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FREQUENCY ELECTRONICS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

July 29, 2014

"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. The factors listed above are not exhaustive. Other sections of this Form 10-K include additional factors that could materially and adversely impact the Company's business, financial condition and results of operations. Moreover, the Company operates in a very competitive and rapidly changing environment. New factors emerge from time to time and it is not possible for management to predict the impact of all these factors on the Company's business, financial condition or results of operations or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not rely on forward-looking statements as a prediction of actual results. Any or all of the forward-looking statements contained in this Form 10-K and any other public statement made by the Company or its management may turn out to be incorrect. The Company expressly disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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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 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 through a process of aggregating actual costs incurred and estimating additional costs to completion based upon the current available information and status of the contract. The effect of any change in the estimated gross margin percentage for a contract is reflected in revenues in the period in which the change is known. Provisions for anticipated losses on contracts are made in the period in which they become determinable.

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

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

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

Costs and Expenses

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

Inventory

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

Marketable Securities

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

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RESULTS OF OPERATIONS

The table below sets forth for the fiscal years ended April 30, 2014 and 2013, the percentage of consolidated net sales represented by certain items in the Company's consolidated statements of operations:

2014 2013 Revenues FEI-NY 77.9 % 76.3 % Gillam-FEI 14.0 17.1 FEI-Zyfer 11.2 15.3 Less intersegment revenues (3.1 ) (8.7 ) 100.0 100.0 Cost of Revenues 65.4 63.6 Gross Margin 34.6 36.4 Selling and Administrative expenses 19.7 21.3 Research and Development expenses 8.1 8.3 Operating Profit 6.8 6.8 Other Income (Expenses), net 2.0 0.6 Provision for Income Taxes (3.2 ) (2.0 ) Net Income 5.6 % 5.4 % Revenues Fiscal years ended April 30, (in thousands) Change 2014 2013 $ % FEI-NY $ 55,772$ 52,567$ 3,205 6 % Gillam-FEI 9,995 11,825 (1,830 ) (15 %) FEI-Zyfer 7,990 10,523 (2,533 ) (24 %) Intersegment sales (2,207 ) (5,983 ) 3,776 $ 71,550$ 68,932$ 2,618 4 % 15



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Fiscal year 2014 compared to fiscal year 2013:

For the year ended April 30, 2014, revenues from commercial and U.S. Government satellite programs accounted for approximately 60% of consolidated revenues and increased by approximately 25% over fiscal year 2013. Revenues on these long-term contracts, which are recorded in the FEI-NY segment, are recognized primarily under the percentage of completion method. Revenues from non-space U.S. Government/DOD customers, which are recorded in both the FEI-NY and FEI-Zyfer segments, accounted for approximately 20% of fiscal year 2014 consolidated revenues. Such revenues decreased by approximately 25% from fiscal year 2013, with some of the decline attributable to continuing uncertainty regarding the U.S. DOD budget. For the year ended April 30, 2014, total revenues from both satellite and non-space programs for which the U.S. Government is the end-user were approximately 54% of consolidated revenues as compared to 62% the prior fiscal year. This decrease is primarily due to a higher ratio of commercial satellite contracts that the FEI-NY segment is working on in comparison to prior years. Network infrastructure and other commercial revenues accounted for approximately 20% of consolidated revenues and declined by approximately 10% from the prior fiscal year. Network infrastructure and other commercial revenues are recorded in all three segments although the largest network infrastructure sales volume is recorded in the Gillam-FEI and FEI-Zyfer segments and accounted for most of the year-over-year revenue declines in those two segments.

Fiscal year 2013 compared to fiscal year 2012:

