Frequency Electronics Inc (FEIM) 2006 Q4 法說會逐字稿

Good day and welcome to the Frequency Electronics fourth-quarter/fiscal year-end 2006 earnings conference call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. (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 will turn the call over to Mr. Joseph Franklin, Chairman of the Board. Please go ahead, sir.

Thank you very much, Pamela, and welcome everyone to our conference call with our fourth-quarter and year-end results from fiscal 2006. You all have received our most recent press releases I am certain. And I would like to repeat, I'm very pleased -- we all are -- with the results that we have achieved for 2006. We are very, very busy and looking ahead to growth in our revenues and operating earnings in 2007.

Our merger and acquisition activity -- opportunities is brisk, but we have nothing to report at this time. We did also report to you today that we're going to begin trading on the NASDAQ on the 18th of July, and I would note for everyone that our symbol will be "FIEM."

I will introduce the folks who are with me -- Alan Miller, our Chief Financial Officer, and Martin Bloch, our Chief Executive Officer. Alan will go through a granular look at our financials, and then Martin the things that are in the news, where we're going in business and where we are with products and with customers. After that, we will have a question and answer and look forward to talking to you then. Alan?

Thanks, Joe. Good afternoon, everyone. For fiscal year 2006, we reported revenues of 52.8 million as compared to 55.2 million last year. As we had anticipated a year ago, our first-half revenues had flattened out at a $45 million run rate. But with the new opportunities that were available to us at that time, we foresaw that second half of the year would show a marked improvement. We finished the year at a $60 million revenue run rate for the second half of the year.

Cost of sales were 34.2 million, yielding gross margin of 18.6 million. This is a rate of 35% as compared to 33% last year. This is the right trend, but we can do better, not only on increased revenue but also on the right product mix and is subject to fluctuations on long-term contract performance.

SG&A spending was 10.6 million compared to 11.7 million last year. This is a rate of 20% of revenues, which is at our target. We continue to invest in research and developments at the rate of 6.3 million this year; this is 12% of revenues. We expect to continue to invest in R&D at approximately this level. As sales increase, the spending will come closer to our target of 10% of revenues. We (technical difficulty) an operating profit of 1.7 million as compared to a $1.2 million operating loss last year, representing a $3 million upswing from the prior year, even though sales were slightly lower -- continues to demonstrate the operating leverage we achieved as revenues continue to improve and costs are contained.

Last year, you may recall that we had some substantial gains on the conversion of our real estate units, or REIT stocks, and subsequent sale of those shares -- 6.9 million. We sold the balance of those REIT shares in the first half of fiscal year 2006. And with some other real estate transactions, we resulted in an additional $3.2 million of real estate-related gains in the current year. So, the end result is a pretax income of 6.6 million compared to 7.2 million last year, a net income of 4.8 million or $0.55 a share compared to $5 million last year and $0.58 a share. That's after an effective tax rate of 27.5% compared to 29.5% last year.

Turning to cash flow, for the year, we resulted in a $2.5 million negative cash from operations, but this is after we paid $3 million of taxes on the prior-year investment gains that I referred to. Absent that, we would've reported a positive cash flow of $0.5 million. We had actually anticipated that we would show positive cash flow despite the taxes earlier on in the year, but the timing of progress billings on certain long-term contracts slipped into fiscal year 2007. And, that of course is reflected in the receivable balance, which is up about 3.2 million from the prior-year period.

Inventory is roughly flat from what it was last year. At the end of the year, our backlog is up almost 20% from what it was a year ago at 36 million. Our book-to-bill ratio for the year was about 1.1, which we expect to see continuing.

I will turn the call over to Martin at this point.

Good afternoon, everybody. In short, business is brisk and very exciting, and we're very happy with our opportunities. I want to address the markets we are involved in one at a time.

As you probably have read in the newspapers, the wireless warning from people like Lucent, Motorola and Nortel are negative. However, for some strange reason, we have are seeing very brisk activity -- hard for us to really model the business opportunities in that area in the short-term. We know that the long-term is very promising.

Just a couple of years ago, close to 60% of our revenue came from the wireless industry. It is now down to approximately 30 to 35%. The diversity of the market we addressed in satellites/military with a new product that was developed, especially the low g product, and the patented quartz have more than made up for the shortfall in that area.

