UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year ended April 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 1-8061
FREQUENCY ELECTRONICS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 11-1986657
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
55 CHARLES LINDBERGH BLVD., MITCHEL FIELD, N.Y. 11553
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 516-794-4500
Securities registered pursuant to Section 12 (b) of the Act:
Name of each exchange on
Title of each class which registered
- --------------------------------------- ------------------------
Common Stock (par value $1.00 per share) American Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes No X
--- ---
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No X
--- ---
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer Accelerated filer Non-accelerated filer X
---- ---- ----
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
The aggregate market value of voting stock held by non-affiliates of the
Registrant as of October 31, 2005 - $60,700,000
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of Registrant's Common Stock, par value $1.00
as of July 24, 2006 - 8,581,625.
DOCUMENTS INCORPORATED BY REFERENCE: PART III incorporates information by
reference from the definitive proxy statement for the Annual Meeting of
Stockholders to be held on or about September 27, 2006.
(Cover page 1 of 65 pages)
Exhibit Index at Page 58
PART I
Item 1. Business
GENERAL DISCUSSION
Frequency Electronics, Inc. (sometimes referred to as "Registrant",
"Frequency Electronics" or the "Company") was founded in 1961 as a research and
development firm in the technology of time and frequency control. Unless the
context indicates otherwise, references to the Registrant or the Company are to
Frequency Electronics, Inc. and its subsidiaries. References to "FEI" are to the
parent company alone and do not refer to any of the subsidiaries.
Frequency Electronics was incorporated in Delaware in 1968 and became the
successor to the business of Frequency Electronics, Inc., a New York
corporation, organized in 1961. The principal executive office of Frequency
Electronics is located at 55 Charles Lindbergh Boulevard, Mitchel Field, New
York 11553. Its telephone number is 516-794-4500 and its website is
www.frequencyelectronics.com.
In the mid-1990's, the Company transformed itself from primarily a defense
contract manufacturer into a high-tech provider of precision time and frequency
products for commercial applications found in both ground-based communication
stations and on-board satellites. The Company also continues to support the
United States government with products for defense and space applications.
The Company is a world leader in the design, development and manufacture of
high-technology frequency, timing and synchronization products for satellite and
terrestrial voice, video and data telecommunications. The Company's technologies
provide unique solutions that are essential building blocks for the next
generation of broadband wireless and for the ongoing expansion of existing
wireless and wireline networks. The Company's mission is to provide the most
advanced control of frequency and time - essential factors for synchronizing
communication networks and for providing reference frequencies for certain
military, commercial and scientific, terrestrial and space applications.
The Company has identified the following major markets for its products and
technology:
(1) Commercial communication satellites- The globe is encircled by over 120
geostationary satellites used for communication, TV and video broadcasting, and
data transmission. These satellites are going through a replacement cycle which
will last for many years with 12 to 20 new satellites expected to be built each
year.
(2) Satellites for U.S. Government Department of Defense ("DoD") and NASA-
Such satellites are used for secure communications, surveillance, guidance,
global positioning (GPS) and weather tracking.
(3) Wireless communications- Cellular telephone infrastructure requires
precise signal synchronization. In the architecture of many of the cellular
systems, this synchronization is obtained through oscillators provided by the
Company. As more services are added and more users come online, the need for
synchronization is increased.
(4) Wireline synchronization- In the developed world, a vast infrastructure
supports the wired communications networks. These networks also require
significant synchronization equipment which is housed in thousands of Central
Offices operated by the telephone companies. These equipments require upgrade
and replacement to maintain the integrity of the wireline networks.
(5) U.S. Government applications- In addition to DoD and NASA satellites,
the U.S. Government is in need of ever more secure communication capabilities
and is developing a secure radio for all branches of the military. The military
is also increasing its use of unmanned aerial vehicles (UAVs) and improving the
accuracy of the radar and guidance systems on all moving platforms.
(6) Other industrial applications- (a) Remote monitoring of networks, such
as power grids and gas lines, can be accomplished through the Company's LYNX
SCADA system. (b) Deep earth drilling for oil and gas in harsh environments can
be done more efficiently through utilization of the Company's high temperature
tolerant oscillators and GPS technology.
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To address these markets, the Company has formed several corporate entities
which operate under four reportable segments. (See also the section entitled
REPORTABLE SEGMENTS below.)
1. Commercial Communications- The Company's space and terrestrial commercial
communications products are designed, developed and manufactured by its
wholly owned subsidiary, FEI Communications, Inc. ("FEIC"). FEIC was
incorporated in Delaware in December 1991, as a separate subsidiary company
to provide ownership and management of assets and other services appropriate
for commercial clients, both domestic and foreign.
Frequency Electronics, Inc. Asia ("FEI-Asia") was established in fiscal year
2002 to be the Company's Asian-based low cost manufacturer of certain
commercial communications products used primarily in the wireless and
wireline markets. FEI-Asia is located in the Free-Trade Zone in Tianjin,
China.
2. U.S. Government - The Company's subsidiary, FEI Government Systems, Inc.
("FEI-GSI"), was formed in fiscal year 2002 to focus on supplying the
Company's technology and legacy proprietary products to the United States
military and other U.S. Government agencies.
3. Gillam-FEI - The Company's Belgian subsidiary, acquired in September 2000,
develops and manufactures products for wireline and network synchronization
systems. Products delivered by Gillam-FEI provide essential network
management and wireline synchronization for a variety of industries and
telecommunications providers in Europe, Africa, the Middle East and Asia.
4. FEI-Zyfer - Precision time and frequency generation and synchronization
products that incorporate global positioning systems ("GPS") technology are
manufactured by the Company's subsidiary FEI-Zyfer, Inc. ("FEI-Zyfer"),
which was acquired in fiscal year 2004. FEI-Zyfer's GPS capability
complements the Company's existing technologies and permits the combined
entities to provide a broader range of embedded systems for a variety of
timing functions.
In addition to the operating segments, the Company has made a strategic
investment in Morion, Inc., a Russian crystal oscillator manufacturer located in
St. Petersburg, Russia. The Company's equity investment in Morion permits the
Company to secure a low cost source for high precision quartz resonators and
crystal oscillators, many of which are based on the Company's design and
development work. In September 2004, the Company increased its investment in
Morion from 19.8% to 36.2% of Morion's outstanding shares. Accordingly, the
Company changed its method of carrying the Morion investment from cost to equity
as required by generally accepted accounting principles. Under the equity
method, the Company records its proportionate share of the earnings of Morion.
In addition, certain amounts in prior period financial statements have been
adjusted for the retroactive application of the equity method since the
inception of the Company's investment in Morion.
FISCAL 2006 and 2005 SIGNIFICANT EVENT
Real Estate Transactions
During the fourth quarter of fiscal year 2005, the Company recorded a gain
of $4.6 million related to the conversion of its real estate operating
partnership units into shares of Reckson Associates Realty Corp. common stock
("REIT stock"). This gain reflects the currently realizable portion related to
the fiscal year 1998 sale and leaseback of the Company's building to Reckson
Operating Partnership, LP. (See Item 2. Properties and Note 6 to the
accompanying consolidated financial statements.) Subsequent to the conversion,
the Company sold all of the REIT stock and realized additional gains of
approximately $2.1 million in fiscal year 2006 and $2.3 million in fiscal year
2005. As a result of the fiscal year 2005 gains, the Company also accrued a
contractually mandated incentive compensation expense of $416,000, which amount
is included in operating expenses in that year. In addition to the gains
indicated above, another $1.3 million gain was deferred and will be recognized
over the remaining term of the Company's building lease in accordance with the
accounting provisions for sale and leaseback transactions. During fiscal year
2006, the Company recognized $353,000 as income from the amortization of the
deferred gain.
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REPORTABLE SEGMENTS
The Company operates under four reportable segments, primarily aligned with
its geographical locations: (1) Commercial Communications; (2) U.S. Government;
(3) Gillam-FEI; and (4) FEI-Zyfer. Within each segment the Company designs,
develops, manufactures and markets precision time and frequency control products
for different markets as described below.
The products for the Commercial Communications segment are principally
marketed to wireless communications networks and to the commercial satellite
market. The operations of FEI-Asia are included in the Commercial Communications
segment since it is a principal supplier of low-cost assemblies primarily used
in wireless communication networks. Most product design, development and
manufacturing for the Commercial Communications and U.S. Government segments is
conducted in the Company's facility located in New York. The Company identified
the U.S. Government business as a reportable segment based upon the more
stringent regulatory environment (Federal Acquisition Regulations or "FAR") to
which it is subject when dealing with U.S. Government procurement contracts
versus the less restrictive commercial environment. The Gillam-FEI segment
designs, develops and manufactures products for wireline and network
synchronization. Its products are currently sold to non-U.S. customers and its
US5G system has recently been introduced to the domestic US market. The
FEI-Zyfer segment designs and manufactures products which incorporate GPS
technologies. FEI-Zyfer sells its products to both commercial and U.S.
Government customers and collaborates with other FEI segments on joint product
development activities.
During fiscal years 2006, 2005 and 2004 approximately 56%, 57% and 56%,
respectively, of the Company's sales were from products sold by the Commercial
Communications segment. For the years ended April 30, 2006, 2005, and 2004,
sales of the U.S. Government segment accounted for approximately 12%, 10%, and
14%, respectively, of the Company's sales. Sales by Gillam-FEI were
approximately 17%, 23% and 24% of fiscal years 2006, 2005 and 2004 revenues,
respectively. In fiscal years 2006, 2005 and 2004, sales for the FEI-Zyfer
segment were 19%, 16% and 13% of consolidated revenues, respectively. Sales
information for the Commercial Communications, U.S. Government, Gillam-FEI, and
FEI-Zyfer markets during each of the last five years is set forth in Item 6
(Selected Financial Data).
Consolidated revenues include sales to end-users in countries located
outside of the United States. During fiscal years 2006, 2005 and 2004, foreign
sales comprised 35%, 50% and 54%, respectively, of consolidated revenues.
Segment information regarding revenues, including foreign sales, operating
profits, depreciation and assets is more fully disclosed in Note 15 to the
accompanying financial statements.
COMMERCIAL COMMUNICATIONS SEGMENT:
The Company provides precision time, frequency and synchronization products
that are found in ground-based communication stations and commercial satellites.
The Company has made a substantial investment in research and development to
apply its core technologies to commercial markets. Revenues for this segment
have varied considerably over the past seven fiscal years, based on
infrastructure spending patterns by wireless telecommunication companies and
demand for new commercial satellites. Over this seven-year time frame, the
Company initially experienced accelerated growth in wireless infrastructure
revenues followed by a "telecom trough" in fiscal years 2002 and 2003.
Accelerated growth began again in late fiscal year 2004 and continued through
early fiscal year 2005, to be followed by another slow down into the first two
quarters of fiscal year 2006. The Company believes that the wireless industry
provides a large opportunity for future sales growth but the timing of any
growth will be based on capital spending decisions by domestic and worldwide
telecommunications companies. The Company also expects to generate substantial
revenues from deployment of new and replacement commercial satellites.
Terrestrial Communications
The development of new and enhanced technologies will bring expanded and
more reliable telecommunications services to the public. As digital cellular
systems and PCS networks grow they require more base stations to meet the demand
for better connectivity, higher data rates and dependable high quality for cell
phone service. Cellular infrastructure integrators and original equipment
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manufacturers, consisting of some of the world's largest telecommunications
companies, are building out existing networks even as they develop new
technologies for future systems. These new technologies include advances such as
EDGE (Enhanced Data rates for Global Evolution), 3G (3rd Generation) and others,
that can provide not only improved voice connectivity but also Internet, video
and data transmission.
Wireless communication networks consist of numerous installations located
throughout a service area, each with its own base station connected by wire or
microwave radio through a network switch. Network operators are in the process
of converting older networks from analog to digital technology and enhanced
systems such as CDMA (Code Division Multiple Access). These upgrades require
more precise frequency control at the base stations to achieve a higher
dependability and quality of services.
With increased demand for wireless services on limited bandwidth, the
requirement for precise timing to ensure system-wide synchronization becomes
paramount. The Company manufactures a Rubidium Atomic Standard, a small, low
cost, temperature-stable atomic "clock" as well as temperature-stable quartz
crystal oscillators, which are ideally suited for use in advanced cellular
communications base stations. Whether the network uses CDMA (Code Division
Multiple Access), TDMA (Time Division Multiple Access), UMTS (Universal Mobile
Telecommunications System) or GSM (Global System for Mobile Communications) or a
hybrid of these systems, timing to ensure signal synchronization is essential.
Over the past five years, in conjunction with its European subsidiary,
Gillam-FEI, the Company has developed a new, state-of-the-art signal
synchronization unit identified as the US5G. This unit is intended to provide
synchronization for wireline networks within the United States where
approximately 35,000 "shelves" are located in 25,000 Central Offices around the
country. The current equipment in these Central Offices is old and in need of
upgrade or replacement. The Company's US5G unit is currently in the validation
phase at two of the Regional Bell Operating Companies ("RBOC") and the Company
anticipates initial U.S. sales of this product during fiscal year 2007.
Commercial Space
The commercial use of satellites launched for communications, navigation,
weather forecasting, video and data transmissions has expanded the need to
transmit increasing amounts of voice, video, and data to earth-based receivers.
This requires more precise timing and frequency control at the satellite. The
Company manufactures the master clocks (quartz, rubidium and cesium) and other
significant timing products for many satellite communication systems, and many
of the Company's other space assemblies are used onboard spacecraft for command,
control and power distribution. Efficient and reliable DC-DC power converters
are also manufactured for the Company's own instruments and as stand-alone
products for space applications. The Company's oven-controlled quartz crystal
oscillators are cost-effective precision clocks suited for high-end performance
required in satellite transmissions, airborne telephony and geophysical survey
positioning systems. Newly developed frequency generation synthesizers,
distribution amplifiers and up/down converters and receivers have augmented the
Company's product offerings and positioned the Company to provide a greater
share of a typical satellite's payload. Commercial satellite programs such as
Intelsat, ANIK, Eutelsat, Inmarsat and Worldstar have utilized the Company's
space-qualified products.
U.S. GOVERNMENT SEGMENT:
In the years ahead, the U.S. Government's Department of Defense will require
more secure communication capabilities, more assets in space and greater
bandwidth. The Global Positioning Satellite System, the MILSTAR Satellite System
and the AEHF Satellite System, are examples of the programs in which the Company
participates. The Company has manufactured the master clock for the Trident
missile, the basic timing system for the Voyager I and Voyager II deep space
exploratory missions and the quartz timing system for the Space Shuttle. The
Company's product offerings for U.S. Government satellite programs are similar
in design and function to those used on commercial satellites, as described
above.
In addition to space-based programs, the Company's proprietary products have
been used in airborne and ground-based guidance, navigation, communications,
radar, sonar surveillance and electronic countermeasure and timing systems. The
Company has recently developed a low-g (gravity)
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sensitivity oscillator which offers a 100-fold improvement in accuracy for
guidance and targeting systems. The Company has demonstrated the functionality
of its oscillators on over a dozen U.S. Government platforms and anticipates
that many of these programs will be a source of substantial future revenue.
Products are built in accordance with DoD standards and are in use on many of
the United States' most sophisticated military aircraft, satellites and
missiles.
The Company's sales on U.S. Government programs are generally made under
fixed price contracts either directly with U.S. Government agencies or
indirectly through subcontracts intended for government end-use. The price paid
to the Company is not subject to adjustment by reason of the costs incurred by
the Company in the performance of the contract, except for costs incurred due to
contract changes ordered by the customer. These contracts are on a negotiated on
terms under which the Company bears the risk of cost overruns and derives the
benefit from cost savings.
Negotiations on U.S. Government contracts are sometimes based in part on
Certificates of Current Costs. An inaccuracy in such certificates may entitle
the government to an appropriate recovery. From time to time, the Defense
Contracts Audit Agency ("DCAA") audits the Company's accounts with respect to
these contracts. The Company is not aware of any basis for recovery with respect
to past certificates.
All U.S. Government end-use contracts are subject to termination by the
purchaser for the convenience of the U.S. Government and are subject to various
other provisions for the protection of the U.S. Government. In the event of such
termination, the Company is entitled to receive compensation as provided under
such contracts and in the applicable U.S. Government regulations.
GILLAM-FEI SEGMENT:
Gillam-FEI extends the Company's competencies into wireline synchronization,
network management, and specialized test equipment. With the advent of new
digital broadband transmission technologies, reliable synchronization has become
the warranty to quality of service for telecommunications operators. Gillam-FEI
is among the world leaders in the field of wireline synchronization technology,
and its products are targeted for telecommunication operators and network
equipment manufacturers that utilize modular and flexible platforms to build
reliable digital-network-systems worldwide. Telecommunications operators such as
Belgacom, France Telecom, Telefonica and other service providers are among
Gillam-FEI's major customers. With the development of the US5G unit for the
Commercial Communications segment and the U.S. market, Gillam-FEI also developed
a state-of-the-art US5Ge unit and ancillary products intended for deployment in
the European, Middle Eastern, Asian and African markets.
Network management systems marketed under the brand name LYNX, are a
flexible suite of complementary software modules that are arranged to satisfy
the specific needs of telecom operators, electrical utilities, and other
operators of distribution networks. The multi-task capability of the LYNX system
allows operators to supervise and manage the distribution of electricity, gas,
video cables, public lighting, and other networks. Deregulation of utilities,
especially in Europe, has created a greater demand for the LYNX product. Major
customers presently using LYNX include SIG Electrical Services of Geneva,
Switzerland; Electricity Distribution Management for the city of Lausanne,
Switzerland; UEM Electricity Distribution Management for the city of Metz,
France; Brussels International Airport and Belgian Railways.
Gillam-FEI's specialized test equipment is mainly targeted for the
telecommunications industry.
FEI-ZYFER SEGMENT:
FEI-Zyfer designs, develops and manufactures products for precision time and
frequency generation and synchronization, primarily incorporating GPS
technology. FEI-Zyfer's products make use of both "in-the-clear" civil and
"crypto-secured" military signals from GPS. In most cases, FEI-Zyfer's products
are integrated into communications systems, computer networks, test equipment,
and military command and control terminals for ground and satellite link
applications. More than 60% of revenues are derived from sales where the end
user is the U.S. Government. FEI-Zyfer's products are an important extension of
FEI's core product line, specifically in the area of GPS capabilities.
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PRODUCTS
The Company's products are manufactured from raw material which, when
combined with conventional electronic parts available from multiple sources,
become finished products used for commercial wireless and wireline
communications, satellite applications, space exploration, position location,
radar, sonar and electronic counter-measures. These products are employed in
ground-based earth stations, fixed, transportable, portable and mobile
communications installations, domestic and international satellites, as well as
aircraft, ships, submarines and missiles. The Company's products are marketed as
components, instruments, or complete systems. Prices are determined based upon
the complexity, design requirement, purchased quantity and delivery schedule.
Components - The Company's key technologies utilize quartz, rubidium and
cesium to manufacture precision time and frequency standards and higher level
assemblies which allow the users to generate, transmit, and receive synchronous
signals in order to communicate effectively, locate position accurately, secure
a communications system, or guide a missile. The components class of the
Company's products includes crystal filters and discriminators, surface acoustic
wave resonators, and high-reliability thick and thin film hybrid assemblies for
space and other applications.
Precision quartz oscillators use quartz resonators in conjunction with
electronic circuitry to produce signals with accurate and stable frequency. The
Company's products include several types of quartz oscillators, suited to a wide
range of applications, including ultrastable and low-g sensitivity units for
moving platforms and satellite systems. These products also feature fast warm-up
and low power consumption for mobile applications, including voice and data
communications.
