Frequency Electronics, Inc.
Q1 2009 Earnings Call Transcript

Published: 16 Sep 2008

[Operator:]

Welcome to the Frequency Electronics, Inc. fiscal 2009 first quarter earnings call. (Operator Instructions) Statements in this release which are not historical facts are forward looking and involve risks and uncertainties including but not limited to the impact of competitive products and pricing, increased investment to support product introductions, market acceptance of products, product transitions by the company and its competitors, currency fluctuations, changes in product sales mix and other risks described in the company’s registration statement and other Securities and Exchange Commission filings. At this time for opening comments and introductions, I’ll turn the call over to General Joseph Franklin, Chairman of the Board.

[Joseph P. Franklin:]

We’re pleased to be able to present this to you this afternoon. I regret that I’ve had to miss our last conference call a time or two. I’ve been speaking to a lot of other audiences actually on the future of our national defense. And as you know, national defense is of central importance to us here at Frequency Electronics. We have a long and rewarding history in that arena. We’ll be doing even more of that as we move ahead. So let me turn to our latest quarterly report for the first quarter of fiscal 2009 to discuss that. I reported to you that we made “hard progress” during this last quarter and that ended on 31 July. What that means is that we’ve been changing our business procedures, our engineering and our manufacturing from what I could say colloquially were our old ways, and they were good ways for the smaller volumes of our business but not for the large volumes that we’re ramping up to. We’ve been doing this now for some time while we were still meeting the commitments of our existing contracts. It’s somewhat akin to trying to change the engines of an airplane while you’re still in a flight pattern. But as a result of that in the ramping up and the improving, we’re just about there. The expenses are now largely behind us and we see continuing improvements as we go forward. What I’d like to do now is introduce our two other participants Alan Miller, who’s our Chief Financial Officer, and Martin Bloch, our Chief Executive Officer. They’ll go ahead with discussions of the finances and operations, and then we’ll have a period for questions and answers. So Alan, please go ahead.

[Alan Miller:]

Revenues for the first quarter of fiscal year 2009 were $13.1 million compared to $15.6 million in the year ago period. As we noted in July our first quarter revenues were impacted by the lower level of new satellite bookings during fiscal year 2008. First quarter satellite payload revenues were comparable to the fourth quarter of fiscal 08 and make up over 30% of total revenues. Telecommunication infrastructure revenue was comparable to the year ago quarter and comprises about 40% of revenues. Non-space government and DOD revenues were slightly lower year-over-year and make up approximately 20% of total revenues. Our cost of sales for the period were $9.9 million compared to $11.1 million a year ago, which yields a gross margin of $3.2 million or 24% as compared to $4.5 million a year ago or 29%. The gross margin rate of 24% still represents a sequential improvement from the 16% rate in the fourth quarter of last year. As we noted previously higher engineering and manufacturing costs and a few satellite programs kept margins at this lower-than-targeted level. We will complete these programs during the second quarter of this year and expect to see improved gross margins over the balance of fiscal 2009. SG&A of $3.1 million is comparable to the prior year and is also 15% lower than the expense reported in the fourth quarter of fiscal 2008. R&D spending was $1.4 million compared to $2.2 million a year ago. During the fiscal 2008 period we were still spending considerable research and development resources on improved designs for satellite payloads. That effort was largely completed last year; hence the lower level of R&D spending in fiscal 2009. Note also that the new cost-plus programs that we have won involve a high degree of development but this effort will be funded by our customers. Consequently we anticipate the internal research and development spending will be lower than in prior years and expect it to be less than 10% of revenues going forward. Our operating loss for the quarter was $1.3 million compared to an $800,000 loss last year. Sequentially this first quarter loss is substantially less than the $3 million loss realized in the fourth quarter last year. Other income comprising of investment income and other expenses was $200,000 compared to $3 million a year ago. Last year you may recall that a reduction on Morion investment resulted in the $3 million pre-tax gain. Our net loss for the quarter was $772,000 and $0.09 a share as compared to $1.4 million net income or $0.16 per share again as a result of the gain on the morion investment. For those who might be modeling us, our effective tax rate we expect to be again back to the 30% rate as we were in prior years. Whereas in the fourth quarter of last year we had positive cash flow of $2.2 million, for the first quarter of fiscal 2009 we reported negative cash from operations of $2.1 million primarily reflecting the timing of invoicing on the larger satellite programs. Our unbilled receivables decreased by $2.4 million from April 30 but the billed amounts were not collected as of the end of July. As we complete the larger satellite programs we expect to generate positive cash flow in fiscal year 2009. Our backlog reported as of the end of July 2008 is $36 million. This backlog does not include the full value of the GPS III contract. Including the full value of GPS III our backlog would exceed $45 million. As I said in the press release, as we complete older high-cost satellite payload programs, transition our resources to recently awarded contracts, and make other adjustments to our operations we expect to show operating profits for fiscal year 2009. We are confident that we will also generate positive cash flow during this fiscal year. With this outlook the company recently repurchased over 650,000 shares of its common stock under our authorized stock buy-back plan. I’ll be available for your questions a little bit later, but at this point let me turn it over to Martin.

