Frequency Electronics Inc (FEIM) 2010 Q3 法說會逐字稿

Greetings and welcome to the Frequency Electronics, Inc. third-quarter fiscal 2010 earnings release conference call. Any statements made by the Company during the conference call regarding the future constitute forward-looking statements pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements inherently involve uncertainties that could cause actual results to differ materially from the forward-looking statements. Factors that would cause or contribute to such differences are included in the Company's press releases and are further detailed in the Company's periodic report filings with the Securities and Exchange Commission. By making these forward-looking statements, the Company undertakes no obligation to update these statements for revisions or changes after the date of this conference call.

At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, General Joseph Franklin, Chairman of the Board for Frequency Electronics, Inc. Thank you, Mr. Franklin. You may begin.

Thank you, Christine and thank you all for tuning in. I am very pleased to be able to bring this report to you this morning. As we have put in our press release, you have seen a very positive outlook, we have increased our operating profits and that is due to the operating efficiencies we have been working on for some time. They are being confirmed and they are paying off.

Our cash position has increased and the work that we are doing on our standardized space products will help us gain a larger share of the satellite market and that is just about ready to go onto full scale. We are sole-source on a number of very large government programs and that means we are going to look ahead to significant additional bookings in the follow-on phases of these programs.

I am joined today with our Chief Executive Officer, Martin Bloch and Chief Financial Officer, Alan Miller, who will comment on the details of those things and then we will have questions and answers to follow. Let me turn it over to Alan right now to give us a financial report.

Thank you, Joe and good morning, everyone. Revenues for the third quarter fiscal 2010 were $12.5 million compared to the year-ago period of $13.2 million in revenues. Year-over-year, our third-quarter telecommunication revenues were 5% lower, but the mix has changed. Revenue from wireless telecommunication equipment sales continued to decline, but sales of wireline synchronization equipment, including our US5G products increased by 20% over last year's third quarter.

Revenues from satellite payloads were comparable to last year, accounting for 33% of fiscal 2010 revenues versus 32% last year. Revenues from US government programs remained strong while commercial satellite program revenues continued soft.

Revenues from our US government non-space program continues to show strength, increasing more than 25% from the year-ago period and accounts for more than 20% of consolidated revenues.

Other commercial revenue in the third quarter of this year was off by $1 million from the year-ago period accounting for the largest change in year-over-year revenue. Cost of sales was $8.1 million compared to $9.7 million a year ago, yielding a gross margin of $4.4 million compared to $3.5 million last year. This is a rate of 35% compared to 26% gross margin rate in the third quarter of fiscal 2009.

The gross margin rate year-to-date is 36%, which is within the range of our expectations as we have previously discussed. Prior to fiscal 2010, we struggled to achieve that level of performance due to the now completed challenging satellite programs.

With the present mix of revenue sources and combined with cost cutting achievements, we anticipate that the gross margin rate for Q4 and for all of 2010 will be in the upper 30% range and we're very pleased to achieve this gross margin rate at these reduced levels of revenue.

SG&A for the third quarter was $2.6 million compared to $2.8 million last year. For fiscal 2010, the SG&A expenses were 20.8% of revenues compared to 21.5% last year and compared to the Company's target of 20% or less of revenues.

The Company's cost-cutting achievements have reduced SG&A expenses by $850,000 year-to-date compared to the nine months of fiscal 2009. R&D spending was $1.5 million compared to $800,000 last year. During the second and third quarters of this year, the Company engaged in a few intense, but short-term development activities, primarily related to new space hardware. This caused our R&D spending to spike above the Company's targeted 10% of revenues for the quarter. Year-to-date, internal R&D spending is at 10.9% of revenues. We expect internal R&D spending for Q4 to decrease from the present level.

Operating profit for the third quarter of fiscal 2010 of $314,000 compared to an operating loss last year of $216,000. Other income and expense in our third quarter included a $306,000 net loss from our equity investment in Elcom Technologies. This loss is composed of our equity share of Elcom's quarterly income, which is offset by a $350,000 non-cash impairment charge based on a reevaluation of the market value of Elcom, a privately held company.

Although Elcom recorded a profit last quarter, it continues to face challenges in executing its business plan. Nevertheless, because of its core technology, Elcom provides a strategic benefit to Frequency.

Now we had a pretax profit for the quarter of $79,000, but you will obviously note that we recorded a very large tax benefit of $1.97 million. As you may recall from last year, in fiscal 2009, Frequency recorded an $11 million loss, which included a $5.3 million tax expense. Under accounting guidelines, the only tax asset we could record last April was the value of the tax refund we expected to receive from carrying back the taxable loss to a previous profitable year. At that time, that meant a carryback of only a portion of the tax loss to the two previous fiscal years, which permitted us to record an income tax receivable of about $900,000. Our expectation was that the remainder of the tax loss would be carried forward to offset future taxable income.

