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FEIM > SEC Filings for FEIM > Form 10-Q on 17-Mar-2014All Recent SEC Filings

Show all filings for FREQUENCY ELECTRONICS INC

Form 10-Q for FREQUENCY ELECTRONICS INC


17-Mar-2014

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.

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                  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:

                                                Nine months            Three months
                                                     Periods ended January 31,
                                             2014        2013        2014        2013
      Revenues
      FEI-NY                                   77.4 %      74.4 %      78.3 %      82.1 %
      Gillam-FEI                               13.4        12.5        13.3        11.2
      FEI-Zyfer                                11.5        17.0         8.9        12.0
      Less intersegment revenues               (2.3 )      (3.9 )      (0.5 )      (5.3 )
                                              100.0       100.0       100.0       100.0
      Cost of revenues                         64.2        62.1        66.5        60.6
      Gross margin                             35.8        37.9        33.5        39.4
      Selling and administrative expenses      20.2        21.2        19.1        22.7
      Research and development expenses         8.8         7.3         7.5         6.5
      Operating profit                          6.8         9.4         6.9        10.2
      Other income, net                         2.5         0.6         2.1         0.4
      Pretax income                             9.3        10.0         9.0        10.6
      Provision for income taxes                3.0         2.7         2.3         1.7
      Net income                                6.3 %       7.3 %       6.7 %       8.9 %



Revenues
                                 Nine months                                           Three months
                                                      Periods ended January 31,
  Segment        2014          2013               Change               2014          2013                Change
FEI-NY         $  40,309     $  38,211     $   2,098          5 %    $  14,270     $  14,076      $     194          1 %
Gillam-FEI         6,990         6,431           559          9 %        2,422         1,913            509         27 %
FEI-Zyfer          5,976         8,742        (2,766 )      (32 %)       1,624         2,054           (430 )      (21 %)
Intersegment
revenues          (1,223 )      (1,993 )         770                       (98 )        (906 )          808
               $  52,052     $  51,391     $     661          1 %    $  18,218     $  17,137      $   1,081          6 %

For the nine and three months ended January 31, 2014, revenues from commercial and U.S. Government satellite programs accounted for approximately 60% of consolidated revenues and increased by approximately 20% and 25%, respectively, over the same periods of fiscal year 2013. Revenues on these contracts, which are recorded in the FEI-NY segment, are recognized primarily under the percentage of completion method. 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 approximately 20% and 30%, respectively, from the same periods of fiscal year 2013. Total revenues from U.S. Government satellite contracts and non-space programs were approximately 55% of consolidated revenues for both the nine and three months ended January 31, 2014. Network infrastructure revenues in the fiscal year 2014 periods accounted for less than 15% of consolidated revenues and declined by approximately 25% and 5%, 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 nine and three-month periods ended January 31, 2014, Gillam-FEI revenues increased over the prior year primarily due to higher sales in its market for remote terminal units which are sold to other industrial customers.

For the nine and three months ended January 31, 2013, FEI-NY revenues from commercial and U.S. Government satellite programs increased 10% over the same periods in the prior year. Revenues from these programs for the nine-month period ended January 31, 2013 accounted for approximately 50% of consolidated sales, approximately the same ratio as the same nine-month period of fiscal year 2012.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

Revenues on these long-term contracts are recognized primarily under the percentage of completion method. For the nine-month period ended January 31, 2013, sales from the U.S. Government/DOD business area, which accounted for more than 25% of consolidated revenues, increased by 40% over revenues for the same period of fiscal year 2012 due primarily to the FEI-Elcom acquisition. For the nine and three months ended January 31, 2013, total revenues from both satellite and non-space programs for which the U.S. Government is the end-user accounted for approximately 60% and 70%, respectively, of consolidated revenues. Such revenues are recorded in the FEI-NY (including FEI-Elcom) and FEI-Zyfer segments. For the nine-months ended January 31, 2013, network infrastructure sales, which are recorded in all three segments, grew approximately 10% year over year and accounted for approximately 20% of consolidated revenues, similar to revenues from this market during the same period of the prior fiscal year. For the first nine months of fiscal year 2013, sales to other industrial and commercial customers not included in the Company's major market areas, as discussed above, declined by approximately 35% from the same nine-month period of fiscal year 2012.

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

                         Nine months                                  Three months
                                        Periods ended January 31,
            2014         2013           Change            2014        2013           Change
          $ 18,609     $ 19,463     $ (854 )     (4 %)   $ 6,111     $ 6,750     $ (639 )     (9 %)
GM Rate       35.8 %       37.9 %                           33.5 %      39.4 %

Gross margin for the nine and three month periods ended January 31, 2014, decreased due to several factors: increased costs related to snow storms impacted the FEI-NY segment; higher than anticipated engineering design and production costs were incurred at the Gillam-FEI segment and lower sales volume at the FEI-Zyfer segment increased unabsorbed overhead costs. These factors reduced aggregate gross margin rates by approximately 1.5% and 4%, respectively, for the nine and three month periods of fiscal year 2014. In addition, product mix impacts gross margin rates.

Fiscal year 2013 gross margin increased over the prior fiscal year due to higher consolidated revenues. The fiscal year 2013 gross margin rates were 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 last quarter of fiscal year 2014 will improve but will fall short of its target rate.

