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October
7, 2009
Ms.
Kristin Lochhead
Division
of Corporation Finance
United
States Securities and Exchange Commission
450 Fifth
Street, N.W.
Washington,
D.C. 20549
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Re:
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Frequency
Electronics, Inc.
Form
10-K for the fiscal year ended April 30, 2009;
Filed
July 29, 2009
Form
10Q for the fiscal quarter ended July 31, 2009
File
No. 001-08061
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Dear Ms.
Lochhead:
This
letter is in response to your letter dated September 23, 2009 to Alan Miller,
Chief Financial Officer of Frequency Electronics, Inc. (“Frequency” or the
“Company”). We appreciate and share in the Staff's objective to
ensure that the disclosures made by the Company reflect the highest level of
transparency.
Our
responses to your comments are set forth below.
Form 10-K for the
period ending April 30, 2009
Results of Operations – page
17
Operating Loss, page
20
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1.
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We
see the discussion on the non-GAAP measure, operating loss, excluding the
effect of inventory reserve. Please note that under Item
10(e)(1)(ii)(B) of Regulation S-K, a registrant must not adjust a non-GAAP
performance measure to eliminate items when the nature of the charge is
such that there was a similar charge within the prior two
years. We see that you recognized inventory provisions in each
of the years presented. Please tell us how your presentation of
the non-GAAP measures is appropriate under Item 10(e)(1)(ii)(B) of
Regulation S-K and Question 8 of the Staff’s Frequently Asked Questions
Regarding the Use of Non-GAAP Financial Measures and where you have
provided all of the disclosures required under the
guidance. Alternatively, remove these measures from future
filings.
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Company
Response
We
acknowledge that inventory write downs are a common occurrence for Frequency
which is not unusual for a manufacturing company. In fiscal years
2005 through 2008, such write downs have ranged from $700,000 to $1.6 million
and are based on regular evaluation of our inventory. During fiscal
year 2009, the total writedown of inventory was $4.4 million, which far exceeded
the write downs of the previous four fiscal years. (See also our
response to Question 2, below.)
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Keeping
in mind the limitations regarding non-GAAP performance measures as expressed in
Item 10(e) of Regulation S-K, we believe it was important to specifically
highlight the $3.4 million write down of inventory for our wireless
telecommunications market not only because of the impact on our fiscal year 2009
operating results and our gross margin rates, but also due to the implications
for the future business of our company. This is why we commented on
the write down in several places in the Form 10-K. (See pages 4 and
17, Fiscal 2009 Significant Matters as well as page 18, Gross Margin Rates; page
19, Operating Loss; and footnotes 4 and 16 which indicate that we recorded $2.9
million out of the total $3.4 million telecommunications inventory write down in
the fourth quarter of fiscal year 2009.) In our opinion, this was a
singular event as the Company experienced a dramatic decline in revenues from
this historically important market area during the second half of our fiscal
year. Further, our customers indicate that they do not anticipate any
significant new business for the near term, if ever, as wireless providers
migrate to different technologies and display a willingness to accept a lower
quality of service. As a consequence, this write down is a key
indicator of not only the value of our inventory, but also the nature of our
future business. We therefore deemed it appropriate to highlight this
element of the fiscal year 2009 inventory adjustments. Such
disclosure is consistent with Item 10(e) of Regulation S-K because this specific
inventory writedown represented an important event. We have not
historically discussed more typical recurring inventory write
downs. We believe our fiscal year 2009 disclosure was consistent with
Item 10(e) of Regulation S-K and did not fall under the purview of Question 8 of
the Staff’s Frequently Asked Questions Regarding the Use of Non-GAAP Financial
Measures. However, in all future filings we will consider such
guidance when preparing our disclosures.
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Note 4 Inventories –
page 39
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2.
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We
see that inventory reserves decreased from $6 million to $4.6 million from
fiscal year 2008 to 2009 despite a charge of $3.4 million to increase the
reserve during fiscal year 2009. Please tell us and revise
future filings to clarify the reasons for the decrease in
reserve. For example, disclose if you wrote off fully-reserved
inventory or otherwise sold inventory that had been previously
reserved. Discuss how your policies are compliant with SAB
Topic 5BB.
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Company
Response
We
acknowledge that during fiscal year 2009, the Company disposed approximately
$5.6 million of inventory that had been written down (“fully
reserved”). The change in consolidated inventory reserves also
reflect an approximate $200,000 foreign exchange adjustment. Thus,
the net change in inventory “reserves” for fiscal year 2009 was a decrease of
$1.4 million after the $4.4 million write down referenced in the preceding
response. By comparison, in fiscal year 2008, we charged $1.2 million
to P&L for inventory write downs and disposed approximately $800,000 of
previously reserved inventory.
In fiscal
year 2007 and prior fiscal years, before Frequency was designated a smaller
reporting company, we provided Schedule II – Valuation and Qualifying
Accounts. In this schedule we provided details of changes in
Inventory Reserves including P&L charges for inventory write downs, the
effect of foreign exchange adjustments and disposals of
inventory. Now that we are no longer required to supply this
schedule, we agree that in future filings we should disclose significant
disposals of previously written down inventory. We will add this
disclosure to our inventory footnote.
We
believe Frequency’s policies regarding inventory write downs are compliant with
SAB Topic 5BB. Once written down, inventories may be disposed but
they are never marked up again even if we are subsequently able to utilize or
sell items previously written down.
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Form
10-Q for the fiscal quarter ended July 31,
2009
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Note 11. Fair Value of
Financial Instruments, page
8
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3.
