Comtech Telecommunications Corp (CMTL) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Comtech Telecommunications Corporation second-quarter and fiscal year 2005 earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded Wednesday, March 8, 2006.

I would now like to turn the conference over to Ms. Stephanie LaMantia of Comtech Telecommunications. Please go ahead, ma'am.

Thank you and good morning. Welcome to the Comtech Telecommunications Corp. conference call for the second quarter of fiscal 2006. With us on the call this morning are Fred Kornberg, President and Chief Executive Officer of Comtech and Robert Rouse, Executive Vice President. A news release from the Company's results was issued earlier this morning. If you have not received a copy please call me and I will be happy to send you one.

Before we proceed I need to remind you of the Company's Safe Harbor language in the following way. Certain information presented in this call will include but not be limited to information relating to the future performance and financial condition of the Company. The plans and objectives of the Company's management and the Company's assumptions regarding such performance and plans are forward-looking in nature and involve certain significant risks and uncertainties. Actual results could differ materially from such forward-looking information. Any forward-looking statements are qualified in their entirety by cautionary statements contained in the Company's Securities and Exchange Commission filings.

With that, I'm pleased to introduce the President of Comtech, Fred Kornberg. Fred?

Good morning and thank you Stephanie. Good morning everyone and thank you for joining us today. This morning we will be discussing our results for the second quarter of fiscal 2006. As you can see from yesterday's press release our performance during the three months ended January 31, 2006 was impressive and an ongoing testament to the leadership positions we enjoy in the markets we serve. Our consistently strong track record has been no small feat and we are proud of our solid growth in recent years.

To continue to manage our growing core activities and to focus also on growth through acquisition which we see as an important part of our future growth plans, we have instituted some important organizational changes as part of a planned evolution of management responsibility at Comtech. Among the changes are a promotion of Rob Rouse, the Chief Operating Officer; the promotion of Mike Porcelain to Chief Financial Officer; and the hiring of Jerome Kapellus as Senior Vice President of Strategy and Business Development. I believe these changes will even better position us to further capitalize on both organic and acquisition growth opportunities in the years ahead.

Also as a reminder in light of another outstanding quarter, I feel compelled to reiterate our view concerning quarterly guidance. As we have mentioned on countless previous occasions, our revenues and earnings can fluctuate dramatically from quarter to quarter particularly in those of our product lines that rely on large contracts. We have consistently cautioned our investors and shareholders to focus on annual rather than quarterly performance and we do so again now.

I'll discuss recent developments and activities in each of our three business segments during the course of this call. And then I'll provide guidance for the balance of fiscal 2006.

First let me introduce Rob Rouse, who will review our operating results for the quarter. Rob?

Thanks, Fred, and good morning to all of you. As Fred mentioned, the second quarter of fiscal 2006 was yet another solid one for Comtech and has firmly positioned fiscal 2006 to be another record year, our fourth in a row. Let's begin the discussion by reviewing the key income statement trends for the quarter ended January 31st, 2006.

Second-quarter sales for fiscal 2006 were $95.7 million compared to $78.1 million in the second quarter of fiscal 2005. And once again the increase in sales was experienced across all three of our business segments. Increased sales in our telecommunications transmission segment were driven by strong demand for our satellite earth station products, and incremental sales of our over the horizon microwave systems including sales related to a $77 million contract that we received in September of 2004.

Sales in Q2 of fiscal 2005 included $1.3 million of revenue related to an adjustment to the estimated gross margins at completion on two large over the horizon microwave contracts. There were no such adjustments in this segment in Q2 of fiscal 2006.

Sales in our mobile data communications segment increased due to higher sales on the MTS contract, including $6.7 million relating to an adjustment has a result of increased funding from the U.S. Army and continued operating efficiencies, higher sales of battlefield command and control applications and sales of $5 million related to Tolt which we acquired in February of 2005. Second-quarter sales in fiscal 2005 were positively impacted by a favorable adjustment to the method used to account for prepaid service time on the MTS contract which contributed $4.6 million of revenue, and a catch-up in funding after a very low level of funding in Q1 of fiscal 2005.

