Frequency Electronics Inc (FEIM) 2009 Q1 法說會逐字稿

Good day, everyone. Welcome to the Frequency Electronics Incorporated fiscal 2009 first quarter earnings call. Today's conference is being recorded at the request of the company. We will open the call up for questions and answers after the presentation.

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. Please go ahead, sir.

Thank you very much, Kevin and welcome everyone. I understand we have about 20 people on the line here. 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, quotes, end quotes, during this last quarter and that ended on 31, July.

By that I mean 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 but -- they were good 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 today our two other participants, Alan Miller who is 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.

Thank you, Joe and good afternoon, everyone. 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 was comparable to fourth quarter of fiscal '08 and make up over 30% of total revenues.

Telecommunication infrastructure revenue is comparable to the year-ago quarter and comprises about 40% of revenues. Non-space government and DOD revenue was 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%. Now this 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 on 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 expending 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 investments and other expenses, investment income rather expenses was $200,000, compared to $3 million a year ago. But, last year you may recall that a reduction in our Morion investment resulted in a $3 million pretax gain.

Our net loss for the quarter was $773,000 or $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. And 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. Where as 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. Now, this backlog does not include the full value of the the GPS III contract. Including the full value of GPS III our backlog would exceed $45 million.

Now 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 buyback plan. I'll be available for your questions a little bit later.

But at this point let me turn it over to Martin.

Good afternoon, everybody. 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 cost by implementing the following systems. To significantly improve our throughput through training of our employees and by introducing efficiency, by applying automatic test systems and by putting in automatic equipment for the assembly of high rail products.

This surge that we had in going from seven systems in 2006 to 147 systems in 2008, this was expensive and now we have to maintain the same or improve on this capability and significantly reduce the cost. I have every confidence in the people at Frequency Electronics that we will achieve those goals. I would also like to emphasize that we have won two very exciting Cost Plus programs and they are based primarily on the Research and Development that Frequency Electronics has done over the past five years.

The GPS III program, which we have outlined in the press release, is $11 plus million to develop precision timing system and microwave frequency generators for the first two spacecraft. And our success of achieving the performance will enable us to participate on the follow-on planned 36 additional satellites that will be procured starting in 2010 and then I believe 2012 or 2013.

The second Cost Plus contract is to develop a very advanced low noise timing system for secure satellite systems. And, again, that puts us an opportunity to significantly achieve bookings on future satellites with that system. And this Cost Plus will significantly, as Alan Miller has outlined, reduce our IR&D, which means in our language is internally funded R&D, and still be able to develop various advanced products for future application on this. We want to aggressively pursue the business on the wire line, based on the US5G products that I'm happy to report we shipped the first production units, I think it was the first week in September.

Alan, right? And to pursue the wireless business, for WiMAX and other application with our patented high performance quartz and rubidium clocks. Another very exciting field that we have invested a lot of Research and Development and we are seeing a payback is the low-G sensitivity. And the low-G sensitivity systems are very important on all moving platforms from ships to trucks to tanks to airplanes and to remote pilotless vehicles.

The objective is to obtain better security and communication systems with wider bandwidth and faster hopping speed, to achieve higher navigational accuracy for various missions and of course to be able to deliver our weapons with more accuracy, to minimize collateral damage and to achieve our final aims.

It's like peeling an onion, as we want to improve this performances, the effect of vibration and motion on our moving platforms are becoming a major problem that we have to overcome. Our new patented technology for this is very effective and we have prototyped about 20 different applications and we are now have on two programs, the preproduction units, and hope to follow on by production units in the near future.

I want to take this opportunity to thank all of the employees at Frequency Electronics for their enormous effort during those trying times, to achieve a major breakthrough in our ability to shift product at an enormous range. And I want to emphasize, again, that the Research and Development of the past put Frequency Electronics first in line on this advanced Cost Plus contract that we now have under our belt.

In the future we will pursue our main business areas, which are satellites, and this commercial communication, and military application for the application of low-G and rigid timing systems required for all of the military forces. With this I would like to open this to questions and answers.