Then last fall in November, as part of its attempts to revive the economy, Congress passed legislation which permitted corporations to carry back tax losses for up to five years. Naturally, Frequency availed itself of this opportunity and we thus carried back the entire tax loss to a more profitable year. Thus, we filed a claim to receive a federal tax refund of $2.8 million and we expect to receive this cash within the next few weeks.

To account for the new receivable, in the quarter ended January 31, 2010, we recorded a tax benefit of $2 million, the amount by which the actual refund exceeds the original receivable we established last April. And of course that led to a net income number for the third quarter of this year of $2 million, or $0.25 a share compared to $0.01 a share last year.

For the quarter, we again reported positive operating cash flow of almost half of $1 million and we have now recorded $3.1 million of positive operating cash flow year-to-date. Our net cash at January 31 increased to $16.9 million from $13.8 million a year ago or at year-end, I should say, and this is after repaying $1 million of our line of credit. And when our tax refund arrives, cash will further increase by the $2.8 million that I mentioned, which would bring us close to the $20 million mark.

Backlog at January 31 was $32 million. Now backlog this year has varied from a low of $31 million to $37 million this year, which is very typical for Frequency as a single space program could add $5 million to $10 million at any one time. At this point, I will turn the call over to Martin.

Thank you, Alan. This is Martin Bloch and I would like to make a few brief comments and leave most of the time for questions and answers. We put an aggressive plan in place at the end of our three years of putting an enormous amount of development in new space hardware and our objective for simple and straightforward improved our performance and throughput with increased efficiency, our developed, our new products, proprietary products for space support our existing customers so we can be in the position to benefit from follow-on phases in programs that we have invested a lot of research and development.

As Alan has indicated, for the nine months, we have achieved all of our goals in spite of a decrease in revenue. Since many of the programs that we are involved with and are sole-source and many of them are proprietary products sole-source to FEI have moved to the right.

So we have achieved operating profit in addition to the tax benefit. The new standard products that we are developing, such as the beacon transmitter and telemetry transmitter, we hope to be completed. The engineering models before the end of this fiscal year, which is April 30 and then to pursue business in this area and this gives us a new opportunity to address, with this equipment, many of the satellites that will be procured over the next 10 years.

We have lots of exciting programs in the pipeline on this and I would say, for the first time, on this programs are in the magnitude of $5 million to $12 million chunks and they are based on equipment that we have developed, all the engineering was done, the risk has been mitigated and most of the programs that are in the pipeline, we have delivered flight hardware already to our customer and in some cases, the hardware is already on orbit. So we are looking forward to this program very much. The only thing we know that the majority of them are ours; we just don't have a precise time plan on when they are going to land.

As Alan has indicated, we have -- we will have within the next few weeks a great war chest of close to $20 million and this is -- and we are looking very carefully for opportunities to add to Frequency Electronics' technology and productline on this and we are very critical on our review of those opportunities. They have to add to our technology and be accretive within a reasonable period of time and if we cannot find them, we will seriously review again, as we do on every Board meeting, to share this good fortune with our stockholders in the form of a dividend.

Our backlog on this, as Alan has indicated, is a little bit down from the last, but any one of these programs, some of them we expect to really be on the books by November and they have moved to a future time, could easily increase our backlog by $10 million with one quantum step.

I feel that, as Joe will always do at the end, but I want to express our great thanks and appreciation to our loyal customers and this is one of the great missions in addition that we have put down on our list of improving performance, [developed] product and supporting our customers to achieve their success because our success is linked to their success. And I also want to appreciate the effort of FEI's employees that made our progress possible.

We have reduced our cost and we have increased our throughput and that is very gratifying from a personal point of view on this item and my mission in the future will be to get the personnel at Frequency to handle more and more of these critical functions for the Company. I would like to finish my short talk by opening up to questions and answers.

Christine, go ahead.

(Operator Instructions).

Christine?

Yes?

Could you please ask that they are to state their name and to address the question either to Martin Bloch, Alan Miller or Joe Franklin? That would be helpful.

Yes. [Frank Boreze], Stifel Nicolaus.

Yes, I had a few questions. The first one was on the new products for the satellite business, you are saying that the engineering models will be done in April, the end of this fiscal year.

That's correct.