The ovenized quartz oscillator is the most accurate of the Company's crystal
oscillators. The crystal is enclosed in a temperature controlled environment
called a proportional oven. The Company manufactures several varieties of
temperature controlling devices and ovens.
The voltage-controlled quartz oscillator features electronic controls for
frequency stabilization or modulation, depending upon the application.
The temperature compensated quartz oscillator is controlled using a
temperature sensitive device to directly compensate for the effect of
temperature on the oscillator's frequency.
The rubidium lamp, filter and resonance cell provide the optical subassembly
for the manufacture of the Company's optically pumped atomic rubidium frequency
standards. The cesium tube resonator is used in the manufacture of the Company's
cesium primary standard atomic clocks.
High reliability hybrid assemblies are manufactured in thick and thin film
technologies for applications from DC to 44 GHz. These hybrids are used in
manufacturing the Company's products and also supplied directly to customers,
for use in space and other high reliability systems.
Efficient and reliable DC-DC power converters are manufactured for the
Company's own instruments and as stand alone products, for space applications.
The Company manufactures filters and discriminators using its crystal
resonators for its own radio-frequency and microwave receiver, signal
conditioner and signal processor products.
Instruments - The Company's instrument line consists of three basic time and
frequency generating instruments and a number of instruments which test and
distribute the time and frequency. The Company's time and frequency generating
instruments are the quartz frequency standard, rubidium atomic standard and
cesium beam atomic standard.
The quartz frequency standard is an electronically controlled solid-state
device which utilizes a quartz crystal oscillator to produce a highly stable
output signal at a standardized frequency. These frequency standards are used in
communications, guidance and navigation and time synchronization systems. The
Company's products also include a precision frequency standard with battery
back-up and memory capability enabling it to remain in operation if a loss of
power has occurred.
The optically pumped atomic rubidium frequency standard is a solid-state
instrument which provides both timing and low phase noise frequency references
used in commercial communications systems. Rubidium oscillators combine
sophisticated glassware, light detection devices and electronics packages
7
to generate a highly stable frequency output. Rubidium, when energized by a
specific radio frequency, will absorb less light. The oscillator's electronics
package generates this specific frequency and the light detection device
ensures, through monitoring the decreased absorption of light by the rubidium
and the use of feedback control loops, that this specific frequency is
maintained. This highly stable frequency is then captured by the electronics
package and generated as an output signal. Rubidium oscillators provide atomic
oscillator stability, at lower costs and in smaller packages.
The cesium beam atomic standard utilizes the atomic resonance
characteristics of cesium atoms to generate precise frequency several orders of
magnitude more accurate and stable than other types of quartz frequency
generators. The Company's atomic standard is a compact, militarized solid-state
device which generates these precision frequencies for use with advanced
communications and navigation equipment. A digital time-of-day clock is
incorporated which provides visual universal time display and digital timing for
systems use. The atomic standard manufactured by the Company is a primary
standard, capable of producing time accuracies of better than one second in
several hundred thousand years.
As the demands on communications systems increase, the requirement for
precise frequency signals to drive a multitude of electronic equipment is
greatly expanded. To meet this growing requirement, the Company manufactures a
distribution amplifier which is an electronically controlled solid-state device
that receives a base frequency from a frequency standard and provides multiple
signal outputs of the input frequency. A distribution amplifier enables many
items of electronic equipment in a single facility, aircraft or ship to receive
a standardized frequency and/or time signal from a quartz, rubidium or cesium
atomic standard.
Systems - The systems portion of the Company's business includes
manufacturing and integrating selections of its specialized components into
higher level subsystems and systems that meet customer-defined needs. The
Company has a unique knowledge and demonstrated capability to interface these
technologies and experience in applying them to a wide range of systems. The
systems generate electronic frequencies of predetermined value and then divide,
multiply, mix, convert, modulate, demodulate, filter, distribute, combine,
separate, switch, measure, analyze, and/or compare these signals depending on
the system application.
This portion of the Company's business includes a complete line of time and
frequency control systems, capable of generating many frequencies and time
scales that may be distributed to widely dispersed users, or within the confines
of a facility or platform, or for a single dedicated purpose. Time and frequency
control systems combine the Company's cesium, rubidium and/or crystal
instruments with its other components, to provide systems for wireless,
wireline, space and defense applications.
For the wireless industry, the Company integrates its core components such
as quartz oscillators and rubidium atomic standards with software applications,
microprocessors, and other digital circuitry into complete subsystems. These
subsystems supply frequency and time reference signals that facilitate wireless
communications and are necessary for the various wireless technologies to
operate properly. The customers for these subsystems are global wireless
infrastructure manufacturers.
For the wireline industry, the Company integrates its core components with
other electronic modules into high-level platforms that provide a total
synchronization solution. These signal synchronization units ("SSUs") are
designed and manufactured by Gillam-FEI. SSUs are inserted into digital
telecommunication networks and provide reliable synchronization for proper
operation of the network. The systems are primarily sold to telecommunication
operators and vary from a few SSUs for a simple network to hundreds of units for
complex networks. For operators of distribution networks such as electrical
utilities and telecommunications operators, the Company offers the LYNX
system--a flexible suite of complementary software modules that are
distinctively combined to satisfy the requirements of the users. With the advent
of digital broadband transmission technologies, reliable synchronization has
become the Quality of Service for telecommunications operators world-wide.
For the space and defense sectors the Company combines its core products in
a wide range of diverse applications that provide systems for space and ground
based communications, space exploration, satellite tracking stations,
satellite-based navigation and position location, secure communication,
submarine and ship navigation, calibration, and electronic counter-measures
applications. These time and frequency control systems can provide up to
quadruple redundancy to assure operational longevity and dependability. The past
experience of major contactors in these sectors
8
has led satellite integrators to outsource increasing amounts of these systems
to highly qualified producers who have validated their capabilities through
extensive successful participation in past defense and space programs.
Historically, the Company ranks among the top producers in this category.
The Company's subsidiary, FEI-Zyfer, manufactures products incorporating GPS
technology by utilizing GPS signals to provide required performance in
conjunction with precision time and frequency information. These systems and
subsystems are used in secure government programs such as SAASM (Selective
Acquisition Anti-spoofing Module) and commercial communications and other
applications.
The GPS expertise of FEI-Zyfer has been joined with the technological
capabilities and experience of the Commercial Communications segment in building
crystal oscillators for harsh environments, to jointly develop a new system to
be utilized to enhance seismic data in deep earth and other exploratory drilling
for natural resources.
BACKLOG
As of April 30, 2006, the Company's consolidated backlog amounted to
approximately $36 million (see Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations). Approximately 80% of this
backlog is expected to be filled during the Company's fiscal year ending April
30, 2007. The backlog, which reflects only firm purchase orders and contracts,
is subject to change by reason of several factors including possible
cancellation of orders, change orders, terms of the contracts and other factors
beyond the Company's control. Accordingly, the backlog is not necessarily
indicative of the revenues or profits (losses) which may be realized when the
results of such contracts are reported.
CUSTOMERS AND SUPPLIERS
The Company markets its products both directly and through approximately 50
independent sales representative organizations located in the United States,
Europe and Asia. Sales to non-U.S. customers, including the revenues of its
overseas subsidiaries, totaled approximately 35%, 50% and 54% of net sales in
fiscal years 2006, 2005 and 2004, respectively.
The Company's products are sold to both commercial and governmental
customers. For the years ended April 30, 2006, 2005 and 2004, approximately 25%,
20% and 21%, respectively, of the Company's sales were made under contracts to
the U.S. Government or subcontracts for U.S. Government end-use.
The Company's consolidated sales for each of the years ended April 30, 2006,
2005 and 2004 included sales to Motorola Corp. ("Motorola") of approximately
$6.8 million, $15.5 million and $16.1 million, respectively. These amounts
represent 13%, 28% and 32%, respectively, of consolidated sales for each of
those years. Lucent Technologies ("Lucent") accounted for $7.4 million, $6.5
million and $5.5 million of revenues in fiscal years 2006, 2005 and 2004 or 14%,
12% and 11%, respectively, of consolidated sales. In fiscal year 2006, revenues
from Space Systems/Loral ("SS/L") were $8.2 million or 16% of consolidated
sales.
During the three years ended April 30, 2006, sales to Motorola and Lucent
were made by the Company's Commercial Communications segment, accounting for 48%
in fiscal year 2006, 70% in fiscal year 2005 and 76% in fiscal year 2004 of that
segment's total sales. Fiscal year 2006 sales by the Commercial Communications
segment to SS/Loral were 28% of the segment's total sales.
Fiscal year 2006 revenues in the U.S. Government segment included sales to
four customers, Northrop Grumman Corporation ("Northrop"), Raytheon Missile
Systems, Inc. ("Raytheon"), BAE Systems Aerospace, Inc. ("BAE"), and the Air
Force Space and Missile Center, which accounted for 82% of that segment's sales.
For fiscal years 2005 and 2004, Northrop, Raytheon, BAE and Lockheed Martin,
accounted for 87% and 85%, respectively, of total segment sales.
During fiscal years 2006, 2005 and 2004, France Telecom and Belgacom were
major customers of the Gillam-FEI segment. These European telecommunication
companies accounted for 41%, 59% and 31%, respectively, of the segment's
revenues in those fiscal years.
In fiscal year 2006, Computer Sciences Corporation ("CSC") and L-3
Communications accounted for 20% of revenues in the FEI-Zyfer segment; in fiscal
year 2005, Northrop and CSC accounted for 21% of the revenues in the FEI-Zyfer
segment; and in fiscal year 2004, General Dynamics accounted for 19% of the
revenues in the FEI-Zyfer segment.
9
The loss by the Company of any one of these customers would have a material
adverse effect on the Company's business. The Company believes its relationship
with these companies to be mutually satisfactory and is not aware of any
prospect for the cancellation or significant reduction of any of its commercial
or existing U.S. Government contracts.
The Company purchases a variety of components such as transistors,
resistors, capacitors, connectors and diodes for use in the manufacture of its
products. The Company is not dependent upon any one supplier or source of supply
for any of its component part purchases and maintains alternative sources of
supply for all of its purchased components. The Company has found its suppliers
generally to be reliable and price-competitive.
RESEARCH AND DEVELOPMENT
The Company's technological expertise continues to be an important factor to
support future growth in revenues and earnings. The Company has focused its
internal research and development efforts on improving the core physics and
electronic packages in its time and frequency products, conducting research to
develop new time and frequency technologies, improving product manufacturability
by seeking to reduce its production costs through product redesign and process
improvements and other measures to take advantage of lower cost components.
The Company continues to focus a significant portion of its own resources
and efforts on developing hardware for satellite (commercial and U.S.
Government) and terrestrial commercial communications systems, including
wireless, wireline and GPS-related systems. During fiscal years 2006, 2005 and
2004, the Company expended $6.3 million, $6.8 million and $5.3 million of its
own funds, respectively, on such research and development activity. (See also
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.) For fiscal year 2007, the Company is targeting to spend
approximately $6.0 million on research and development in similar areas. The
actual amount spent will depend on market conditions and identification of new
opportunities.
PATENTS AND LICENSES
The Company believes that for the most part its business is not dependent on
patent or license protection. Rather, it is primarily dependent upon the
Company's technical competence, the quality of its products and its prompt and
responsible contract performance. However, employees working for the Company
assign all rights to inventions to the Company and the Company presently holds
such patents and licenses. In certain limited circumstances, the U.S. Government
may use or permit the use by the Company's competitors of certain patents or
licenses the government has funded. During fiscal year 2003, the Company
received a broad and significant patent for new, proprietary quartz oscillator
technology which the Company intends to exploit in both legacy and new
applications.
COMPETITION
The Company experiences competition in all areas of its business. The
Company competes primarily on the basis of the accuracy, performance and
reliability of its products, the ability of its products to function under
severe conditions, such as in space or other extreme hostile environments,
prompt and responsive contract performance, technical competence and price. The
Company has a unique and broad product line which includes all three frequency
standards - quartz, rubidium, and cesium. Because of the very high precision of
certain of its products, the Company has few competitors. For lower precision
components there is significant competition from a number of suppliers.
In recent years, the Company has successfully outsourced certain component
manufacturing processes to third parties and more recently to its wholly-owned
subsidiary, FEI-Asia in Tianjin, China and to Russian-based Morion, Inc., in
which the Company is a minority shareholder. The Company expects this
outsourcing to enhance its competitive position on cost while maintaining its
high quality standards. The Company believes its ability to obtain raw
materials, manufacture finished products, integrate them into systems and
sub-systems and interface these systems with end-user applications provides a
strong competitive advantage.
10
Certain of the Company's competitors are larger, have greater financial
resources and have larger research and development and marketing staffs. The
Company has a strong history of competing successfully in this environment due
to the quality, reliability and outstanding record of performance its products
have achieved.
With respect to its instruments and systems, the Company competes with
Hewlett-Packard Company, Symmetricom, Inc, E. G. and G., Inc. and others.
Systems for the wireline industry produced by the Gillam-FEI segment compete
with Symmetricom, Inc. The Company's principal competition for space products is
the in-house capability of its major customers.
EMPLOYEES
The Company employs approximately 425 persons worldwide. None of the U.S.
employees are represented by labor unions, while in Europe approximately five
employees in one facility are represented by a French labor union.
OTHER ASPECTS
The Company's business is not seasonal although it expects to experience
some fluctuation in revenues during the second fiscal quarter as a result of
extended holiday periods in August. No unusual working capital requirements
exist.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers hold office until the annual meeting of the Board of
Directors following the annual meeting of stockholders, subject to earlier
removal by the Board of Directors.
The names of all executive officers of the Company and all positions and
offices with the Company which they presently hold are as follows:
Joseph P. Franklin - Chairman of the Board of Directors
Martin B. Bloch - President, Chief Executive Officer and Director
Markus Hechler - Executive Vice President, President of FEI
Government Systems, Inc. and Assistant Secretary
Steven Strang - President, FEI-Zyfer
Hugo Fruehauf - Chief Technical Officer
Charles S. Stone - Vice President, Low Noise Development
Leonard Martire - Vice President, Marketing and Sales
Oleandro Mancini - Vice President, Business Development
Thomas McClelland - Vice President, Commercial Products
Alan Miller - Treasurer and Chief Financial Officer
Harry Newman - Secretary
None of the officers and directors is related.
Joseph P. Franklin, age 72, has served as a Director of the Company since
March 1990. In December 1993 he was elected Chairman of the Board of Directors.
He also served as Chief Executive Officer from December 1993 through October
1998 and as Chief Financial Officer from September 1996 through October 1998.
From August 1987 to November 1993, he was the Chief Executive Officer of
Franklin S.A., a Spanish business consulting company located in Madrid, Spain,
specializing in joint ventures, and was a director of several prominent Spanish
companies. General Franklin was a Major General in the United States Army until
he retired in July 1987.
Martin B. Bloch, age 70, has been a Director of the Company and of its
predecessor since 1961. Mr. Bloch is the Company's President and Chief Executive
Officer and has held such positions since inception of the Company, except for
the period from December 1993 through October 1998 when General Franklin held
the CEO position. Previous to forming the Company, Mr. Bloch served as chief
electronics engineer of the Electronics Division of Bulova Watch Company.
11
Markus Hechler, age 60, joined the Company in 1967. He was elected to the
position of Executive Vice President in February 1999, prior to which he served
as Vice President, Manufacturing since 1982. In October 2001, he was named
President of the Company's subsidiary, FEI Government Systems, Inc. He has
served as Assistant Secretary since 1978.
Steven Strang, age 42, was named President of FEI-Zyfer, Inc., effective
May 1, 2005. Previously, Mr. Strang was Executive Vice President of this
subsidiary and its predecessor companies where he has served for 17 years in
various technical and management positions.
Hugo Fruehauf, age 67, became an officer of the Company when the net
assets of Zyfer, Inc. were acquired in May 2003. Effective May 1, 2005, Mr.
Fruehauf was named Chief Technical Officer of the Company. Mr. Fruehauf served
as CEO and CTO of Zyfer, Inc. for 6 years. Prior to joining Zyfer, Mr. Fruehauf
was vice president of Alliant Techsystems from 1995 to 1997 and from 1982 to
1995 was president of Datum-Efratom and its predecessor, Ball-Efratom.
Charles S. Stone, age 75, joined the Company in 1984, and has served as
its Vice President since that time. Prior to joining the Company, Mr. Stone
served as Senior Vice President of Austron Inc., from 1966 to 1979, and Senior
Scientist of Tracor Inc., from 1962 to 1966.
Leonard Martire, age 69, joined the Company in August 1987 and served as
Executive Vice President of FEI Microwave, Inc., the Company's wholly-owned
subsidiary, until May 1993 when he was elected Vice President, Marketing and
Sales.
Oleandro Mancini, age 57, joined the Company in August 2000 as Vice
President, Business Development. Prior to joining the Company, Mr. Mancini
served from 1998 as Vice President, Sales and Marketing at Satellite
Transmission Systems, Inc. and from 1995 to 1998 as Vice President, Business
Development at Cardion, Inc., a Siemens A.G. company. From 1987 to 1995, he held
the position of Vice President, Engineering at Cardion, Inc.
Thomas McClelland, age 51, joined the Company as an engineer in 1984 and
was elected Vice President, Commercial Products in March 1999.
Alan Miller, age 57, joined the Company in November 1995 as its corporate
controller and was elected to the position of Treasurer and Chief Financial
Officer in October 1998. Prior to joining the Company, Mr. Miller served as an
operations manager and a consultant to small businesses from 1992 through 1995
and as a Senior Audit Manager with Ernst & Young, L.L.P. from 1980 to 1991.
Harry Newman, age 59, Secretary, has been employed by the Company since
1979, prior to which he served as Divisional Controller of Jonathan Logan, Inc.,
apparel manufacturers, from 1976 to 1979, and as supervising Senior Accountant
with Clarence Rainess and Co., Certified Public Accountants, from 1971 to 1975.
Item 1A. Risk Factors
In addition to the other information contained in this Form 10-K and the
exhibits hereto, the following risk factors should be considered carefully in
evaluating the Company's business. Additional risks not presently known to the
Company or that the Company currently deems immaterial may also adversely affect
its business, financial condition, or results of operations.
A variety of factors may cause the price of the Company's stock to be
volatile.
In recent years, the stock market in general, and the market for shares of
technology companies in particular, including Frequency Electronics, have
experienced price fluctuations. For example, for fiscal year 2006, the price of
the Company's Common Stock ranged from a closing high of $14.20 to a closing low
of $10.00. The market price of the Company's Common Stock is likely to continue
to fluctuate significantly in the future, including fluctuations unrelated to
its performance. The Company believes that fluctuations of its stock price may
be caused by a variety of factors, including:
o fluctuations in the Company's operating results;
o announcements of technological innovations, new commercial products
or other developments by the Company or its competitors;
12
o published reports by securities analysts;
o general market conditions, general economic conditions;
o announcements by the Company or its competitors of significant
acquisitions, strategic partnerships or joint ventures;
o the Company's cash position and cash commitments;
o additions or departures of key personnel;
o sales or purchases of the Company's Common Stock in the marketplace;
o an outbreak of hostilities, diseases, natural disasters or
terrorism;
o developments in patents or other intellectual property rights; and
o developments in the Company's relationships with customers and
suppliers.
If the Company fails to keep pace with rapid technological change and
evolving industry standards, its products could become less competitive or
obsolete.