We continue to invest in future products to address upcoming markets. And, our patented quartz product is finding its way in new applications, and we will be addressing the WiMAX opportunities in terms of the very exciting market that's in the military for the low g ruggedized units for which we have prototyped, as we've mentioned in the press release, over 15 major systems where we are a critical part, which we hope will go into production. Some of them will definitely go into production in the near future.

I would like to address that because of our investment in inventory, we're able to respond to the new satellite market and that gives us great opportunities. The demand is for products that can be turned around in less than a year from beginning to end in order to meet the replacement and the new application. Frequency Electronics is in an excellent position to supply cost-effective solutions timely. So, both with our investments in technology and investment in long lead delivery items in our inventory, we're able to make that response.

The activities, as we mentioned in the press release, in proposal is very high. We can do very well on addressing and capturing a small portion of a new commercial and military satellite market that's emerging in this coming 2007 and 2008 and beyond. I would not like to take anymore time up and leave most of the time for you guys and women to ask any questions you have.

Okay, Pamela, let's go right to the questions/answers.

(Operator Instructions). Hardin Bethea, Deprince, Race and Zollo.

I think the first question is for Alan. The progress billing that slipped into fiscal '07, has that subsequently been received?

It hasn't been received, but it has been billed. We expect payment shortly.

The other question, Alan, would be related to -- relative to the fourth quarter rather than full year gross profit and R&D expense. Can you describe the factors that caused gross profit to decline sequentially on flat revenues as well as significant increase in R&D expense?

Yes, I kind of alluded to it in my commentary about these fluctuations in long-term contracts. In the quarter, we did experience some challenges on a couple of programs that at these revenue levels will have a more magnifying effect on our operating results in a particular period.

In R&D, (multiple speakers) the research and development activity is pretty much in line with what our expectations are for the quarter. It's going to be fluctuating from quarter to quarter. I think it was rather low in Q3 by comparison because we had a lot of people dedicated to specific funded programs if you will. As they got freed up, we put them back onto these development activities. So, we're rolling out some new activities as well as we identified.

Hardin, did you hear it?

Yes, I did actually. Sorry, I had it muted. A little more detail on the gross margin issue. So the challenges you speak of are related to delivering against the contracts or is it more just the timing of costs without revenue?

I'm not sure I quite follow you there with a cost about revenue.

There's a 330 basis point sequential decline in gross margin on flat revenues. So, either there's a big mix issue or you're having cost problems.

This is Martin Bloch. On a quarter-to-quarter basis, it's not unusual to have a couple of points fluctuation on one of two contracts in the mix on this side. We have to look on what's happening on a year-to-year basis because that's more representative of the way frequency operates. So, we don't expect any decline in margins going forward, if that's what you are asking.

Yes, that's perfect.

Thank you. I knew what you were driving at.

The tax rate is the other thing, Alan. Could you tell me how you recorded a benefit without a loss?

That was basically a correction, if you will, of the more conservative approach we've taken in the first half of the year. I think we were accruing taxes at around a 34% rate. Then when you finally go through all the timing differences at the end of the year in more detail, determined that the more appropriate effective rate is around 27.5%, as I saw that was sort of a giveback to prior overaccruals.

What about for '07? Is there an expectation for the tax rate?

Yes, I tried to be a little bit conservative in that, so I usually go with about a 30% number. So, I think that's probably where I would expect it to be.

Okay, and is there anything at this point, Martin or Alan, that indicates significant quarter-to-quarter fluctuations in sales from the last couple of quarters' higher level?

You always ask that question, and we always give you the same answer. It is very difficult for us to predict on what happens quarter to quarter. As Joe has mentioned in the opening statement, we see that fiscal 2007 will have an increase in sales and operating profit. And the model is on a quarter to quarter; another type of satellite and military and even the wireless business is almost impossible. So, we can see the year. We cannot see what happens on a quarter-to-quarter basis but the year looks great.

What about, Martin, maybe -- could you describe what you are seeing currently on a terrestrial wireless side?

Well, we have been going -- you probably read all the warning reports that came out from Lucent, Motorola and Nortel, and we don't understand what's going on because we are under enormous pressure to increase output at phenomenal rates way beyond that we expected. So we don't know what's going on, either there are decreases in other areas of business or there's some gigantic bump that they are now facing.

So it's a very difficult way to predict on what's going on there. It's clear to see what the long-term is. The long-term is they are going to need lots of more space station and lots of more pico cells and lots of more pico cells for the WiMAX technology. That's where we will do very well with our new developed products.