I believe you said they will double the size of your potential business for every satellite launch. I guess I am wondering, when you are talking about this $5 million to $10 million, I assume you're talking about with the new products? And also that -- I mean with the new extension of the satellite offering, and just how long would it be before you will start to see -- you will have the engineering models, how long do you think before you will start to see orders and then revenues on that?

And then my second question was just -- when I was reading, and I am addressing these to whoever you think could answer them most effectively, the second question is just on the accounting. It talks about the weaknesses in the accounting system. I was wondering if you could address to a non-accountant and those of us who are not accountants, what exactly that is talking about and what plans you have to resolve that. Because I think it said in the last 10-Q that you had made changes or whatever. Or maybe I misread that, but that was it.

Okay, well, I'll -- Martin Bloch will address the product and I will turn Alan Miller over for answering your second question. The normal way, the way it goes with new products for space is you finish the engineering models and you go through a very stringent space qualification process, which we expect to start sometime in May of this year. And in parallel, we start pushing this product for new satellite programs to our existing customers. Taking history as an example, we normally see the sales of this type of effort within a year to 18 months.

And that means like shipments, like billings in (multiple speakers)?

We will book it. Bookings, well, in space products, there are bookings and milestones, so they almost -- once you book, you already actually start the shipping process because, in most of the space products, we are fortunate to establish a milestone billing based on achievements of our progress on our manufacturability of the product.

Okay. So you will start to see some of the revenue then -- I mean if things go well within 12 to 18 months, you'll start to get the front end of the revenue as you start (multiple speakers)

That's correct on this item. And this has been typical and the basic idea. We have in some respects an advantage with this product because we have taken a look at all the old products that have been used for this mission and we started with a clean piece -- a sheet of paper and our products I feel will be smaller, more competitive in cost and cycle time and consume less power, which are all important parameters for the satellite. So we feel that we will be in a very competitive arena for getting those products out to our customers.

Frank, as to your other question with respect to the near-term bookings. Those are mostly based on legacy products.

Oh, and you are talking even there like $5 million to $10 million projects or --?

Yes. We have quite a few products, a project that we have submitted final proposal on equipment that we have delivered already to our customers and it is the next phase. Satellites and military programs are built in phases, so we have delivered phase 1, 2 and 3 and now the follow-on is going to be a phase of 4 through 10 of those are products that -- all the risk has been mitigated; it is a matter just of manufacturing our proprietary technology for those programs. And they are in orders of magnitude between $5 million and $12 million.

And how many of these are there -- opportunities are there out there?

About a dozen.

Okay, about a dozen of those. And I guess how many of them go forward and how fast is --?

Well, that's right. We know that the majority of them are going to go forward. The only unknown is the timeline on this side and there are many programs, for example, that we expect will be released in October, November of last year and although they have been funded by government, they have not yet come out of the queue.

Okay. And now you have the new products you talk about, are the majority of these projects satellite or are there many of these new?

The majority of the products that we have are for end use in satellite and also for very ruggedized timing system for the military in the mobile platforms.

And are there many of these -- I guess that is the low G, a lot of that or is that that the low G, these ruggedized --?

They are the low G, low phase noise and very rugged to be able to operate in very severe mobile environments.

And are there many of those? I mean of the dozen, is that a --?

We have about 20 programs that we have prototyped and we have one or two that are in pilot production right now and there are many. How many of them are going to go into large-scale production is unknown, but there are many programs and they do a great job for our armed services and we are very happy to be a major contributor to their success.

Okay, well, great. That sounds pretty interesting and then I guess somebody can try to explain this accounting to us.

I assume, Frank, that you are talking about the last couple pages of our 10-Qs. We talk about internal controls.

Yes.

All right. This is sort of fairly typical for small businesses where we don't have an awful lot of breadth of talent if you will because one of the things that we did highlight in there is that a material weakness is in my own position because I don't have enough people to do all the checking and testing that may be a larger company would have. So it is sort of an inherent weakness within a company. It doesn't mean that our financial statements are wrong, it just simply says that, for example, if I am preparing some analysis, I can make a mistake and there is nobody here, other than my external auditors who might catch it and not the Company itself.

So there is a potential that an error could be made that would not be caught until the auditors did their thing or maybe it could even possibly go out without anybody else noticing it. So it is something we have to beef up the talent in our own organization here.

Also, we have to document some of our procedures and that is something that is taking place in our subsidiaries and we have to test them. So some of those things have not yet been fully accomplished and those are things that we are working to go forward on. It is hard to say whether we will ever get a fully clean bill of health here because, again, of the small size and lack of as much depth in the accounting areas as some companies might have.

