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October 19, 2005
Frequency Electronics, Inc.
55 Charles Lindbergh Blvd.
Mitchel Field, NY 11553
Mr. Jay Webb
Reviewing Accountant
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Frequency Electronics, Inc.
Form 10-K for the fiscal year ended April 30, 2005;
Filed July 28, 2005
File No. 1-08061
Dear Mr. Webb:
This letter is in response to your letter dated October 7, 2005 to Martin B.
Bloch, President and Chief Executive Officer of Frequency Electronics, Inc. (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, 2005
Consolidated Statement of Operations - page 30
1. In future filings, please present the compensation charges in cost of
sales, selling and administrative expenses and other major line items,
after appropriate allocation. We would not object if you show a
parenthetical inclusion. Refer to SAB Topic 14(F).
Company Response
----------------
Regular compensation expenses are included in the Statement of Operations
within the line items Cost of sales, Selling and administrative expenses,
and Research and development expenses. The line item captioned
"Compensation charges" in the Consolidated Statements of Operations for
fiscal years 2005 and 2004 includes unusual and/or non-recurring
compensation-related charges that were incurred in those years. Because
these charges are unique and are not expected to recur in future years, the
Company believes that a separate delineation of these items in the
Statement of Operations for fiscal years 2005 and 2004 is more meaningful
to shareholders. By distinguishing these unique compensation-related
charges from normally recurring selling and administrative costs, the
reader can more readily determine the costs necessary to achieve the
reported revenues and operating profits. The expenses included in the
Compensation charges line item were as follows:
a. Change in estimate (FY2005) - $327K was the result of
utilization of a more current life expectancy table for
determining the future deferred compensation liability. This
matter was more fully explained in Footnote 13 under
Deferred Compensation plan and is discussed in MD&A. (See
also Item 5 of this letter.)
b. Bonus not based on Operating Profits (FY2005) - $416K was
the incentive compensation accrual related to gains on the
real estate and stock transactions recorded in the 4th
quarter of 2005. Although the bonus accrual impacts
operating profit, the related gains do not. Thus, the
Company believes that such costs should not be included in
recurring Administrative expenses but are reported under a
separately identifiable line in the Statement of Operations.
This transaction was explained in MD&A under Significant
Events and Compensation Charges.
c. Litigation with a former employee (FY2005) - $133K was
related to a litigation accrual for settlement of a
termination suit brought by a former employee of the
Company's Belgian subsidiary. This item is similar in nature
to a restructuring charge which the Company also believes
should be separately reported from normally recurring
Administrative costs. This item was explained in MD&A.
d. Restructuring Charge (FY2004) - In the prior year, the $428K
costs to restructure its European operation consisted almost
entirely of severance compensation for former employees.
This amount was separately reported due to the nonrecurrence
of this type of expense and is explained in MD&A.
e. Stock bonus (FY2004) - A stock bonus (value $297K) was
awarded to the Company's Chairman during fiscal year 2004.
This also was a one-time award that was unrelated to the
Company's performance for the fiscal year but was related to
an employment agreement dating back to 1993.
SAB Topic 14(F) sets forth the staff's views regarding the classification
of compensation expense associated with share-based payment arrangements.
As indicated above, the Compensation charges line item in the Statement of
Operations does not include such expenses unless they are unusual and/or
non-recurring. Note also that in fiscal year 2005, the Company applied the
disclosure-only provisions of FAS 148 and will continue to do so in fiscal
year 2006. The Company will fully comply with the provisions of FAS 123R,
as required, in fiscal year 2007 (the year beginning May 1, 2006).
Notes to Financial Statements - page 34
Note 4 Inventories - page 38
2. In future filings, please disaggregate Work in Progress from Finished Goods
in your inventory footnote disclosure. Refer to Rule 5-02(6)(a) of
Regulation S-X.
Company Response
----------------
Historically, the Company's inventory of Finished Goods has been very small
if not non-existent. Only in recent quarters have Finished Goods increased
to approximately 5% of total inventory. This was not deemed material for
separate listing. The Company will consider this comment for future
presentations and will either list the value of Finished Goods or will
discontinue using that term if the balance of Finished Goods is
insignificant.