How much of your inventory is either guaranteed or in some way supported?

(multiple speakers) It's about roughly two-thirds that you committed or a work in process or guaranteed.

Buddy Howard, TM Capital.

I had actually a clarification I guess from one of Hardin's questions. As I look at it, it seems to me that in the fourth quarter, you actually had one of your more profitable quarters in the sense that if you look at SG&A that actually dropped well below the 20% that you typically target, your 16% of revenues if you look at SG&A. My first question -- will it be back up? Point being that if you take the sum of the cost of goods sold and SG&A, you actually had the lowest cost ratio in the fourth quarter that you did in any of the quarters. So I think that's an important point that's worth bringing out.

Then my other question that relates to that is SG&A in fact was lower than what I thought it was going to be on a percentage basis. The gross margin was lower also than what I thought it was going to be. I just wondered, was there any kind of reclassification or anything like that when you did the final numbers that resulted in that?

If you're saying -- asking I guess whether there's reclassification from overhead or to SG&A -- no, that does not occur. There perhaps are some previous quarters where we had accrued some additional expenses that did not materialize like compensation because we anticipated higher profits or something of that nature, things of that nature could impact the level of SG&A that we reverse the overaccruals. I don't have any specifics at this point that is of any sizable amount to report. So, it's just an aggregate amount of things that are happening.

As far as the cost of sales is concerned, we kind of discussed that with respect to the one of couple programs that we ran into some challenges on.

In our type of satellite business, it's not unusual to have a couple of points fluctuation on a quarter to quarter on one program and that affects it. That's why we have to look at what happens over the year, both in sales and in gross margin.

Why was SG&A -- how are you able to get the kind of operating leverage in that area then that you are able to? I mean you are at 16%. You typically target 20% as a goal. You have not been close to 16% in recent past. Is there anything behind that? Do you feel like your normal rate is going to be between the 16 and 20%? I was a little surprised it was as good as it was.

I don't know that I would anticipate we would be at 16% on a go-forward basis all the time. There are some -- as I said, some things that have been incurred, but we probably did not incur as much in commission expenses this past quarter as we might have had in preceding quarters. It's a broad mix of things that goes into it. As I said, compensation is another factor that goes into that.

But we target 20% as a maximum; that's our goal. We want to drive that number down as we go forward. And as our value will go up, that's going to be our challenge to drive that number below the 20% maximum target that we set for ourselves.

Good, all right. Can you talk a little bit more about the satellites and particularly I would be interested in knowing how the sort of average revenue per satellite is changing and if you can give us any -- if you can quantify that in some way as you have sort of provided I guess a broader set of components that go into the satellites. And also, if you can give us some feel for just the volume in terms of number of satellites and some of the information on the quota activity.

Okay. Traditionally, we provided the timing solution for the satellites, which varies between 0.5 million and $1 million per birth, depending on their complexity and accuracy. With the investment in IR&D, we developed a family of frequency generators and we are now finishing the development of up/down converters. What this means is that there is one triple redundant clock on a satellite that could be anywhere from 30 to 70 channels per satellite. So, the frequency generator numbers go significantly up.

To translate this into revenue, instead of having an average of about 0.5 million per satellite, we now have an average of about 7 to $10 million per satellite. And when we continue qualifying the up/down converters, that will further increase. If you take a look at the number of satellites that are predicted on an average to be purchased over the next five years, the best estimates of the study is about 170 satellites, so that calculates about between 30 and 35 satellites per year. We based our business plan on a 20 to 22 satellites that will be purchased. You can see we don't have to win many of those satellites to significantly increase our satellite business.

So, we are very encouraged. Our proposals are very brisk on those satellites. In the next month, I know that there are going to be placed -- someplace between three to five additional satellites, which we have proposals in for.

How many do you have actual contracts for now?

On commercial, we have five. On military, we have 1, 2, 3 -- 4.

And those would be delivered over -- or the revenue would be recognized over what period?

Well on the commercial, all of them have to be delivered in fiscal 2007. On the military, they stretch out longer on this.

And is there--?

By the way, only two of those five commercial satellites were we successful in getting the clock in addition to their freq generators. The other three we're supplying a smaller portion of it.

Okay, all right, that's fair. Is that a fairly typical ratio that you think you'll get?

