2012
Revenues
FEI-NY                                   76.9 %      70.5 %      75.6 %      69.9 %
Gillam-FEI                               13.5        13.2        11.0        14.9
FEI-Zyfer                                12.9        19.5        13.9        19.0
Less intersegment revenues               (3.3 )      (3.2 )      (0.5 )      (3.8 )
                                        100.0       100.0       100.0       100.0
Cost of revenues                         63.1        62.9        63.4        61.7
Gross margin                             36.9        37.1        36.6        38.3
Selling and administrative expenses      20.8        20.4        20.5        20.0
Research and development expenses         9.5         7.6         8.7         6.8
Operating profit                          6.6         9.1         7.4        11.5
Other income, net                         2.9         0.6         5.3         0.5
Pretax income                             9.5         9.7        12.7        12.0
Provision for income taxes                3.4         3.2         4.5         3.8
Net income                                6.1 %       6.5 %       8.2 %       8.2 %



Revenues

                                 Six months                                        Three months
                                                   Periods ended October 31,
  Segment        2013          2012             Change              2013          2012              Change
FEI-NY         $  26,039     $  24,135     $   1,904       8 %    $  12,865     $  12,287      $     578       5 %
Gillam-FEI         4,568         4,518            50       1 %        1,873         2,610           (737 )   (28 %)
FEI-Zyfer          4,352         6,688        (2,336 )   (35 %)       2,363         3,331           (968 )   (29 %)
Intersegment
revenues          (1,125 )      (1,087 )         (38 )                  (94 )        (659 )          565
               $  33,834     $  34,254     $    (420 )    (1 %)   $  17,007     $  17,569      $    (562 )    (3 %)

For the six and three months ended October 31, 2013, revenues from commercial and U.S. Government satellite programs accounted for more than 55% of consolidated revenues and increased by approximately 20% over the same periods 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, accounted for approximately 20% of fiscal year 2014 consolidated revenues. Such revenues decreased by 10% and 36%, respectively, from the same periods of fiscal year 2013. Total revenues from U.S. Government satellite contracts and non-space programs approached 60% of consolidated revenues for the six months ended October 31, 2013 and were approximately 55% of revenues for the three-month period then ended. Network infrastructure revenues in the fiscal year 2014 periods accounted for approximately 15% of consolidated revenues and declined by approximately 20% and 30%, respectively, from the same periods of fiscal year 2013. Network infrastructure revenues are recorded in all three segments although the largest network infrastructure sales volume is recorded in the Gillam-FEI and FEI-Zyfer segments and accounted for most of the year-over-year decline in FEI-Zyfer's revenues. For the three-month period ended October 31, 2013, Gillam-FEI revenues decreased over the prior year primarily due to lower intersegment sales which are eliminated in consolidation.

16 of 24

FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

For the six and three months ended October 31, 2012, FEI-NY revenues from commercial and U.S. Government satellite programs increased 10% over the prior year. Revenues from these programs accounted for just under 50% of consolidated sales, approximately the same ratio as the same six-month period of fiscal year 2012. Revenues on these long-term contracts are recognized primarily under the percentage of completion method. Sales from the U.S. Government/DOD business area, which accounted for more than 20% of consolidated revenues, increased almost 20% over fiscal year 2012 revenues due primarily to the FEI-Elcom acquisition. Between sales from FEI-NY (including FEI-Elcom) and FEI-Zyfer, total revenues from U.S. Government satellite and non-space programs exceeded 50% for the six months ended October 31, 2012 and neared 60% for the three month period then ended. Network infrastructure sales, which are recorded in all three segments, grew approximately 15% year over year and accounted for approximately 20% of consolidated revenues, similar to the prior fiscal year.

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 remain at approximately the same level as the prior year. Satellite payload revenues will continue to be the dominant portion of the Company's business and represents the Company's best growth opportunity.

Gross margin

                         Six months                                   Three months
                                        Periods ended October 31,
            2013         2012           Change            2013        2012             Change
          $ 12,498     $ 12,713     $ (215 )     (2 %)   $ 6,232     $ 6,732     $ (500 )     (7 %)

GM Rate       36.9 %       37.1 %                           36.6 %      38.3 %

Gross margin for the six and three month periods ended October 31, 2013, decreased due to lower revenues and lower gross margin rates. The gross margin rate is impacted by product mix as well as by unabsorbed overhead costs during fiscal year 2014.

Fiscal year 2013 gross margin increased over the prior fiscal year due to higher consolidated revenues. The fiscal year 2013 gross margin rate was reduced from the fiscal year 2012 rates due to the effect of low sales volume and higher costs incurred on certain customer-funded nonrecurring engineering projects at FEI-Elcom whose results of operations are included in the FEI-NY segment.

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 approach its target rate.

Selling and administrative expenses

Six months Three months Periods ended October 31, 2013 2012 Change 2013 2012 Change $ 7,045 $ 6,996 $ 49 1 % $ 3,485 $ 3,511 $ (26 ) (1 %)

For the six and three-month periods ended October 31, 2013 and 2012, selling and administrative expenses varied from 20% to 21% of consolidated revenues which approximates the Company's target for such expenditures. The fluctuation in expenses in the fiscal year 2014 periods compared to the same periods of fiscal year 2013 is due to primarily to variations in stock-based compensation and accruals for incentive compensation plans. For the remainder of fiscal year 2014, the Company expects selling and administrative expenses to be incurred at approximately the same rate.

17 of 24

FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

Research and development expense

Six months Three months Periods ended October 31, 2013 2012 Change 2013 2012 Change $ 3,226 $ 2,618 $ 608 23 % $ 1,483 $ 1,203 $ 280 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 six and three-month periods ended October 31, 2013, was approximately 10% and 9% of consolidated revenues, respectively, compared to 8% and 7% for the same periods of the prior fiscal year. In the fiscal year 2014 periods, 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 periods, increased R&D spending is due primarily to product development expenditures at FEI-Elcom to improve its own product line.