[Martin B. Bloch:]

I would like to outline the main objective for the remainder of fiscal 2009 which ends April 30, 2009. Item one is to maintain our capacity which we paid so dearly to achieve. Number two is to reduce operating costs by implementing the following systems

[Operator:]

(Operator Instructions) Our first question comes from [Sam Bergman - Mayberry Asset Management].

[[Sam Bergman:]

Perhaps Martin you can answer the first question for me. How much is remaining of the low margin programs that you talked about in the press release?

[Martin B. Bloch:]

We expect to ship most of them out within the next four to eight weeks.

[[Sam Bergman:]

Can you give us some kind of percentages of what’s been shipped already?

[Martin B. Bloch:]

I would say that 75% have shipped.

[Alan Miller:]

As far as revenue is concerned, we’ve probably recognized about 95% of it.

[Martin B. Bloch:]

Yes, because they’re 100% complete.

[[Sam Bergman:]

Again Martin, a question regarding the throughput and the operating costs showing some kind of improvement. Have you already purchased the test equipment to get the throughput improved or not?

[Martin B. Bloch:]

Yes. We have all the equipment in the place. I mean there might be some minor like 200,000 that might be necessary to do it but we have the bulk of the equipment in-house. What is necessary is to put together those systems so they can operate with less coffee breaks and less errors in human beings and to achieve the same put-through with a lot less touch labor.

[[Sam Bergman:]

Alan, can you give me an employee count at the end of this quarter versus last quarter?

[Martin B. Bloch:]

244.

[Alan Miller:]

That’s here in New York.

[Martin B. Bloch:]

In New York is 244. I think worldwide it’s 450.

[[Sam Bergman:]

Alan also perhaps you can answer this question or maybe Joseph, either or. The pipeline, can you give us a comparison of what the pipeline looks like this first quarter of 09 versus fourth quarter of 08?

[Alan Miller:]

Are you talking about backlog now?

[[Sam Bergman:]

Not backlog. The actual pipeline of RFPs

[Martin B. Bloch:]

For satellites we have about ending at $100 plus million worth of proposals. The only thing we cannot predict is when they’re going to be placed.

[[Sam Bergman:]

Of those proposals?

[Martin B. Bloch:]

Yes.

[[Sam Bergman:]

Can you give me a dollar amount of the largest one of those proposals?

[Martin B. Bloch:]

$30 million.

[[Sam Bergman:]

The last question, the unbilled receivables that was talked about in the fourth quarter, is the rest of it going to be billed this quarter or still spread out over a couple quarters?

[Alan Miller:]

There’s always going to be some unbilled receivables, they’re going to be rolling over, but the number has come down from what it was at the end of January and at the end of April, down to about $7.1 million so I suspect that that number will come down substantially as of the end of the second quarter. But, there will always be some number there, it’s not something that goes to zero.

[[Sam Bergman:]

I just have one more, on the buy back of the shares has that $5 million be completely filled or is there some remaining on the buy back?

[Alan Miller:]

The authorization was for $5 million and we spent about $4 million so far.

[Operator:]

Our next question comes from [Robert Smith - Center for Performance Investing].

[[Robert Smith:]

What did you guys pay for the stock?

[Alan Miller:]

The average price was around $4.34.

[[Robert Smith:]

Second, you spoke of peeling the onion. It kind of brings tears to my eyes. You know Martin we’re not getting any younger. So how can you have misread this so dramatically? I mean the year and a half or so ago when you were talking about the billed and revenues and the gross margins that you were targeting, you said you had equipment in to make this happen, and bingo. What happened?