We are pushing very hard to get all the frequency generators on there, and we're competing with in-house capability. So as their need to reduce costs and reduce cycle times, we stand better and better opportunities to capture more of those -- the clock plus the frequency generator.

I think you are going to have a follow-up from another person I talked to earlier about China. But can you talk a little bit about China and the wireless piece and kind of what you are envisioning for that?

Well, only the Chinese know. We hear very exciting things with prototypes. Four out of the six major Chinese equipment manufacturer -- what is going to be their result and which way they are going to go -- are they going to go with their home-grown CDMA, or are they going to go with the established technology of CDMA and GSM and UMTS? That is something that nobody at this time knows. But they must conclude within the next couple of months if they are going to be ready for the Olympics. So we were forced to play all of those possibilities since we don't know which way they're going to go.

Marc Robins, Robins Group.

Help me understand R&D. I know this is a fairly rudimentary question, but I'm trying to catch up on things. When you classify things in R&D, what does that really mean? Is it new technology or is it development of existing technology? How would you characterize that?

This is Martin Bloch. I will take that question and it's a good one. And basically, IR&D -- that means internally-sponsored IR&D support the development of new products for upcoming markets or products that are necessary for the same -- for the existing market, which is not met with existing technology.

Let me give you some example. There was a need to have a super performing fourth clock for the wireless and the WiMAX in a pico cell market that are coming out. They could not afford the price of a rubidium atomic clock, and they couldn't afford the power drain. So they wanted what we labeled as a him poor man's rubidium. That means a fourth clock that does almost as good as rubidium and is considerably more cost-effective, has higher reliability and uses one-tenth the power. We identified that market. We developed it -- the clock. We were very successful in obtaining two passes to cover it.

Another example is there have been a 30 year need to improve the g sensitivity of clocks in order to improve secure communications, weapon delivery, identifying targets, improve navigation and interoperability between various services. Since 1955, the limit was a positive ten to the ninth per g, and that was a severe limitation on this equipment. We've been studying it for a long time. But in the last three years, we came up with an approach where we develop low g sensitivity that will improve it by a factor of 1,000. And that's opened some new markets for us in a variety of systems, such as the new fighter -- the upgrades of the C-130 and the F-15 and the remote pilotless vehicles and secure communications systems that goes on land and sea and air vehicles. So those are specific items that we are identifying in R&D, solve the problems and whenever applicable apply for patent.

But if you have developmental R&D and it's not IR&D, is that paid for by the customer?

Of course, many --

Is part of the cost of goods sold and so forth mixed? And so what I'm trying to distinguish is if you do -- your R&D is truly new frontier R&D or product modification R&D?

It's both, but it's basically not related to a specific project on this because related to a specific project is the government or the customer pays for it. So I will give you an example. We just delivered advanced EHF clock for their satellite system. There was a significant amount of R&D expended in order to achieve system requirements and it was all paid by customer.

I would like to shift the questioning back to the gross margin. And again, I apologize fellows. I'm not trying to be difficult; I'm just trying to understand.

No problem.

I'm curious first of all, how much of your business vis-a-vis the military, does it come under say a percentage of completion contract versus just a regular normal purchase and payment?

Well it does depend on the size of the contracts that we have and the nature of them. But of the revenues that we generated from government-related activities, as you said, we imported 13.3 million in this past fiscal year. A lot of that is not under percent incomplete because it comes from our Zyfer folks, who sell pretty much well-established parts and products systems. So roughly, about half of the 13 pre-used is probably coming from percentage of completion contracts.

So I guess what I'm wondering, half of only the 13 million of the 50 some odd million?

Half of the 13 million.

Yes, okay. So --

(multiple speakers) that's recognized revenue on so many of the space programs as well.

Say that -- I missed the sentence; I'm sorry.

Many of our space contracts are also on a percentage of completion basis because they are likewise long-term contracts.

And approximately how much would that be in dollars?

That will be 14.7 million that we recognize, and this is a mix here by the way of government and commercial. So the bulk of that is recognized on a percentage of completion basis (multiple speakers).

In this quarter, you just had some costs and so forth that there were some problems putting together the instruments that you were putting together. Would that have been say more of a percentage of completion kind of pickup or would that have been just the other side?

It can affect any of the programs. Basically, yes, you have a very severe test and qualification program. During the test cycle, you uncover something that -- excuse me -- that does not meet the system requirements and you have to redo it. It happens from time to time.