RF microwave amplifier segment sales increased as a result of strong defense-related sales particularly in improvised explosive device jamming amplifier contract. Fred will discuss the status of this contract and related opportunities more during his remarks.

Of the fiscal 2006 second-quarter sales, 37.2% were to international end users; 47.5% were to the U.S. government or primes to the U.S. government; and 15.3% were to domestic commercial customers. Our gross profit increased to $41.1 million in the second quarter of fiscal 2006 from $32.3 million in the second quarter of fiscal 2005. During the three months ended January 31st, 2006, we recorded favorable cumulative gross profit adjustments in connection with our ongoing review of total estimated revenues and costs on certain large contracts partially offset by a warranty provision on another contract. The net impact of these adjustments on gross profit was $5.6 million in this fiscal 2006 second quarter.

During the three months ended January 31st, 2005, we recorded favorable cumulative adjustments aggregating $3.7 million. Excluding both the sales and gross profit from prior periods related to these adjustments and the warranty provision, our gross profit percentage for the second quarter of fiscal 2006 was 39.9% versus 39.6% in the second quarter of fiscal 2005.

SG&A expenses increased from $12 million in the second quarter of fiscal 2005 to $15.8 million in the second quarter of fiscal 2006. The increase was primarily attributable to expenses associated with Tolt, which we acquired in February of 2005, and the increased level of sales and activity in all three of our business segments. In addition, SG&A for the second quarter of fiscal 2006 includes $1.2 million of stock based compensation in connection with our adoption of FASB statement 123R in fiscal 2006. Excluding the stock base compensation expense, SG&A remained largely unchanged at 15.3% and 15.4% of sales respectively in the second quarters of fiscal 2006 and 2005.

Although higher than the prior year's second quarter, R&D expenses of $6 million were lower than we anticipated in Q2 of fiscal 2006 due to the delayed timing of certain R&D projects. Accordingly, we expect R&D to ramp up in (technical difficulty) Q4 of fiscal 2006.

Operating income for the three months ended January 31st, 2006, was $18.7 million compared to $14.7 million in the prior year period. The impact on operating income of the aforementioned adjustments was $4.7 million in Q2 of fiscal 2006 and $3.3 million in Q2 of fiscal 2005. Keep in mind that the second quarter of fiscal 2006 also includes stock based compensation aggregating $1.5 million.

Interest expense which primarily represents interest on our 2% convertible notes was consistent between the quarters at approximately $700,000. And interest income increased from $905,000 in the second quarter of fiscal 2005 to $2.2 million in the second quarter of fiscal 2006 primarily due to higher interest rates. As a result of the higher level of pre-tax income, the expiration of the federal research and experimentation credit and the nondeductibility of compensation expense related to incentive stock options, we anticipate that our effective tax rate for fiscal 2006, excluding other items, will be 36.5%.

In Q2 of fiscal 2006 we recorded a net tax benefit of $585,000 primarily relating to the favorable settlement of a state tax matter. However, offsetting this benefit in Q2 was an increase to the cumulative tax provision for fiscal 2006 to reflect the 36.5% effective rate. On a non-GAAP basis excluding the expensing of stock options, our effective tax rate would be 35.5%.

Net income for the second quarter of fiscal 2006 was $13.3 million or $0.50 per diluted share. Once again because we believe that many investors may want to measure our operating results before the expensing of stock based compensation, we intend to continue to disclose on a pro forma basis, what our earnings would be if we did not expense stock options. With that in mind, net income for the second quarter of fiscal 2006 excluding stock option expensing, would have been $14.5 million or $0.54 per share versus net income for the second quarter of fiscal 2005 of $10.2 million or $0.39 per share.