The markets for the Company's products are characterized by technological
change, new product introductions, changes in customer requirements and evolving
industry standards. The Company may cease to be competitive if it fails to
timely introduce new products or product enhancements that address these
factors. To continue to introduce new products and product enhancements on a
timely basis, the Company must:
o identify emerging technological trends in the Company's target
markets;
o accurately define and design new products or product enhancements to
meet market needs;
o develop or license the underlying core technologies necessary to
create new products and product enhancements; and
o respond effectively to technological changes and product
introductions by the Company's competitors.
If the Company fails to timely identify, develop, manufacture, market or
support new or enhanced products successfully, its competitors could gain market
share or its new or enhanced products might not gain market acceptance.
Delays in the development of new or enhanced products could harm the
Company's operating results and its competitive position.
The development of new, technologically advanced products is a complex and
uncertain process requiring high levels of innovation, highly skilled
engineering and development personnel and accurate anticipation of technological
and market trends. Consequently, product development delays are typical in the
Company's industry. If the Company fails to timely introduce a product for an
emerging standard or customers defer or cancel orders expecting the release of a
new or enhanced product, its operating results could suffer. Product development
delays may result from numerous factors, including:
o changing product specifications and customer requirements;
o unanticipated engineering complexities;
o difficulties with or delays by contract manufacturers or suppliers
of key components or technologies;
o difficulties in allocating engineering resources and overcoming
resource limitations; and
o difficulties in hiring and retaining necessary technical personnel.
The Company faces uncertainty relating to economic conditions affecting its
customers.
The Company faces uncertainty in the degree to which the current global
economic climate will affect the rate of growth for its existing and potential
customers. In particular, the timing and magnitude of capital spending by
international telecommunications companies, including those in China, will
materially impact the Company's business. Frequency Electronics may experience
instances of customers delaying or deferring orders and longer lead times to
close sales. Similarly, spending on U.S. Government programs is determined by
the annual defense department budget. To the extent that support for the
liberation and rebuilding of Iraq takes precedence, funding for certain
Department of Defense programs may be delayed or significantly reduced
13
in the near term. Such delays can have a materially negative impact on the
Company's business, its operating results and financial condition.
The Company faces competition. Its inability to remain competitive in the
industry would adversely affect the Company's ability to maintain its current
sales and growth.
The Company experiences competition in all areas of its business. Frequency
Electronics competes primarily on the basis of the accuracy, performance and
reliability of its products, the ability of its products to function under
severe conditions, such as in space or other extreme hostile environments,
prompt and responsive contract performance, technical competence and price. The
Company has a unique and broad product line which includes all three frequency
standards - quartz, rubidium, and cesium. For its high precision
products, the Company has few competitors, but for lower precision components,
the Company faces significant competition from a number of suppliers. Certain of
the Company's competitors are larger, have greater financial resources and have
larger research and development and marketing staffs. If its competitors develop
more accurate or reliable products, or otherwise improve their products,
Frequency Electronics could experience a decline in its sales or loss of market
acceptance of its products.
With respect to the Company's instruments and systems, it competes with
Hewlett-Packard Company, Symmetricom, Inc, E. G. and G., Inc. and others.
Systems for the wireline industry produced by the Gillam-FEI segment compete
with Symmetricom, Inc. Frequency Electronics' principal competition for space
products is the in-house capability of its major customers.
The Company's reliance on third parties could materially adversely affect its
business.
In recent years, the Company has outsourced certain component manufacturing
processes to third parties and more recently to its wholly-owned subsidiary,
FEI-Asia in Tianjin, China and to Russian-based Morion, Inc., in which the
Company is a minority shareholder. The Company expects this outsourcing to
enhance its competitive position on cost while maintaining its high quality
standards. Any unanticipated changes in such third parties' ability to perform
the component manufacturing processes or any delay in such manufacturing could
materially adversely affect the Company's business, financial condition and
operating results.
The Company's executive officers and certain key personnel are critical to
its business.
The Company's future success is dependent upon the contributions of its
senior corporate management team, particularly Martin Bloch, President and Chief
Executive Officer, who has been with the Company since 1961, Markus Hechler,
Executive Vice President, who has been with the Company since 1967, Oleandro
Mancini, Vice President of Business Development, who has been with the Company
since 2001 and certain other key employees. If Messrs. Bloch, Hechler and
Mancini no longer serve in their positions, the Company's business, financial
conditions and results of operation could be substantially adversely affected.
The Company's future operating results also depend in significant part upon
its ability to attract and retain qualified management, manufacturing,
technical, engineering, marketing, sales and support personnel. Competition for
qualified personnel is intense, and the Company cannot ensure success in
attracting or retaining qualified personnel. There may be only a limited number
of persons with the requisite skills to serve in these positions and it may be
increasingly difficult for the Company to hire personnel over time. The
Company's business, financial conditions and results of operation could be
substantially adversely affected by its inability to attract and retain skilled
employees.
Economic, political and other risks associated with international sales and
operations could adversely affect sales.
Because the Company sells its products worldwide, its business is subject to
risks associated with doing business internationally. The Company recognized 35%
of its revenue from sales to end-users in countries located outside of the
United States in the fiscal year ended April 30, 2006. The Company anticipates
that revenue from international operations will continue to represent a
substantial portion of its revenue. In addition, several of the Company's
manufacturers' facilities and suppliers are located outside the United States of
America. Accordingly, the Company's future results could be harmed by a variety
of factors, including:
o changes in a specific country's or region's political or economic
conditions, particularly in emerging markets;
o tariff and trade policies;
o export license requirements and restrictions of the export of
technology;
14
o import regulations;
o domestic and foreign tax policies;
o foreign governmental regulations;
o difficulty in staffing and managing widespread operations;
o ongoing health epidemics (e.g., Bird Flu);
o fluctuations in foreign currency exchange rates;
o stability of international monetary conditions;
o differing labor regulations;
o political unrest, war, actual or threatened acts of terrorism, other
international conflicts and the resulting military, economic and
political responses (including, without limitation, war between
sovereign nations) as well as heightened security measures which may
cause significant disruption to commerce worldwide;
o differing protection of intellectual property; and
o unexpected changes in regulatory requirements.
The Company's products may contain defects that cause it to incur significant
corrective costs, divert its attention from product development efforts and
result in a loss of customers.
Highly complex products such as the Company's high-technology frequency,
timing and synchronization products may contain defects when they are installed
in its customers' systems. If any of the Company's products contain defects or
have reliability, quality or compatibility problems, its reputation may be
damaged and customers may be reluctant to buy its products. In addition, these
defects could interrupt or delay sales. The Company may have to invest
significant capital and other resources to alleviate these problems. If any
problem remains undiscovered until after the Company has commenced production of
a new product, it may be required to incur additional development costs and
product recall, repair or replacement costs. These problems may also result in
claims against the Company by its customers or others. In addition, these
problems may divert the Company's technical and other resources from other
development efforts.
If the Company fails to manage its operations effectively, its business could
suffer.
The Company's ability to offer products and implement its business plan
successfully in a rapidly evolving market requires effective planning and
management. Failure by the Company's management or personnel to properly
allocate resources to meet its current and existing needs as well as unforeseen
complications and inefficiencies in planning its operations can adversely impact
the morale of the Company's personnel and lead to further complications and
operational inefficiencies. If this were to occur, the Company's profitability
or financial position could be negatively impacted and its operating results
could suffer.
Claims that the Company infringed third-party intellectual property rights
could result in significant expenses or restrictions on its ability to sell its
products.
Although the Company's industry is not characterized by frequent claims or
litigation regarding patent rights, the Company cannot be certain that its
products do not or will not infringe issued patents or the intellectual property
rights of others. Historically, patent applications in the United States of
America have not been publicly disclosed until the patent is issued, and the
Company may not be aware of filed patent applications that relate to its
products or technology. If patents are later issued in connection with these
applications, the Company may be liable for infringement. Periodically, other
parties, including some of the Company's competitors, may assert patent,
copyright and other rights to technologies in various jurisdictions that are
important to its business. Any claims asserting that the Company's products
infringe or may infringe the rights of third parties, including claims arising
through its contractual indemnification of its customers, regardless of their
merit or resolution, would likely be costly and time-consuming, divert the
efforts of the Company's technical and management personnel, cause product
shipment delays or require the Company to enter into royalty or licensing
agreements. Royalty or licensing agreements, if required, may not be available
on terms acceptable to the Company, or at all.
At present, the Company does not believe that its products infringe any other
party's intellectual property rights in any way that would have a material
adverse effect on the Company's operations. However, if any material claims do
arise and if these claims cannot be resolved through a license or similar
arrangement, the Company could become a party to litigation. The results of any
litigation are inherently uncertain. In the event of an adverse result in any
litigation with third parties that could arise in the future, the Company could
be
15
required to pay substantial damages, including treble damages if it is held
to have willfully infringed, to cease the manufacture, use and sale of
infringing products, to expend significant resources to develop non-infringing
technology, or to obtain licenses to the infringing technology. In addition,
lawsuits, regardless of their success, would likely be time consuming and
expensive to resolve and would divert management time and attention from the
Company's business.
Any failure to protect the Company's intellectual property adequately may
significantly harm its business.
The Company protects its proprietary processes, software, know-how and other
intellectual property and related rights through copyrights, patents, trademarks
and the maintenance of trade secrets, including entering
into confidentiality agreements. The Company's success and ability to compete
depends in part on its proprietary technology. However, the Company cannot
provide any assurance that other companies will not develop technologies that
are similar to its technology. Although the Company has patent applications
pending, patents may not issue as a result of these or other patent
applications. Any patents that ultimately issue may be successfully challenged
or invalidated, or may not provide the Company with a significant competitive
advantage. Despite the Company's efforts to protect its intellectual property
rights, existing laws in the United States of America and in differing
international jurisdictions and its contractual arrangements provide only
limited protection. Unauthorized parties may attempt to copy or otherwise obtain
and use the Company's products or technology. Third parties may breach
confidentiality agreements or other protective contracts with the Company and it
may not be able to enforce its rights in the event of these breaches.
Monitoring unauthorized use of the Company's products is difficult and may be
expensive, and the Company cannot be certain that the steps it has taken will
prevent unauthorized use of its intellectual property, particularly in foreign
countries where the laws may not protect the Company's proprietary rights as
fully as in the United States of America. The Company may be required to spend
significant resources to protect its intellectual property rights, including
pursuing remedies in court. Frequency Electronics may become involved in legal
proceedings against other parties, which may also cause other parties to assert
claims against it. In the future the Company may not be able to detect
infringements and may lose its competitive position in its markets before it
does so. In addition, competitors may design around the Company's technologies
or develop competing technologies. The laws of other countries in which the
Company markets its products might offer little or no effective protection of
its proprietary technology. Reverse engineering, unauthorized copying or other
misappropriation of the Company's proprietary technology could enable third
parties to benefit from its technology without payment, which could
significantly harm the Company's business. The Company's failure to enforce and
protect its intellectual property rights or any adverse change in the laws
protecting intellectual property rights could harm its business. Furthermore,
the Company may become involved in legal proceedings against other parties,
which may also cause other parties to assert claims against it.
Future sales of substantial amounts of the Company's common stock by it or by
its existing stockholders could cause the Company's stock price to fall.
Additional equity financings or other share issuances by the Company could
adversely affect the market price of its Common Stock. Sales by existing
stockholders of a large number of shares of Frequency Electronics' Common Stock
in the public trading market (or in private transactions) such as this offering
by the Selling Stockholders, or the perception that such additional sales could
occur, could cause the market price of the Company's common stock to drop.
Some of the Company's revenue is generated from a limited number of key
customers and the loss of a key customer could substantially reduce its
revenues.
A large portion of the Company's sales are generated from a small number of
key customers at each of the Company's segments, including, without limitation,
three customers of the Commercial Communications segment, Space Systems/Loral,
Lucent Technologies and Motorola Corp., which accounted for 16%, 14% and 13% of
consolidated sales for fiscal 2006, respectively. In fiscal year 2006, Northrop,
Raytheon, BAE and the Air Force Space and Missile Center were significant
customers of the Company's U.S. Government segment; France Telecom and Belgacom
were significant customers of the Company's Gillam-FEI segment; and Computer
Sciences Corporation and L-3 Communications were significant customers of the
FEI-Zyfer segment. The Company's top 10 customers accounted for 63% of its
consolidated sales for fiscal year 2006. The Company expects that its top 10
customers in the aggregate will continue to account for a large portion of its
consolidated sales in the foreseeable future, and the loss of one or more of
these customers would materially
16
harm the Company's business and operating results. The loss of a key customer
could also be perceived as a loss of momentum in the Company's business and an
adverse impact on its financial results, and this may cause the market price of
the Company's common stock to fall.
The Company is subject to anti-takeover provisions that could delay or
prevent an acquisition of the Company
The Company is subject to the anti-takeover provisions of the Delaware
General Corporation Law, which could have the effect of delaying or preventing a
change of control of Frequency Electronics. These factors could materially
adversely affect the price of the Company's common stock.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
The Company operates out of several facilities located around the world.
Each facility is used for manufacturing its products and for administrative
activities. The following table presents the location, size and terms of
ownership/occupation:
Location Size (sq. ft.) Own or Lease
-------- ------------- ------------
Long Island, NY 93,000 Lease
Anaheim, CA 20,885 Lease
Liege, Belgium 34,000 Own
Chalon Sur Saone, France 5,000 Lease
Tianjin, China 27,000 Lease
The Company's facility located in Mitchel Field, Long Island, New York, is
part of the building that the Company constructed in 1981 and expanded in 1988
on land leased from Nassau County. In January 1998, the Company sold this
building and the related land lease to Reckson Associates Realty Corp.
("Reckson"), leasing back the space that it presently occupies.
The Company leases its manufacturing and office space from Reckson under an
11-year lease at an annual rental of $400,000 per year with the Company paying
its pro rata share of real estate taxes along with the costs of utilities and
insurance. The lease provides for two 5-year renewal periods, exercisable at the
option of the Company, with annual rentals of $600,000 during the first renewal
period and $800,000 during the second renewal period. Under the terms of the
lease, new office and engineering facilities for the Company were constructed at
the cost of Reckson. The leased space is adequate to meet the Company's domestic
operational needs which encompass the principal operations of the Commercial
Communications and U.S. Government segments and also serves as the Company's
world-wide corporate headquarters.
The sale of its building to Reckson, a real estate investment trust ("REIT")
whose shares are traded on the New York Stock Exchange, was effected through a
tax-deferred exchange of the building for approximately 513,000 participation
units of Reckson Operating Partnership, L.P. ("REIT units") which were valued at
closing at $12 million. Each REIT unit was convertible into one share of the
common stock of the REIT. Under the accounting provisions for sale and leaseback
transactions, the sale of this building was considered a financing and the REIT
units received were reflected as a noncurrent liability while the related
building continued to be reflected as an asset. In March 2005, the Company
exercised its option to convert all of the REIT units into 513,000 shares of the
REIT. Upon conversion of the REIT units, the Company recognized a gain of $4.6
million and deferred an additional $1.3 million gain. The deferred gain will be
recognized into income over the remaining term of the initial leaseback period.
As a result of the conversion of the REIT units, both the building and the
noncurrent liability were removed from the balance sheet of the Company. (See
Note 6 to the accompanying financial statements.)
17
When the Company completed the acquisition of Gillam-FEI it also acquired
the property located in Belgium as well as a manufacturing facility in France.
During fiscal year 2006, the Company sold the French building to the former
president of Gillam-FEI at an appraised value of $975,000 and recognized a gain
of approximately $680,000. The France sales office is now housed in a leased
facility. These facilities are adequate to meet the present and future
operational requirements of Gillam-FEI.
The Tianjin, China facility is the location of the Company's wholly-owned
subsidiary, FEI-Asia. In late fiscal year 2005, the subsidiary acquired
additional leased space within a manufacturing facility located in the Tianjin
Free-Trade Zone. The lease is renewable annually with rent of $14,000 payable
quarterly. The new facility is adequate for the near-term manufacturing
expectations for the Company.
The Anaheim, California facility is leased by the Company's subsidiary,
FEI-Zyfer, Inc. The facility consists of a combination office and manufacturing
space. The lease, which expires in May 2007, requires monthly payments of
$22,600.
Item 3. Legal Proceedings
No material legal proceedings are pending.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were required to be submitted by Registrant to a vote of security
holders during the fourth quarter of fiscal year 2006.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
The Common Stock of the Company is listed on the American Stock Exchange
under the symbol "FEI". The Company is in the process of listing its Common
Stock on The Nasdaq Global Market. The Company anticipates that its Common Stock
will continue to be traded on the American Stock Exchange through the close of
business on Monday, July 31, 2006 and expects that the first day of trading of
its Common Stock on The Nasdaq Global Market will be Tuesday, August 1, 2006,
under the ticker symbol "FEIM."
The following table shows the high and low sale price for the Company's
Common Stock for the quarters indicated, as reported by the American Stock
Exchange.
FISCAL QUARTER HIGH SALE LOW SALE
-------------- --------- --------
2006 -
FIRST QUARTER $13.75 $10.56
SECOND QUARTER 12.95 10.14
THIRD QUARTER 12.60 9.90
FOURTH QUARTER 14.35 11.00
2005 -
FIRST QUARTER $14.70 $11.65
SECOND QUARTER 13.40 10.22
THIRD QUARTER 16.05 12.00
FOURTH QUARTER 15.90 9.80
As of July 24, 2006, the approximate number of holders of record of common
stock was 600. The closing share price of the Company's stock on April 28, 2006
was $13.85. The closing share price of the Company's stock on July 24, 2006 was
$11.49.
18
DIVIDEND POLICY
Since 1997, the Company has adhered to a policy of distributing a cash
dividend to shareholders of record as of April 30 and October 31, payable on
June 1 and December 1, respectively. The Board of Directors will determine
dividend amounts prior to each declaration based on the Company's financial
condition and financial performance.
STOCK BUYBACK PROGRAM
In March 2005, the Company's Board of Directors authorized a stock
repurchase program for up to $5 million of the Company's outstanding common
stock. Shares may be purchased in open market purchases, private transactions or
otherwise at such times and from time to time, and at such prices and
in such amounts as the Company believes appropriate and in the best interests of
its shareholders. The timing and volume of repurchases will vary depending on
market conditions and other factors. Purchases may be commenced or suspended at
any time without notice. During fiscal year 2005, the Company repurchased 6,300
shares under the buyback program, paying an average of $10.38 per share. No
shares were repurchased during fiscal year 2006.
EQUITY COMPENSATION PLAN INFORMATION
Number of Securities
Remaining available for
Number of Securities to Weighted-Average Future Issuance under
be Issued upon exercise Exercise Price of Equity Compensation Plans
of Outstanding Options Outstanding Options (Excluding Securities
Plan Category Warrants and Rights Warrants and Rights Reflected in Column (a))
- --------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
Equity Compensation Plans
Approved by Security Holders 483,700 $ 9.61 399,000
Equity Compensation Plans Not
Approved by Security Holders 813,237 $12.83 -
--------- -------
TOTAL 1,296,937 $11.58 399,000
========= ====== =======
Item 6. Selected Financial Data
The following table sets forth selected financial data including net sales
and operating profit (loss) for the five-year period ended April 30, 2006. The
information has been derived from the audited financial statements of the
Company for the respective periods.