Martin, I will go on because it sounds like my questioning is causing apoplexy with you.

No, not at all. I just ate a cookie in the wrong pipeline.

Well, stay away from those cookies; they can kill you. Help me -- and I apologize to the other listeners because these are such rudimentary questions. You said that the demand for clocks for communications -- wireless communications was robust or that wasn't actually what you were saying -- was not unbelievable but very robust. I guess my question is, are these being used for base stations? Where are they being used? Can you tell us that?

The increase that we have gotten -- the increase in demand have been for base station.

[Morgan Frank], Manchester Management.

Just some housekeeping. What were the breakdowns in the quarter by group, like how much was commercial communications? What was Gillam? What was Zyfer?

Reverence?

We kind of alluded to this in the discussion in the press release, and that is (multiple speakers) --

Right, but there was nothing really broken up by quarter and then also you (multiple speakers) -- you sort of started changing the way you have done categorization and so it's a little confusing.

Yes, I understand. That's why we try to give a little more information about markets. So, I don't have readily available what was specifically commercial communications versus US government because the US government, as we indicated, is part of the New York operation (multiple speakers).

Right, so what were the two in aggregate for the quarter?

The two in aggregate -- we had 34.8 million at the New York location and Zyfer --

But that's for the year (multiple speakers). I'm looking for the quarter.

Out of the 15 million. In a moment -- he's looking it up. Do you have another question?

Yes. What were bookings for the quarter?

I have no idea. I will check this up for you too. I know that bookings was about 20% above our target for the year. But what happened in this quarter, I don't remember. But I will look it up.

Let me think if there was anything else. What's the status of the deep hole drilling product?

Very exciting there. We are way ahead of the schedule in delivering the clocks. The big problem is our customer has to update all his software and the analysis in order to make maximum use of that improved capability. And they've ordered some limited number of additional clocks and they are getting great results. But they have a lot of work to do in trying to improve their models in order to take advantage of the enormous improvement in accuracy that they are now getting.

You probably have seen and read that many of the present oil fields, they are exploring the lower levels below the surface in order to increase future production. And that has significantly increased the demand for this equipment, so our customer is working around the clock to try to get their gearing in place because everybody is waiting for them to solve the problem so they can start drilling.

So when do you expect this could begin to become you know a meaningful business with you guys?

I don't know. I can't predict. The only thing I can tell you is that it's going to be a contributor to the profitability of the Company because it's such a high profit margin device. When it's going to happen, I have no control of.

But is it just -- I mean even ballpark, is it six months, six years, two years?

Yes, six months to a year. They were supposed to have all those problems and software resolved last year. But you know the whole saying in this case is that software is like a deep black hole. In this case, it applies double. So they are working very hard to get those resolved, and they have customers standing in line for those equipment. And we will keep you informed as we get better definition from them.

Okay, so did you guys ever come up with the segment data?

Yes, from New York, it was a combination of the government and the commercial -- it's about $11 million -- just shy of 11 million. Zyhper did two and Gillam about 2.5. About two-thirds of Zyhper's business is government on a pretty consistent basis, so you can kind of figure out where we're go with that one.

So basically, everything was -- these things were relatively -- okay, I got it.

Yes, they were pretty flat from quarter to quarter.

Where is the US 5G in its qualification cycle right now? How long?

It's being tested in what they call an office application, and we are all waiting for the RBOCs to really start rolling out the replacement plan and the upgrading of the offices, which is moving very slow. But again, we cannot predict what's going to happen. But the equipment is performing very, very well and being very well accepted.

Good. I think that takes care of me -- one (multiple speakers) --

By the way, you did see that we were successful to get the first contract on a US 5G in Europe so that was very encouraging. It's the first one. And after 5.5 years of development, it's very gratifying.

Good. A parting thank you for moving to NASDAQ.

Our pleasure.

I know that some of us have been less than shy with our opinions about this in the past, but thank you for listening.

Well, we are listening. It takes us a little bit longer sometimes.

Perseverance pays off, Morgan.

All is well that ends well.

Dr. Robert Lambert, RLR Capital.

This is a follow-up to Buddy Howard's question about China and wireless. I'm really into wireless. I guess my largest investment is into another company that is making a higher scale. I think it's encouraging with especially the report that came out of Ireland today that we're going to see China move probably in the next 90 days. My question is, how lined up are we for getting the business, not only in China but in India?