Earnings before interest taxes depreciation and amortization including the amortization of stock based compensation were $22.3 million for Q2 of fiscal 2006 compared to $16.6 million for Q2 of fiscal 2005. Our backlog as of January 31st, 2006 was $151 million compared to $153.3 million at July 31st, 2005. Our balance sheet remained very strong as of January 31st, 2006, as evidenced by $218.7 million of unrestricted cash.

As we anticipated during December's call, receivables continued to grow in Q2 due to higher unbilled receivables primarily related to a large over the horizon microwave contract. As we have noted before, our receivables can fluctuate based on the timing of our performance and related billings on large contracts. For example, the first six months of fiscal 2005 cash flows from operating activities included the liquidation of a large contract receivable that had built up over previous quarters. While the first six months of fiscal 2006 include the buildup of a receivable on the large over the horizon microwave contract. We expect that the unbilled portion of receivables related to this contract will decrease the increased billings in Q3 and then begin to convert to cash in Q4.

All in all the second quarter of fiscal 2006 was in itself a success story. But more importantly it has further solidified another outstanding year for Comtech. And now back to Fred.

Thanks, Rob. First I'd like to just discuss recent business developments in each of our three business segments and then provide some guidance for the remainder of fiscal 2006.

Once again our telecommunications transmission segment outdid itself recording profit levels and strong sales. This is our largest segment representing 51% of consolidated sales in the second quarter of fiscal 2006. Our established leadership positions in the satellite earth station products and over the horizon microwave systems continue to provide the foundation for our sustained success. As a reminder, our largest product line in this segment is the satellite earth station products. Comtech EF Data is well-recognized as the one-stop shop for satellite earth station products. Most of this product line is commercial and we sell our products to a broad group of global communications service providers as well as domestic and international satellite network integrators.

We also sell to the U.S. and foreign governments. We believe our modem technology is the de facto standard in optimizing satellite bandwidth utilization using our patented forward error correction technique thus significantly reducing transmission costs for our end customers. But just don't take our word for it. Look to our primary competitors which have incorporated our patented technology into their high-end modems, a clear sign of our technology leadership.

Now to our over the horizon microwave product line. Here we are the world leader in providing equipment and systems which use the troposphere as the layer of Earth's atmosphere as a [repeater] to transmit voice, video and data. Until recently our primary target markets have been foreign governments and the oil and gas industry. In fact, these markets have grown quite nicely in recent years.

Although a world leader, we have not stood still and during the past few years we have made a number of advancements in this technology. For instance we have increased data rates from 2 Mb to 16 Mb. thereby opening the door for a variety of new applications including the transmission of color video over this type of channel for the first time. This higher data rate capability made possible by our technology has also driven a renewed interest in introducing tropo systems back into the U.S. Department of Defense communications infrastructure. This potentially huge market has recently attracted those who abandoned the technology for the past 20 to 30 years.

Although revenues in this product line were higher than we have assumed in our Q2 guidance, they were lower than in Q1 and are expected to decrease further during the second half of fiscal 2006 as the $77 million contract we received in the September 2004, moves out of its peak production phase. However, there are significant follow-on opportunities for this product line in the long and also in the intermediate term. We believe now that because of delays however that such opportunities will most likely not impact sales and profits until fiscal 2007.

As you know we've also been diligently working with the U.S. Department of Defense in demonstrating the effectiveness of our modem technology. We have partnered with this important customer and have made the investment and research dollars and senior management and engineering time to be totally responsive to their needs.

In the full year guidance that we provided in December, we expected to have approximately $7 million of sales relating to the U.S. Government orders with a track 170 upgrade. Such amount represented the amount we believed we could ship by our fiscal year end assuming the initial received orders by February of this year. Obviously the award continues to move to the right. That said, we remain confident that we will win this opportunity. It is just a matter of time. However, we will at this time remove any related sales from our guidance since depending on the timing of the receipt of those orders it is possible that revenue in such orders most likely will not be recognized in fiscal 2006. Although we obviously want to receive these orders as soon as possible this scenario would be a nice way to enter fiscal 2007.