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
------------------------------------------
Years Ended April 30,
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(in thousands, except share and dividend data)
Net Sales
Commercial Communications $29,491 $31,464 $28,235 $15,051 $26,663
U.S. Government 6,310 5,603 7,053 8,906 4,513
Gillam-FEI 9,170(1) 12,599(1) 12,197(1) 8,137 11,223
FEI-Zyfer 10,055 8,803 6,560 - -
less intersegment sales (2,216)(1) (3,296)(1) (3,939)(1) (567) (1,220)
------- ------- ------- ------- -------
Total Net Sales $52,810 $55,173 $50,106 $31,527 $41,179
======= ======= ======= ======= =======
Operating Profit (Loss) $ 1,710 $(1,269) $(1,646) ($12,490)(6) $ 89(7)
======= ======= ======= ======= =======
Net Income (Loss) $ 4,798(2) $ 5,037(3) $ 320(4,5) ($ 8,811)(5) $ 1,378(8)
======== ======= ======= ======= =======
Average Common Shares Outstanding
Basic 8,537,427 8,484,682 8,374,399 8,331,785 8,350,735
Diluted 8,690,617 8,684,758 8,542,575 8,331,785 8,529,175
Earnings (Loss) per Common Share
Basic $ 0.56 $ 0.59 $ 0.04(5) ($ 1.06) $ 0.17
====== ====== ====== ====== ======
Diluted $ 0.55 $ 0.58 $ 0.04(5) ($ 1.06) $ 0.16
====== ====== ====== ====== ======
19
CONSOLIDATED BALANCE SHEET DATA
-------------------------------
Total Assets $86,741 $88,374 $92,867(9) $85,778(9) $96,011
======= ======= ======= ======= =======
Long-Term Obligations
and Deferred Items $ 9,120 $ 9,337 $17,609 $17,903 $17,796
======= ======= ======= ======= =======
Cash dividend declared
per common share $ 0.20 $ 0.20 $ 0.20 $ 0.20 $ 0.20
======= ======= ======= ======= =======
Notes to Selected Financial Data
(1) Includes intercompany sales to Commercial Communications segment of
$0.9 million, $2.4 million and $3.5 million in fiscal years 2006, 2005
and 2004, respectively, for development of US5G product.
(2) Includes $2.1 million from gain on the sale of REIT common shares and
$680,000 from gain on the sale of a European subsidiary's former
manufacturing facility.
(3) Includes $6.9 million from gain on conversion of REIT units into REIT
common shares and subsequent sale of a portion of the REIT common
shares.
(4) Includes $400,000 reversal of tax liabilities established in prior
years
(5) Includes $158,000 and $49,000, respectively, for restatement of equity
income from Morion, Inc. in fiscal years 2004 and 2003, which also
increased fiscal year 2004 Earnings per Common Share by $0.02 from the
amount reported before restatement.
(6) Includes goodwill impairment of $6.2 million and adjustments to
inventory of $3.6 million.
(7) Includes insurance reimbursement of $1.5 million for expenses related
to certain litigation with the U.S. Government less inventory reserves
and writeoffs aggregating $1.0 million.
(8) In addition to items in (7) above, includes $300,000 investment loss
for an other than temporary decline of value in a marketable security.
(9) Total assets are restated by $207,000 for fiscal year 2004 and by
$49,000 for fiscal year 2003 from amounts reported in prior fiscal
years to reflect the Company's equity interest in Morion, Inc.
Item 7. 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 Annual Report on Form 10-K 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. Forward-looking statements
inherently involve risks and uncertainties that could cause actual results to
differ materially from the forward-looking statements. Factors that would cause
or contribute to such differences include, but are not limited to, inability to
integrate operations and personnel, actions by significant customers or
competitors, general domestic and international economic conditions, consumer
spending trends, reliance on key customers, 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, the availability of capital, and the outcome of any
litigation and arbitration proceedings. 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. 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
20
Company to make use of reasonable 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. 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 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.
For customer orders in the Company's Gillam-FEI and FEI-Zyfer segments or
smaller contracts or orders in the other business segments, 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 reserves are established
for slow-moving and obsolete items and are based upon management's experience
and expectations for future business. Any changes in reserves arising from
revised expectations are reflected in cost of sales in the period the revision
is made.
Equity-based Compensation
Through fiscal year 2006, the Company applied the disclosure-only provisions
of FAS No. 148, "Accounting for Stock-Based Compensation- Transition and
Disclosure" and continues to measure compensation cost in accordance with APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Historically, this
has not resulted in compensation cost upon the grant of options under a
qualified stock option plan. However, in accordance with FAS No. 148, the
Company provides pro forma disclosures of net income (loss) and income (loss)
per share as if the fair value method had been applied beginning in fiscal 1996.
The following table illustrates the effect on the Company's consolidated
statements of operations for the fiscal years ended April 30, had compensation
cost for stock option awards under the plans been determined based on the fair
value at the grant dates consistent with the provisions of FAS No. 148:
(in thousands, except per share data)
2006 2005 2004
---- ---- ----
Net Income, as reported $4,798 $5,037 $ 320
Cost of stock options, net of taxes (309) (525) (707)
------ ------ -----
Net Income (Loss)- pro forma $4,489 $4,512 ($ 387)
====== ====== ======
21
Income per share, as reported:
Basic $0.56 $0.59 $0.04
===== ===== =====
Diluted $0.55 $0.58 $0.04
===== ===== =====
Income (Loss) per share- pro forma
Basic $0.53 $0.53 ($0.05)
===== ===== =====
Diluted $0.52 $0.52 ($0.05)
===== ===== =====
The weighted average fair value of each option has been estimated on the
date of grant using the Black-Scholes options pricing model with the following
weighted average assumptions used for grants in each of the three years ended
April 30, 2006, 2005 and 2004; dividend yield of 1.4%, 1.1% and 1.8%; expected
volatility of 59%, 59% and 63%; risk free interest rate of 4.1%, 3.9% and 3.6%;
and expected lives of six and one-half years, respectively.
22
RESULTS OF OPERATIONS
The table below sets forth for the fiscal years ended April 30 the
percentage of consolidated net sales represented by certain items in the
Company's consolidated statements of operations:
2006 2005 2004
---- ---- ----
Net Sales
Commercial Communications 55.8% 57.0% 56.4%
U.S. Government 12.0 10.2 14.1
Gillam-FEI 17.4 22.8 24.3
FEI-Zyfer 19.0 16.0 13.1
Less intersegment sales (4.2) (6.0) (7.9)
----- ----- -----
100.0 100.0 100.0
Cost of Sales 64.8 67.1 68.9
----- ----- -----
Gross Margin 35.2 32.9 31.1
Selling and Administrative expenses 20.1 21.2 22.3
Compensation Charges 0.0 1.6 1.5
Research and Development expenses 11.9 12.4 10.6
---- ---- ----
Operating Profit (Loss) 3.2 (2.3) (3.3)
Other Income, net & Minority Interest 9.3 15.2 3.8
Provision for Income Taxes 3.4 3.8 0.2
--- ---- ----
Net Income 9.1% 9.1% 0.3%
=== === ====
Significant Events
As more thoroughly described elsewhere in this Form 10-K and in the notes to
the financial statements, the Company's fiscal year 2006, 2005 and 2004 results
of operations were materially impacted by several specific events. During fiscal
year 2006, the Company recognized gains on the sale of certain assets: $2.1
million from additional sales of shares of Reckson Associates Realty Corp.
common stock ("REIT stock") (See Item 2. Properties, Note 6 to the accompanying
consolidated financial statements and comments in the following paragraph) and a
gain of $680,000 upon the sale of a manufacturing facility owned by one of its
European subsidiaries. (See Note 7 to the accompanying consolidated financial
statements.)
During fiscal year 2005, the Company recorded a gain of $4.6 million on the
conversion of its real estate operating partnership units ("REIT units") into
shares of REIT stock, thus completing a transaction which was initiated in
fiscal year 1998. Subsequent to the conversion, the Company sold a portion of
the REIT stock and realized additional gains of approximately $2.3 million, or
total pretax gains of approximately $6.9 million. As a result of these gains,
the Company also accrued a contractually mandated incentive compensation expense
of $416,000, which amount is included in operating expenses under the caption
"Compensation Charges."
During fiscal year 2004, the Company acquired the business and net assets of
Zyfer, Inc. In addition to the purchase price, the Company invested an
additional $2.5 million of working capital to support the operations of
FEI-Zyfer until it could return to profitability. Also, in fiscal year 2004, the
Company realized a $400,000 tax benefit as the result of the reversal of certain
tax liabilities established in prior years.
Without these significant events, the Company's operating profit (loss),
pre-tax income and net income would be materially different from that reported
in the financial statements.
23
Operating Profit (Loss)
-----------------------
Fiscal 2006 to Fiscal 2005 Fiscal 2005 to Fiscal 2004
------------------------------- -------------------------------
Years ended April 30,
2006 2005 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
$1,710 ($1,269) $2,979 NM ($1,269) ($1,646) $377 23%
(NM = Not meaningful)
For the fiscal year ended April 30, 2006, the Company realized an operating
profit of $1.7 million compared to an operating loss of $1.3 million in fiscal
year 2005. This substantial improvement in operating results was the result of
several factors including improved gross margins, lower compensation related
charges and lower discretionary spending on research and development.
The operating loss for the fiscal year ended April 30, 2005, decreased to
$1.3 million from a $1.6 million operating loss for fiscal year 2004. The
improvement is attributable to the 10% year-over-year increase in sales coupled
with improved gross margins but offset by higher selling and administrative
costs, compensation charges and research and development expenditures. The
research and development expenditures represent investments that keep the
Company's products at the leading edge of time and frequency technology and
enhance competitiveness for future sales.
Net Sales
---------
Fiscal 2006 to Fiscal 2005 Fiscal 2005 to Fiscal 2004
-------------------------------- ----------------------------------
Years ended April 30,
(in millions)
2006 2005 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
Commercial Communications $29.5 $31.5 ($2.0) (6%) $31.5 $28.2 $3.2 11%
U.S. Government 6.3 5.6 0.7 13% 5.6 7.1 (1.4) (21%)
Gillam-FEI 9.2 12.6 (3.4) (27%) 12.6 12.2 0.4 3%
FEI-Zyfer 10.0 8.8 1.2 14% 8.8 6.5 2.3 34%
Intersegment sales (2.2) (3.3) 1.1 (3.3) (3.9) 0.6
------ ------ ----- ------ ------ -----
$52.8 $55.2 ($2.4) (4%) $55.2 $50.1 $5.1 10%
For the year ended April 30, 2006, revenues of the Commercial Communications
segment declined 6% primarily as a result of a 33% decrease in revenues related
to wireless telecommunication infrastructure spending. This decline was
partially offset by a doubling in revenues from commercial satellite projects.
Revenues related to U.S. Government programs increased by 13% as the Company
began new programs primarily for U.S. Government satellite programs. Revenues
for Gillam-FEI (exclusive of intercompany sales of $945,000 in fiscal year 2006
and $2.4 million in fiscal year 2005 related to a research and development
program) decreased by $2.0 million or 19%, as a number of wireline
synchronization projects were postponed by its customers. FEI-Zyfer continued to
show year-over-year improvement in revenues as the segment introduced new
products and continued to solidify its position with its customer base.
In fiscal year 2005, sales increases were experienced in three of the
Company's four segments over the fiscal year 2004 results. Commercial
Communications revenues increased largely on increased revenues from commercial
space programs. Gillam-FEI revenues (exclusive of intercompany sales of $2.4
million in fiscal year 2005 and $3.5 million in fiscal year 2004 related to a
research and development program) improved by $1.5 million (18%) of which
approximately 40% is attributable to appreciation in the value of the euro to
the dollar during fiscal year 2005. FEI-Zyfer's revenues continued the
improvements which began in the second half of fiscal year 2004 after the
Company acquired it and stabilized its operations. These sales gains were offset
by a decline in revenues from U.S. Government programs as the Company worked on
several smaller dollar development contracts versus higher volume production
programs in prior years.
During fiscal year 2007, based on current backlog and current proposal
activity, the Company expects to again realize significant revenues from
commercial and U.S. Government satellite programs. In addition, the Company's
recent work on U.S. Government-sponsored development contracts and current
proposal activity should generate increased revenues from U.S. Government
programs such as secure radios, new communication satellites, unmanned aerial
vehicles, weapons guidance systems and
24
secure communications. The timing and magnitude of revenues from these sources
is dependent on the U.S. Government's procurement and budgeting process. The
expected increased revenue stream will benefit the Company's fiscal year 2007
FEI-NY segment (the combination of the Commercial Communications and U.S.
Government segments) and the FEI-Zyfer segment.
Demand for the Company's products by wireless infrastructure original
equipment manufacturers, has fluctuated in recent years. Demand peaked during
the Company's fourth quarter of fiscal year 2004 and through the first quarter
of fiscal year 2005. This was followed by sequential declines in the subsequent
quarters of fiscal year 2005 and the first half of fiscal year 2006 as end-users
postponed deployment of next generation cellular base stations. The Company
continues to believe, however, that the world-wide market for its
synchronization products for the wireless industry, particularly in China,
remains large and will grow. The Company anticipates that some of this growth
will materialize during mid- to late-fiscal year 2007 which should result in
increased revenues for the Commercial Communications (to become the FEI-NY)
segment. In addition, the Company expects that world-wide capital spending on
wireline synchronization systems will increase as older systems are upgraded or
replaced. Accordingly, the Company believes future sales in the Gillam-FEI
segment will increase over the level achieved in fiscal year 2006.
Gross Margin Rates
------------------
Fiscal 2006 to Fiscal 2005 Fiscal 2005 to Fiscal 2004
------------------------------------------- -------------------------------------------
Years ended April 30,
2006 2005 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
$18,617 $18,160 $457 3% $18,160 $15,577 $2,583 17%
GM Rate 35.3% 32.9% 32.9% 31.1%
For the year ended April 30, 2006, gross margin improved by 3% over the
prior year even though the level of sales decreased by 4% from fiscal year 2005.
This result was achieved through better utilization of resources and product mix
which was partially offset by developmental and technical issues that the
Company experienced during fiscal year 2006 with respect to two long-term
contracts.
The gross margin rate for fiscal year 2005 improved to 33% of net sales
compared to 31% in fiscal year 2004. The improvement is primarily attributable
to increased revenue in fiscal year 2005 which was able to absorb a greater
share of fixed costs. Gross margin improvements were partially offset by
additional work required on certain space programs to address technical issues
encountered at the near conclusion of these programs.
The Company's target is to achieve an overall gross margin rate of 40% or
better through greater sales volume, continued process improvements, better
performance on long-term contracts and utilization of lower cost manufacturing
in Russia and China. During fiscal year 2007, if revenues increase as
anticipated, the Company expects to realize gross margin rates approaching its
targeted rate.
Compensation Charges
--------------------
Fiscal 2006 to Fiscal 2005 Fiscal 2005 to Fiscal 2004
--------------------------------------------- --------------------------------------------
Years ended April 30,
2006 2005 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
$ - $876 ($876) NM $876 $725 $151 21%
Under the caption "Compensation Charges," the Company has recorded certain
expenses which are defined as operating expenses which are not expected to
recur.
There were no material non-recurring expenses in fiscal year 2006.
As indicated above, during fiscal year 2005 the Company accrued a $416,000
incentive compensation expense related to the conversion and sale of REIT units.
In addition, the Company recorded a non-cash charge of $327,000 to increase the
liability under its deferred compensation plan. This charge was based on updated
life expectancy charts utilized by the Company's actuary. (See Note 12 to the
accompanying consolidated financial statements.) The Company's Belgian
subsidiary recorded an accrual for $133,000 related to litigation with a former
employee.
25
During fiscal year 2004, the Company's majority-owned subsidiary in France
substantially completed a restructuring of its operations as a result of the
Company's decision to convert it from a manufacturing facility to a regional
sales office. This resulted in a charge to earnings of $428,000, consisting
primarily of employee severance costs, for the year ended April 30, 2004. In
addition, in the fourth quarter of fiscal year 2004, in connection with an
employment agreement initiated in 1993, the Company awarded its Chairman of the
Board and former CEO a stock bonus of 20,000 shares which had a value of
approximately $297,000.
Selling and Administrative expenses
-----------------------------------
Fiscal 2006 to Fiscal 2005 Fiscal 2005 to Fiscal 2004
--------------------------------- -----------------------------
Years ended April 30,
2006 2005 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
$10,616 $11,719 ($1,103) (9%) $11,719 $11,162 $557 5%
For the year ended April 30, 2006, selling and administrative costs declined
by 9% compared to fiscal year 2005, as a result of lower compensation costs,
including incentive compensation charges, reduced deferred compensation expense,
lower sales commission expense and substantially reduced fees for professional
and consulting services as prior year projects were concluded. These cost
reductions were partially offset by increased recruiting and employee retention
expenses.
The increase in selling and administrative costs in fiscal year 2005
compared to fiscal year 2004, was a result of larger deferred compensation
expense (exclusive of the charge included in "Compensation Charges"), increased
salaries for support personnel, information technology consulting fees as the
Company upgraded its ERP system and higher professional fees related to the
Company's efforts to comply with the provisions of Section 404 of the
Sarbanes-Oxley Act of 2002. These expenses were partially offset by savings
obtained from the mid-year closing of the Company's European sales office and
merging those functions into the Company's Belgian subsidiary.
As a percentage of sales, selling and administrative expenses were 20.1% in
fiscal year 2006, 21.2% in fiscal year 2005 and 22.3% in fiscal year 2004. The
Company targets selling and administrative expenses not to exceed 20% of
consolidated sales. As revenues increase as anticipated in fiscal year 2007, the
Company expects to achieve its targeted level of selling and administrative
expenses.
Research and Development expenses
---------------------------------
Fiscal 2006 to Fiscal 2005 Fiscal 2005 to Fiscal 2004
-------------------------------- ------------------------------
Years ended April 30,
2006 2005 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
$6,291 $6,834 ($543) (8%) $6,834 $5,336 $1,498 28%
Research and development expenditures represent investments that keep the
Company's products at the leading edge of time and frequency technology and
enhance competitiveness for future sales. For the year ended April 30, 2006,
research and development expenditures decreased by 8% from the level of spending
in fiscal year 2005. The decline resulted from decreased spending on development
of the new US5G wireline synchronization product, which is near completion, but
was offset by new initiatives in developing a ruggedized rubidium clock for
secure military communications, enhancing and miniaturizing products for
wireless communications, upgrading its GPS-based synchronization product line,
and developing enhanced network monitoring equipment and software.
Research and development expenses in fiscal year 2005 increased over fiscal
year 2004 as the Company devoted significant resources to completion of its US5G
unit for deployment in the U. S. and associated products for wireline
synchronization, developed new hardware for space applications and further
enhanced the performance of low-g (gravity) sensitivity oscillators which have
broad applications in both commercial and U.S. Government systems.
The Company will continue to focus its research and development activities
on those products which it expects will provide the best return on investment
and greatest prospects for the future growth of the Company. For fiscal year
2007, the Company will make investments to develop related products for its new
US5G wireline synchronization products and make manufacturing process
improvements; invest in development of a broader range of space-based components
and systems, improve and miniaturize
26
rubidium atomic clocks, develop new GPS-based synchronization products and
further enhance the capabilities of its line of crystal oscillators. The
Company's target is to spend approximately 10% of revenues on research and
development activities, although the actual level of spending is dependent on
new opportunites and the rate at which it succeeds in bringing new products to
market. Internally generated cash and cash reserves will be adequate to fund
these development efforts.