This is Martin Bloch. I might add that historically in being almost 50 years in business, we had no issues on this thing. We don't expect any issues, but how to best paper the trail and basically Alan is being checked and me as Chief Executive Officer, my safety is my own review and most important it is the accountants that review all our work to make sure that everything is kosher.

Right. And the things that I guess would be most concerning would be like at a subsidiary -- well, just control of making sure you are reporting all the expenses and all correctly.

You are absolutely right. We are doing that and even more importantly is that they operate within the law of the country since we have a subsidiary in Belgium and one operating in Tianjin and we are doing that to the best of our ability and we are reviewing it very thoroughly on an annual basis to make sure that this is so and we have had no incidents in any of the facilities since we have been operating there. Belgium since 2001, I believe and Tianjin since 2002. So we are trying to be very, very vigilant.

But I don't think we are any different than thousands of other small corporations that are facing up with the same challenges here.

Okay. Well, I appreciate that. And one other thing. The cash, if I might ask -- is the cash on the balance sheet, how do you guys invest your cash?

Pretty conservatively. Most of the marketable securities are in agency paper, Federal Home Loan Bank and that sort of thing.

Okay. And they are less than -- I guess they are all less than a year duration?

No. I think some of them mature in 2011, 2012, something like that. And they all have coupon rates around 5%, 6%, something of that nature.

Okay, got you. All right, then. Well, thanks.

[Michael Omari], [Omari Co., Inc.]

Hello, guys. Good quarter regardless.

Thank you.

Let me ask -- continuing an accounting question to Alan. What kind of NOL we have against future profits?

Zero.

Zero. You already used it?

Yes, that was the point. We thought we were going to have an NOL carryforward for future application, but since we were unable to carry it back, we consumed all of it.

I understand. Meanwhile, to Martin, I urge you and the Board to reinitiate some sort of a dividend because that will make it possible for mutual funds that are interested in dividend to invest in the Company as we used to in the past. So please put a very important emphasis on that.

Michael, as I preempted your question on this, we are reviewing it very carefully. We have a $20 million war chest and we are looking at what is the best opportunity and I assure you that the dividend will be brought up on every Board of Directors meeting and it will be done so on the next meeting without fail as it was done on the meeting yesterday.

Great. Good luck to you, guys.

Thank you, Michael.

Sam Rebotsky, SER Asset Management.

Yes, good morning, gentlemen.

Good morning.

As far as the inventory, could you sort of give me some idea -- is the inventory built for specific projects or what does is the expectation of use and what can you do to reduce the inventory because your sales -- relative to sales, it seems pretty high to me?

Yes, we recognize that and sort of the nature of the beast here unfortunately. A large portion of the inventory is work in process, which is then obviously dedicated for a specific program. In some cases, we have to build up an inventory to meet demand from some of our customers. We are learning that particularly with our wireline business and then there is -- a large portion of our inventory is in raw materials and again, that is something where we have to be responsive to some expected bookings that may not materialize for several months because a lot of these things do have a long lead, so we have to build that inventory up to be prepared to meet some of those challenges. So it is a number that has been, by comparison to other companies in different industries, is relatively high. But with Frequency, it has generally historically been this type of size.

Excluding the raw materials, what percentage is applicable to specific orders that you have, this $31 million to $37 million backlog? Do you sort of correlate in that way?

Well, I can tell you what the work in process is.

Yes, that would be a good number -- this is Martin Bloch. That would be a good number. While he is looking it up, I just wanted --

50%.

About 50% is work in process for specific programs. But our inventory will go down as a percentage as we increase our volume of business. But at this moment, some of our customers, especially in the wireline and wireless, they want to place an order on Monday and ship it on the following Friday. So it is a very short cycle time and the only way to take advantage of that business is to have product (inaudible).

The other area, which is also important to us, is in our space products. There are what is called minimum buys. You need 10 parts, but in order to get that part on time, you have to buy 100 or 1000 and then you have inventory left for the future, which is also a big advantage to us because, first of all, we can get it at a lower cost and second of all, it significantly affects us to reduce the cycle time.

Now if you look at the business changing in the commercial satellites and even some of the military satellites, the demand five years ago was for 36 to 40 months cycle time. Right now, everybody is scrambling to reduce the cycle time from cradle to launch in less than 24 months. So having those parts gives us a significant advantage to meet our customers' requirements for shorter cycle time.

Now do you ship any of your product to a distributor or is everything direct?

Everything is direct. We don't have any distributors.

Okay. Now your backlog, the $31 million to $37 million, do we expect to complete that within a year?

No, we use a metric of about 70% of the current backlog is shippable.

70%. Now, tell me what is the pipeline? What does it look like compared to the previous quarter and compared to the same time last year?