In China, we have an operation and we are quite embedded in many of the systems that are rolling out. In India, we're supporting the major suppliers, primarily Motorola and Lucent, that are really driving to get that business. In India, again one of the things that they emphasize is that cost reliability and power is important. So the new quartz that we developed for the base station is baseline for that application on this area.

When you start to think of the amount of power cell, whatever, it gets pretty large numbers.

The numbers are astronomical if they materialize and if they are still (multiple speakers) needing a couple 100,000 base stations.

Right. So assuming that this happens, can you say that we would get the majority of that business?

We sure deserve it. But how much we're going to get is hard to predict. But we have constantly been able to increase our market share in this area, so we're very encouraged.

I just think that is a very exciting future for us, and I think that future might be a little bit sooner than maybe you think. Because like you said, the Olympics is in 2008 and I would guess that they are going to have to start this before the end of this year.

Well I was last year in China, and they told me that they had to start it by December of 2005 in order to meet their schedule. But you know the philosophy in China is that we have to make decisions in four years because our president change or he needs to be reelected. The Chinese philosophy is they have 30 years to make changes. But I believe with you that at this time, I think they haven't got a choice. They really have to make the decision. From all the planning that I've seen, if they don't make a decision by October, they are not going to be ready for the Olympics.

[Dave Starkey], Smith Barney.

I had a couple of quick questions for you on the backlog situation. Can you tell us anything about you said bidding activity is strong. Is that holding up for the first quarter here so far?

This is Martin. Their activity is faster than we've had in the past five years, and there's just enormous demand for us to get proposals finished and delivered to our customer with fast turnaround. To give you an idea, this week alone, we will be submitting 11 proposals.

How is your capacity looking for to handle what could be a big increase in business here over the next couple years?

We are working very hard to increase our capacity, and you have hit the nail on the head. That's a major undertaking that I am spending a lot of time. I'm dividing my time between proposals and working very hard to increase our capacity, especially in the satellite arena.

I know you can't really predict this. But overall then, even with perhaps some increased cost of new plants and equipment over time, you expect with the new products your margins to at least stay steady?

It will be improved. By the way, we need very little improvement in equipment and plants on this. We have -- of course, satellite doesn't take a lot of space. What we need is a few good people. That's the major investment that we have to make.

So you anticipate your satellite business is going to become bigger and bigger as a percentage of your overall business, or do you think the government business with the new programs now (multiple speakers) --

Well, they are all growing and it's hard at this time to see this. They all grow at different times. But we're doing great with the government and we're doing very exciting with the satellite, both commercial and military. And the wireless, we're just holding our breath to see how it's going to expand on this. In the meantime, we got ourselves ready to be able to respond to this burst demand.

Great and from a cash flow standpoint, Alan, do you see that improving over the next 12 months?

Absolutely.

It sounds good. It looks like your ducks are in a row, and we're ready to hear some more good news. One other quick question -- are you going to be a little more -- I know you've moved over to the NASDAQ now, which is great. I vote for that also. But as far as another shareholder-friendly thing, some of these larger contracts as they come through, will you be actually announcing those instead of going two or three months without any press release this year?

Yes, we are a little bit shy on that item but we will do better.

Hardin Bethea, Deprince, Race and Zollo.

One question related to government opportunities. I know in the press release, you indicate the results -- well, 15 important weapon programs today. I guess what I am more interested in is the final sentence in that bullet. Many of these programs represent large potential future revenue opportunities for the Company. The timing of that -- of those opportunities, is there something that is elusive to me. Can you help frame that opportunity a little better?

Well, they are elusive to us too and that's why we have to support both the new initiatives as well as upgrading on the platforms because we don't know which ones are going to win out and go. That's why we're supporting all of them. We're getting encouraging indications that secure communication has to move out because it's a necessity. It puts American lives in harm's way because our enemies can test and test and decode our present radios. Some of the smart surveillance and weapons are being pushed ahead, so we think that they are going to have to sooner than later. But the exact timing is hard for us to predict.

Hardin, Joe Franklin. I haven't been in the business a few years back in uniform. The way the government works, you have to take into account here too. Because that budget every year, it actually comes down to the service that has the responsibility to develop a new program is always at risk, depending upon what O&M is, what other costs are going to be in development for the service.