Other Income (expense)
----------------------
Fiscal 2006 to Fiscal 2005 Fiscal 2005 to Fiscal 2004
------------------------------ ------------------------------
Years ended April 30,
2006 2005 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
Investment income $3,280 $3,850 ($570)(15%) $3,850 $2,321 $1,529 66%
Equity in Morion 634 315 319 101% 315 158 157 99%
Interest expense (118) (298) 180 60% (298) (365) 67 18%
Other, net 1,121 4,548 (3,427) 75% 4,548 (181) 4,729 NM
----- ----- ------ ----- ---- -----
$4,917 $8,415 ($3,498)(42%) $8,415 $1,933 $6,482 335%
With respect to other income and expense, the principal difference between
the three fiscal years is the conversion of REIT units for REIT stock in fiscal
2005 and the subsequent partial sale of these shares in fiscal years 2006 and
2005, as described above under Significant Events. (See Item 2. Properties and
Note 6 to the accompanying financial statements.)
Investment income in both fiscal years 2006 and 2005 contained gains of $2.1
million and $2.3 million, respectively, on the sale of REIT stock. Gains on
sales of other marketable securities in fiscal year 2004 were less than $600,000
by comparison. Investment income also includes interest and dividend income on
marketable securities. Income from this source decreased in fiscal year 2006
since the Company no longer receives dividend income from its former investment
in REIT stock. This decline was partially offset by increased interest income on
a higher level of bond investments and increasing interest rates. The Company
anticipates that during fiscal year 2007 it will realize lower income from
investments. The primary source of income for this category will be from
interest income on its bond portfolio. While more interest will be earned on
rising interest rates, the Company does not anticipate realizing any substantial
investment gains.
The Company began to record equity income in Morion, Inc. during the second
quarter of fiscal year 2005, when the Company increased its ownership interest
in Morion to 36% of Morion's outstanding shares. Accordingly, the Company
changed its method of accounting from the cost to the equity method and restated
fiscal year 2004 financial statements to reflect the appropriate accounting
method. The 100% increase in equity income from Morion for fiscal year 2006 over
fiscal year 2005 and fiscal year 2005 compared to fiscal year 2004 is due to two
factors: a) the increased profitability of Morion during the year ended April
30, 2006 compared to the year ago period and b) during the first five months of
fiscal year 2005 the Company held only 19% of Morion's shares and equity income
was recorded at this lower rate for that period as well as for all of fiscal
year 2004.
Interest expense for the year ended April 30, 2006, decreased as a result of
the gain realized on the conversion of REIT units to REIT stock. Prior to the
conversion, the financing arrangement for the sale and leaseback of the U.S.
manufacturing facility was considered as debt on which interest expense was
recorded. In addition, with the proceeds from the REIT stock sale, the Company
repaid the outstanding balance on its credit line. The Company also incurred
interest expense on and for certain deferred compensation payments which also
declined in fiscal year 2006 on lower interest rates. The 18% decline in
interest expense for fiscal year 2005 is due to the paydown during the year of
both short-term and long-term credit obligations. The Company anticipates that
interest expense in fiscal year 2007 will be approximately the same as that
recorded in fiscal year 2006, depending on the trend in interest rates.
As indicated in the Significant Events section above, in fiscal year 2006,
the Company sold the building formerly owned by its French subsidiary. Following
the fiscal year 2004 staffing cutbacks in this entity, the building had been
largely vacant and available for sale. Upon receipt of an independent appraisal,
the building was sold to the president of the Company's subsidiary, Gillam-FEI.
The Company realized a gain on the sale of the building of approximately
$680,000 which is included in the caption Other, net. In addition, during fiscal
year 2006, the Company recognized $353,000 of income from
27
amortization of the deferred gain from the 1998 sale of its corporate
headquarters building in New York. The deferred gain is being amortized over the
remaining life of the original eleven-year lease. For the year ended April 30,
2005, Other, net includes a $4.6 million gain on the conversion of the REIT
units to REIT stock. (See Item 2. Properties and Note 6 to the accompanying
consolidated financial statements.) This gain was offset by certain recurring,
non-operating expenses. In fiscal year 2004, Other, net was an expense of
$181,000 resulting primarily from certain one-time charges at the Company's
French subsidiary. In future fiscal years, Other, net will include annual
amortization into income of the final $942,000 deferred gain on the 1998 sale of
its building. Using the straightline method over the remaining 32 months of the
initial leaseback period, the Company will recognize approximately $350,000 of
amortized income during fiscal year 2007. The Company anticipates that in future
years other items in this category will not be significant to pretax earnings.
Income Taxes
The Company is subject to taxation in several countries. The statutory
federal rates vary from 34% in the United States to 35% in Europe. The effective
rate for the Company for the year ended April 30, 2006 was 28%, compared to 30%
in fiscal year 2005 and 26% in fiscal year 2004. The effective rate is impacted
by the income or loss of certain of the Company's European and Asian
subsidiaries which are currently not taxed. In addition, the Company utilizes
the availability of research and development tax credits in the United States to
lower its tax rate. In fiscal year 2004, the Company reversed certain tax
liabilities which had been established in prior years to cover certain tax
contingencies. During fiscal year 2004, the Company's income tax returns were
examined by the Internal Revenue Service and no changes were required for the
years under audit. Accordingly, the tax liabilities established for the audited
years were no longer required and the reversal of such tax liabilities were
recorded as a tax benefit in fiscal year 2004. (See Note 13 to the Consolidated
Financial Statements.)
The Company's European subsidiaries have available net operating loss
carryforwards of approximately $1.5 million to offset future taxable income.
These loss carryforwards have no expiration date.
LIQUIDITY AND CAPITAL RESOURCES
The Company's balance sheet continues to reflect a highly liquid position
with working capital of $59.8 million at April 30, 2006. Included in working
capital at April 30, 2006 is $24.5 million consisting of cash, cash equivalents
and short-term investments. The Company's current ratio at April 30, 2006 is 9.6
to 1.
Net cash used in operating activities for the year ended April 30, 2006, was
$2.5 million compared to cash provided by operations of $2.5 million in fiscal
year 2005. The primary cause for the decrease in cash was the payment in fiscal
year 2006 of approximately $3 million in income taxes on non-operating gains
recorded at the end of fiscal year 2005. This payment was deferred in the prior
year, contributing to positive operating cash flow in that period. The Company
had anticipated generating positive cash flow in fiscal year 2006 despite the
large income tax payments but was prevented from doing so due to the timing of
certain milestone billings under long-term contracts. The billings and cash
collection could not be made until after the end of the fiscal year, which also
accounts for the growth in the Company's accounts receivable. (See Note 2 to the
accompanying financial statements.)
Net cash provided by investing activities for the fiscal year ended April
30, 2006, was $317,000. Approximately $1.6 million was generated by the sale or
maturity of certain marketable securities, including REIT stock, net of
purchases of other marketable securities. An additional $975,000 was received on
the sale of the Company's building in France. (See Significant Events above and
Note 7 to the accompanying financial statements.) During fiscal year 2006, the
Company made additional investments in FEI-Zyfer and Morion, Inc. which
aggregated $104,000 and acquired capital equipment of $2.1 million. Net cash
provided by investing activities for the fiscal year ended April 30, 2005, was
$3.6 million. Approximately $6.1 million was generated by the sale or maturity
of certain marketable securities, primarily REIT stock, net of purchases of
other marketable securities. The Company also made additional investments in
FEI-Zyfer, Satel-FEI and Morion, Inc. which aggregated $970,000 and acquired
capital equipment of $1.6 million. Net cash provided by investing activities for
the fiscal year ended April 30, 2004, was $529,000. Approximately $4.4 million
was generated by the sale or maturity of certain
28
marketable securities, net of purchases. Most of this cash was used to acquire
FEI-Zyfer for $2.5 million (excludes $120,000 of acquisition expenses paid in
fiscal year 2003) and to provide additional working capital support for this
subsidiary as indicated above. (See Note 11 to the accompanying financial
statements.) Approximately $1.3 million was used to acquire additional capital
equipment. 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. It intends
to spend approximately $2 million on capital equipment during fiscal year 2007.
Internally generated cash will be adequate to acquire this capital equipment.
In fiscal year 2004, the Company established a $5 million line of credit
with the financial institution which also manages a substantial portion of its
investment in marketable securities. The line is secured by the investments
which earn, on average, approximately a 5.5% annual return. Rather than
liquidate some of these investments to meet short-term working capital
requirements, during fiscal years 2006, 2005 and 2004, the Company borrowed $1.0
million, $1.5 million and $3.2 million, respectively against the line of credit
at fixed and variable interest rates between 2.39% and 5.91%. The Company must
annually repay any borrowings under the line of credit on their anniversary date
but may also obtain new funding up to the credit limit. In addition, the
Company's European subsidiaries have available approximately $3.0 million in
bank credit lines to meet short-term cash flow requirements. The rate of
interest on these borrowings is based on the one month EURO Interbank Offered
Rate (EURIBOR). During fiscal year 2006, the Company repaid all outstanding debt
balances such that, as of April 30, 2006, no amounts were outstanding under any
lines of credit.
During the year ended April 30, 2006, the Company used cash in financing
activities in the net amount of $1.6 million. As in prior years, the principal
use of cash was payment of the semi-annual dividend of $1.7 million. As
indicated above, during the fiscal year the Company borrowed and repaid $1.0
million under its line of credit while $144,000 was received upon the exercise
of stock options. Net cash used in financing activities in fiscal year 2005 was
$5.3 million. The primary causes for this decline was payment of the Company's
semi-annual cash dividend of $1.7 million and payment of $5.3 million against
lines of credit offset by additional borrowings of $1.5 million. (See preceding
paragraph and Note 8 to the financial statements.) Net cash provided by
financing activities in fiscal year 2004 was $1.5 million. The principal source
of funds was short-term financing from financial institutions in the amount of
$3.4 million. Cash was used to pay the Company's semi-annual cash dividend of
$1.7 million and $479,000 was used to make regularly scheduled long-term
liability payments. These outflows were partially offset by the receipt of
$252,000 for repayment of a stock loan and the exercise of stock options. The
Company will continue to use treasury shares to satisfy the future exercise of
stock options granted to officers and employees. 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.
The Company will continue to expend resources to develop and improve
products for space applications, guidance and targeting systems, wireless
networks and wireline communication systems which management believes will
result in future growth and continued profitability. During fiscal year 2007,
the Company intends to make a substantial investment of capital and technical
resources to develop new products to meet the needs of the U.S. Government,
commercial space and commercial communications 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 approximately 10% of revenues to
achieve its development goals. Internally generated cash will be adequate to
fund these development efforts.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that have or
are reasonably likely to have a current or future effect on the Company's
financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources that
is material to investors.
29
Contractual obligations
-----------------------
As of April 30, 2006
Total Less than More than
Contractual Obligations (in thousands) 1 Year 1 to 3 Years 3 to 5 Years 5 Years
----------------------------------- -------------- --------- ------------ ------------ ---------
Long-Term Debt Obligations...... $ - $ - $ - $ - $ -
Operating Lease Obligations 1,634 736 778 72 48
Deferred Compensation 8,122* 325 342 224 7,231
------- ------ ------ ----- ------
Total $ 9,756 $1,061 $1,120 $ 296 $7,279
======= ====== ====== ===== ======
*Deferred Compensation liability (See Note 12 in the accompanying financial
statements) reflects payments due to current retirees receiving benefits. The
amount of $7,231 in the more than 5 years column includes benefits due to
participants in the plan who are not yet receiving benefits although some
participants may opt to retire and begin receiving benefits within the next 5
years.
As of April 30, 2006, the Company's consolidated backlog amounted to
approximately $36 million (see Item 1). Approximately 80% of this backlog is
expected to be filled during the Company's fiscal year ending April 30, 2007.
*******
The Company's liquidity is adequate to meet its foreseeable operating and
investment needs. In addition, with its available cash and marketable
securities, the Company is able to continue paying semi-annual dividends,
subject to the review and approval of its Board of Directors.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued Statement No. 151 "Inventory Costs."
("FAS 151") This statement amends Accounting Research Bulletin No. 43, Chapter
4, "Inventory Pricing" and removes the "so abnormal" criterion that under
certain circumstances could have led to the capitalization of these items. FAS
151 requires that idle facility expense, excess spoilage, double freight and
re-handling costs be recognized as current-period charges regardless of whether
they meet the criterion of "so abnormal." FAS 151 also requires that allocation
of fixed production overhead expenses to the costs of conversion be based on the
normal capacity of the production facilities. The provisions of this statement
are effective for fiscal years beginning after June 15, 2005; i.e., fiscal year
2007 for the Company. The adoption of FAS 151 is not expected to have a material
impact on the Company's financial position or results of operations.
In December 2004, the FASB issued Statement No. 123(R), "Stock-Based
Payment" ("FAS 123(R)"). FAS 123(R) supercedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and amends FAS No. 95, "Statement of Cash
Flows." Generally, the approach in FAS 123(R) is similar to the approach
described in FAS 123. FAS 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
FAS 123(R) requires that the fair value of such equity instruments be recognized
as an expense in the historical financial statements as services are performed.
Prior to FAS 123(R), only certain pro forma disclosures of fair value were
required. The provisions of this statement are effective for fiscal years
beginning after June 15, 2005; i.e., fiscal year 2007 for the Company. The
adoption of FAS 123(R) will have an impact on the Company's financial position
and results of operations similar to the pro forma disclosure in the
Equity-based Compensation disclosure in Note 1 to the accompanying financial
statements.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No.
3." ("FAS 154") This Statement requires retrospective application to prior
period financial statements of a voluntary change in accounting principle unless
it is impracticable and is effective for fiscal years beginning after December
15, 2005. Previously, most voluntary changes in accounting principle were
recognized by including in net income
30
of the period of the change the cumulative effect of changing to the new
accounting principle. The Company will comply with the provisions of FAS 154
although the impact of such adoption is not determinable at this time.
OTHER MATTERS
The financial information reported herein is not necessarily indicative of
future operating results or of the future financial condition of the Company.
Except as noted, management is unaware of any impending transactions or events
that are likely to have a material adverse effect on results from operations.
INFLATION
During fiscal 2006, as in the two prior fiscal years, the impact of
inflation on the Company's business has not been materially significant.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
The Company is exposed to market risk related to changes in interest rates
and market values of securities. The Company's investments in fixed income and
equity securities were $21.8 million and $37,000, respectively, at April 30,
2006. The investments are carried at fair value with changes in unrealized gains
and losses, net of taxes, recorded as adjustments to stockholders' equity. The
fair value of investments in marketable securities is generally based on quoted
market prices. Typically, the fair market value of investments in fixed interest
rate debt securities will increase as interest rates fall and decrease as
interest rates rise. Based on the Company's overall interest rate exposure at
April 30, 2006, a 10% change in market interest rates would not have a material
effect on the fair value of the Company's fixed income securities or results of
operations (investment income).
Foreign Currency Risk
With its investment in Gillam-FEI and FEI-Asia, the Company is subject to
foreign currency translation risk. For each of these investments, the Company
does not have any near-term intentions to repatriate its invested cash. For this
reason, the Company does not intend to initiate any exchange rate hedging
strategies which could be used to mitigate the effects of foreign currency
fluctuations. The effects of foreign currency rate fluctuations will be recorded
in the equity section of the balance sheet as a component of other comprehensive
income. As of April 30, 2006, the amount related to foreign currency exchange
rates is a $3,137,000 unrealized gain.
The results of operations of foreign subsidiaries, when translated into US
dollars, will reflect the average rates of exchange for the periods presented.
As a result, similar results in local currency can vary significantly upon
translation into US dollars if exchange rates fluctuate significantly from one
period to the next.
31
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
---------------------
The Board of Directors and Shareholders
Frequency Electronics, Inc. and Subsidiaries
Mitchel Field, New York
We have audited the accompanying consolidated balance sheets of Frequency
Electronics, Inc. and Subsidiaries as of April 30, 2006 and 2005 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years then ended. We have also audited the consolidated schedule listed in
Item 15(a)(2) of this Form 10-K for the years ended April 30, 2006 and 2005.
These consolidated financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and the schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Frequency Electronics, Inc. and Subsidiaries at April 30, 2006 and 2005 and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the related consolidated financial statement
schedule for the years ended April 30, 2006 and 2005, when considered in
relation to the basic financial statements taken as a whole, present fairly, in
all material respects, the information set forth therein.
/s/ Holtz Rubenstein Reminick LLP
- ---------------------------------
Holtz Rubenstein Reminick LLP
Melville, New York
July 20, 2006
32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
------------------------------
To the Board of Directors and Stockholders of Frequency Electronics, Inc.:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) on page 56 present fairly, in all material
respects, the results of operations, changes in stockholders' equity, and cash
flows of Frequency Electronics, Inc. and Subsidiaries for the year ended April
30, 2004 in conformity with accounting principles generally accepted in the
United States of America. In addition, in our opinion, the financial statement
schedule listed in the index appearing under Item 15(a)(2) on page 54 presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audit. We
conducted our audit of these statements in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
As discussed in Note 10, the Company has changed its method of accounting for
its investment in an entity from the cost method to the equity method for all
periods presented due to an increase in the ownership of such entity in fiscal
2005.
/s/PricewaterhouseCoopers LLP
- -----------------------------
Melville, New York
July 6, 2004, except for Note 10,
as to which the date is September 28, 2004
33
FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
Consolidated Balance Sheets
April 30, 2006 and 2005
-----------
ASSETS: 2006 2005
---- ----
(In thousands)
Current assets:
Cash and cash equivalents $ 2,639 $ 6,701
Marketable securities 21,836 23,532
Accounts receivable, net of allowance for
doubtful accounts of $276 in 2006 and $172 in 2005 15,868 12,728
Inventories, net 22,971 22,948
Deferred income taxes 2,135 2,269
Income taxes receivable 68 -
Prepaid expenses and other 1,246 1,362
-------- --------
Total current assets 66,763 69,540
Property, plant and equipment, at cost,
less accumulated depreciation and amortization 6,663 6,770
Deferred income taxes 2,842 2,644
Goodwill and other intangible assets 513 591
Cash surrender value of life insurance 6,318 5,838
Other assets 3,642 2,991
-------- --------
Total assets $ 86,741 $ 88,374
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable - trade $ 2,202 $ 1,896
Accrued liabilities 3,929 3,912
Income taxes payable - 3,184
Dividend payable 857 852
-------- --------
Total current liabilities 6,988 9,844
Deferred compensation 8,122 7,812
Deferred gain and other liabilities 998 1,525
-------- --------
Total liabilities 16,108 19,181
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock - authorized 600,000 shares
of $1.00 par value; no shares issued - -
Common stock - authorized 20,000,000 shares
of $1.00 par value; issued - 9,163,940 shares 9,164 9,164
Additional paid-in capital 45,688 45,289
Retained earnings 15,527 12,440
-------- --------
70,379 66,893
Common stock reacquired and held in treasury -
at cost (592,194 shares in 2006 and
646,709 shares in 2005) (2,437) (2,601)
Accumulated other comprehensive income 2,691 4,901
-------- --------
Total stockholders' equity 70,633 69,193
-------- --------
Total liabilities and stockholders' equity $ 86,741 $ 88,374
======== ========
The accompanying notes are an integral part of these financial statements.
34
FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
Consolidated Statements of Operations
Years ended April 30, 2006, 2005 and 2004
-----------
2006 2005 2004
---- ---- ----
(In thousands, except share data)
Net sales $52,810 $55,173 $50,106
Cost of sales 34,193 37,013 34,529
------- ------- -------
Gross margin 18,617 18,160 15,577
Selling and administrative expenses 10,616 11,719 11,162
Compensation charges - 876 725
Research and development expenses 6,291 6,834 5,336
------- ------- -------
Operating profit (loss) 1,710 (1,269) (1,646)
Other income (expense):
Investment income 3,280 3,850 2,321
Equity in Morion 634 315 158
Interest expense (118) (298) (365)
Other, net 1,121 4,548 (181)
------- ------- -------
Income before minority interest and
provision for income taxes 6,627 7,146 287
Minority interest in loss of consolidated subsidiary -- (1) (144)
------- ------- -------
Income before provision for income taxes 6,627 7,147 431
Provision for income taxes 1,829 2,110 111
------- ------- -------
Net income $ 4,798 $ 5,037 $ 320
======= ======= =======
Net income per common share:
Basic $ 0.56 $ 0.59 $ 0.04
======= ======= =======
Diluted $ 0.55 $ 0.58 $ 0.04
======= ======= =======
Average shares outstanding:
Basic 8,537,427 8,484,682 8,374,399
========= ========= =========
Diluted 8,690,617 8,684,758 8,542,575
========= ========= =========
The accompanying notes are an integral part of these financial statements.