For the year ended April 30, 2013, FEI-NY revenues from commercial and U.S. Government satellite programs increased 11% over the prior year. Revenues from these programs accounted for 50% of fiscal year 2013 consolidated sales, approximately the same ratio as for fiscal year 2012. Revenues on these long-term contracts are recognized primarily under the percentage of completion method. For the year ended April 30, 2013, sales from the non-space U.S. Government/DOD business area accounted for more than 25% of consolidated revenues and increased by more than 40% over fiscal year 2012. This increase is due to the impact of FEI-Elcom which was acquired by the Company in late fiscal year 2012 and is part of the FEI-NY segment. For the year ended April 30, 2013, total revenues from both satellite and non-space programs for which the U.S. Government is the end-user, accounted for 62% of consolidated revenues compared to approximately 45% in the prior fiscal year. Such revenues are recorded in the FEI-Zyfer segment as well as FEI-NY (including FEI-Elcom). For the year ended April 30, 2013, network infrastructure and other commercial sales, which are recorded in all three segments, accounted for approximately 25% of consolidated revenues as compared to approximately 30% of revenues in the prior fiscal year. Network infrastructure sales were 8% lower in fiscal year 2013 compared to fiscal year 2012 and is the partial cause of decreased revenue at the FEI-Zyfer and Gillam-FEI segments. The decline in revenues at the Gillam-FEI segment is also partially attributable to a 6% year-over-year decrease in the rate of exchange between the U.S. dollar and the euro. The revenue decline at FEI-Zyfer is also due to delays in orders from U.S. Government customers as a result of recent U.S. budget issues.

Based on the Company's current backlog, over three-fourths of which represent satellite payload business, and the potential for additional new orders, fiscal year 2015 revenues are expected to grow. Satellite payload revenues will remain the dominant portion of the Company's business and represent a large opportunity for long-term growth, benefiting from both commercial and U.S. Government programs. Fiscal year 2015 revenues from U.S. Government/DOD non-space, network infrastructure and other commercial programs, are expected to remain in approximately the same range as realized in fiscal year 2014.

Gross Margin Fiscal years ended April 30, (in thousands) Change 2014 2013 $ % $ 24,750$ 25,110$ (360 ) (1 %) GM Rate 34.6 % 36.4 %



For the year ended April 30, 2014, gross margin and the gross margin rate decreased from that of the prior fiscal year. Several factors contributed to the fiscal year 2014 result, including higher than anticipated engineering design and production costs both at FEI-NY and Gillam-FEI and lower sales volume at FEI-Zyfer which increased unabsorbed overhead costs at that reporting segment. Increased costs related to improving production capacity to meet expected future demand at FEI-NY plus inventory write downs of approximately $500,000 as well as differing product mix also impacted gross margin rates.

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For the year ended April 30, 2013 gross margin was reduced by $1.4 million (2% of consolidated revenues) as a result of the write down of certain inventory recorded in the Gillam-FEI segment due to lack of certainty regarding the realizability of such inventory. Based on slower than anticipated rollout of implementation of the French government's plans to initiate a "smart grid," the Company has less visibility regarding the probable schedule for obtaining production-level orders which are now anticipated to occur no earlier than fiscal year 2015. Improved gross margins from satellite payload revenues in the FEI-NY segment were offset by historically lower gross margins at FEI-Elcom. Gross margin rates in the FEI-Zyfer and Gillam-FEI segments were also lower on reduced sales. During the fiscal year ended April 30, 2013, cost of sales included approximately $2.4 million of inventory write downs, including the Gillam-FEI inventory write down, which reduced gross margin rates by 3.4% in fiscal year 2013.

Taking into consideration only the current mix of programs and orders in its backlog, the Company expects its fiscal year 2015 gross margin rate to be less than its target rate of 40%. As revenues increase in future periods, the Company expects to realize a higher gross margin as more of its fixed costs are covered.

Selling and Administrative Expenses

Fiscal years ended April 30, (in thousands) Change 2014 2013 $ % $ 14,064$ 14,704$ (640 ) (4 %)



In the fiscal years ended April 30, 2014 and 2013, selling and administrative costs were 20% and 21%, respectively, of consolidated revenues. Fiscal year 2014 incentive compensation expense decreased from the prior year due to reduced operating profits. Selling costs were also lower but partially offset by increased deferred compensation costs. For the years ended April 30, 2014 and 2013, selling and administrative expenses include stock compensation expense of $676,000 and $537,000, respectively. The Company expects fiscal year 2015 selling and administrative expenses to be incurred at approximately the same rate relative to revenues.