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. 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 R&D projects. Internally generated cash and cash reserves are adequate to fund these development efforts.

In addition to internal R&D efforts, the Company continues to conduct development activities on customer-funded programs the cost of which appears in cost of revenues.

Operating profit

                         Six months                                   Three months
                                        Periods ended October 31,
           2013        2012            Change            2013        2012            Change
          $ 2,227     $ 3,099     $ (872 )     (28 %)   $ 1,264     $ 2,018     $ (754 )     (37 %)

Accelerated R&D spending in the fiscal year 2014 periods along with flat revenues and decreased gross margin rates as compared to the same periods of fiscal year 2013 resulted in reduced operating profit for the six and three months ended October 31, 2013. Fiscal year 2014's six- and three-month operating profit was 6.6% and 7.4%, respectively, of consolidated revenues compared to 9.1% and 11.5%, respectively, of consolidated revenues in the same periods of the prior year.

The late fiscal year 2012 addition of FEI-Elcom reduced consolidated operating results for the first half 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)

                                           Six months                              Three months
                                                        Periods ended October 31,
                              2013       2012          Change           2013      2012          Change
Investment income             $ 351     $  319     $  32        10 %    $ 208     $ 152     $  56        37 %
Interest expense                (95 )     (103 )       8        (8 %)     (36 )     (47 )      11       (23 %)
Other income (expense), net     734         (6 )     740        NM        725       (12 )     737        NM
                              $ 990     $  210     $ 780       371 %    $ 897     $  93     $ 804       865 %

18 of 24

FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

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 fiscal year 2014 periods, the Company recorded a gain of approximately $74,000 on the sale of certain marketable securities. No investment gains or losses were recorded in the fiscal year 2013 periods. During the six and three months ended October 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 six and three months ended October 31, 2012, investments were held in higher yielding marketable securities than those held during the same periods ended October 31, 2011.

The decrease in interest expense for the six and three months ended October 31, 2013 compared to the same periods of fiscal year 2013 is due to the lower interest rate under the Company's new credit facility from a bank. During the fiscal year 2014 periods, the Company refinanced the $6 million used to acquire FEI-Elcom during fiscal year 2012 and increased its borrowings by an additional $4.1 million for working capital and capital equipment acquisitions.

Other income in the fiscal year 2014 periods consists primarily of a $736,000 gain recognized upon the sale of certain manufacturing equipment to Morion, Inc. under the terms of a license agreement related to the Company's rubidium oscillator production technology. (See Note G to the accompanying condensed financial statements.) During the fiscal year 2013 periods, other income consisted of insignificant non-operating expenses.

Income tax provision

                                     Six months                                   Three months
                                                     Periods ended October 31,
                        2013          2012           Change           2013          2012           Change
                      $   1,150     $   1,100     $  50       5 %   $     770     $     670     $ 100      15 %

Effective tax rate
on pre-tax book
income:                    35.7 %        33.3 %                          35.6 %        31.8 %

The provision for income taxes for the six and three months ended October 31, 2013 increased over the same periods of fiscal year 2013 due to the estimated increased effective tax rate. For the full year, 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 for which no net tax provision or benefit is recognized. As of October 31, 2013 and April 30, 2013, the remaining deferred tax asset valuation allowance is approximately $1.9 million.

The provision for income taxes for the six and three months ended October 31, 2012 decreased from the same periods of fiscal year 2012 due to decreased pretax income and reduced effective tax rate.

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.

Net income

                          Six months                                  Three months
                                         Periods ended October 31,
             2013        2012           Change            2013        2012           Change
            $ 2,067     $ 2,209     $ (142 )     (6 %)   $ 1,391     $ 1,441     $ (50 )     (3 %)

19 of 24

FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

As discussed above, accelerated research and development expenses and reduced gross margins based on flat sales and higher costs, reduced net income for the six and three months ended October 31, 2013 as compared to the same periods of the prior year. Based on recent bookings and its backlog, the Company expects continued growth in satellite revenues and increased profitability over that of the prior fiscal year.

LIQUIDITY AND CAPITAL RESOURCES

The Company's balance sheet continues to reflect a strong working capital position of $77.2 million at October 31, 2013, compared to working capital of $71.7 million at April 30, 2013. Included in working capital at October 31, 2013 is $20.9 million consisting of cash, cash equivalents and marketable securities. The Company's current ratio at October 31, 2013 is 12.3 to 1.

For the six months ended October 31, 2013, the Company used cash from operations in the amount of $2.5 million compared to the use of cash from operating activities of $981,000 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 the six-month periods ended October 31, 2013 and 2012, the Company incurred approximately $2.8 million and $2.6 million, respectively, of non-cash operating expenses, such as depreciation and amortization and accruals for employee benefit programs. Net income in fiscal year 2014 also included a $736,000 gain on the sale of equipment and such gain is excluded from operating cash flow. For the balance of fiscal year 2014, as receivables are billed and collected and the pace of purchases of inventory slows, the Company expects to generate positive cash flow from operating activities.

Net cash used in investing activities for the six months ended October 31, 2013, was $1.1 million compared to $447,000 provided by such activity for the same period of fiscal year 2013. During the fiscal year 2014 period, marketable securities were sold or redeemed in the amount of $1.8 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 October 31, 2013 and 2012 in the amount of $67,000 and $947,000, respectively. In the fiscal periods ended October 31, 2013 and 2012, the Company acquired property, plant and equipment in the amount of approximately $2.8 million and $612,000, 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 . . .

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