[Martin B. Bloch:]

Putting the cards right on the table on this, we had a major cultural change that had to overcome the company. In 2006 we shipped seven microwave systems and the surge was so enormous that in 2008 we had to ship 147 to maintain this rate. I grossly underestimated the effort that it will take to change the tribal culture that Frequency had from producing a few units with a few good skilled people and what it would take to do the engineering investment, equipment and training in order to be able to build up to that capacity. I’m happy to say that we have achieved it and we’re delivering on all of the contracts, but it was very brutal and expensive.

[[Robert Smith:]

So you’re confident you have your arms around this now?

[Martin B. Bloch:]

We have shipped 70+% and we expect on the last three contracts to be completed within the next four to eight weeks.

[[Robert Smith:]

The second half should be dramatically better?

[Martin B. Bloch:]

No question about it.

[[Robert Smith:]

Guys, I’m holding you to this.

[Martin B. Bloch:]

I’m going to do my best to hold me to it.

[Operator:]

Our next question comes from [Sam Robowsky - SER Asset Management].

[[Sam Robowsky:]

Your backlog was $39 million at the end of the year and you stated that $9 million plus. Was that included in the $39 million and what is your backlog at the end of the July quarter?

[Alan Miller:]

At the end of July the reported backlog is $36 million. As I mentioned in my remarks that does not include the full value of the GPS III contract. That value will then increase the value of the backlog by about $10 million when the contract gets fully finalized.

[[Sam Robowsky:]

Is funding, is that what you need?

[Martin B. Bloch:]

On most of those large contracts you’ve got an ATP which is an authorization to proceed and then you negotiate for a couple of months all of the details. And we are in the process of it. No, that program I’m happy to report is fully funded.

[[Sam Robowsky:]

Did you say that you expect to be profitable for the current year?

[Alan Miller:]

Yes.

[[Sam Robowsky:]

Which quarter does that begin?

[Martin B. Bloch:]

The third quarter.

[[Sam Robowsky:]

I guess the one person that had as much shares that you could have bought, Dalton, were they the sellers of the block?

[Alan Miller:]

Yes. We said our largest institutional shareholder is the one we [inaudible].

[[Sam Robowsky:]

Would you want to have authorization to buy more? I mean you only have another $1 million. Do you plan to seek authorization to buy more stock?

[Martin B. Bloch:]

It will be reviewed on the next Board meeting as we do all the time.

[[Sam Robowsky:]

You’re bidding on $100 million+ business. Is there less business available to bid on than is normally available? Do you find there’s less business that’s available to be divided amongst the competition?

[Martin B. Bloch:]

What we find is that the timing is very unpredictable on this. On a commercial satellite business, there is a little upheaval on getting it financed. On the military systems they’re just unpredictable. As an example, GPS III was supposed to be placed on October 1, 2007 and we didn’t get it until May 2008. And some of the other government systems on this, they were all eminent but somehow they slipped. The opportunities and the number of satellites stays about the same.

[[Sam Robowsky:]

The people managing your money, which money managing firm is managing money and do you have any involvement with either Lehman or AIG?

[Martin B. Bloch:]

No, thank you very much.

[[Sam Robowsky:]

What are your assets held in currently?

[Alan Miller:]

The investments?

[[Sam Robowsky:]

Yes.

[Alan Miller:]

They’re mostly in government agencies.

[[Sam Robowsky:]

Do you still have recs in stock or is that finished?

[Alan Miller:]

No. That was done a couple years ago.

[[Sam Robowsky:]

Are you looking at anything to acquire? Are there any opportunities that are out there to add to your business or to grow your business?

[Martin B. Bloch:]

We always keep our eyes out and looking out for the opportunities that add synergy to our growth.

[[Sam Robowsky:]

Do you think there would be an opportunity that would develop in the current year?

[Martin B. Bloch:]

I hope so.

[Operator:]

Our next question comes from [David Starkey - Smith Barney].

[[David Starkey:]

A couple questions for Alan here. On the stock buy-back, you had about $14.3 million in cash at the end of the quarter. Did you fund the buy-back from that cash?

[Alan Miller:]

Yes, primarily.

[[David Starkey:]

Over $30 million in inventories. Is that all spoken for or are we going to see a fourth quarter write-off on obsolete stuff at the end of the year?

[Alan Miller:]

It won’t be as dramatically as we anticipate but there are always some inventory reserves that we put up as we go through the year. The inventory primarily is spoken for or will be applied to active programs.