Well, I will tell you -- the opportunity that we are looking for, for example in calendar -- in our fiscal 2011, which starts in five weeks, is about in excess of $100 million. How much of it we can turn into orders is a challenge.

Okay, okay.

And if you look in the following years, it escalates up by about 20% a year.

Does it appear that there is a better shot of closing deals than previously? Does it seem like the time to close is shorter? What is your take on what is going on? Is the government opening the purse strings?

Well, government is opening the purse strings, but it seems like it always takes longer than it used to, so the purse strings are open because some of the programs, for example, have already been funded to our customers, but it takes longer to trickle down to the subcontractors (inaudible). We don't see any tightening on this critical program by the government at all.

All right. So would you say that you have cut across and everything that we appear that the things on the backlog that the revenue would increase more significantly going forward?

That is our goal and that is why I am working my tush off.

All right. All right. This is okay and I will vote for the dividend too.

Okay, thank you.

Thanks, good luck.

Thank you, Sam.

Larry Litton, Second Line Capital Management.

Good morning. I will start with Alan. What is the total debt, long term and short term, if you have that detail?

The only debt we have is a capital lease and the short term is around $230,000 and the long term is about $500,000 or thereabouts.

And that includes the capital lease?

That is the capital lease.

That is the capital lease. Okay.

There is about $700,000 left on that capital lease.

Okay. And it seems like you are kind of suggesting that the gross margin in the fourth quarter stays in the high 30%s, so 37% plus or minus is fair?

In that range, yes.

And based on your outlook and progress, what type of goal or range is reasonable for next fiscal year on the gross margins?

Well, if the revenue levels remain roughly at that area, we would expect something comparable. Increasing revenues should generate increasing gross margins because we think we have a pretty good leverageable situation here. We don't want to add an awful lot of new staff in order to meet some of these revenue expectations that we have.

So there is nothing -- there is no additional runoff, so this 37% rate is consistent with this revenue level. Unless revenues increase, gross margins are not going to change much?

This is Martin. That is right. That is a very good assessment on this because in our type of business, there is a certain level of cost that is difficult to cut without reducing our ability to respond on this. However, the delta business that we booked -- that we can book and ship is a very high gross margin.

So Martin, it begs the question -- I realize there is a lot of uncertainty and you never know when the government will award a program, but what is the range of expectation for the next fiscal year? Would you be disappointed with revenue -- realistically, would you be disappointed with revenue growth of less than 10% or should we be looking at flat to 10% growth? What is possible?

I would be very disappointed if it is less than 10% increase, very disappointed.

And by the same token though, while you have hopes for a longer-term growth rate of 20%, I don't think we are going to see that in fiscal '11.

Well, as I mentioned, we have -- the book of opportunities for fiscal 2011 is about $100 million. How much of this we will be successful in bringing in is our challenge and we're working very hard to do it.

Now, you may correct me, Martin, but it seems to me that, frankly, for the last many years, this pipeline has probably been in the $100 million range. So I am not sure that is really much of a change. There has always been enormous opportunity, but a very difficult time in pulling in any results.

Well, you're absolutely right with one basic change. The programs that we now have and we are looking at is programs that we have -- did the development and we have already delivered hardware and they are in the field, so it is much more cemented that I have ever seen in a long time.

But just -- okay, fair enough and that is critical, but just in terms of that pipeline, it probably was about $100 million a year ago too, right, but it is more cemented now?

That is correct. And it had also a certain amount of IR&D associated with it and this future is, like I said, a lot of it is based on programs that we have delivered our hardware.

Okay. Two more questions. First of all, the war chest and acquisition scares me a little bit or a lot. I mean the Company has obviously had a great deal of time, difficult time executing on what they had; acquisitions are difficult. So I know you are going to take some care there, this company, it would be nice if it could do what we do already properly as opposed to trying to assimilate acquisitions.

No question about it. That is why we have been so cautious on this and we are very, very selective.

Okay. And lastly, I think it was -- was it Northrop Grumman, they sold their little satellite business to --.

No, that was General Dynamics sold -- you are talking about the sale of this small satellite builder to Orbital, that was General Dynamics.

Is that something that we looked at and does that have any relevance to us competitively or that is really quite different?

Well, it sold to a customer that we are supplying product to on this point. We have provided product to General Dynamics and we will provide product to Orbital on this. Did we have the opportunity to look at it? The answer is no. It was done in great secrecy.

Okay, but the transaction itself doesn't create a greater opportunity or a lesser opportunity for us, it is fairly --?

It is the same. It doesn't change.