Keep in mind that in addition to our high-profile tropo U.S. government opportunities, the advancements we have made in our over their horizon microwave systems are also resulting in strong interest and opportunities with other new and existing customers for a broader array of applications that given the higher data rate capability can run over this type of channel. In summary, within our telecommunications transmission segment our technology leadership continues to firm up our competitive positions, to open up new applications for our product offerings and we intend to continue our technology innovation to fuel future growth.

Our mobile data communication segment posted another strong performance in Q2 of fiscal 2006. On the government side of this business we continue to roll out our new RFID enabled satellite transceiver known as the model MT-2012. This technology is a good example of our working with the customer in this case the MTS program in developing a solution to an important operational need. We also continued to experience increase in funding for the MTS program as well as improved operating efficiencies, which as Rob mentioned, resulted in a favorable adjustment to sales and gross profits based on the MTS contract's higher estimated margin at completion.

As you know on the last investor conference call, I mentioned the large opportunity for incremental MTS funding through a National Guard supplemental funding bill. This bill has now been passed and the National Guard is preparing a fielding plant for an additional rollout of MTS systems. The ultimate amount of funding we will receive will depend on a variety of factors. But based on the initial funding request for the MTS, the amount of the total bill, and the estimating funding to be retained by the program office, the orders related to this opportunity could be in the neighborhood of about $75 million.

Since the timing of such large orders can be difficult to predict particularly with the National Guard which is organized by State, we will not assume any revenues for fiscal 2006 in our guidance. Once again, we would like to receive the National Guard orders as soon as possible but such a scenario would be again a nice way to enter fiscal 2007. This opportunity is another good example of how quarterly sales and profits can be impacted by the timing of the receipt of funded orders on the government side of this segment.

Another thing to mention is our fiscal 2007 MTS funding. These are expected to increase in 2007 to approximately $75 million. We also continue to provide hardware, satellite services and other support to the war fighter community most notably the FBCB2 or Blue Force Tracking program. Here our technology is being used to address line of site limitations when forces are spread out in the battlefield.

All in all in number of opportunities for growth exists on the government side of this product line. We're actively pursuing such opportunities, the National Guard being just one of many in the pipeline. That is the good news.

The bad news is that the successes we have achieved to date on the government side of this business have not been matched on the commercial side. The commercial satellite mobile data communications market is extremely price competitive. As you know we acquired Tolt in February of 2005 as a way to supplement our limited commercial sales force without spending a significant amount of financial resource or time in building a sales infrastructure from scratch. To date Tolt's penetration into the commercial satellite based mobile data applications market has not met our expectations.

As a result in February, '06, we revamped the incentive compensation plan for our Tolt salespeople in order to better focus their efforts on selling commercial satellite based mobile data applications as opposed to the lower margin product, Tolt products. As such Tolt is expected to remain a net cost center during this transition period. While we believe the Tolt management team is firmly committed to redirecting marketing efforts to the more profitable and relevant satellite based product, this is a situation that we will be monitoring closely over the next six months.

We continue to believe strongly, however, that our advanced technology is well-suited for certain vertical commercial markets particularly those requiring near real-time communications. In our minds it's only a matter of time before we break through. That said the mobile data communication segment as a whole is on its way to another record year and should significantly exceed the sales and profit records set in fiscal 2005.

And now to our third segment, RF microwave amplifiers. This segment continued its solid performance in the second quarter of fiscal 2006. We expect quarterly sales in this segment to be lower in the second half of fiscal 2006 compared to the first half due to the absence of sales relating to the WARLOCK jamming program. However, we continue to build strong relationships with various companies who are potential system providers for the growing IED jamming market. It is important to note that this segment is not about one large program. In fact, bookings for the first six months of fiscal 2006 were an unprecedented $32.6 million which is a clear evidence of the strength of this business.