Thank you very much. The question-and-answer session will begin at this time. (OPERATOR INSTRUCTIONS) stand by for your first question. The first question comes from Sam Bergman at Bayberry Asset Management.

Good afternoon, gentlemen, how are you?

Good afternoon.

Couple questions. First of all, can you tell me --

Would you address the question directly to one of the three of us?

Okay. Sure. Maybe perhaps Martin you can answer the first question for me.

Shoot.

How much is remaining of the low margin programs that you talked about in the press release?

Well, we expect to ship most of them out within the next four to eight weeks.

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

Well, yes, let me -- I'll give you -- I would say that 75% have shipped.

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

Yes, because they are on percent complete.

Right, they are on percent complete.

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

Yes. We have all the equipment in the place, I mean there might be some minor like couple hundred K left 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 with less errors and human beings and to achieve the same put through with a lot less touch labor.

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

I have it. It's 244.

That's here in New York.

Yes, in New York it's 244. I think worldwide, it's 450.

We're probably down to about 450,.

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

Talking about backlog now?

Not backlog, the actual pipeline of RFPs.

Oh, this is Martin Bloch. I'll answer that. We have -- for satellites we have outstanding about 100 plus million dollars worth of proposals. Only thing we cannot predict is when they are going to be -- when they're going to be placed.

Of those proposals?

Yes.

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

$30 million.

$30 million. And 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?

There's always going to be some unbilled receivables, so 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. We're down to about $7.1 million, so I expect that that number will come down substantially as of the end of the second quarter. But there always will be some number there. It's not something goes to zero.

And just had one more, so I won't get back on the line. I'll have somebody else get in on next on the buyback of the shares. Has that $5 million been completely filled or is there some remaining on the buyback?

No. The authorization was for $5 million we spent about four so far.

Okay. Thank you very much.

Next up we have a question from Robert Smith, Center for Performance Investing.

Hi. Good afternoon.

Good afternoon.

What did you guys pay for the stock?

The average price was around $4.34.

Okay. Second, you spoke of peeling the onion, kind of brings tears to my eyes.

(LAUGHTER). I know.

So Martin, we're not getting any younger, so how can you have misread this so dramatically. I mean a year and-a-half or so ago, we're talking about the build in revenues and the gross margins that you were targeting. You said you had equipment in to make this happen and bingo, what happened?

Well, 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 and that in 2008 we had to ship 147 to maintain this rate.

And 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.

And I'm happy to say that we have achieved it and we are delivering on all of the contracts but it was very brutal and expensive.

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

Well, we have shipped 70 plus percent and we expect on the last three contracts to be completed within the next four to eight weeks.

So the second half should be dramatically better?

No question about it.

Okay. Guys, I'm holding you to this.

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

Okay. Good luck.

Thank you.

Moving on to our next question, this is Sam Rebotsky at SER Asset Management.

Yes. Good afternoon, gentlemen.

Good afternoon.

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?

At the July, our backlog is -- 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 increase the value of the backlog by about $10 million when the contract gets fully finalized.

Is funding, is that what you need?

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

Okay. And as far as -- did you say that you expect to be profitable for the current year?

Yes.

And which quarter does that begin?

Third quarter.

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

Yes. We said our largest institutional shareholder is the one we [were hoping would buy a bunch of shares].

OKay. So would you want to have authorization to buy more? I mean, you only have another million. Do you plan to seek authorization to buy more stock?

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

Okay. And in the field, do you find that the -- I mean, you're bidding on 100 million plus business. Is this less business available to bid on than is normally available? Do you find there's less business that's -- so that's available to be divided amongst the competition?

No. What we find is that the timing is very unpredictable on this. On the commercial satellite business, there's a little upheaval in getting it financed. On the military systems, they're just unpredictable. And as example, GPS III was supposed to be placed on October one of 2008. And we didn't get it until May 15, 2000 -- on October one, 2007. And we didn't get it until May 2008. And some of the other Government Systems, they were all imminent, but somehow they slipped. But the opportunities and the number of satellites stayed about the same.