Thanks a lot.

You are welcome.

(Operator Instructions). David Starkey, Morgan Stanley Smith Barney.

Hey, guys. How are you doing? I haven't talked to you in a while, but doing well here. A couple of quick questions just related to what your expectations are. I know you can't get too specific, but do you think you will be able to maintain profitability going forward over the next fiscal year on a quarter-to-quarter basis without any unusual circumstances?

Yes.

Okay. And then the inventory at $28 million or so that you have got in inventory, we are in the fourth quarter with five weeks to go right now. Is there going to be any kind of obsolete or obsolescent write-off related to any of that?

We have taken reserves in the past, but we don't anticipate any large write-offs at this point in time and we do anticipate that some of that inventory, that work in process in particular, will probably decline. So it will be natural attrition in that regard.

So we ought to see a lower inventory number on the fourth quarter?

That would be my expectation, yes.

Okay, great. And cash flow, obviously, on an annual basis now with that $850,000 in savings through the first nine months, that will add, what, about $1.1 million, $1.2 million a year in additional cash flow going forward?

Well, we're already at $3.3 million now, so we'd probably end up the year, if and when we collect this tax refund, it we will be over $5 million. That money may not come in by April 30. We will see.

Okay. And the question related to the $20 million or so in cash that you have got on the books or you will have on the books, at $0.20 or $0.40 dividend wouldn't be out of the question I am assuming. Is there another board meeting coming up here shortly on that?

Well, there is a Board meeting that is coming up in July and we finished one yesterday. Like I said, David, in the beginning, first is to take a look to see what type of opportunities we have that is accretive and adds to our technology and then we will take a close look at our next Board meeting on a dividend.

Okay, great. And can you please, if you get one of these $5 million or $10 million pieces, make an announcement on that?

We will do that. Some of them, they put chains on us because of the classification nature, but we will do our best to share this news with our stockholders as soon as possible.

That would help. We went through this whole last quarter without a single noise from you guys, so it would be helpful to hear from you a little bit more.

David, don't you like the idea of being silent with good performance.

Silence with good is good, but bad would be worse I guess. So yes.

Okay, my friend, we will do our best.

All right, thank you, guys. Take care.

[Robert Lempert], RLR Capital Partners.

Good morning, how are you doing? Nice quarter. A simple calculation, if you paid a $0.25 dividend, would be $2 million a year. Alan mentioned that we are getting an average of 4% to 5% return on our money or maybe on some of it, so if you did the math, you would see that, assuming 5% on $20 million, you would see that the dividend would really only cost us about $1 million a year. So I would definitely reinstate a dividend of $0.25 if I can give you my two cents. That wasn't my question.

My question is, Martin, can you address the future of drones as far as what our products could be? I know that we aren't there yet. What are some of the new products you have in mind for these unmanned aircraft?

Well, we have made major technological breakthroughs in the first five years to achieve two critical parameters. One is ruggedized timing sources that can survive and perform under the harsh environment and the second is to enhance their performance by minimizing the effect of the G, which deteriorates their accuracy. And as I mentioned, we have -- we prototyped during the process about 20 programs on this and some of the programs will -- my personal assessment is that that is a very good business and is going to grow significantly because it is cost-effective, it is very precise on this and gives us enormous capability.

And at the same time by the way, in addition to the drones, those low G sensitivity ruggedized clocks are becoming more and more important for secure communication systems because they provide the ability to achieve wider bandwidth and interoperability between the Air Force, Navy, all the various services in the field. So both of those areas offer a great opportunity for that productline.

The Frequency generators don't go into these, do they?

The Frequency generators go into some of the mobile platforms like the drones and helicopters and aircraft.

And then I read somewhere recently Israel was testing an unmanned plane that had much longer ranges and I don't know if that is going to be a future growth area for us in regular aircraft unmanned.

We are doing the same thing on this. That is the future; there is no question about it. And as you get better accuracy, you get longer hours in the field at a fraction of the cost of a manned vehicle. So I personally feel that that is going to be a significant portion. We got a general over here on this side. Obviously, the macho of having a man in an aircraft is something we overcome, but from a science point of view, there is no question that you can achieve significant improvement in accuracy and performance with unmanned vehicles and literally at a fraction of the cost. And you don't put human beings in harm's way. So I think a big future.

I really sense a difference in Frequency now versus two years ago and Alan, check my math about that dividend because I think it would only cost us something like $1 million a year after we make money from our money.

Let me clarify one thing though. Right now, we have maybe about $10 million in these marketable securities that have a coupon rate of 5%, but new money unfortunately of course you can't invest at that rate right now. You would be lucky to get 1%, so it's a little more of a challenging environment for that.