Much of the revenue impact related to these bookings, however, will be realized in fiscal 2007 since our delivery times in this segment generally range from 6 to 12 months. Our high-power broadband amplifiers also play an important role in a variety of other electronic warfare applications as well as commercial applications such as oncology treatment systems, and air to ground satellite communications on commercial aircraft which have recently shown an increase in activity. This segment has been a major success story in the past 1.5 years, and based on bookings so far this fiscal year is showing signs that its best days are still to come.

And now onto guidance. Obviously as I have mentioned in previous investor conference calls and my remarks earlier today, there continue to be many factors that make the projection of revenues and EPS very difficult including the quarter to quarter fluctuations in bookings and related revenues in certain of our product lines. These quarterly fluctuations unfortunately are not going to go away. They are inherent part of our business.

As mentioned earlier in fiscal 2006, we adopted the provisions of a new accounting pronouncement relating to the expensing of stock options. I will provide our guidance on a GAAP basis which includes stock option expensing as well as on a non-GAAP basis which excludes stock option expensing. Our earnings releases and quarterly investor presentations will continue to reconcile the GAAP and the non-GAAP information.

With that in mind excluding the impact of stock option expensing we are raising our non-GAAP diluted EPS for fiscal 2006 by $0.07 to $1.63 to $1.65. Fiscal 2006 revenues are expected to be in the range between $365 million and $370 million. Keep in mind that netted against the increase in annual guidance are $0.05 relating to our assumption that the Track 170 revenue shift from the fourth quarter to fiscal 2006 into fiscal 2007, as discussed in my earlier remarks. And $0.04 relating to a higher than previously expected loss of Tolt in connection with the slow transition from low margin legacy products to satellite based products as also discussed in my earlier remarks.

Our GAAP diluted EPS for fiscal 2006 is estimated to be between $1.49 to $1.51. Because of the volatility in sales and earnings between quarters, as I have discussed at length on this and previous investor calls, commencing in fiscal 2007 we intend to provide guidance only on an annual basis. However, for continuity sake in fiscal 2006, we will continue to provide guidance for the third and fourth quarter. Excluding the impact of stock option expenses, non-GAAP diluted EPS for Q3 of fiscal 2006 is estimated in the range of $0.30 to $0.32. GAAP diluted EPS for Q3 of fiscal 2006 is estimated at $0.26 to $0.28. Fiscal 2006 third-quarter revenues are expected to be between 83 and $85 million.

Once again all three of our business segments continued to perform remarkably well and as you can see fiscal 2006 is well on its way to being another record year for Comtech. We are projecting this tremendous performance in fiscal 2006 without any revenue contribution from three of our largest opportunities that we are currently pursuing, namely the MTS National Guard funding; the over the horizon follow-on opportunities with our North African customer; and the Track 170 upgrade program. Accordingly, these opportunities could represent powerful growth drivers going into fiscal 2007.

With 2006 well on its way to being a record year, we are already working on making 2007 even better.

Thank you very much. And now Rob and I would be happy to take your questions. Operator?

(OPERATOR INSTRUCTIONS) Tim Quillin from Stephens Inc.

Good morning. First of all congratulations to Rob on the management changes and the others impacted. Rob, could you provide the backlog broken down by segment please?

Sure, as of January 31st the backlog of $151 million was $61.6 million telecom transmission; $55.5 million global data; and $33.9 million amplifiers.

Great, thank you. In the telecom transmission business it looks like if you exclude your North African customer that the business was up pretty strong, I think 29% year-to-year, 12% quarter-to-quarter. And presumably a lot of that is in the satellite earth station business. Can you talk about the trends that are driving that and if any of the new products specifically carrier on carrier are starting to get traction?

I think, Tim, your analysis is correct. As I mentioned, the satellite communications business continues to perform very, very well. It's performing at record levels. I think all of our products, carrier on carrier included, some of our forward error correcting devices that we put in various products and various model numbers which I won't bore you with at this time are performing extremely well. We believe we continue taking market share.