Research and Development Expenses

Fiscal years ended April 30, (in thousands) Change 2014 2013 $ % $ 5,813$ 5,727$ 86 2 %



Research and development ("R&D") expenditures represent investments intended to keep the Company's products at the leading edge of time and frequency technology and enhance competitiveness for future revenues. As a percentage of consolidated revenue, R&D spending for the years ended April 30, 2014 and 2013 was approximately 8% each year. In fiscal year 2014, the Company continued the accelerated level of development that began in fiscal year 2013 of new satellite payload microwave receivers/converters from DC to Ka band. These satellite payload products are anticipated to be available for customer evaluation and new contract awards in early fiscal year 2015. In addition to the satellite payload products, internal R&D spending includes development and improvement of quartz-based and rubidium atomic clocks, development of new GPS-based synchronization products and further enhancement of the capabilities of the Company's line of low g-sensitivity and ruggedized rubidium oscillators. The Company also continued to engage in customer-funded development activity the cost of which appears in cost of revenues, thus reducing the level of internal R&D spending. Although funding is obtained from customers, the Company retains the rights to any products developed. The Company will continue to devote significant resources to develop new products, enhance existing products and implement efficient manufacturing processes. For fiscal year 2015, the Company anticipates that internal research and development spending will be less than 10% of revenues. The Company believes that internally generated cash and cash reserves are adequate to fund these development efforts.

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Table of Contents Operating Profit Fiscal years ended April 30, (in thousands) Change 2014 2013 $ % $ 4,873$ 4,679$ 194 4 %



For the year ended April 30, 2014, operating profit increased over the prior year due to lower selling, general and administrative expenses as described above, partially offset by lower gross margin and higher R&D spending. As in the prior year, the FEI-NY segment where the Company's satellite payload contracts are performed, accounted for all of fiscal year 2014's operating profit. The Company's other two segments, FEI-Zyfer and Gillam-FEI, both incurred operating losses on lower sales volume.

For the year ended April 30, 2013, operating profit was reduced by the $1.4 million inventory write down in the Gillam-FEI segment, higher selling and administrative costs and increased R&D spending. All of the fiscal year 2013 operating profit was generated by the FEI-NY segment which enjoyed the benefit of rising satellite payload revenues. The Company's other segments, FEI-Zyfer and Gillam-FEI, both incurred operating losses on reduced revenues, higher costs and the inventory write down.

On anticipated increased revenues and favorable product mix, the Company expects to realize an improved gross margin while maintaining other operating expenses within their targeted amounts. Thus, the Company expects to report higher operating profits in fiscal year 2015.

Other Income (Expense) Fiscal years ended April 30, (in thousands) Change 2014 2013 $ % Investment income $ 880$ 671$ 209 31 % Interest expense (156 ) (195 ) 39 20 % Other income (expense), net 703 (69 ) 772 NM $ 1,427$ 407$ 1,020 251 %



Investment income is derived primarily from the Company's holdings of marketable securities. Earnings on these securities may vary based on fluctuating dividend payout levels and interest rates and the timing of purchases or sales of securities. During fiscal years 2014 and 2013, investment income included gains upon the sale or redemption of marketable securities of approximately $367,000 and $47,000, respectively. During fiscal year 2015, the Company anticipates that investment income will be approximately the same as that earned in fiscal year 2014, depending on the yield and size of its investment portfolio.

In fiscal year 2014, interest expense was incurred on borrowings under the Company's $25 million credit facility with a bank, on deferred compensation payments and capital leases for equipment. The new bank credit facility replaced the previous $9.3 million credit line against which the Company had borrowed approximately $6 million as of the end of fiscal year 2013. As a result of the new credit facility, the Company maintained a higher level of debt than in fiscal year 2013, but since the new credit facility carries a lower interest rate than the previous credit line, fiscal year 2014 interest expense was lower than that incurred in fiscal year 2013. Interest expense in future years will be dependent on interest rates in the U.S.

Other income in fiscal year 2014 includes a $736,000 gain recognized upon the sale of certain manufacturing equipment to Morion, Inc. under the terms of a license agreement related to the Company's rubidium oscillator production technology. (For more information regarding the Company's investment in Morion see Note 10 to the Consolidated Financial Statements.) During the fiscal year 2013, other income consisted of insignificant non-operating expenses

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Table of Contents Income Tax Provision Fiscal years ended April 30, (in thousands) Change 2014 2013 $ % $ 2,260 $ 1,400$ 860 61 % Effective tax rate on pre-tax book income: 35.9 % 27.5 %



For the year ended April 30, 2014, the effective tax rate on pre-tax income increased as a result of lower tax credits for the U.S. subsidiaries and losses at the Company's foreign subsidiaries for which no tax benefit is currently available. During the year ended April 30, 2013, certain tax law changes were enacted which enabled the Company to obtain larger U.S. federal tax credits and nontaxable losses at foreign subsidiaries were less than that incurred in fiscal year 2014, thus reducing the Company's effective tax rate on pre-tax income.