But we will look at it.

Okay. Thanks.

[Michael Eisner], Private Investor.

Martin, how are you?

Hey, Mike.

Michael, good morning.

Good morning, all you guys. What level of revenue can you move up to before you have to hire more people?

Well, there is a delta on this side. With all of our fixed resources and automatic test equipment that we have on this, we can -- to give you an idea, if we move up $10 million in revenue, maybe we would have to add 10 to 15 direct people.

You mean $10 million in revenue for the year?

Per year, yes.

So you have to go to like say $60 million, it will only go up 10 or 15 people?

That is a rough estimate. It depends, of course, the mix of both business on this, but that is a good number.

And that is in New York people?

The biggest growth that we see in revenue is going to come out of our basic facility in New York.

How many people are in New York now?

I think 170.

Oh, so it's like 5% or 6% more people to go up 20% in revenue?

That's a good number, Mike.

So that means your gross margins would go up decently.

There is no question about this. At this time, any increase in revenue will significantly help us improve our gross margins.

And going out in two years, say regular just in 2012 calendar year, what percent of the Company do you think will be defense?

Probably 50% plus.

And where are you right now?

50%, plus maybe even 60%. I am just taking a look at the programs that we are looking at. Our technology, our proprietary technology is finding quite a niche in this new defense and security arena.

What percent are you at now?

I presume you are talking about DoD ground, airborne and space?

Yes, correct.

Yes, we are in excess of 50% of revenues is coming from all government sources.

At this point or in two years, I am saying?

Right now.

And it is going to go up, Michael.

That's what I am getting at. That is what I am saying. In two years, is it going to be more like 70%?

That is a possible good number. It is going to be more than 50%.

Okay. And if you take out the cash, this is just a statement. The Company is selling for under $3 a share.

Well, --.

I know you can't (multiple speakers).

Mike, I just want to cut you off. My job over here is to generate profit, new products and to have a good cash reserve for acquisition or dividends on this. It is beyond my expertise to do anything about the stock price.

No, that is not where I was going. I was just making -- that's why I said a statement, how cheap it is for your technology, nothing to do with the share price, which I know you have nothing to do with whatsoever.

As my mother would say -- from your mouth into God's ears.

Yes, because, for a technology company, counting the Company's technology, only like $25 million is basically just what I am saying as a statement.

We are all in violent agreement.

You should call the Wall Street Journal and tell them, Michael.

All right. Thank you. Great job.

Thank you, Michael.

[Frank Wisniewski], Private Investor.

Hi, this is probably for Alan. The $350,000 investment impairment charge, I assume that was in the interest and other line?

Yes. You will see it broken out separately in the 10-Q.

Okay. But I don't have that yet.

I understand.

And the $2000 -- $200,000 earlier in the year, was that also related to Elcom?

Yes.

How much is left of Elcom?

I don't have the number right in front of me. I think it is about $1.3 million -- $1.2 million, $1.3 million of our investment and we have $1.5 million in loan to build. So about $2.7 million in total.

Okay. And what would be your analysis of the likelihood of further write-offs at Elcom?

Well, that is really going to depend on their future performance. We think that they have kind of right-sized the ship and going forward, we think they have some good products and they will also be assisting us in some technical areas. So we think that they can stabilize, but as market conditions and things can change rapidly, so it is somewhat out of our control in that regard. So don't really know.

Okay.

I just want to add -- this is Martin Bloch. I just want to add, the importance is also that we are trying to utilize their technology and adopting their products for space environments and that is very important to us.

Okay. Again, on the interest and other line, obviously interest income is there and Elcom is there. Is there anything else in there that is material?

No, not on a recurring basis. We have some things. Some foreign exchange losses occur sometimes at our subsidiaries and things of that nature.

Okay. And Elcom is running profitably now?

They are up and down. We had an income last quarter, their last fiscal quarter, which ended in December, but I think the previous couple quarters, they had losses, so they are up and down and like I said, we are hoping that we will see some stabilization there going into 2010.

On the R&D, I think, Alan, you mentioned that it would go down. You obviously had quite a spike-up in this quarter, which you covered. You said it would go down in the fourth quarter. Two questions related to that. One, did you mean it would go down on an absolute basis or as a percentage of sales?

Both.

Both?

It won't be a dramatic drop-off, but we do expect that $1.5 million is probably the high point for the year.

Okay. Do you suspect that you will be something over 10% for the year then in R&D?

A little bit, for the year, yes. For the year-to-date, yes.