Okay. And then on the amplifier business, this looks if I'm computing the bookings correctly from the backlog number you just provided, it looked like about $12 million in bookings this quarter and I think it was about $20 million in bookings in the first quarter. And so it looks like the bookings are actually trending quite a bit higher than your guidance for the second half of the year in terms of revenue in that segment would imply. Is that conservatism or are these bookings going further out, are they kind of longer-term in nature?

I think I mentioned maybe I didn't in my remarks, but I think these bookings unfortunately are for deliveries in the six to nine month to twelve month areas. And so even though we've booked them just recently, they will actually most of them will actually fall into the 2007 timeframe.

So is it fair to think that you might be on a quarterly revenue run rate in amplifier business of $10 million or better in fiscal '07? Is that kind of a level that you think is achievable without additional orders for WARLOCK jammers?

I think so. I think we pretty well I think can state that we're involved in a number of IED programs and a number of jamming programs with other customers, customers being prime customers for us. And as I mentioned, WARLOCK -- it's not all about just being one big program. We have a number of programs which we're going to participate in and I think what you are seeing is our typical quarterly variations that we've spoken to this point in a number of telecom conferences before. The trend from the first two quarters will be slightly down and then it will pick up in 2007.

Very good. And just lastly, and then I'll jump back into the queue, but on the National Guard fielding plan, do you have any sense of the timing of that? I know it's hard to predict. Do you feel like its progressing at this point and you might be able to get some better visibility on the timing of the potential $75 million in sales at least by your next conference call?

I think the best we can probably say in that area is that the good news is that we now know that the National Guard money has been transferred to the MTS program office. That is the good part. The dragging part is the fielding plan, because the National Guard really operates in various states in the U.S. The fielding plan is taking longer than I think anybody anticipated. Our best guess right now, Tim, is that orders will probably start being placed somewhere in the May, June timeframe. And again those sales will really dump into 2007.

That is helpful, thank you.

Rich Valera of Needham & Co.

Thanks, good morning and congratulations as well, Rob.

Thank you, Rich.

Can you talk about on the over the horizon side the pipeline of opportunities there? It sounds like there's not too much short-term but could you just sort of give us a feeling maybe for the number of opportunities and magnitude in addition to the one large follow-on to the program you're working on now?

There are a number of opportunities, Rich. As I mentioned in the last telephone conference call as well, there are a number of opportunities that we have anywhere from the $20 million to $40 million to a $70 million type of numbers. Unfortunately as we've mentioned ad nauseam, it's very, very difficult to predict exactly when those will come in. As you've seen that in the past this just continues, that is the nature of our business. So the opportunities are there, certainly on the commercial or call it the international side. On the government side, we still feel very, very bullish. We've demonstrated our modem and we feel very, very bullish on the modem program.

Any sense on when that RFP should be hitting? It sounds like it's been expected for some time now?

It's always been expected and unfortunately as I kind of alluded, things move to the right. I would think that somewhere between now and the end of this fiscal year we should see it happen.

On the MTS front, I think you mentioned in your prepared remarks that your fiscal '07 MTS funding looked to be increased to about $75 million -- if that was your comment?

Yes.

Could you talk about how that related to your fiscal '06 funding level?

The funding that I'm referring to there is the what's called the Palm funding, that's in the government plan. The MTS funding has from the beginning of the program has been on an increasing level except for '06; '06 for some strange reason went from -- and again I'm talking a little bit without total facts -- but went from about $40 million funding down to about $25 million funding. But the good news is that '07 is funded for $75 million. So it has been an up-and-down ride on the MTS funding.

Now I just want to add that the MTS funding is not only the Palm funding, there are other fundings that come in from other pools of money that the Army has. As you can see I mean even '06 or '05 funding let's say which was in the vicinity of $40 million but in this segment we did quite a bit more than $40 million in revenues.

When do you think you actually start seeing the fiscal '07 Palm funding? In that in your fiscal '07 do you think that starts hitting?

No, that is in the government's fiscal year which starts October 1 in this year. I would mention this just as some more information. The funding for '06 MTS believe it or not here we are in March still has not been forwarded to us. That is something that is yet to come.