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

No, thank you very much.

Okay. Okay. Well, that's -- and what are your assets held in currently?

The investments?

Yes.

They're mostly in government agencies.

Okay. Okay. Do you still have Rex in stock or is that finished?

No, that was done a couple years ago.

Okay, alright. Are you looking at anything to acquire? Is there any opportunities that are out there or to add to your business or to grow your business?

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

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

I hope so.

Okay. Good luck.

Thank you very much.

We'll continue with David [Starkey] at Smith Barney.

Hello, David.

Hi, how you guys doing?

Is Barney still in business?

Who?

Is Smith Barney still in business?

Yes. Ask Mr. CitiGroup that question.

That's what I'm worried about with it dropping three bucks today.

I think we're doing okay though, but we'll see. I can't officially say anything about that. Couple questions for Alan here. On the stock buyback, you had about $14.3 million in cash at the end of the quarter. Did you fund the buyback from that cash?

Yes, primarily.

Okay. And couple other questions there. 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 here?

Well, there won't be a dramatic as we anticipate but there's always some inventory reserves that we put up as we go through the year. But no, the inventory primarily is spoken for, it will be applied to active programs.

You don't have any product obsoletion or anything like that in there or very little?

Nothing out of the ordinary. Every year we write off some stuff we reserve for. It's nothing terribly unusual.

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

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

Okay, great. For Martin, in this new 3G contract for the government here, this first $11 million is technically for just the first two satellites and you've only --

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

Okay. And was this a competitive bid that you won?

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

Okay. And then 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?

Well, it's actually official on this.

Yes.

We are -- we probably by tomorrow or the day after, we'll finish out all of the details of the ATP. This is normal way, by the way, Dave.

All right. Okay. And then you're saying that this total program is eventually going to be 36 satellites, so this is just for the first two?

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

Okay, great. And so you're looking at about $5.5 million per satellite out of this contract?

No.

Or --

A good portion of it is the development phase of it.

Okay.

On this, and don't want to put an exact number per satellite because it's competitive sensitive.

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

Well, the government will be very pissed if it's higher.

All right.

The objective for putting the development monies to come up with performing systems that are affordable and that's our objective.

Okay. But this is 36 satellites, this could be a program that runs ten or 15 years; right?

Well, the timing is that the next phase is going to be released by 2010 and then there is the next phase that is released by 2012 and I think all of them will be released by I think 2013.

Okay.

I'm not sure. But that's the time frame because they are timed very closely to replace the present satellites that are becoming either obsolete for accuracy or inoperative due to the absorption of fuel or other function on the systems.

Okay. All right.

This is not a luxury. It's a necessity.

Right. This is just one program that you have. There's a lot of other ones out there too, I'm sure.

There is.

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, and I don't think --

We've gotten already significant returns. The US5G for the wireline is a result of the development of Gillam-FEI and that has 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 a modern equipment that is very cost effective. And with FEI Zyfer we have gotten a GPS capability of precision timing and many systems we are pursuing that is based on our joint technology.

And you've already gotten some preproduction orders shipped; right?

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

And do they know what kind of review period for these things we're looking at before we -- ?

No this is past the review. This is just going straight in line.

Okay so now you should be looking at some production orders?

Well we shipped the production orders and we're waiting for the budget of the wire line, people which I think it's supposed to be released in November.

Yes, late this year from what we understand.

I think in November is when they budget on what they're going to procure for the next 12 months.

Okay. Just other question in general and 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?

Not really.

Not really. Okay. Is there anything to that really?

Well over the past couple of years, there's always been some wild guy calling, but nothing concrete.

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 discussion just with normal contract phases, parts of your business, with the Northrop of the world and things like that?

Absolutely. We're dealing with the fortune 25 companies is most of our business.

Right, okay. Well good luck going forward. We're going to hang in there.