The Company is subject to taxation in several countries. The statutory federal rates are 34% in the U.S., 33% in Europe and 25% in China. The Company utilizes the availability of research and development tax credits ("R&D credit") in the U.S. to lower its tax rate. The R&D credit expired on December 31, 2013 and the U.S. Congress has yet to reinstate it. Thus, the Company is able to utilize the R&D credit for only a portion of its fiscal year 2014 expenses. (See Note 13 to the Consolidated Financial Statements for a reconciliation of the actual tax benefit to the expected tax provision at the federal statutory rate.)

The Company's European subsidiaries have available net operating loss ("NOL") carryforwards of approximately $3.6 million to offset future taxable income. The associated deferred tax asset for the foreign subsidiary NOL is fully reserved by the deferred tax valuation allowance. These loss carryforwards have no expiration date. As a result of the acquisition of FEI-Elcom, the Company has a federal NOL carryforward of $5.6 million which may be applied in annually limited amounts to offset future U.S.-sourced taxable income over the next 18 years.

LIQUIDITY AND CAPITAL RESOURCES

The Company's balance sheet continues to reflect a highly liquid position with working capital of $78.2 million at April 30, 2014. Included in working capital at April 30, 2014 is $23.7 million consisting of cash, cash equivalents and short-term investments. The Company's current ratio at April 30, 2014 is 9.1 to 1 compared to 8.7 to 1 at the end of the prior fiscal year.

Net cash provided by operating activities for the year ended April 30, 2014, was $3.6 million compared to $2.8 million for the prior fiscal year. During fiscal years 2014 and 2013, the Company incurred $3.8 million and $6.0 million, respectively, in non-cash charges to earnings, including depreciation and amortization expense, inventory write downs, warranty and accounts receivable reserves, certain employee benefit plan expenses, including accounting for stock-based compensation. For fiscal year 2014, operating cash was reduced by increases to inventories and accounts receivable. During fiscal year 2013, operating cash was reduced by increases to inventories and payment of estimated income taxes. In fiscal year 2015, the Company anticipates that it will maintain positive cash flow from operations by continuing to generate operating profits and managing its inventory levels.

Net cash used in investing activities was $3.6 million and $2.0 million, respectively, for the fiscal years ended April 30, 2014 and 2013. In fiscal year 2014, investing activities included net proceeds from the redemption, sale or purchase of marketable securities for $1.8 million offset by the acquisition of capital equipment for $5.4 million. The fiscal year 2013 activities consisted of net proceeds from marketable securities transactions of $170,000 and acquisitions of capital equipment for $2.2 million. The Company may continue to invest cash equivalents in longer-term securities or to convert short-term investments to cash equivalents as dictated by its investment and acquisition strategies. The Company will continue to acquire more efficient equipment to automate its production process. The Company intends to spend between $3.0 million and $4.0 million on capital equipment during fiscal year 2015. Internally generated cash is expected to be adequate to acquire this property, plant and equipment.

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The Company has a five-year, $25 million credit facility from a bank. As of April 30, 2014, the Company has borrowed a total of $10.1 million under the credit facility. Such funds were used to fund the 2012 acquisition of FEI-Elcom in the amount of $6 million with the balance used principally to finance the purchase of additional manufacturing equipment to meet increased production output demands. The Company may draw on this bank credit facility to provide additional working capital and to fund acquisitions. The interest rate on the credit facility is based on LIBOR plus either 75 basis points or 175 basis points depending on under which of the two tranches the Company chooses to borrow. For a more complete description of the credit facility, see Note 7 to the Consolidated Financial Statements. In addition, the Company's European subsidiaries have available approximately $350,000 under a bank credit line to meet short-term cash flow requirements. The rate of interest on any borrowings is based on the one month EURO Interbank Offered Rate (EURIBOR). The European subsidiaries had no borrowings against this line of credit during fiscal years 2014.