So it's very hard for us to be able to say when a new program is online just how much money is going to be coming into it every year. And we don't get funded -- Martin made reference for example, a satellite that might have four or $5 million of work on it -- but we don't get funded for that immediately for the 4 million or the 7 million. It comes in tranches.

If the budget for the government is reduced or for that unit of the government is reduced, then they wind up with a little bit less in the coming year. That's what makes it very difficult for us to be able to give you a forecast that says, yes, we have this program. It's going to be finished at this time and this is how much it's going to be.

But what we can do is that -- and we will do a better job on this -- as those programs become visible to us, we will more publicly announce it so you guys can track it better.

I go back to the presentation on your website that indicates the government/Department of Defense market opportunity over the next five years of a very large number. That's at least addressable by product you produce. Again though, over the next five years doesn't help me understand potential ramping in volumes of product once the orders are released or once really -- because at this point, you don't even have -- you have development orders -- development projects (multiple speakers).

We have development and we have preproduction. You know the basic sequence in government is that your first do development model to demonstrate the principal. You then go into limited production. And then after limited production is validated, not only is it good but it's producible, you then go into production. So out of those 15 programs, about 5 of them are limited production. So I expect that some of those programs will materialize in the next 12 months. On a quarter to quarter, it's impossible to predict.

I guess as it relates to the space portion of the government DoD opportunity, how much of that opportunity is already included in the four military satellite contracts you already have?

Ask that again. I'm sorry --

You said currently, you have orders for nine satellites -- five commercial, four military and deliverable timeframe for the military side is longer than just fiscal '07. So, I guess I'm trying to understand the magnitude of those contracts and you know --

Well the commercials are fully funded, and so there's no question on this. On the military out of the four programs, we have Phase I funding on three out of the four and one is totally funded. And the additional funding that we expect is this October.

So okay, the new government year.

There is a new fiscal year on this. So we have -- we've been given enough money for long lead and the development portions to last us through November with anticipation that the additional -- that Phase II will start by October 1.

Joe, at the beginning of the call, you mentioned that M&A opportunities were brisk but nothing had been identified specifically. Can you kind of describe the parameters the Company uses to gauge the attractiveness of a potential acquisition target? Can you kind of from a high level describe as well where that activity is focused?

(multiple speakers) I'll start but I want Martin to talk particularly about how we put our technologies together. We want to be accretive first and foremost; that's natural. And then it's looking for the technology matches that make it either additive to what we do or supplements what we do. I'll let you talk more to that, Martin, on the technology side.

Well, basically, the two most important criteria is we want to stay close to our knitting, so we're looking for partners or acquisitions in areas of RF microwave technology, where this is where we see the largest expansion for military and the satellites. Of course, the next criteria is that we want to make sure it's accretive. So, those are the opportunities we're examining and we're trying very hard to -- it's easy to get something. It's difficult to get something that will fit in and produce long-term profitability and growth. But we're actively looking on quite a few opportunities. As soon as they become definitive, we will of course be required to make them public.

Is there an -- I guess given the nearer term and more exciting opportunities in the satellite business, are there -- since you compete with internal in-house portions or divisions of integrators, you know maybe a larger company that has an in-house development team and that produces subassemblies and all of that stuff, is there an opportunity for them to outsource that to you?

Are they trying to prevent it you mean?

No, no, no. I mean is that an opportunity?

It is an opportunity and we're definitely looking at a couple of those exact opportunities of can we take over that and achieve their ultimate goals, which is basically to lower their cost and what's most important lower the cycle time. We're looking at such opportunities.

I guess really, you are just acquiring people more than anything else.

Well people is the key. The equipment requirements for satellite equipment in our technology is not a significant investment; it's really negligible. Key people, skilled people is number 1, 2 and 3 on our hit parade.

There appears to be no further questions at this time. I would like to turn the call back over to you, Mr. Franklin, for the closing statement.

Thank you, Pamela. On behalf of Alan and Martin and myself, thanks to all of you who tuned in. We are happy to be able to speak to you and give you as much insight as we can now on where we're going. Things look very positive. We're going to be very, very busy in the months ahead with all the things that we've been discussing. So we will take to heart the comments and some of the things you've offered us to keep you informed and going to look to be sure to be back to you here at the end of September, at the end of this quarter and be able to report again as we are saying today for this year, we're going to be increasing our revenues and our operating profits. We look forward to a very good year. Thanks again to everybody. Bless you all and god bless our soldiers.

Thanks, everybody. Have a good day.

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