Thank you, David.

Hi, Dave. Before you get off, how are you doing down there?

Well, it's a nice sunny day today.

Good.

So Texas got it this time. So we're okay here for now.

I've been speaking around the country. I've been avoiding the Southeast because of all your problems. After Christmas sometime I'll give you a call.

Okay. That sounds good. I'll have a place for you. Thanks a lot. Bye-bye.

Next up is David Shapiro at Aegis Financial.

Hi, guys.

Hi, Dave.

Just wanted to see, maybe Alan can answer this, just wanted to see the timing on these two large contracts, the GPS III and the Advanced Secure Space Systems program. For these first two blocks, the 11 and nine million block, 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 flow of those?

Well, let me -- this is Martin Bloch. Let me take it because I'm adjusting 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 is going to be an additional couple of years of testing and validating the systems because the whole idea of this system is to verify the longevity and reliability of this newly-developed system. Because they're really pushing the envelope.

Okay. So the revenues from these two contracts are going to flow through many years or -- ?

Well, a good portion will be spent in the first 18 months.

Okay.

And there's going to be some gradual -- after the development, the testing and validation and thermal vacuum testing to simulate space, takes a lot of time but it doesn't take a lot of dollars.

Okay. And then so you would expect that the sort of the next phase is for these projects would start up at some point in 2010? So you would get the initial phase done you now, then there would be some sort of review and then the next phase, if everything is going all right, would start up in '010, is that -- ?

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

Okay. That's helpful. And then on the sort of the cultural change that's -- that I think you mentioned earlier and that's gone on, what's sort of the target here for SG&A? I mean I saw it -- 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?

Yes, as revenues increase dramatically, yes, there is quite a bit of leverage in there. At these levels, at $15 million a quarter there abouts and $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.

Okay. So we should take anywhere between the $3 and $4 million SG&A level as appropriate, even as the revenues continue to ramp?

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

Okay. And then on the R&D side of things, that's sort of been going down for the last four sequential quarters.

Yes.

How does that look going forward, at this point?

Well as we indicated, 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 will see that effort, if you will be part of our cost of sales numbers. Those same individuals will not be charging our Internal Research and Development. That's why we think going forward for this fiscal year that the total dollars spent in R&D will be probably less than 10% of revenues, where as in the past we've been above that.

Okay. And then sort of where does that net out on the gross margins? Does it sort of net out equal to the fixed pricing contracts or sort of how do those compare with the fixed price contract?

Are you talking about the Cost Plus programs?

Right. How does the Cost Plus compare?

So the Cost Plus programs, the gross margins on those would be less than what we would historically see on a fixed price contract simply because you have a fixed percentages are part of the fee structure or are part of the cost structure. But we'd expect, coupled with the other programs that we have in house, that we would see an increase in our gross margin overall. [4%].

Okay. And then on the -- then on the CapEx side of the business you guys have some pretty fully depreciated PP&E there and you're going up into a production ramp. Is there any meaningful amount of CapEx that needs to be spent or are you guys really fully sourced there and are able to handle the volumes on your current PP&E level?

Historically we're not heavily dependent on CapEx. Last year we did spend about $3 million on some of the test equipment that Martin was alluding to earlier. Our more normal is probably around $2 million or less per year and this past quarter we didn't truly spend much at all, I think it was about $100,000 in just the quarter.

So, there's no big large upcoming replacement cycle?

No, we don't anticipate anything of that nature.

No, we have all -- this is Martin Bloch. We have all of the equipment in place as I mentioned before and there's going to be some minor round-up of building blocks to add for this automation, both in assembly and in test. There's nothing major is budgeted for this year at all.

Okay. And then 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?

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

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?

Well, not for stock for sure but for cash, definitely.

Okay. Thank you.

You're welcome.

Moving on now to a question from Robert Lambert.

Hi, good evening. Good afternoon I should say.

Good afternoon.