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We
see that you have significant unrealized losses representing 35% of fair
value on available for sale securities as of April 30, 2009 and July 31,
2009. Tell us and in future filings disclose to investors the
specific positive and negative factors you considered in concluding that
there is no other than temporary impairment of available for sale
securities as of those dates. Please also enhance the
disclosures to address all of the subtopics discussed in paragraph 17(b)
of FASB Staff Position FAS 115-1/FAS 124-1 regarding the severity and
duration of the impairments.
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Company
Response
The
Company’s investment in marketable securities includes two bonds issued by GMAC
with an aggregate face value of $2 million which the Company acquired several
years ago at approximately par value. These bonds have a maturity
date of 2011. During fiscal year 2009, these bonds traded at steep
discounts to face value, one at 43.5% of face and the other at 61.5% of
face. Subsequent to our fiscal year end, these bonds have recovered
significantly and more recently were trading at 73% and 93% of face value,
respectively. More importantly, with recent U.S. Government actions
to support financial markets, the Company is reasonably assured that GMAC will
be able to fully pay its obligations when they come due in two
years. In the meantime, the Company has no immediate need for the
cash and has the financial ability to wait for the bonds to
mature. Hence, any decline in market value is deemed to be
temporary.
Similarly,
the Company has a small investment in a publicly-traded electronics company, the
original cost of which is $450K. The market value of this stock has
been very volatile during the time the Company owned it. At one point
the stock traded at over two times our purchase price while during our most
recent reporting periods, its value declined along with the rest of the stock
market, hitting a low of $0.51 during December 2008. As of the date
of this letter, the investee company’s stock is trading at approximately $2 per
share compared to the Company’s average purchase price of approximately $1.75
per share. Thus, if this price range holds for the duration of our
fiscal year 2nd
quarter, this investment will be removed from the “continuous unrealized loss
position” disclosure in our next Form 10-Q filing. This volatility
illustrates why the Company considered the unrealized loss on this investment to
be temporary. Once again, the Company has no immediate cash needs
that would require it to sell this investment at a loss.
In future
filings, the Company will provide enhanced disclosure including matters
concerning the severity and duration of the impairment of our investment in
commercial paper.
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Note 11. Fair Value of
Financial Instruments, page
8
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4.
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As
a related matter, the evaluation of available for sale securities for
other than temporary impairment may involve complex and subjective
considerations. Please provide critical accounting policy
disclosure about the complexities and uncertainties involved in the
evaluation, including disclosure about the susceptibility of the estimates
to variability. Please make the disclosure specific to the
nature of your actual investments.
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Company
Response
In future
filings, we will add a section in Critical Accounting Policies and Estimates
which will note that all of our investments in marketable securities are Level 1
securities which trade on public markets and have current prices that are
readily available. In general our investments in fixed price
securities are only in the commercial paper of financially sound corporations or
the bonds of U.S. Government agencies. Thus, although during our
ownership period the value of such investments may fluctuate significantly based
on economic factors, the Company’s own financial strength enables it to wait for
the securities to either recover their value or to mature such that any interim
unrealized gains or losses are deemed to be temporary.
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Item 4T, page
17
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Management’s report on
Internal Control over Financial Reporting, page
17
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5.
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We
reference the disclosure that you conducted an assessment of internal
control over financial reporting as of July 31, 2009. As a
smaller reporting company, under Item 4T of Form 10-Q, you are only
required to furnish the information required by Items 307 and 308T(b) of
Regulation S-K. In this regard, management’s assessment of the
effectiveness of internal control over financial reporting is provided on
an annual basis in your Form 10-K, as set forth in Item 308T(a) of
Regulation S-K. Please tell us why management’s assessment of
the effectiveness of internal control over financial reporting was
provided for the interim periods and clarify whether an assessment under
Item 308T(a) of Regulation S-K was actually performed as of July 31,
2009.
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Company
Response
As
disclosed in its Form 10-K for the year ended April 30, 2009, the Company has
identified several material weaknesses in its internal control over financial
reporting. While the Company did not conduct a full assessment of the
effectiveness of internal controls over financial reporting at July 31, 2009,
for the first quarter of fiscal year 2010, no substantial changes were realized
since management’s assessment of April 30, 2009, and therefore the weaknesses
previously identified still exist. Accordingly, the intent of our
Form 10-Q disclosure was to convey the current status of the Company’s internal
control over financial reporting and to indicate the efforts now being made to
mitigate the identified weaknesses. In subsequent quarters, in
addition to the disclosure required by Item 307 of Regulation S-K, we intend to
report on only the actions taken by the Company to address the material
weaknesses in the Company’s internal controls over financial reporting
previously identified, including our progress toward documenting and testing
internal controls at our two significant subsidiaries and the greater degree of
involvement by accounting personnel other than the CFO in the preparation of
original data for inclusion in the Company’s financial statements, and any other
changes in the Company’s internal control over financial reporting required to
be reported under Item 308T(b) of Regulation S-K.
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As you
requested in your letter dated September 23, 2009 we acknowledge the
following:
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The
Company is responsible for the adequacy and accuracy of the disclosure in
its filings;
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Staff
comments or changes to disclosure in response to staff comments in the
filing reviewed by the staff do not foreclose the Commission from taking
any action with respect to the
filing;
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The
Company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
laws of the United States.
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We
welcome the opportunity to discuss any aspect of this letter with you
further.
Sincerely,
/s/Alan
Miller
Alan
Miller
Treasurer
and Chief Financial Officer
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