[[David Starkey:]

You don’t have any product obsoletion or anything like that in there?

[Alan Miller:]

No. It’s nothing out of the ordinary. Every year we write off some stuff. We reserved for it. So it’s nothing terribly unusual.

[[David Starkey:]

The other situation with the current liabilities now somewhat exceeding your current cash balance now at this point. Is that unusual or do you expect these accounts receivables to be picked up here pretty soon to cover that?

[Alan Miller:]

Yes. We definitely expect that as we complete these satellite programs and do the final milestone billing that we’ll be collecting a substantial amount of cash in the next couple of months.

[[David Starkey:]

For Martin, in this new 3G contract for the government. This first $11 million is technically for just the first two satellites?

[Martin B. Bloch:]

That’s correct. It’s for the development effort and to build the timing system and the frequency generators for the first two vehicles.

[[David Starkey:]

Was this a competitive bid that you won?

[Martin B. Bloch:]

Well they went out for proposals to about three or four people and we won it because of our technical excellence.

[[David Starkey:]

Once you get the final negotiations done, do you think you’ll be able to announce that it’s an official order for the rest of the $9 million?

[Martin B. Bloch:]

It’s actually official on this. We probably by tomorrow or the day after will finish out all of the details for the ATP. This is the normal way by the way.

[[David Starkey:]

And then you’re saying that this total program is eventually going to be 36 satellites so that’s just for the first two?

[Martin B. Bloch:]

That’s correct. That’s the necessary constellation of GPS in order to keep us navigating and it’s divided into three phases. Phase 1A is the development and the first two satellites. Then there’s a Phase B which is 10 additional satellites. And then there’s a Phase C and each of those satellites have improved capability for accuracy and navigational systems.

[[David Starkey:]

So you’re looking at about $5.5 million per satellite out of this contract?

[Martin B. Bloch:]

No. A good portion of it is the development phase of it. I don’t want to put an exact number per satellite because it’s competitive sensitive.

[[David Starkey:]

Right. But it could be higher than that actually when you get through the development part of it, right?

[Martin B. Bloch:]

The government will be very pissed if it’s higher. Their objective for putting the development money is to come up with performance systems that are portable, and that’s our objective.

[[David Starkey:]

But this is 36 satellites. This could be a program that runs 10 or 15 years, right?

[Martin B. Bloch:]

The timing is that the next phase is going to be released by 2010 and then there’s the next phase that is released by 2012, and I think all of them will be released by I think 2013. I’m not sure but that’s the timeframe because they are timed very closely to replace the present satellites that are becoming either obsolete for accuracy or inoperative due to the exhaustion of fuel or other malfunction on the systems. This is not a luxury. It’s a necessity.

[[David Starkey:]

Right. And this is just one program that you have. There are a lot of other ones out there too, I’m sure.

[Martin B. Bloch:]

There is.

[[David Starkey:]

One other question related to your subsidiaries. Are you going to see some return from these at some point? I know it’s been a while now.

[Martin B. Bloch:]

We have gotten already significant returns. The US5G for the wireline is a result of the development of Gillam-FEI and that has a very large opportunity. There are 25,000 shelves that need to be updated and we expect to get a good share of that business because we have the modern equipment that is very cost effective. And with FEI-Zyfer we have gotten the GPS capability of precision timing and there are many systems we are pursuing based on our joint technology.

[[David Starkey:]

And you’ve already gotten some pre-production orders shipped, right?

[Martin B. Bloch:]

That’s correct. We shipped a significant amount in the first week in September.

[[David Starkey:]

Do they know what kind of review period for these things we’re looking at?

[Martin B. Bloch:]

No, we’re past the review. This is just going straight in line.

[[David Starkey:]

So now you should be looking at some production orders?

[Martin B. Bloch:]

We shipped the production orders and we are waiting for the budget of the wireline people which I think is supposed to be released in November. I think in November is when they budget on what they are going to procure for the next 12 months.

[[David Starkey:]

One other question in general. This isn’t something you can probably answer, but the stock is trading at about 50% of book value here. Have you guys been approached by anybody regarding any kind of joint ventures or anything from outside sources at this point?

[Martin B. Bloch:]

Not really. I’d say over the past couple of years there’s always been some wild guy calling but nothing concrete.