Feels like evening. Anyway, you did answer some of the questions. But can you go about the wire line synchronization equipment. Is that just a US product or can that be used in Europe also?

It's worldwide. We have -- the US5G was primarily developed for the American market and then we developed a US5GE which is for the European market and we have started installation in Europe and are trying to market it worldwide. But our two primary targets is the United States and Europe.

And how do we actually market that? Is that a sales effort or is that just proving out our equipment by them actually installing it, using a simulation? And then actually -- I mean, I know that they're going to be extremely sensitive to this.

Well, the first step is to go through all the qualification hurdles which we have completed. And now the equipment is on line and they're going to look carefully on how the equipment is performing, because we're now actually servicing active lines. And if there's 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.

Okay. Well, thanks.

You're welcome, Bob.

Next up is Larry Litton at Second Line Capital.

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

Well, it's somewhat dependent on the volume of business. If sales go up we're going to see some increases in some of those categories but yes, 4.5 this the ballpark, surely.

Okay and then R&D though now takes into account 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.

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

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

Okay. And exiting the year in terms of the fiscal year, what type of gross margin range do you think you'll achieve, Alan?

Gross margin range?

Yes.

It will be in the 30% level, mid-30s.

So 35%, plus or minus, you hope?

Yes.

And if I look at the $13 million in revenues today, how much of the -- what percent or what's the absolute number of revenues that's garnering very low gross margins there?

A million and-a-half, thereabouts.

So a million and-a-half of bad business in there?

Yes.

And I'm not doing the calculation on the fly, but is the other $11 million of business at that 30, 35% range.

Yes, it varies a bit on type of product, but yes it is in that range.

In terms of the share buyback 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?

We don't know. To tell you the truth. We will probably find out when they file their September report. 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.

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

Yes.

Okay. Lastly, 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 continue tinkering and installing it?

No, no, it's running full speed. A lot of the equipment are manually interfaced with human beings. What we're expanding the effort now, is to put computer software on it so the equipment can run automatically, 24/7 with minimum touch labor.

Okay and in phasing in that automation, what's the timetable for that?

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

But the rest of that project is almost completed over the next six months or over the next -- ?

Way before that.

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

That's correct.

Okay. Thank you.

We'll go back now to Robert Smith.

Yes, hi. Most of my questions have been subsequently answered, although 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 the subsequent years? I mean, you mentioned something in the area of the mid-to high 50s or 60% gross margin. Is that still a target?

We have -- that's still in 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.

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

Within the next few years, that's my goal.

Few is three or more, so --

A few is two or three.

(LAUGHTER) Okay. And I would like you to think about revisiting the dividend as well because I think that -- I'd like to see you reinstate it when you can.

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

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.

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

Thanks.

Next, we will return to Sam Rebotsky.

Yes, hi. Just one further. Martin, you've been rather positive in buying stock. And I guess with the 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 be positive about your buying and hopefully the rest of the Board sort of sees that as a good value as Frequency bought this block at 434.

Well, 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.

Right. Understandable. And 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 sort of bet on FEI. Anyhow, it was just a suggestion.

It sounds like a good one.

Okay. Good luck.

Thank you.

We also have a follow-up from Larry Litton.

Alan, 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? In the quarter?

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

Okay. Because -- so 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?

That's correct.

Okay. Thank you.

At this time, with no other questions in the queue, I would like to turn the conference back over to General Franklin.

Okay. Thank you very much, Kevin and thanks to all of you. We appreciate you coming on-board, especially since we're competing with Secretary Paulson at the same time. I'm sure there will be a rebroadcast of that for those of you who missed it.

We would like to say, again, that we've made some hard progress, hard means it's hard to do but it also means once it's done it's hard in place. And we plan to make -- 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. For Martin's greeting, God bless our soldiers, until next time.

Ladies and gentlemen, if you wish to access a replay for the call you may do so by dialing 888-203-1112 or 719-457-0820, use the pass code 2314071. This concludes our conference for today. Thank you all very much for participating. Have a good day. You may now all disconnect.