Note 6 Property, Plant and Equipment - page 39
3. We refer to the sale of the Long Island building to Reckson Associates
Realty Corp in exchange for approximately 513,000 participation units of
Reckson Operating Partnership, L.P. Please tell us in detail the accounting
for all aspects of this transaction, including the conversion of the REIT
units and recognition of the deferred gain. In your response please show
your calculations and tell us how you determined the fair market value.
Please cite appropriate GAAP literature to support your accounting.
Company Response
----------------
In 1998, the Company sold its building to Reckson Associates Realty Corp.
("Reckson"), a publicly-traded Real Estate Investment Trust ("REIT").
Simultaneously, the Company leased back 43% of the building from Reckson
for its continuing operations. Rather than receive cash, the Company
elected to accept a tax-free, like-kind exchange, obtaining approximately
513,000 units of Reckson Operating Partnership, L.P. The Company continued
to hold the partnership units until March 2005 when it decided to exchange
100% of the units for an equal number of shares of publicly-traded Reckson
common stock.
In accordance with Sale and Leaseback accounting, in particular FAS 98,
paragraph 13, it was determined that the Company maintained a "continuing
involvement" in the sold property by virtue of its ownership of Reckson
Operating Partnership units. The 513,000 units represented a value at the
time of closing of $12 million (see discussion below), which amount
represented less than 1% of Reckson's total real estate holdings.
Nevertheless, based on professional guidance it received, the Company
determined that even an immaterial investment was sufficient to conclude
that it maintained a continuing involvement in the building. Therefore, in
accordance with FAS 98 and FAS 66, the original 1998 transaction was
treated as a financing with no gain to be recognized until the units were
converted to stock or to cash.
As a consequence, the Company retained the building on its balance sheet
and recorded an offsetting "REIT liability" representing the deferred gain
and other elements of the eventual conversion and gain on the sale
(including income taxes on the gain). In subsequent years, that portion of
the REIT liability representing the financing ($3.1 million) was amortized
over the leaseback period. As a result, from 1998 through March 2005, the
Company made annual lease payments of $400,000 but did not report any rent
expense. Rather, the payments were apportioned to interest expense and to
the "principal" of the financing liability.
In fiscal year 2005, when the operating partnership units were converted to
the common stock of Reckson, the continuing involvement in the building was
deemed to have ceased. In accordance with FAS 98 and FAS 66 the Company
then recomputed the gain on the original 1998 transaction as a Sale and
Leaseback transaction. See the separate analysis attached hereto as Annex A
which includes the journal entry to record the gain and remove the assets
and related liability. That analysis shows the calculation of a realized
gain of $4.6 million and a deferred gain of $1.3 million. The deferred gain
will be amortized into income over the remaining three and three-quarter
years of the original lease.
The original 1998 transactions and valuations were as follows:
o The value of the building was agreed to between the parties to be $12
million. Using a price of $23.38 per share (the value of Reckson
common stock at the time of the transaction) the Company was given
513,259 Reckson Operating Partnership units, convertible into an equal
number of shares of Reckson common stock beginning one year after the
date of sale.
o The present value of the REIT liability was determined to be $3.137
million based on annual rent payments of $400,000, payable over 11
years and using a discount rate of 6.5%, an appropriate rate in
January 1998. (The Facilities Capital Cost of Money Rate per the
Federal Register was 6.25% at that time.)
o From 1998 through February 2005, the Company continued to depreciate
the leased back building for financial statement purposes but
discontinued such for tax purposes, in accordance with sale and
leaseback guidance and IRS regulations.
Note 10 Investment in Morion, Inc. - page 41
4. Since it appears in 2004 your equity in the income from your investment in
Morion exceeded 20% of your 2004 income from continuing operations before
taxes, extraordinary items and cumulative effect of a change in accounting
principle, it appears to us you are required to include Rule 3-09 of
Regulation S-X financial statements for this investee in your Form 10-K.
Please file an amended 2005 Form 10-K with all required financial
statements or tell us why you believe no such amendment is necessary. Also,
note that your future Form 10-Q's should include the disclosure required by
Item 4-08(g) of Regulation S-X for any significant equity investees.