[[David Starkey:]

But you’re continuing to deal with some of the major defense companies out there and they like to outsource product to you guys and you’re in constant discussions just with normal contract phases parts of your business with the Northrups of the world and things like that?

[Martin B. Bloch:]

Absolutely. We’re dealing with the Fortune 25 companies as most of our business.

[Operator:]

Our next question comes from David Shapiro - Aegis Financial.

[David Shapiro:]

I just wanted to see if maybe Alan could answer this. I just wanted to see the timing on these two large contracts, the GPS III and the Advanced Secure Space Systems program. For these two blocks the $11 million and $9 million, are those both going to run through by the end of 2010 or by the end of 09? What’s sort of the timing on the flows of those?

[Martin B. Bloch:]

Let me take it because I’m in charge of the planning and laying out the schedule. The majority of the effort has to be finished by the end of calendar 2009 on both of these programs. And then there’s going to be an additional couple of years of testing and validating the systems because the whole idea of the systems is to verify their longevity and reliability of these newly developed systems. Because they’re really pushing the envelope.

[David Shapiro:]

So the revenues from these two contracts are going to flow through many years?

[Martin B. Bloch:]

A good portion will be spent in the first 18 months and there’s going to be some gradual. After the development testing and validation and thermal vacuum testing to simulate space, it takes a lot of time but it doesn’t take a lot of dollars.

[David Shapiro:]

So you’d expect that sort of the next phase is for these projects would start up at some point in 2010? You’d get the initial phase done now; then there’d be some sort of review; and then the next phase if everything’s going all right would start up in 10, is that right?

[Martin B. Bloch:]

Yes. The next phase is at this time budgeted to be released in government fiscal 2010.

[David Shapiro:]

Then on the cultural change that I think you mentioned earlier and that’s gone on. What’s sort of the target here for SG&A? I mean it seems to be running year-over-year pretty flat. Are you guys going to be able to have operating leverage as you ramp up here or is this SG&A really going to continue to stay around the 20% of revenue figure?

[Alan Miller:]

As revenues increase dramatically, yes there is quite a bit of leverage in there. At these levels, at $15 million a quarter thereabouts, $3 million in SG&A is not out of line. But yes as we ramp up from that level we should see much better results.

[David Shapiro:]

So we should take anywhere between the $4 million and $5 million SG&A level as appropriate even as the revenues continue to ramp?

[Alan Miller:]

Within this range that we’ve been at, under 20% or thereabouts, is about what we would expect to see. Now if you get on an annualized basis up to $100 million level, yes we would see a dramatic decrease; lower teens.

[David Shapiro:]

On the R&D side of things, that’s been going down for the last four sequential quarters. How does that look going forward?

[Alan Miller:]

As we indicated, with the cost-plus programs we’re going to absorb quite a bit of our R&D resources and that will be customer funded. So you’ll see that effort if you will with part of our cost of sales numbers, so those same individuals will not be charging our internal research and development. That’s why we think that going forward for this fiscal year that the total dollars spend in R&D will be probably less than 10% of revenues whereas in the past we’ve been above that.

[David Shapiro:]

Where does that net out on the gross margins? Does it sort of net out equal to the fixed pricing contracts or how do those compare with the fixed price contracts?

[Alan Miller:]

Are you talking about the cost-plus programs?

[David Shapiro:]

Right. How does the cost-plus compare?

[Alan Miller:]

The cost-plus programs, the gross margins on those will be less than what we might historically see on a fixed price contract simply because fixed percentages are part of the fee structure or part of the cost structure. We’d expect coupled with the other programs that we have in-house that we would see an increase in our gross margin overall.

[David Shapiro:]

On the cap ex side of the business, you guys have some pretty fully depreciated TP&E there and you’re going up into a production ramp. Is there any meaningful amount of cap ex that needs to be spent or are you guys really fully sourced there and then are able to handle the volumes on your current TP&E level?

[Alan Miller:]

Historically we’ve not heavily depended on cap ex. Last year we did spend about $3 million on some of the test equipment that Martin was alluding to earlier. But more normal is probably around $2 million or less per year and this past quarter we didn’t really spend much at all; just about $100,000 in just the quarter.

[David Shapiro:]

So there’s no big large upcoming replacement cycle?

[Alan Miller:]

No. We don’t anticipate anything of that nature.

[Martin B. Bloch:]

We have all of the equipment in place as I mentioned before and there are going to be some minor roundup of building blocks to add for this automation both in assembly and test. Nothing major is budgeted for this year at all.