35
FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended April 30, 2006, 2005 and 2004
-----------
2006 2005 2004
---- ---- ----
(In thousands)
Cash flows from operating activities:
Net income $4,798 $5,037 $ 320
Adjustments to reconcile net income
to net cash provided by (used in) operating activities:
Deferred tax (benefit) expense 886 (2,610) 411
Depreciation and amortization 1,870 2,014 2,098
Provision for losses on accounts
receivable and inventories 797 771 710
Gain on REIT conversion (353) (4,629) -
Gain on marketable securities and other assets, net (2,815) (2,169) (618)
Stock grant to officer - - 297
Minority interest in loss of consolidated subsidiary - (1) (144)
Equity income from Morion (634) (315) (158)
Changes in assets and liabilities, exclusive of
assets and liabilities acquired:
Accounts receivable (3,667) 2,868 (4,149)
Inventories (904) (1,526) (3,035)
Prepaid and other 62 364 (379)
Other assets (455) (526) (500)
Accounts payable trade 388 (1,729) 1,004
Accrued liabilities 189 (118) 200
Liability for employee benefit plans 1,052 1,655 719
Income taxes (3,253) 3,517 975
Other liabilities (465) (67) (320)
------ ----- ------
Net cash (used in) provided by operating activities (2,504) 2,536 (2,569)
------ ----- ------
Cash flows from investing activities:
Payment for acquisition (84) (135) (2,538)
Purchase of minority interest in manufacturing partner (20) (835) --
Purchase of marketable securities (11,518) (6,393) (6,053)
Proceeds from sale or redemption of marketable
securities 13,068 12,514 10,435
Proceeds from sale of real property 975 -- --
Capital expenditures (2,104) (1,640) (1,343)
Other- net -- 72 28
------ ----- ------
Net cash provided by investing activities 317 3,583 529
------ ----- ------
Continued
36
FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended April 30, 2006, 2005 and 2004
(Continued)
-----------
2006 2005 2004
---- ---- ----
(In thousands)
Cash flows from financing activities:
Payment of short-term credit and
other long-term obligations (1,009) (5,264) (479)
Proceeds from short-term debt 1,000 1,548 3,361
Payment of cash dividend (1,706) (1,692) (1,671)
Repurchase of stock for treasury - (66) -
Repayment of officer loan - 17 99
Exercise of stock options 144 177 153
------ ------ -----
Net cash (used in) provided by financing activities (1,571) (5,280) 1,463
------ ------ -----
Net (decrease) increase in cash and cash equivalents
before effect of exchange rate changes (3,758) 839 (577)
Effect of exchange rate changes on cash and
cash equivalents (304) 163 324
------ ------ -----
Net (decrease) increase in cash and cash equivalents (4,062) 1,002 (253)
Cash and cash equivalents at beginning of year 6,701 5,699 5,952
------ ------ -----
Cash and cash equivalents at end of year $2,639 $6,701 $5,699
====== ====== ======
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 118 $ 303 $ 271
====== ====== ======
Income taxes $4,204 $1,200 $ 450
====== ====== ======
Other activities which affect assets or liabilities but
did not result in cash flow during the fiscal years:
Declaration of cash dividend, not paid $ 857 $ 852 $ 843
====== ====== ======
Acquired net assets of Zyfer, Inc.
Accounts receivable -- -- $ 894
Inventory -- -- 1,397
Customer Lists -- -- 602
Goodwill -- $ 83 134
Other current assets -- -- 25
Fixed assets -- -- 787
Accounts payable -- -- (974)
Accrued expenses -- -- (71)
-- $ 83 $2,794
The accompanying notes are an integral part of these financial statements.
37
FREQUENCY ELECTRONICS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
Years ended April 30, 2006, 2005 and 2004
(In thousands, except share data)
Treasury stock Accumulated
Common Stock Additional (at cost) Other other
------------ paid in Retained --------- Stockholders' comprehensive
Shares Amount capital earnings Shares Amount equity income(loss) Total
------ ------ ------- -------- ------ ------ ------ ------------ -----
Balance at May 1, 2003 9,163,940 $9,164 $43,806 $10,464 824,739 ($3,062) ($116) $1,502 $61,758
- ----------------------
Exercise of stock options 74 (25,300) 79 153
Stock grant to officer 236 (20,000) 61 297
Contribution of stock to 401(k) plan 326 (41,011) 125 451
Repayment of receivable common stock 99 99
Cash dividend (1,680) (1,680)
Increase in market value of
marketable securities 991 991
Foreign currency translation 994 994
adjustment
Net income (restated) 320 320
--------
Comprehensive income- 2004 2,305
--------- ------- -------- --------- ------- -------- ------- ------------- --------
Balance at April 30, 2004 9,163,940 9,164 44,442 9,104 738,428 (2,797) (17) 3,487 63,383
- -------------------------
Exercise of stock options 109 (24,950) 68 177
Contribution of stock to 401(k) plan 300 (30,621) 93 393
Repayment of receivable common stock 17 17
Cash dividend (1,701) (1,701)
Additional investment in Morion, Inc. 438 (42,448) 101 539
Repurchase of stock for treasury 6,300 (66) (66)
Increase in market value of
marketable securities 1,018 1,018
Foreign currency translation 396 396
adjustment
Net income 5,037 5,037
--------
Comprehensive income- 2005 6,451
--------- ------- -------- --------- ------- -------- ------- ------------- --------
Balance at April 30, 2005 9,163,940 9,164 45,289 12,440 646,709 (2,601) -- 4,901 69,193
- -------------------------
Exercise of stock options 84 (19,792) 60 144
Contribution of stock to 401(k) plan 315 (34,723) 104 419
Cash dividend (1,711) (1,711)
Decrease in market value of
marketable securities (1,390) (1,390)
Foreign currency translation (820) (820)
adjustment
Net income 4,798 4,798
--------
Comprehensive income- 2006 2,588
--------- ------- -------- --------- ------- -------- ------- ------------- --------
Balance at April 30, 2006 9,163,940 $9,164 $45,688 $15,527 592,194 ($2,437) $ -- $2,691 $70,633
- ------------------------- ========= ======= ======== ========= ======= ======== ======= ============= ========
The accompanying notes are an integral part of these financial statements.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Accounting Policies
Principles of Consolidation:
The consolidated financial statements include the accounts of Frequency
Electronics, Inc. and its wholly-owned subsidiaries (the "Company" or
"Registrant"). References to "FEI" are to the parent company alone and do not
refer to any of its subsidiaries. The Company is principally engaged in the
design, development and manufacture of precision time and frequency control
products and components for microwave integrated circuit applications. See Note
15 for information regarding the Company's Commercial Communications (which
includes the subsidiaries FEI Communications, Inc., and FEI-Asia, Inc.), U.S.
Government (subsidiary FEI-Government Systems, Inc.), Gillam-FEI, and FEI-Zyfer
business segments. Intercompany accounts and significant intercompany
transactions are eliminated in consolidation. To accommodate the different
fiscal periods of Gillam-FEI, the Company recognizes its share of net income or
loss on a one month lag. Any material events which may occur during the
intervening month at Gillam-FEI will be accounted for in the consolidated
financial statements.
These financial statements have been prepared in conformity with generally
accepted accounting principles and require management to make estimates and
assumptions that affect amounts reported and disclosed in the financial
statements and related notes. Actual results could differ from these estimates.
Change in Accounting:
Prior period financial statements have been restated to reflect the
Company's change in accounting from the cost method to the equity method for its
investment in Morion, Inc. (See Note 10.)
Reclassifications:
Certain prior year amounts have been reclassified to conform to current
year presentation. These reclassifications had no effect on reported
consolidated earnings.
Cash Equivalents:
The Company considers certificates of deposit and other highly liquid
investments with original maturities of three months or less to be cash
equivalents. The Company places its temporary cash investments with high credit
quality financial institutions. Such investments may be in excess of the FDIC
insurance limit. No losses have been experienced on such investments.
Marketable Securities:
Marketable securities consist of investments in common stocks, mutual
funds, and debt securities of U.S. government agencies. Substantially all
marketable securities at April 30, 2006 were held in the custody of two
financial institutions. Investments in debt and equity securities are
categorized as available for sale and are carried at fair value, with unrealized
gains and losses excluded from income and recorded directly to stockholders'
equity. The Company recognizes gains or losses when securities are sold using
the specific identification method.
Allowance for Doubtful Accounts:
Losses from uncollectible accounts receivable are provided for by utilizing
the allowance for doubtful accounts method based upon management's estimate of
uncollectible accounts. Management specifically analyzes accounts receivable and
the potential for bad debts, customer concentrations, credit worthiness, current
economic trends and changes in customer payment terms when evaluating the
allowance for doubtful accounts.
Inventories:
Inventories, which consist of finished goods, work-in-process, raw
materials and components, are accounted for at the lower of cost (specific and
average) or market.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Property, Plant and Equipment:
Property, plant and equipment are recorded at cost and include interest on
funds borrowed to finance construction. Expenditures for renewals and
betterments are capitalized; maintenance and repairs are charged to income when
incurred. When fixed assets are sold or retired, the cost and related
accumulated depreciation and amortization are eliminated from the respective
accounts and any gain or loss is credited or charged to income.
If events or changes in circumstances indicate that the carrying amount of
a long-lived asset may not be recoverable, the Company estimates the future cash
flows expected to result from the use of the asset and its eventual disposition.
If the sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the long-lived asset, an impairment
loss is recognized. To date, no impairment losses have been recognized.
Depreciation and Amortization:
Depreciation of fixed assets is computed on the straight-line method based
upon the estimated useful lives of the assets (40 years for buildings and 3 to
10 years for other depreciable assets). Leasehold improvements are amortized on
the straight-line method over the shorter of the term of the lease or the useful
life of the related improvement.
Amortization of identifiable intangible assets is based upon the expected
lives of the assets and is recorded at a rate which approximates the Company's
utilization of the assets
Intangible Assets
Intangible assets consist of customer lists which result from the excess
purchase price over the fair value of acquired tangible assets. The customer
lists are measured at fair value and amortized over the estimated useful life of
3 to 5 years.
Goodwill:
The Company records goodwill as the excess of purchase price over the fair
value of identifiable net assets acquired. In accordance with Statement of
Financial Accounting Standards ("FAS") No. 142 "Goodwill and Other Intangible
Assets," goodwill is tested for impairment on at least an annual basis. When it
is determined that the carrying value of investments may not be recoverable, the
Company writes down the related goodwill to an amount commensurate with the
revised value of the acquired assets. The Company measures impairment based on
revenue projections, recent transactions involving similar businesses and
price/revenue multiples at which they were bought and sold, price/revenue
multiples of competitors, and the present market value of publicly-traded
companies in the Company's industry.
Revenue and Cost 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. For
U.S. Government and other fixed-price contracts that 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.
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 may result in
revisions to costs and revenue and are recognized in the period in which
revisions are determined to be required. Provisions for anticipated losses are
made in the period in which they become determinable.
For customer orders in the Company's subsidiaries, and smaller contracts or
orders in the other business segments, sales of products and services to
customers are reported in operating results upon shipment of the product or
performance of the services pursuant to terms of the customer order.
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.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
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.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income includes unrealized gains or losses, net of tax, on
securities available for sale during the year and the effects of foreign
currency translation adjustments.
Research and Development expenses:
The Company engages in research and development activities to identify new
applications for its core technologies, to improve existing products and to
improve manufacturing processes to achieve cost reductions and manufacturing
efficiencies. Research and development costs include direct labor, manufacturing
overhead, direct materials and contracted services. Such costs are expensed as
incurred. In the normal course of business the Company is also contracted to
perform research and development for others. The costs incurred under such
contracts are recorded in cost of sales.
Income Taxes:
The Company recognizes deferred tax liabilities and assets based on the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred tax liabilities
and assets are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amount expected to be realized.
Earnings Per Share:
Basic earnings per share are computed by dividing net earnings by the
weighted average number of shares of common stock outstanding. Diluted earnings
per share are computed by dividing net earnings by the sum of the weighted
average number of shares of common stock and the if-converted effect of
unexercised stock options.
Fair Values of Financial Instruments:
Cash and cash equivalents and loans payable are reflected in the
accompanying consolidated balance sheets at amounts considered by management to
reasonably approximate fair value based upon the nature of the instrument and
current market conditions. Management is not aware of any factors that would
significantly affect the value of these amounts.
Foreign Currency Adjustments
The local currency is the functional currency of each of the Company's
non-US 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 US
dollars, reflect the average rates of exchange for the periods presented. The
balance sheets of foreign subsidiaries, except for equity accounts, are
translated into US 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
significantly upon translation into US dollars if exchange rates fluctuate
significantly from one period to the next.
Equity-based Compensation:
Through fiscal year 2006, the Company applied the disclosure-only
provisions of FAS No. 148, "Accounting for Stock-Based Compensation," and
continues to measure compensation cost in accordance with Accounting Principles
Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees."
Historically, this has not resulted in compensation cost upon the grant of
options under a qualified stock option plan. However, in accordance with FAS No.
148, the Company provides pro forma disclosures of net income (loss) and income
(loss) per share as if the fair value method had been applied beginning in
fiscal 1996.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The following table illustrates the effect on the Company's consolidated
statements of operations had compensation cost for stock option awards under the
plans been determined based on the fair value at the grant dates consistent with
the provisions of FAS No. 123:
(in thousands, except per share data)
2006 2005 2004
---- ---- ----
Net Income, as reported $4,798 $5,037 $320
Cost of stock options, net of taxes (309) (525) (707)
------ ------ ----
Net Income (Loss)- pro forma $4,489 $4,512 ($387)
====== ====== ====
Income per share, as reported:
Basic $0.56 $0.59 $ 0.04
====== ====== ======
Diluted $0.55 $0.58 $ 0.04
====== ====== ======
Income (Loss) per share- pro forma
Basic $0.53 $0.53 ($ 0.05)
====== ====== ======
Diluted $0.52 $0.52 ($ 0.05)
====== ====== ======
The weighted average fair value of each option has been estimated on the
date of grant using the Black-Scholes options pricing model with the following
weighted average assumptions used for grants in each of the three years ended
April 30, 2006, 2005 and 2004; dividend yield of 1.4%, 1.1% and 1.8%; expected
volatility of 59%, 59% and 63%; risk free interest rate of 4.1%, 3.9% and 3.6%;
and expected lives of six and one-half years, respectively.
New Accounting Pronouncements:
In November 2004, the FASB issued Statement No. 151 "Inventory Costs."
("FAS 151") This statement amends Accounting Research Bulletin No. 43, Chapter
4, "Inventory Pricing" and removes the "so abnormal" criterion that under
certain circumstances could have led to the capitalization of these items. FAS
151 requires that idle facility expense, excess spoilage, double freight and
re-handling costs be recognized as current-period charges regardless of whether
they meet the criterion of "so abnormal." FAS 151 also requires that allocation
of fixed production overhead expenses to the costs of conversion be based on the
normal capacity of the production facilities. The provisions of this statement
are effective for fiscal years beginning after June 15, 2005; i.e., fiscal year
2007 for the Company. The adoption of FAS 151 is not expected to have a material
impact on the Company's financial position or results of operations.
In December 2004, the FASB issued Statement No. 123(R), "Stock-Based Payment"
("FAS 123(R)"). FAS 123(R) supercedes APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and amends FAS No. 95, "Statement of Cash Flows."
Generally, the approach in FAS 123(R) is similar to the approach described in
FAS 123. FAS 123(R) establishes standards for the accounting for transactions in
which an entity exchanges its equity instruments for goods or services. This
statement focuses primarily on accounting for transactions in which an entity
obtains employee services in share-based payment transactions. FAS 123(R)
requires that the fair value of such equity instruments be recognized as an
expense in the historical financial statements as services are performed. Prior
to FAS 123(R), only certain pro forma disclosures of fair value were required.
The provisions of this statement are effective for fiscal years beginning after
June 15, 2005; i.e., fiscal year 2007 for the Company. The adoption of FAS
123(R) will have an impact on the Company's financial position and results of
operations similar to the pro forma disclosure in the Equity-based Compensation
disclosure in Note 1.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No.
3." ("FAS 154") This Statement requires retrospective application to prior
period financial statements of a voluntary change in accounting principle unless
it is impracticable and is effective for fiscal years beginning after December
15, 2005. Previously, most voluntary changes in accounting principle were
recognized by including in net income of the period of the change the cumulative
effect of changing to the new accounting principle. The
42
Company will comply with the provisions of FAS 154 although the impact of such
adoption is not determinable at this time.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
2. Accounts Receivable
Accounts receivable include costs and estimated earnings in excess of
billings on uncompleted contracts accounted for on the percentage of completion
basis of approximately $4,857,000 at April 30, 2006 and $4,138,000 at April 30,
2005. Such amounts represent revenue recognized on long-term contracts that has
not been billed, pursuant to contract terms, and was not billable at the balance
sheet date.
3. Earnings Per Share
Reconciliations of the weighted average shares outstanding for basic and
diluted Earnings Per Share are as follows:
Years ended April 30,
--------------------------------------
2006 2005 2004
---- ---- ----
Basic EPS Shares outstanding
(weighted average) 8,537,427 8,484,682 8,374,399
Effect of Dilutive Securities 153,190 200,076 168,176
--------- --------- ---------
Diluted EPS Shares outstanding 8,690,617 8,684,758 8,542,575
========= ========= =========
Options to purchase 430,500, 505,550 and 471,750 shares of common stock
were outstanding during the years ended April 30, 2006, 2005 and 2004,
respectively, but were not included in the computation of diluted earnings per
share because the exercise price of the options was greater than the average
market price of the Company's common shares during the respective periods. Since
the inclusion of such options would have been antidilutive they are excluded
from the computation.
4. Inventories
Inventories, which are reported net of reserves of $3,923,000 and
$4,289,000 at April 30, 2006 and 2005, respectively, consisted of the following
(in thousands):
2006 2005
---- ----
Raw Materials and Component Parts $ 11,172 $ 10,353
Work in Progress 11,799 12,595
-------- --------
$ 22,971 $ 22,948
======== ========
5. Marketable Securities
Marketable securities at April 30, 2006 and 2005 are summarized as follows
(in thousands):
April 30, 2006
--------------------------------------
Unrealized
Market Holding
Cost Value Loss
---- ----- ----
Fixed income securities $22,531 $21,799 $ (732)
Equity securities 46 37 (9)
------- ------- ------
$22,577 $21,836 $ (741)
======= ======= ======
April 30, 2005
---------------------------------------
Unrealized
Market Holding
Cost Value (Loss) Gain
---- ----- -----------
Fixed income securities $16,627 $16,221 $ (406)
Equity securities 5,331 7,311 1,980
------- ------- -------
$21,958 $23,532 $ 1,574
======= ======= =======
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Maturities of fixed income securities classified as available-for-sale at
April 30, 2006 are as follows (in thousands):
Current $ 2,197
Due after one year through five years 16,954
Due after five years through ten years 3,380
-------
$22,531
=======
During fiscal year 2005, the decline in market value of certain fixed
income securities was deemed to be other than temporary. Accordingly, during
that fiscal year, the Company charged $20,000 against investment income to
record the impairment in value of these securities.