Remember, one of the missions that we put down for this year is that with a reduction in revenues, which our goals were, A, to be profitable and B is to utilize our talent for new product development. So in one respect, that slowdown in industry and programs moving to the right gave us the opportunity to complete our in-house plan products earlier than we could have otherwise anticipated and that was in partial responsible for the slight spike in NRE.

And have you got any early feel for next year as far as R&D as a percentage of sales?

Taking a look at the programs that we are looking for, our goal is still to keep it below 10% of revenue and I believe that we will be able to achieve that.

That would be a lot easier to achieve obviously if revenue goes up a lot.

No question about it.

One final thing. General Franklin said at the end of the last quarter that Frequency had received the highest level of RFPs in recent years. Could you update that statement? It doesn't seem that a lot of that was -- that RFP activity was translated into backlog.

You are absolutely right. This is Martin Bloch addressing it. The activity of request for proposal is enormous on this and all of the programs on this, and let's separate them in three different areas then. The commercial satellites have all moved to the right due to funding issues on this. They need them, they must have them, but they have moved to the right on this and their activity is still violent, if I can describe it on this.

On the military programs, the same thing on this. They are all there, they are all -- most of them are funded, but they have not been released to the second-tier subcontractors on this. And with respect to the wireline and wireless, the same thing is true. Lots of inquiries of what products are going to need, but with great difficulty of them getting the funding to release it.

Thank you very much.

You are very welcome.

Larry Litton, Second Line Capital Management.

Martin, first for you. In terms of the aggressiveness of the RFPs that are out there, who else is responding to them usually? Who is most often seen as your competitor for all these RFPs?

As in the past, the majority of those RFPs are basically our competitors, our in-house integrator. That means that we propose let's say to Boeing, SS Larousse, the question is always how much are they going to buy and how much are they going to try to get the key components from us and build the rest of it in-house. So those are our biggest and then we have a few international competitors in Europe that are competing for the commercial programs and that is about the majority.

Okay, and then, Alan, for you, you might have addressed it, but I forgot if you did. The gross margins dipped in the third quarter to around 35% from around 36.5% in the first six months. Why did it decline?

Well, it's a combination of product mix that is going to vary a bit. You may have noticed that our Zyfer facility had lower sales this quarter. They often have some of the highest gross margins in the Company, so when they dip, we are going to have a little bit of a hit there. So just who is making the sales and who the customers are.

Okay, but it wasn't related to any program overruns.

No.

Small program overruns?

We are in good shape in that respect.

I still want to push you a little bit, Alan. I mean you are running at the mid-30%s gross margin. I think your comments were high 30s gross margins. So realistically in the fourth quarter, are we going to be closer to 37%, 38% or you are talking about it being --.

That is the target at this point in time, our expectation.

And for the full year, if in fiscal '11, you have 10% revenue growth, given the contributory margin, that would certainly suggest the ability to have a full-year gross margin of possibly 38%.

38% to 40%, sure.

And we talked about R&D in terms of SG&A, which runs at around $10.5 million for this year, given possibly you addressing some concerns that you articulated in the accounting area, but SG&A is going to rise by 5% or can you hold it flat?

It probably would still -- especially if we had a rise in revenues, I would expect that we would get under the 20% of revenues threshold. It all depends on incentive plans and compensation and things of that nature that are going to be variable there as well.

But basically for a 10% revenue increase, hopefully SG&A goes up by less than 5% or 6%?

Yes, yes. I would expect that.

That's a good number.

Okay, so I mean if you guys actually hit some of these results, if the revenues do climb by 10%, you would have a rather significant increase in profitability, you might even get to a 10% operating margin?

That is what we're working very hard to achieve and I think it is within our grasp.

I know you're always working very hard, Martin, but we have got to actually report it to the SEC at some point.

I understand.

All right, thank you.

But don't you like the progress we are making?

I like the progress we have made, Martin, but I can look back over three years, five years, 10 years, a couple decades and we have been stuck in quicksand for a long time. So progress is wonderful, but we need some quantum improvement and we need to put together more than one quarter. We have to put together four quarters or eight quarters.

I agree wholly and we will do our best.

Thank you.

There are no further questions in the queue at this time. I would now like to turn the floor back over to management for closing comments.

Thank you very much, Christine. And to repeat what Martin said, thanks, first of all, to our customers for what they have done with us and to our shareholders for sticking with us and especially to our employees for the dedicated efforts that they have given us that have produced these very, very good results and we are looking ahead to the next time. We will be anxious to talk to all of you in July when our fourth quarter ends. Until then, hope all of you are well digging out from under the snow and we have a happy spring. Thanks again.

Thanks, everybody.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.