[David Shapiro:]

Final question, you mentioned that you guys are still actively looking for acquisitions. I just wonder how the company’s looking at that versus the fact that I guess the growth that’s coming into the business is not really been fully digested yet the margins obviously have not reached an appropriate profitability level for what you’re handling already and then I guess with your stock trading at such a low potential value of EBITDA and basically liquidation value for all intents and purposes, how are you looking at the acquisitions versus what you already have in-house?

[Martin B. Bloch:]

We’re looking for opportunities that we can go in joint ventures on this and possibly find some products that help us and improve our margins and improve our technology to do that. Understand we have the cash if we get the right opportunity.

[David Shapiro:]

I guess I’m just wondering if there’s going to be any more attractive investment out there than where your stock is currently selling at?

[Martin B. Bloch:]

Not for stock for sure but for cash definitely.

[Operator:]

Our next question comes from [Robert Lepperd].

[[Robert Lepperd]:]

You did answer some of the questions, but can you go about the wireline synchronization equipment. Is that just a US product or can that be used in Europe also?

[Martin B. Bloch:]

It’s worldwide. The US5G was primarily developed for the American market. And then we developed the US5GE which is for the European market, and we have started an installation in Europe and are trying to market it worldwide. But our two primary targets are the United States and Europe.

[[Robert Lepperd]:]

How do we actually market that? Is that a sales effort or is that just proving our equipment by them actually installing it, using assimilation? I know that they’re going to be extremely sensitive to this.

[Martin B. Bloch:]

The first step is to go through all the qualification hurdles, which we have completed. And now the equipment is on line and they are going to look carefully on how the equipment is performing because we’re now actually servicing active lines. And if there are no hiccups which we don’t expect because this equipment has gone through so much testing. It is an advanced software system; it’s much easier to install than our competitor and I think we’ll have the opportunity to get a significant portion of what is budgeted for replacements.

[Operator:]

Our next question comes from Larry Litton - Second Line Capital.

[Larry Litton:]

Only a clarification on a prior question. Alan, looking at this most recent quarter with the total operating expense around $4.5 million down from I think $5.2 million a year ago. The $4.5 million, is that a good normalized run rate for the next three or four quarters?

[Alan Miller:]

It’s somewhat dependent on the volume of business. If sales go up, we’re going to see some increases in some those categories. But yes, $4.5 million is in the ballpark surely.

[Larry Litton:]

And then R&D though now takes into account the customer funded R&D. That’s not going to come down a lot further here? I know you talked about the 10% number that’s partly a function of revenues going up though.

[Alan Miller:]

Yes, but like I said if you’re doing a comparison of last year when we had $2.2 million in R&D spending, that was very sizable compared to where our historical run rate had been given the effort that we were putting in at that time. So $1.5 million thereabouts per quarter R&D is in line.

[Martin B. Bloch:]

Let’s put it in perspective. In 2007 we spent $9.4 million in IR&D. In 2008 we spent $7.1 million and in 2009 we expect to be significantly less than the $7.1 million.

[Larry Litton:]

Exiting the year in terms of the fiscal year, what type of gross margin range do you think you’ll achieve Alan?

[Alan Miller:]

It’ll be in the 30% level. Mid-30%s.

[Larry Litton:]

35% +/- you hope?

[Alan Miller:]

Yes.

[Larry Litton:]

If I look at the $13 million in revenues today, what percent or what’s the absolute number of revenues that’s garnering very low gross margins there?

[Alan Miller:]

$1.5 million or thereabouts.

[Larry Litton:]

So $1.5 million of bad business in there. Alan Miller. Yes.

[Larry Litton:]

Not doing the calculation on the fly, but is the other $11 million of business at that 30% to 35% range?

[Alan Miller:]

Yes. It varies depending on the type of product but yes it’s in that range.

[Larry Litton:]

In terms of the share buy-back from your largest shareholder, that would still leave them with substantial shares left. Did you buy merely what you had an appetite for and there’s still an overhang of stock from them or that’s all they wanted to sell or what’s the status there?

[Alan Miller:]

We don’t know to tell you the truth. We will probably find out when they file their September report and that will be sometime in October. But we have reason to believe that they’ve sold quite a bit more than what they sold to us prior to that purchase that we made.

[Larry Litton:]

So if they had offered you more you had the wherewithal and the desire, you would have purchased it?