6. Property, Plant and Equipment
Property, plant and equipment at April 30, 2006 and 2005, consists of the
following (in thousands):
2006 2005
-------- --------
Buildings and building improvements $ 2,649 $ 4,185
Machinery, equipment and furniture 32,765 31,351
-------- --------
35,414 35,536
Less, accumulated depreciation 28,751 28,766
-------- --------
$ 6,663 $ 6,770
======== ========
Depreciation expense for the years ended April 30, 2006, 2005 and 2004 was
$1,783,000, $1,908,000, and $1,969,000, respectively.
Maintenance and repairs charged to operations for the years ended April 30,
2006, 2005 and 2004 was approximately $724,000, $585,000 and $437,000,
respectively.
In January 1998, the Company sold the Long Island New York building that it
occupies to Reckson Associates Realty Corp., a real estate investment trust
("REIT") whose shares are traded on the New York Stock Exchange. The sale
involved a tax-deferred exchange of the building for approximately 513,000
participation units of Reckson Operating Partnership, L.P. ("REIT units") which
were valued at closing at $12 million. Each REIT unit was convertible into one
share of the common stock of the REIT.
The Company leased back approximately 43% of the building from the purchaser
(the "Reckson lease"). Under the accounting provisions for sale and leaseback
transactions, the sale of this building was considered a financing and the REIT
units received were reflected as a noncurrent liability ($10,534,000 at April
30, 2004) while the related building continued to be reflected as an asset. In
March 2005, the Company exercised its option to convert all of the REIT units
into 513,000 shares of the REIT. Upon conversion of the REIT units, the Company
recognized a gain of $4.6 million and deferred an additional $1.3 million gain.
The deferred gain will be recognized into income over the remaining term of the
initial leaseback period. As a result of the conversion of the REIT units, both
the building and the noncurrent liability were removed from the balance sheet of
the Company. Prior to conversion of the REIT units, the Company's annual rental
payment of $400,000 was characterized as repayment of the financing with a
portion allocated to interest expense at an assumed interest rate of 6.5% and
the balance was considered repayment of principal. During the years ended April
30, 2005 and 2004, the Company charged $80,000 and $114,000, respectively, to
interest expense under the financing agreement.
The Reckson lease contains two five-year renewal periods at the option of
the Company. Annual rental payments are $400,000 for the initial 11-year term
which ends in January 2009. Under the terms of the lease, the Company is
required to pay its proportional share of real estate taxes, insurance and other
charges. In addition, the Company's subsidiaries in China, France and California
lease their office and manufacturing facilities. The lease for the FEI-Asia
facility is for a one-year term with rent of $14,000 payable quarterly. The
lease for the FEI-Zyfer facility is for a two year term at a rate of $22,600 per
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
month, terminable with six months written notice. Satel-FEI, a wholly-owned
subsidiary of Gillam-FEI, occupies office space under a 9-year lease, cancelable
after three years, at an approximate rate of $2,000 per month.
Future minimum lease payments required by the leases are as follows
(in thousands):
Years ending
April 30,
2007 $ 736
2008 430
2009 324
2010 24
2011 24
Thereafter 96
------
$1,634
======
7. Related Party Transaction
During the year ended April 30, 2006, the Company sold the remaining
building formerly owned by its French subsidiary to the president of Gillam-FEI.
The sale price of the building was approximately $975,000 and was based upon an
independent appraisal of the building. The Company recognized a gain of
approximately $680,000 on the sale.
8. Debt Obligations
The Company has a $5 million line of credit with the financial institution
which also manages a substantial portion of its investment in marketable
securities. The line is secured by the investments. During the 2006 fiscal year,
the Company borrowed and repaid $1 million. No amount is outstanding as of April
30, 2006. During the year, advances against the line of credit bore interest at
variable interest rates between 5.67% and 5.91%.
The Company's European subsidiaries have available approximately 2.4
million Euros (approximately $3.0 million based on current rates of exchange
between the dollar and the Euro) in bank credit lines to meet short-term cash
flow requirements. As of April 30, 2006, no amount was outstanding under such
lines of credit. Interest on these credit lines varies from 0.5% to 1.5% over
the EURO Interbank Offered rate (EURIBOR). At April 30, 2006 and 2005, the rate
was 3.166% and 2.096%, respectively, based on the 1 month EURIBOR.
All remaining debt that was scheduled to mature has been repaid in full at
April 30, 2006.
9. Accrued Liabilities
Accrued liabilities at April 30, 2006 and 2005 consist of the following
(in thousands):
2006 2005
---- ----
Other compensation including payroll taxes $2,161 $2,202
Due customers 491 506
Vacation accrual 593 552
Other 684 652
------ ------
$3,929 $3,912
====== ======
10. Investment in Morion, Inc.
On September 28, 2004, the Company increased its investment in Morion from
19.8% to 36% of the privately-held Russian company's outstanding shares. The
acquisition was accomplished by a cash payment and the issuance of 42,448 shares
of the Company's common stock. During fiscal year 2006, the Company acquired
another 200 shares of Morion to increase the ownership interest to 36.6%.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
As a result of the increased ownership of Morion, in fiscal year 2005 the
Company changed its method of carrying the investment from cost to equity as
required by generally accepted accounting principles. Under the equity method,
the Company records its proportionate share of the earnings of Morion. The
effect of the change in accounting method for the fiscal year ended April 30,
2005, was to increase income before provision for income taxes and net income by
$315,000 ($0.04 per diluted share). The financial statements for the prior
fiscal years were restated for the change in accounting method. For the fiscal
year ended April 30, 2004, income before income taxes and net income were
increased by $158,000 ($0.02 per share). Retained earnings as of the beginning
of fiscal year 2005 were increased by $207,000 for the effect of retroactive
application of the equity method.
At April 30, 2006, 2005, and 2004, the Company's share of the underlying
net assets of Morion exceeded the investment by $471,000, $549,000 and $249,000,
respectively. The excess relates to certain property, plant and equipment and is
being amortized into income by increasing the Company's share of Morion's net
income. The Company uses the straightline method to amortize the excess over the
remaining useful lives of the property, plant and equipment.
During the fiscal years ended April 30, 2006, 2005 and 2004, the Company
acquired product from Morion in the aggregate amount of approximately $467,000,
$659,000 and $730,000, respectively, and the Company sold product to Morion in
the aggregate amount of approximately $462,000, $181,000 and $181,000,
respectively.
11. Acquisition of Zyfer, Inc.
On May 9, 2003, the Company acquired the business and net assets of Zyfer,
Inc., a wholly-owned subsidiary of Odetics, Inc., in a cash transaction. (Note-
Subsequent to this transaction, Odetics changed its corporate name to Iteris,
Inc.) The business of the new subsidiary, FEI-Zyfer, Inc., is the design and
manufacture of products for precision time and frequency generation and
synchronization, primarily incorporating GPS technology.
The Company paid $2.3 million at closing, plus acquisition costs of
approximately $400,000. According to the terms of the purchase agreement, the
Company was required to make additional payments up to a maximum of $1 million
in each of fiscal years 2004 and 2005 if FEI-Zyfer achieved certain revenue
levels in those years. The contingent payments were based on a percentage of
revenues in excess of $6 million in fiscal year 2004 and as a percentage of
revenues in excess of $8 million in fiscal year 2005. Based on FEI-Zyfer's
performance, with sales of $8.8 million and $6.5 million during fiscal years
2005 and 2004, respectively, the Company paid an additional $217,000 to Iteris,
Inc. This amount was recorded as goodwill in the accompanying consolidated
balance sheet and is included in intangible assets.
The FEI-Zyfer acquisition is treated as a purchase acquisition. The
purchase price was allocated to net assets acquired of approximately $1.8
million. The purchase price in excess of net assets acquired, approximately
$900,000, was allocated to fixed assets ($300,000) and to customer lists
($600,000) which will be amortized over 6 years. Amortization expense for the
years ended April 30, 2006, 2005 and 2004 was approximately $78,000, $106,000
and $127,000, respectively. For the next two fiscal years ending April 30, 2008,
amortization expense will decline to $48,000, followed by a "balloon" writeoff
of the customer list balance, expected to be $186,000, for the year ending April
30, 2009.
12. Employee Benefit Plans
Profit Sharing Plan:
The Company adopted a profit sharing plan and trust under section 401(k) of
the Internal Revenue Code. This plan allows all eligible employees to defer a
portion of their income through voluntary contributions to the plan. In
accordance with the provisions of the plan, the Company can make discretionary
matching contributions in the form of cash or common stock. For the years ended
April 30, 2006, 2005 and 2004, the Company contributed 34,723, 30,621 and 41,011
shares of common stock,
47
respectively. The approximate value of these shares at the date of issuance was
$419,000 in fiscal year 2006, $393,000 in fiscal year 2005 and $451,000 in
fiscal year 2004.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Income Incentive Pool:
The Company maintains incentive bonus programs for certain employees which
are based on operating profits of the individual subsidiaries to which the
employees are assigned. The Company also adopted a plan for the President and
Chief Executive Officer of the Company, which formula is based on consolidated
pre-tax profits. The Company charged $572,000, $694,000 and $315,000 to
operations under these plans for the fiscal years ended April 30, 2006, 2005 and
2004, respectively.
Independent Contractor Stock Option Plan:
Through early fiscal year 2006, the Company had an Independent Contractor
Stock Option Plan under which up to 350,000 shares could be granted. An
Independent Contractor Stock Option Committee determined to whom options may be
granted from among eligible participants, the timing and duration of option
grants, the option price, and the number of shares of common stock subject to
each option. Options were granted in prior fiscal years to certain independent
contractors at a price equal to the then fair market value of the Company's
common stock. The options were exercisable over specified periods per terms of
the individual agreements. In fiscal year 2005, the Company granted 30,000
shares to a new member of the Company's Board of Directors. One-third of the
options may be exercised one year after the grant date; two-thirds, two years
after the grant date and all of the options, three years after the grant date.
The exercise price of the grant was at the then fair market value of the
Company's common stock, consequently, no compensation expense was recognized
because the Company applied the intrinsic value method for a director of the
Company under the provisions of APB 25. No compensation expense was recorded
during the years ended April 30, 2006, 2005 and 2004 as no other grants were
made in those years and previous grants have been fully expensed. As a result of
the adoption by the stockholders of the 2005 Stock Award Plan, the Independent
Contractor Stock Option Plan was discontinued. No additional grants will be made
under this plan.
Transactions under this plan, including the weighted average exercise
prices of the options, are as follows:
2006 2005 2004
------------------- ----------------- --------------------
Wtd Avg Wtd Avg Wtd Avg
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at beginning of year 141,050 $15.33 111,050 $15.49 114,350 $15.31
Granted -- -- 30,000 $14.76 --
Exercised -- -- -- -- (3,300) $9.25
------- ------- -------
Outstanding at end of year 141,050 $15.33 141,050 $15.33 111,050 $15.49
======= ======= =======
Exercisable at end of year 121,050 $15.43 111,050 $15.49 111,050 $15.49
======= ======= =======
Available for grant at end of year -- 189,500 219,500
======= ======= =======
Weighted average fair value
of options granted during the year $ -- $7.81 $ --
======= ======= =======
Employee Stock Option Plans:
The Company has various stock option plans for key management employees,
including officers and directors who are employees. The plans are both
Nonqualified Stock Option ("NQSO") plans and Incentive Stock Option ("ISO")
plans. Under both types of plans, options are granted at the discretion of the
Stock Option committee at an exercise price not less than the fair market value
of the Company's common stock on the date of grant. Under one NQSO plan the
options are exercisable one year after the date of grant. Under the remaining
plans the options are exercisable over a four-year period beginning one year
after the date of grant. The options expire ten years after the date of grant
and are subject to certain restrictions on transferability of the shares
obtained on exercise. As of April 30, 2006, eligible employees had been granted
options to purchase 1,182,500 shares of Company stock under ISO plans of which
approximately 395,000 options are outstanding and approximately 234,000 are
exercisable. Through April 30, 2006, eligible employees have been granted
options to acquire 1,090,000 shares of
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Company stock under NQSO plans. Of the NQSO options, approximately 738,000 are
both outstanding and exercisable (see tables below).
The excess of the consideration received over the par value of the common
stock or cost of treasury stock issued under both types of option plans has been
recognized as an increase in additional paid-in capital. No charges are made to
income with respect to the ISO or NQSO plans.
Transactions under these plans, including the weighted average exercise
prices of the options, are as follows:
2006 2005 2004
-------------------- --------------------- --------------------
Wtd Avg Wtd Avg Wtd Avg
Shares Price Shares Price Shares Price
--------- ------- --------- ------- --------- -------
Outstanding at beginning of year 1,109,987 $11.26 1,081,437 $11.00 1,031,062 $12.63
Granted 39,000 $11.32 59,500 $14.40 128,500 $9.13
Exercised (19,725) $7.27 (24,950) $7.06 (22,000) $5.58
Expired or canceled -- -- (6,000) $8.80 (56,125) $5.86
--------- --------- ---------
Outstanding at end of year 1,133,387 $11.32 1,109,987 $11.26 1,081,437 $11.00
========= ========= =========
Exercisable at end of year 972,337 $11.39 895,587 $11.46 760,312 $11.07
========= ========= =========
Available for grant at end of year 399,000 11,500 71,000
========= ========= =========
Weighted average fair value
of options granted during the year $6.08 $7.60 $5.57
========= ========= =========
The following table summarizes information about stock options outstanding
at April 30, 2006:
Options Outstanding Options Exercisable
-------------------------------------- ------------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Actual Range of Outstanding Contractual Exercise Exercisable Exercise
Exercise Prices at 4/30/06 Life Price at 4/30/06 Price
--------------- ---------- ---- ----- ---------- -----
$4.375 - 9.970 488,700 4.4 $ 7.64 411,275 $ 7.45
10.167 - 16.625 562,687 4.8 12.71 479,062 12.66
23.75 82,000 4.3 23.75 82,000 23.75
Restricted Stock Plan:
During fiscal 1990, the Company adopted a Restricted Stock Plan which
provided that key management employees could be granted rights to purchase an
aggregate of 375,000 shares of the Company's common stock. The grants,
transferability restrictions and purchase price were determined at the
discretion of a special committee of the board of directors. The purchase price
could not be less than the par value of the common stock. As a result of the
adoption by the Company's stockholders of the 2005 Stock Award Plan, the
Restricted Stock Plan was discontinued. No additional grants will be made under
this plan.
2006 2005 2004
----------------- ----------------- ----------------
Wtd Avg Wtd Avg Wtd Avg
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at beginning of year 22,500 $4.00 22,500 $4.00 22,500 $4.00
Exercised -- -- -- -- -- $4.00
------ ------ ------
Outstanding at end of year 22,500 $4.00 22,500 $4.00 22,500 $4.00
====== ====== ======
Exercisable at end of year 22,500 $4.00 22,500 $4.00 22,500 $4.00
====== ====== ======
Balance of shares available for
grant at end of year -- 98,250 98,250
====== ====== ======
Transferability of shares is restricted for a four-year period, except in
the event of a change in control as defined.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Employee Stock Ownership Plan/Stock Bonus Plan:
During 1990 the Company amended its Stock Bonus Plan to become an Employee
Stock Ownership Plan ("ESOP"). By means of a bank note, subsequently repaid, the
Company reacquired 561,652 shares of its common stock during fiscal 1990. These
shares plus approximately 510,000 additional shares issued by the Company from
its authorized, unissued shares were sold to the ESOP in May 1990. Shares were
released for allocation to participants based on a formula as specified in the
ESOP document. By the end of fiscal 2000, all shares (1,071,652) had been
allocated to participant accounts of which 562,052 shares remain in the ESOP.
Deferred Compensation Plan:
The Company has a program for key employees providing for the payment of
benefits upon retirement or death. Under the plan, each key employee receives
specified retirement payments for the remainder of the employee's life with a
minimum payment of ten years' benefits to either the employee or his
beneficiaries. The plan also provides for reduced benefits upon early retirement
or termination of employment. The Company pays the benefits out of its working
capital but has also purchased whole life or term life insurance policies on the
lives of certain of the participants to cover the optional lump sum obligations
of the plan upon the death of the participant.
Deferred compensation expense charged to operations during the years ended
April 30, 2006, 2005 and 2004 was approximately $636,000, $1,266,000 and
$371,000, respectively. During fiscal year 2005, the Company recorded a change
in accounting estimate in the amount of $327,000 to reflect the use of a revised
actuarial mortality tables to determine its deferred compensation liability.
13. Income Taxes
The income (loss) before provision (benefit) for income taxes consisted of
(in thousands):
Year Ended April 30,
--------------------
2006 2005 2004
---- ---- ----
U.S. $5,446 $6,977 $ 466
Foreign 1,181 170 (35)
------ ------ ------
$6,627 $7,147 $ 431
====== ====== ======
The provision (benefit) for income taxes consists of the following (in
thousands):
2006 2005 2004
---- ---- ----
Current:
Federal $ 850 $4,200 ($ 300)
Foreign (7) 70 -
State 100 450 -
------ ------ ------
Current provision (benefit) 943 4,720 (300)
------ ------ ------
Deferred
Federal 650 (2,250) -
Foreign 136 40 95
State 100 (400) -
Valuation allowance- foreign - - 316
------ ------ ------
Deferred provision (benefit) 886 (2,610) 411
------ ------ ------
Total provision $1,829 $2,110 $ 111
====== ====== =====
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
The following table reconciles the reported income tax expense with the
amount computed using the federal statutory income tax rate (in thousands).
2006 2005 2004
---- ---- ----
Computed "expected" tax (benefit) expense $2,253 $2,430 $ 147
State and local tax, net of federal benefit 132 297 --
Nontaxable income from foreign subsidiaries (255) (61) (50)
Valuation allowance on foreign deferred taxes -- -- 316
Nondeductible losses at foreign subsidiaries -- -- 218
Nondeductible expenses 164 159 121
Nontaxable life insurance cash value increase (100) (96) (103)
Reversal of tax liabilities -- -- (400)
Tax credits (217) (549) (144)
Other items, net, none of which individually
exceeds 5% of federal taxes at statutory rates (148) (70) 6
------ ------ -----
$1,829 $2,110 $ 111
====== ====== =====
The components of deferred taxes are as follows (in thousands):
2006 2005
---- ----
Deferred tax assets:
Employee benefits $4,157 $4,012
Inventory 1,450 1,550
Accounts receivable 200 100
Marketable securities 296 170
Research & development 632 430
Other liabilities 61 8
Foreign net operating loss carryforwards 116 430
Miscellaneous 110 118
------ ------
Total deferred tax asset 7,022 6,818
------ ------
Deferred tax liabilities:
Property, plant and equipment 1,048 838
------ ------
Net deferred tax asset 5,974 5,980
Valuation allowance (997) (1,067)
------ ------
$4,977 $4,913
====== ======
At April 30, 2006, the Company has available approximately $1.5 million in
net operating losses available to offset future income of certain of its foreign
subsidiaries. The total valuation allowance relates to deferred tax assets of
foreign subsidiaries.