Company Response
----------------
Equity income from the Morion investment had a material impact on fiscal
year 2004 results, after restatement. However, the reason for this impact
is due to very low operating results compared to preceding years. As
specified under Rule 1-02(w) of Regulation S-X, when measuring the
significance of a subsidiary not consolidated or a 50% or less owned
person, one must consider the operating results of the year in question to
the average of the preceding years: "If income ... for the most recent
fiscal year is at least 10 percent lower than the average of the income for
the last five fiscal years, such average income should be substituted for
purposes of the computation."
As illustrated in the "Morion Analysis" attached hereto as Annex B, FEI's
pretax and pre-Morion income was $273K. This is 91% less than the Company's
average pretax income for the preceding 5 fiscal years which was $3,186K.
Thus, in measuring the significance of the Morion equity income, the
Company used the 5-year pretax income average. Equity income from the
Morion investment, as included in the restated Statement of Operations for
fiscal year 2004, was $158K or 5% of the 5-year average. This ratio falls
below the threshold for determining whether an investee is significant.
Therefore, the Company believes that separate financial statements for its
Morion, Inc. investment are not required disclosure in its fiscal year 2005
Form 10-K. Accordingly, the Company does not believe an amended Form 10-K
is required.
The Company acknowledges that if and when a subsidiary not consolidated or
a 50% or less owned person meets the significance requirements of Rule
1-02(w) of Regulation S-X, it will comply with the requirements of Item
4-08(g) of Regulation S-X. As of this writing, the Company has no such
significant investees, including its investment in Morion, Inc.
Note 13 Employee Benefit Plans - page 42
Deferred Compensation Plan - page 45
5. During the year 2005, the Company recorded a $327,000 change in accounting
estimate reflecting the use of updated actuarial mortality tables to
determine its deferred compensation liability. Please tell us in detail the
circumstances surrounding the adjustment. Specifically, discuss the facts
and circumstances that support the timing of this referenced change in
estimate.
Company Response
----------------
Over 25 years ago, the Company implemented a deferred compensation program
for its executives and certain other key employees. Under terms of the
plan, participants are entitled to annual life-time compensation benefits
following their retirement from the Company, as specified in the individual
deferred compensation agreements. Currently, the Company's plan includes 25
participants, 12 of whom are retired and 13 of whom are active employees.
The Company has recorded a deferred compensation liability on its balance
sheet to reflect the present value of the liability to be paid to these
participants over their remaining lives. In order to determine this
liability, for many years the Company employed the services of the benefits
consulting group of PricewaterhouseCoopers, LLP (PwC). During that time,
PwC actuaries employed the GAM 1983 Mortality Table, with margin, to
compute the Company's liability at the end of each fiscal year.
In fiscal year 2004, reflecting concerns over auditor independence, PwC
advised the Company that its actuaries would no longer compute the deferred
compensation liability and encouraged the Company to engage another
actuary. The Company did so, engaging the firm Steven L. Greene Pension &
Actuarial Services. For fiscal year 2004, Mr. Greene's firm continued to
utilize the 1983 mortality table to maintain comparability and consistency
with the prior year calculations.
In September 2004, the Company decided to engage a new public accounting
firm to conduct the audits of its financial statements, Holtz Rubenstein
Reminick LLP (HRR). In the process of reviewing prior year workpapers and
getting to know the Company, HRR representatives observed that updated
actuarial tables were available and the Company may wish to reappraise its
liability using more current information.
As a consequence, for the fiscal year 2005 audit, the Company requested Mr.
Greene's firm to utilize both the 1983 mortality table and compare the
resultant liability to that obtained by using a more current table. Mr.
Greene's firm did as requested, using the 1994 GAM Mortality Table, with
margin, as well as the former 1983 table. The more current table resulted
in a liability that was $327,387 higher than the older table. After
discussion with the actuaries and its auditors, the Company determined that
it would be appropriate to accrue the higher liability, accounting for the
increase as the result of a change in accounting estimate.
General Comment
6. Please comply with our [futures] comments in any amendment required in
response to this comment letter.
Company Response
----------------
As indicated in its response to Comment 4 above, the Company does not
believe an amendment to its 2005 Form 10-K is required. However, if it is
eventually determined that an amendment is required to be filed, the
Company will address all of the above comments, as applicable, in such
amendment.