Selling and administrative expenses

Nine months Three months Periods ended January 31, 2014 2013 Change 2014 2013 Change $ 10,534 $ 10,883 $ (349 ) (3 %) $ 3,488 $ 3,887 $ (399 ) (10 %)

For the nine and three-month periods ended January 31, 2014 and 2013, selling and administrative expenses varied from 19% to 23% of consolidated revenues which approximates the Company's target for such expenditures. The reduced expenses in the fiscal year 2014 periods compared to the same periods of fiscal year 2013 are due to reduced accruals for incentive compensation plans and lower marketing costs related to lower sales volume at the FEI-Zyfer segment. For the remainder of fiscal year 2014, the Company expects selling and administrative expenses to be incurred at approximately the same rate.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

Research and development expense

Nine months Three months Periods ended January 31, 2014 2013 Change 2014 2013 Change $ 4,589 $ 3,731 $ 858 23 % $ 1,363 $ 1,113 $ 250 22 %

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 nine and three-month periods ended January 31, 2014, was approximately 9% and 7% of consolidated revenues, respectively, compared to 7% and 6% for the same periods of the prior fiscal year. In the fiscal year 2014 periods, the Company increased its development of new products including a new line of satellite payload microwave receivers/converters from DC to Ka band. The satellite payload products are anticipated to be ready for customer evaluation and new contract awards by the end 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, also includes 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

                        Nine months                                    Three months
                                        Periods ended January 31,
         2014        2013             Change              2014        2013            Change
        $ 3,486     $ 4,849     $ (1,363 )      (28 %)   $ 1,260     $ 1,750     $ (490 )      (28 %)

Increased R&D spending in the fiscal year 2014 periods combined with decreased gross margin rates as compared to the same periods of fiscal year 2013 resulted in reduced operating profit for the nine and three months ended January 31, 2014. Fiscal year 2014's nine- and three-month operating profit was 6.8% and 6.9%, respectively, of consolidated revenues compared to 9.4% and 10.2%, 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.

In the fourth quarter of the prior fiscal year, the Company recorded an operating loss due to an asset write down at its Gillam-FEI segment. Consequently, for the full fiscal year 2014, the Company anticipates that it will generate an operating profit that exceeds that of fiscal year 2013.

Other income (expense)

                                     Nine months                                     Three months
                                                      Periods ended January 31,
                       2014          2013            Change             2014          2013            Change
Investment income    $     775     $     509     $   266      52 %    $     425     $     190     $  235     124 %
Interest expense          (120 )        (156 )        36     (23 %)         (25 )         (53 )       28     (53 %)
Other income
(expense), net             714           (73 )       787      NM            (22 )         (67 )       45     (67 %)
                     $   1,369     $     280     $ 1,089     389 %    $     378     $      70     $  308     440 %

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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 periods ended January 31, 2014, the Company recorded gains of approximately $367,000 and $293,000, respectively, on the sale of certain marketable securities. During the same periods of fiscal year 2013, the Company recorded an investment gain of approximately $40,000. During the nine and three months ended January 31, 2014, 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 nine and three months ended January 31, 2013, investments were held in higher yielding marketable securities than those held during the same periods ended January 31, 2012.

The decrease in interest expense for the nine and three months ended January 31, 2014 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 nine-month period includes 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

Nine months Three months Periods ended January 31, 2014 2013 Change 2014 2013 Change $ 1,570 $ 1,400 $ 170 12 % $ 420 $ 300 $ 120 40 %

Effective tax rate on pre-tax book income:
32.3 % 27.3 % 25.6 % 16.5 %

The provision for income taxes for the nine and three months ended January 31, 2014 increased over the same periods of fiscal year 2013 due to the estimated increased effective tax rates. For the full year, the effective tax rate in fiscal year 2014 is expected to be in the range of 30% to 35% 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 January 31, 2014 and April 30, 2013, the remaining deferred tax asset valuation allowance is approximately $1.9 million.

The provision for income taxes for the three months ended January 31, 2014 and 2013 were reduced due to the impact of tax law changes that were enacted during the respective fiscal quarters. The lower effective rates and lower tax provisions correct the higher estimated tax rates employed by the Company in the first half of each fiscal year prior to the enactment of the new tax laws.

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 consolidated effective tax 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

                        Nine months                                   Three months
                                        Periods ended January 31,
           2014        2013            Change            2014        2013            Change
          $ 3,285     $ 3,729     $ (444 )     (12 %)   $ 1,218     $ 1,520     $ (302 )     (20 %)

As discussed above, increased research and development expenses and reduced gross margins based on flat sales and higher costs, reduced net income for the nine and three months ended January 31, 2014 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.

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FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
(Continued)

LIQUIDITY AND CAPITAL RESOURCES

The Company's balance sheet continues to reflect a strong working capital position of $78.5 million at January 31, 2014, compared to working capital of $71.7 million at April 30, 2013. Included in working capital at January 31, 2014 is $22.6 million consisting of cash, cash equivalents and marketable securities. The Company's current ratio at January 31, 2014 is 11.4 to 1.

For the nine months ended January 31, 2014, the Company had positive cash from operations in the amount of approximately $700,000 compared to cash from operating activities of $3.2 million in the comparable fiscal year 2013 . . .

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