14. Product Warranties
The Company generally provides its customers with a one-year warranty
regarding the manufactured quality and functionality of its products. For some
limited products, the warranty period has been extended. The Company establishes
warranty reserves based on its product history, current information on repair
costs and annual sales levels. Changes in the carrying amount of accrued product
warranty costs are as follows (in thousands):
Year Ended April 30,
--------------------
2006 2005 2004
---- ---- ----
Balance at beginning of year $200 $400 $300
Warranty costs incurred (411) (319) (280)
Product warranty accrual 561 119 380
---- ---- ----
Balance at end of year $350 $200 $400
==== ==== ====
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
15. Segment Information
The Company operates under four reportable segments:
(1) Commercial Communications - consists principally of precision time and
frequency control products used in two principal markets- commercial
communication satellites and terrestrial cellular telephone or other
ground-based telecommunication stations. and other components and
systems for the U.S. military.
(2) U.S. Government - consists of time and frequency control products used
for national defense or space-related programs.
(3) Gillam-FEI - the Company's Belgian subsidiary primarily sells wireline
synchronization and network management systems
(4) FEI-Zyfer - the products of the Company's subsidiary incorporate
Global Positioning System (GPS) technologies into systems and
subsystems for secure communications, both government and commercial,
and other locator applications.
The accounting policies of the four segments are the same as those
described in the "Summary of Significant Accounting Policies." The Company
evaluates the performance of its segments and allocates resources to them based
on operating profit which is defined as income before investment income,
interest expense and taxes. The Company's Commercial Communications and U.S.
Government segments operate principally out of a U.S.-based manufacturing
facility with both segments sharing the same managers, manufacturing personnel,
and machinery and equipment. Consequently, data for these two segments includes
allocations of depreciation and corporate-wide general and administrative
charges. The assets of these two segments consist principally of inventory and
accounts receivable. All other U.S.-based assets are assigned to the corporation
for the benefit of all four segments. The European-based director of Gillam-FEI
and the president of FEI-Zyfer manage the assets of these segments. All acquired
assets, including intangible assets, are included in the assets of these two
segments.
The table below presents information about reported segments for each of
the years ended April 30 with reconciliation of segment amounts to consolidated
amounts as reported in the statement of operations or the balance sheet for each
of the years (in thousands):
2006 2005 2004
---- ---- ----
Net sales:
Commercial Communications $29,491 $31,464 $28,235
U.S. Government 6,310 5,603 7,053
Gillam-FEI 9,169** 12,599** 12,197**
FEI-Zyfer 10,055 8,803 6,560
less intersegment sales (2,215)** (3,296)** (3,939)**
------- ------- -------
Consolidated Sales $52,810 $55,173 $50,106
======= ======= =======
Operating profit (loss):
Commercial Communications $3,509** $968** ($1,093)**
U.S. Government (1,645) (1,584) 656
Gillam-FEI (525)** 200** 353**
FEI-Zyfer 903 292 (1,059)
Corporate (532) (1,145) (503)
------- ------- -------
Consolidated Operating Profit (Loss) $1,710 ($1,269) ($1,646)
======= ======= =======
** For the fiscal years ended April 30, 2006, 2005 and 2004, includes
Gillam-FEI intersegment sales of $945,000, $2.4 million and $3.5 million,
respectively, to the Commercial Communications segment for development of a
wireline synchronization product for ultimate production and sale in the
U.S. These amounts were recorded as research and development expense of the
Commercial Communications segment, resulting in lower operating profits in
fiscal years 2006 and 2005 and an operating loss in fiscal year 2004 at
that segment. In the Gillam-FEI segment, these transactions reduced the
operating loss in fiscal year 2006 and produced operating profits in each
of fiscal years 2005 and 2004.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
2006 2005 2004
---- ---- ----
Identifiable assets:
Commercial Communications $33,956 $26,261 $22,988
U.S. Government 5,592 6,245 5,189
Gillam-FEI 13,755 13,877 14,904
FEI-Zyfer 5,356 4,796 5,541
less intersegment balances (14,585) (9,892) (5,673)
Corporate 42,667 47,087 49,918
------- ------- -------
Consolidated Identifiable Assets $86,741 $88,374 $92,867
======= ======= =======
Depreciation and amortization (allocated):
Commercial Communications $1,013 $1,105 $1,100
U.S. Government 225 220 267
Gillam-FEI 185 244 307
FEI-Zyfer 428 426 405
Corporate 19 19 19
------- ------- -------
Consolidated Depreciation and Amortization Expense $1,870 $2,014 $2,098
======= ======= =======
Major Customers
In fiscal year 2006, sales to three customers of the Commercial
Communications segment aggregated $22.5 million or 76% of that segment's total
sales. These customers accounted for 16%, 14% and 13%, respectively, of the
Company's consolidated sales for the year. During the year ended April 30, 2006,
sales to four customers of the U.S. Government segment aggregated $5.2 million
or 82% of that segments revenues. In the Gillam-FEI segment, sales to two
customers aggregated $3.8 million or 46% of that segment's revenues (exclusive
of the $945,000 intersegment sale). In the FEI-Zyfer segment, two customers
accounted for $1.9 million or 19% of that segment's sales. None of the customers
in the U.S. Government, Gillam-FEI or FEI-Zyfer segments accounted for more than
10% of consolidated revenues.
During fiscal year 2005, sales to two customers accounted for approximately
$22.0 million of the Commercial Communications segment's total sales. This
amount represents 70% of Commercial Communications' total revenues and 28% and
12%, respectively, of the Company's consolidated sales for that year. In the
U.S. Government segment, sales to four customers aggregated $4.9 million or 87%
of that segment's revenues in fiscal year 2005. Sales to two customers,
aggregating $6.0 million, accounted for 59% of the revenues of the Gillam-FEI
segment (exclusive of the $2.4 million intersegment sale). In the FEI-Zyfer
segment, two customers accounted for $1.9 million or 21% of that segment's
sales. None of the customers in the U.S. Government, Gillam-FEI or FEI-Zyfer
segments accounted for more than 10% of consolidated revenues.
In fiscal year 2004, sales to two customers of the Commercial
Communications segment aggregated $21.6 million or 76% of that segment's total
sales. These customers accounted for 32% and 11%, respectively, of the Company's
consolidated sales for the year. In the U.S. Government segment, sales to three
customers aggregated $5.8 million or 82% of that segment's revenues in fiscal
year 2004. In the Gillam-FEI segment, sales to two customers aggregated $2.7
million or 31% of that segment's revenues (exclusive of the $3.5 million
intersegment sale). In the FEI-Zyfer segment, one customer accounted for $1.2
million or 19% of that segment's sales. None of the customers in the U.S.
Government, Gillam-FEI or FEI-Zyfer segments accounted for more than 10% of
consolidated revenues.
The loss by the Company of any one of these customers would have a material
adverse effect on the Company's business. The Company believes its relationship
with these companies to be mutually satisfactory.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Foreign Sales
Revenues in the each of the Company's segments include sales to foreign
governments or to companies located in foreign countries. Revenues, based on the
location of the procurement entity, were derived from the following countries:
(in thousands)
2006 2005 2004
---- ---- ----
China $ 5,301 $11,422 $14,141
Belgium 4,198 5,171 3,876
France 2,924 4,412 3,987
Canada 2,447 1,021 1,046
Other 3,748 5,385 4,242
------- ------- -------
$18,618 $27,411 $27,292
======= ======= =======
16. Interim Results (Unaudited)
Quarterly results for fiscal years 2006 and 2005 are as follows:
(in thousands, except per share data)
2006 Quarter
---------------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
Net sales $11,057 $11,499 $15,113 $15,141
Gross margin 4,097 4,098 5,462 4,960
Net income 1,142 1,332 1,248 1,076
*Earnings per share
Basic $0.13 $0.16 $0.15 $0.13
Diluted $0.13 $0.15 $0.14 $0.12
*Quarterly earnings per share data do not equal the annual amount due to
changes in the average common equivalent shares outstanding.
(in thousands, except per share data)
2005 Quarter
---------------------------------------------
1st 2nd 3rd 4th
--- --- --- ---
Net sales $17,683 $14,362 $11,222 $11,906
Gross margin 5,778 5,259 3,693 3,430
Net income (loss), as reported 977 854 (368) 3,520
Restated Equity in Morion (see Note 10) 54
-----
Net income (loss), restated 1,031
*Earnings (loss) per share
Basic $0.12 $0.10 ($0.04) $0.41
Diluted $0.12 $0.10 ($0.04) $0.41
During the fourth quarter of fiscal year 2005, the Company recorded
additional deferred compensation expense of $327,000 to reflect a change in
accounting estimate based on updated life expectancy tables for its deferred
compensation program.
*Quarterly earnings per share data do not equal the annual amount due to
changes in the average common equivalent shares outstanding.
55
FREQUENCY ELECTRONICS, INC. and SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Additions
---------
Description Balance Charged Charged
at to costs to other Balance at
beginning and accounts- Deductions end of
of period expenses describe -describe period
--------- -------- -------- ---------- ------
Year ended April 30, 2006
- -------------------------
Allowance for doubtful
accounts $172 $117 - $13(a) $276
Inventory reserves $4,289 $680 ($52)(c) $994(b) $3,923
Year ended April 30, 2005
- -------------------------
Allowance for doubtful
accounts $140 $ 45 $13(a) $172
Inventory reserves $3,495 $726 $68(c,d) - $4,289
Year ended April 30, 2004
- -------------------------
Allowance for doubtful
accounts $124 $16 - $140
Inventory reserves $3,598 $694 $28(c) $825(b) $3,495
(a) Accounts written off
(b) Inventory disposed or written off
(c) Foreign currency translation adjustments
(d) Includes $30 reclassification of other liabilities to inventory reserves
56
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
NONE
Item 9A Controls and Procedures
Disclosure Controls and Procedures. The Company's management, with the
participation of the Company's chief executive officer and chief financial
officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the
end of the period covered by this report. Based on such evaluation, the
Company's chief executive officer and chief financial officer have concluded
that, as of the end of such period, the Company's disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by the Company in the
reports that it files or submits under the Exchange Act.
Internal Control Over Financial Reporting. There have not been any changes
in the Company's internal control over financial reporting (as such term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fourth fiscal quarter to which this report relates that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
Item 9B Other Information
NONE
PART III
Item 10. Directors and Executive Officers of the Company
The information required to be furnished pursuant to this item with respect
to Directors of the Company, in compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, and the Company's code of ethics is
incorporated herein by reference from the Company's definitive proxy statement
for the annual meeting of stockholders to be held on or about September 27,
2006. The information required to be furnished pursuant to this item with
respect to Executive Officers is set forth, pursuant to General Instruction G of
Form 10-K, under Part I of this Report.
Item 11. Executive Compensation
This item is incorporated herein by reference from the Company's definitive
proxy statement for the annual meeting of stockholders to be held on or about
September 27, 2006.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
This item is incorporated herein by reference from the Company's definitive
proxy statement for the annual meeting of stockholders to be held on or about
September 27, 2006.
Item 13. Certain Relationships and Related Transactions
This item is incorporated herein by reference from the Company's definitive
proxy statement for the annual meeting of stockholders to be held on or about
September 27, 2006.
Item 14. Principal Accountant Fees and Services
This item is incorporated herein by reference from the Company's definitive
proxy statement for the annual meeting of stockholders to be held on or about
September 27, 2006.
57
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) Index to Financial Statements, Financial Statement Schedule and Exhibits
The financial statements, financial statement schedule and exhibits are
listed below and are filed as part of this report.
(1) FINANCIAL STATEMENTS
Included in Part II of this report:
Page(s)
-------
Reports of Independent Registered Public Accounting Firms 32-33
Consolidated Balance Sheets
April 30, 2006 and 2005 34
Consolidated Statements of Operations
-years ended April 30, 2006, 2005 and 2004 35
Consolidated Statements of Cash Flows
- years ended April 30, 2006, 2005 and 2004 36-37
Consolidated Statements of Changes in Stockholders' Equity
- years ended April 30, 2006, 2005 and 2004 38
Notes to Consolidated Financial Statements 39-53
(2) FINANCIAL STATEMENT SCHEDULE
Included in Part II of this report:
Schedule II - Valuation and Qualifying Accounts 54
Other financial statement schedules are omitted because they are not required, or the
information is presented in the consolidated financial statements or notes thereto.
(3) EXHIBITS
Exhibit 23.1 Consents of Independent Registered Public Accounting Firms 61
Exhibit 31.1 Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 62
Exhibit 31.2 Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 63
Exhibit 32.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 64
Exhibit 32.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 65
The exhibits listed on the accompanying Index to Exhibits beginning on page 58 are filed
as part of this annual report.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FREQUENCY ELECTRONICS, INC.
By /s/ Martin B. Bloch
-------------------------
Martin B. Bloch
President and CEO
By: /s/ Alan L. Miller
-------------------------
Alan L. Miller
Chief Financial Officer
and Controller
Dated: July 28, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ Joseph P. Franklin Chairman of the Board 7/28/06
-----------------------
Joseph P. Franklin
/s/ Joel Girsky Director 7/28/06
-----------------------
Joel Girsky
/s/ E. Donald Shapiro Director 7/28/06
-----------------------
E. Donald Shapiro
/s/ S. Robert Foley Director 7/28/06
-----------------------
S. Robert Foley
/s/ Richard Schwartz Director 7/28/06
-----------------------
Richard Schwartz
/s/ Martin B. Bloch President and CEO 7/28/06
----------------------- (Principal Executive Officer)
Martin B. Bloch
/s/ Alan L. Miller Chief Financial Officer 7/28/06
----------------------- and Controller
Alan L. Miller (Principal Financial Officer)
59
INDEX TO EXHIBITS
ITEM 15(a)(3)
Certain of the following exhibits were filed with the Securities and Exchange
Commission as exhibits, numbered as indicated below, to the Registration
Statement or report specified below, which exhibits are incorporated herein by
reference:
Exhibit No. in
this Form 10-K Description of Exhibit NOTE
- -------------- ------------------------------------------------------ ----
3.1 Copy of Certificate of Incorporation of the Registrant
filed with the Secretary of State of Delaware (1)
3.2 Amendment to Certificate of Incorporation of the
Registrant filed with the Secretary of State
of Delaware on March 27, 1981 (2)
3.3 Amendment to Certificate of Incorporation of the Registrant
filed with Secretary of State of Delaware on October 26, 1984 (6)
3.4 Amendment to Certificate of Incorporation of the Registrant
filed with the Secretary of State of Delaware on October 22,
1986 (8)
3.5 Amended and Restated Certificate of Incorporation of the
Registrant filed with the Secretary of State of Delaware on
October 26, 1987 (10)
3.6 Amended Certificate of Incorporation of the Company filed
with the Secretary of State of Delaware on November 2, 1989 (10)
3.7 Copy of By-Laws of the Registrant, as amended to date (3)
4.1 Specimen of Common Stock certificate (1)
10.1 Registrant's 1997 Independent Contractor Stock Option Plan (11)
10.2 Stock Bonus Plan of Registrant and Trust Agreement
thereunder (4)
10.3 Employment agreement between Registrant and Martin B. Bloch (4)
10.4 Employment agreement between Registrant and Abraham Lazar (4)
10.5 Employment agreement between Registrant and John C. Ho (4)
10.6 Employment agreement between Registrant and Marvin Meirs (4)
10.7 Employment agreement between Registrant and Alfred Vulcan (4)
10.8 Employment agreement between Registrant and Harry Newman (4)
10.9 Employment agreement between Registrant and Marcus Hechler (4)
10.10 Employment agreement between Registrant and Charles Stone (9)
10.11 Employment agreement between Registrant and Jerry Bloch (9)
60
Exhibit No. in
this Form 10-K Description of Exhibit NOTE
- -------------- ----------------------------------------------------------- ----
10.12 Contribution Agreement between Registrant and Reckson
Operating Partnership L.P. dated January 6, 1998 (12)
10.13 Lease agreement between Registrant and Reckson Operating
Partnership, L.P. dated January 6, 1998 (12)
10.14 Plea Agreement, Civil Settlement and Related Documents dated
June 19, 1998 (12)
10.15 Registrant's 1984 Incentive Stock Option Plan (6)
10.16 Registrant's Cash or Deferral Profit Sharing Plan and
Trust under Internal Revenue Code Section 401,
dated April 1, 1985 (7)
10.17 Amendment dated April 19, 1981 to Stock Bonus Plan
of Registrant and Trust Agreement (3)
10.18 Amendment Restated Effective as of May 1, 1984 of the
Stock Bonus Plan and Trust Agreement of Registrant (7)
10.19 Amendment Restated Effective as of May 1, 1984 of the Stock
Bonus Plan and Trust Agreement of Registrant (8)
10.20 Form of stock escrow agreement between Vincenti & Schickler as
escrow agent and certain officers of Registrant (4)
10.21 Form of Agreement concerning Executive Compensation (2)
10.22 Registrant's 1987 Incentive Stock Option Plan (9)
10.23 Registrant's Senior Executive Stock Option Plan (9)
10.24 Amendment dated Jan. 1, 1988 to Registrant's Cash or
Deferred Profit Sharing Plan and Trust under Section 401
of Internal Revenue Code (9)
10.25 Executive Incentive Compensation Plan between Registrant
and various employees (9)
10.26 Registrant's Employee Stock Option Plan (10)
10.27 Loan agreement between Registrant and Nat West
dated May 22, 1990 (10)
10.28 Loan Agreement between Registrant's Employee Stock
Ownership Plan and Registrant dated May 22, 1990 (10)
11 Computation of Earnings per Share of Common Stock Included in the
Financial Statements
15 Registrant's 1982 Incentive Stock Option Plan (5)
21 List of Subsidiaries of Registrant (10)
61
Exhibit No. in
this Form 10-K Description of Exhibit NOTE
- -------------- -------------------------------------------------------- --------------
23.1 Consent of Independent Registered Public Accounting Firm
to incorporation by reference of 2006 audit report in
Registrant's Form S-8 Registration Statement. Filed herewith
31.1 Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 Filed herewith
31.2 Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 Filed herewith
32.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 Filed herewith
32.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 Filed herewith
NOTES:
(1) Filed with the SEC as an exhibit, numbered as indicated above, to the
registration statement of Registrant on Form S-1, File No. 2-29609,
which exhibit is incorporated herein by reference.
(2) Filed with the SEC as an exhibit, numbered as indicated above, to the
registration statement of Registrant on Form S-1, File No. 2-71727,
which exhibit is incorporated herein by reference.
(3) Filed with the SEC as an exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061 for the year
ended April 30, 1981, which exhibit is incorporated herein by
reference.
(4) Filed with the SEC as an exhibit, numbered as indicated above, to the
registration statement of Registrant on Form S-1, File No. 2-69527,
which exhibit is incorporated herein by reference.
(5) Filed with the SEC as an exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061, for the
year ended April 30, 1982, which exhibit is incorporated herein by
reference.
(6) Filed with the SEC as an exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061, for the
year ended April 30, 1985, which exhibit is incorporated herein by
reference.
(7) Filed with the SEC as exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061, for the
year ended April 30, 1986, which exhibit is incorporated herein by
reference.
(8) Filed with the SEC as an exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061, for the
year ended April 30, 1987, which exhibit is incorporated herein by
reference.
(9) Filed with the SEC as an exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061, for the
year ended April 30, 1989, which exhibit is incorporated herein by
reference.
(10) Filed with the SEC as an exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061, for the
year ended April 30, 1990, which exhibit is incorporated herein by
reference.
(11) Filed with the SEC as an exhibit, numbered as indicated above, to the
registration statement of Registrant on Form S-8, File No. 333-42233,
which exhibit is incorporated herein by reference.
(12) Filed with the SEC as an exhibit, numbered as indicated above, to the
annual report of Registrant on Form 10-K, File No. 1-8061, for the
year ended April 30, 1998, which exhibit is incorporated herein by
reference.
62