During the year ended April 30, 2014, cash provided by financing activities was $4.3 million. The Company borrowed $4.1 million under the bank credit facility and made payments on capital lease obligations in the amount of $15,000. The Company also realized $182,000 from the tax benefit arising from the exercise of stock-based awards during fiscal year 2014. During fiscal year 2013, cash used in financing activities was $1.9 million consisting of borrowings and subsequent repayment of $5.0 million under its previous line of credit and payments of $357,000 against capital lease obligations. In addition, during the third quarter of fiscal year 2013, the Company paid a special cash dividend of $1.7 million. Partially offsetting these financing cash outflows, the Company also received $172,000 upon the exercise of stock-based awards and the tax benefit arising from such exercises. The Company will continue to use treasury shares to satisfy the future exercise of stock options and stock appreciation rights 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 fixed repurchase plan nor commitments to purchase additional shares in the future. As of the end of fiscal year 2014, the Company has repurchased approximately $4 million of its common stock out of the $5 million authorization.

The Company will continue to expend resources to develop, improve and acquire products for space applications, guidance and targeting systems, and communication systems which management believes will result in future growth and continued profitability. During fiscal year 2015, the Company intends to make a substantial investment of capital and technical resources to develop and acquire new products to meet the needs of the U.S. Government, commercial space and network infrastructure marketplaces and to invest in more efficient product designs and manufacturing procedures. Where possible, the Company will secure partial customer funding for its R&D efforts but is targeting to spend its own funds at a rate of up to 10% of revenues to achieve its development goals. Internally generated cash will be adequate to fund these development efforts. The Company may also pursue acquisitions to expand its range of products and may use internally generated cash and external funding in connection with such acquisitions.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements, other than operating leases, 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.

As of April 30, 2014, the Company's consolidated backlog amounted to approximately $48 million as compared to approximately $51 million at the beginning of the fiscal year. (See Item 1). Approximately 70% of this backlog is expected to be filled during the Company's fiscal year ending April 30, 2015. Included in the backlog at April 30, 2014 is approximately $3.5 million under cost-plus-fee contracts which the Company believes represent firm commitments from its customers for which the Company has not received full funding to date. The Company excludes from backlog any contracts or awards for which it has not received authorization to proceed. On fixed price contracts, the Company excludes any unfunded portion. The Company expects any partially funded contracts to become fully funded over time and will add the additional funding to its backlog at that time. The backlog 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.

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The Company's liquidity is adequate to meet its operating and investment needs through at least April 30, 2015.

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RECENT ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 eliminates most of the existing industry-specific revenue recognition guidance and significantly expands related disclosures. The required disclosures will include both quantitative and qualitative information about the amount, timing and uncertainty of revenue from contracts with customers and the significant judgments used. Entities can retrospectively apply ASU 2014-09 or use an alternative transition method. This ASU is effective for public companies for annual reporting periods beginning on or after December 15, 2016 and for the Company, must be adopted for its fiscal year 2018 beginning on May 1, 2017. The Company is in the process of determining the effect that ASU 2014-09 may have on its financial statements.

In February 2013, the FASB issued ASU No. 2013-02, Other Comprehensive Income. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This ASU is effective for periods beginning after December 15, 2012 and the Company adopted ASU 2013-02 in fiscal year 2014 which began on May 1, 2013. Such adoption had no effect on the Company's financial statements since no reclassification adjustments were made.

In July 2012, the FASB issued ASU No. 2012-02, Intangibles - Goodwill and Other (Topic 350): Test Indefinite-Lived Intangible Assets for Impairment. Under the requirements of ASU 2012-02 an entity has the option to assess qualitative factors when testing indefinite-lived intangible assets annually to determine whether it is more likely than not that the asset is not impaired. An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test or resume performing the qualitative assessment in any subsequent period. If, after assessing the totality of events and circumstances, an entity concludes that it is more likely than not that the indefinite-lived intangible asset is impaired, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The Company adopted ASU 2012-02 for its fiscal year 2014 which began on May 1, 2013. The adoption of this ASU had no material impact on the Company's financial statements.

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 internal events that are likely to have a material adverse effect on results from operations.

INFLATION

During fiscal year 2014, as in fiscal year 2013, the impact of inflation on the Company's business has not been materially significant.


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