[Alan Miller:]

Yes.

[Larry Litton:]

Coming back to Martin’s point about the automatic test equipment, I’m not clear. You bought that stuff, it’s getting set up. Is it running full speed or you’re still tinkering and installing it?

[Martin B. Bloch:]

No. It’s running full speed but a lot of the equipments are manually interfaced with human beings and what we are extending the effort now is to put the computer software on it so the equipment can run automatically 24/7 with minimum touch labor.

[Larry Litton:]

And the phasing in that automation, what’s the timetable for that?

[Martin B. Bloch:]

I would say we are 60% done. We have quite a few automatic test stations now running 24/7 and we are installing this automatic equipment for service assembly which we expect will be on line within the next two to three weeks. And every week we have a target to convert some of this manual equipment to do it automatically.

[Larry Litton:]

The rest of that project is almost completed over the next six months?

[Martin B. Bloch:]

Way before that.

[Larry Litton:]

So this quarter is a real big quarter. In entering the second half for the fiscal year, things should be in place?

[Martin B. Bloch:]

That’s correct.

[Operator:]

Our next question comes from [Robert Smith - Center for Performance Investing].

[[Robert Smith:]

I want to revisit the gross margin targets. I think before we spoke of the ramp in revenues. Martin you were saying that you were targeting much higher gross margins I guess a year or two out. So I think you answered the question for this year, but how about subsequent years? You mentioned something in the area of the mid to high 50s or 60s in gross margin. Is that still a target?

[Martin B. Bloch:]

We have debt still on the books on this item. I don’t remember 60 but in the mid to high 50s, that’s our target. A lot of our expenses are fixed. As our volume goes up, the gross margins will significantly improve.

[[Robert Smith:]

So when do you think you might be able to approach that number? Two years out or what?

[Martin B. Bloch:]

Within the next few years. That’s my goal.

[[Robert Smith:]

Well a few is three or more.

[Martin B. Bloch:]

A few is two or three.

[[Robert Smith:]

And I’d like you to think about revisiting the dividend as well because I think I’d like to see you reinstate it when you can.

[Martin B. Bloch:]

We will review it on every Board meeting including the next one on October 7.

[[Robert Smith:]

I think it can differentiate you from others and there are institutions that will readily buy a dividend-paying security and others that will not.

[Martin B. Bloch:]

Thank you for your input. We will bring it forward to the meeting.

[Operator:]

Our next question comes from [Sam Robowsky - SER Asset Management].

[[Sam Robowsky:]

Martin, you’ve been rather positive in buying stock and I guess with most of the members of the Board with the stock price being significantly below their options and everything, I’m sure everybody does it individually. But I’m sort of being positive about your buying and hopefully the rest of the Board sees that as a good value as Frequency bought this block at $4.34.

[Martin B. Bloch:]

I only do what my conscience tells me. I thought it’s a good buy and I bought it. And the only reason I didn’t buy more is I wasn’t going to compete with FEI.

[[Sam Robowsky:]

Understandable. Basically but assuming that most of the options are under water and if some people wanted to have a little more stock or establish some positions, it would be a good idea to bet on FEI. Anyhow, just a suggestion.

[Martin B. Bloch:]

It sounds like a good one.

[Operator:]

Our next question comes from Larry Litton - Second Line Capital.

[Larry Litton:]

I just want to follow up on the gross margin question. The $2 million of troubled revenues in the quarter, did you book a loss on that from a gross margin standpoint for the quarter?

[Alan Miller:]

Those contracts resulted in more cost than we recognized in revenue.

[Larry Litton:]

On $11 million of business just coming back, the gross margins are reasonable. But you had an offsetting loss in the other business that pulled it down.

[Alan Miller:]

That’s correct.

[Operator:]

There are no other questions in the queue.

[Joseph P. Franklin:]

Thanks to all of you. We appreciate you coming on board especially since we’re competing with Secretary [Balson] at the same time. I’m sure there will be a rebroadcast of that for those of you who missed it. We’d like to say again that we’ve made some hard progress. Hard means it’s hard to do but it also means much is done and it’s hard in place, and we plan to take good advantage of that with significant growth in the following years. And this year as I’ve said, the full fiscal year will be a profitable one for Frequency Electronics. Thank you all very much. Thanks again to our employees from Martin’s greeting. God bless our soldiers. Till the next time.