As you requested in your letter dated October 7, 2005, we acknowledge the
following:
o The Company is responsible for the adequacy and accuracy of the
disclosure in its filings;
o 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;
o 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.
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
ANNEX A
Reckson Analysis
Frequency Electronics Inc.
Convert REIT Units
Facts and Assumptions:
Sale of Building- January 1998
==============================
1 513,259 units @ $23.38 $12,000,000 (Sale Price)
===========
Building & Improvements 8,750,814
Accum Dep. to 01/98 (2,798,983)
----------
2 NBV (book basis) @ 01/98 5,951,831
----------
3 Deferred Book Gain (1 - 2) $6,048,169
4 PV of Financing Obligation $3,137,619
Payment: $400,000 annually
Interest: 6.5%
Term: 11 years
5 Deferred taxes/Other $2,814,212
-----------
Initial REIT Liability (3 + 4 + 5) $12,000,000
===========
Convert Units to RA Stock- March 10, 2005
=========================================
513,259 shares @$31.36 (Avg of hi/lo) $16,095,802 (Proceeds)
less unrealized gain (4,095,802)
----------
A Original value 12,000,000
B Building NBV @ 2/28/05 4,356,237
-----------
C Potential Gain $7,643,763 A-B
D Rent charged to finance obligation thru 02/05
$33,333.33 multiplied by 86 months = $(2,866,666)
E Interest expense charged to income thru 02/05 $1,147,098
----------
F Total Gain to recognize $5,924,195 C+D+E
G PV of remaining lease payments $1,354,004
Monthly: $33,333.33
No. months: 46
Interest: 6.5%
----------
H Gain to recognize @ 3/10/05 $4,570,191 F-G
+ 2 months amort of def gain $58,870 G/46*2
----------
FY2005- Recognized Gain $4,629,061
==========
I Gain in each of: FY06 $353,218
FY07 $353,218
FY08 $353,218
Gain in FY09 (8 months amortization) $235,479
----------
J Deferred Gain @ 4/30/05 $1,295,134
==========
March 10, 2005 Journal Entry
- ----------------------------
DR REIT Liability $10,280,432
DR Accum Dep- Building 4,394,577
CR Building $8,750,814
CR Deferred Gain 1,354,004
CR Gain on Bldg Sale 4,570,191
----------- -----------
$14,675,009 $14,675,009
Journal Entry for
last 2 months of FY2005:
- ------------------------
DR Deferred Gain (B/S) $58,870
CR Gain (P&L) $58,870
- --------------------------------------------------------------------------------
ANNEX B
Morion Analysis
Frequency Electronics, Inc.
Morion, Inc.- Significant Acquisition?
On September 28, 2004, FEI completed the acquisition of an additional 8,721
shares of Morion, Inc. increasing its ownership interest from 19.76% to 36.17%.
This increase results in accounting for the investment on the Equity method
versus the previously employed Cost method and a restatement of prior year
financial statements to account for the effects of this change.
As a result of the restatement, net income for FY2004 increased from $162K
($0.02 per share) to $320K ($0.04 per share)- i.e. double previously reported
earnings.
Question:
Since the restatement had such a relatively large impact on FY04
results, should FEI consider Morion a significant, unconsolidated
acquisition which requires separate financial statements in its
Form 10-K as per Rule 3-09 of Regulation S-X?
Measuring Significance
1- FY04 pretax income is 91% less than the average pretax
income of preceding 5-years. Therefore, use the 5-year
average to determine significance.
Fiscal Year Pre-tax Income
2004 $ 273 (income before Morion equity
adjustment)
2003 $ - (loss- use zero)
2002 $1,698
2001 $8,236
2000 $4,424
1999 $1,573
---------------------
Average $3,186
---------------------
2- Significant subsidiary P&L thresholds (% of 5-year Average):
20% $ 637
40% $1,274
50% $1,593
3- FEI's actual share of Morion income on the equity method:
FY2004 $ 158
FY2003 $ 49
- --------------------------------------------------------------------------------
Conclusion: Separate financial statements in FEI's Form 10-K are not required
for its investment in Morion, Inc. The equity income from Morion in FY2004 is
below the threshold for measuring whether an entity is a significant subsidiary
not consolidated or a 50% or less owned entity for which separate financial
statements are required.
- --------------------------------------------------------------------------------