Do you expect some orders from that?

Some orders. Yes.

Okay, I'll yield the floor. Thank you.

James McIlree of Unterberg, Towbin.

Good morning and my congratulations also, Rob.

Thanks, Jim.

On the guidance of $1.64, I just want to make sure that includes the contract adjustments that you book is quarter?

The guidance -- the high end of the guidance, Jim, of $1.65 includes obviously the actual results through the six months. And then as Fred mentioned in his remarks, we did assume a couple of things that kind of offset the increase which was the push out of the Track 170 stuff to the right although as Fred said, pretty confident that we're going to ultimately get it. And then also the greater loss than we had anticipated last time at Tolt. And as Fred mentioned also with the National Guard not sure of the timing, we're assuming all of that comes in in '07. It does include the adjustments because they are included in the actual --

Okay. Terrific, I wanted to make sure of that. In your remarks you talked about R&D ramping in the second half. Can you in ballpark that ramp?

Yes. I would think, Jim, we're probably going to see R&D because we do have a few projects that got delayed a bit. We've run just over 6% during the first half of a year. I would expect that to be let's say in the 7.5 to 8% for the second half of the year. It's just a good example of it's not necessarily directly correlated with revenues during the period, during the second half of the year our revenues will be lower for the reasons that Fred mentioned. But there are just certain projects that we will be working on that have been planned. I would assume let's say in the 7.5% closer to 8% range of revenue.

Terrific. I think finally on the Tolt's -- I'm going to call it restructuring -- is it just the sales force compensation that you've changed or have you made other changes in the business? And then you talked about a transition period for that business. Can you give us a timeframe on how long that transition lasts?

Keep in mind, Jim, that the reason as Fred mentioned we had purchased Tolt was to really kind of jump start our efforts in this area. And Tolt is primarily in the new employee mobility solution area. There has been some transition going on to our satellite based technology. The efforts have really been to get people better focused on that. So it is not like we've changed the business model so to speak. We're trying to get people just more focused on selling our satellite based products going forward. We expect over the next six months to hopefully see some improvements in there. If not, we're just going to have to relook at our strategy.

But we ultimately believe that our technology particular given the fact that it is reliable, it is used over in the theater right now, that it has a very useful applications particularly for people who need real-time communications. Not everyone out there we're competing with is offering real-time communications. The next six months will tell us if we need to redirect efforts. We're pretty confident that we will get the ship straightened out and move forward.

Okay. That is great. Actually lastly, you said that $0.04 -- you're expecting $0.04 lower from Tolt in the guidance. Were you originally expecting breakeven from that business this year? Or profits?

We were hoping by the latter part of the year for the second part of the year they would get to a breakeven basis. But there is going to be during this transition period, Jim, hopefully. There's not going to be an immediate uptick in satellite based revenues but it's going to take some time for people to refocus. The way the satellite revenues are accounted for also we believe that those will be spread over time. If we book a satellite sale, we'll probably recognize that revenue over the contract period including the hardware. The revenue recognition model will also drive down our revenues at bit during the transition period until it becomes mature. So that drove some of that as well.

Okay. Great, thanks very much.

Andy Schopick of Nutmeg Securities.

Good morning. Bob, I went to ask you several questions here as I'm looking at the 10-Q which was filed more or less simultaneously with the earnings release. I've noticed a couple of things and I do want to ask you some questions about the presentation of financial results and the use of non-GAAP measures. First, why has the Company reduced the expected volatility and the expected term on its stock options? And what was what really is the impact in terms of calculating the stock comp expense by having made those adjustments because I see it in the Q on page 6?

The expected term was actually revised when we adopted FAS 123R and it was driven by the fact that our options prior to July 31st 2005 were a ten-year life with a five-year vesting period. Starting in the first quarter of '06 -- and these measures only apply to the new options.

I understand.

We've reduced the option life from five years down to -- from 10 years down to five years and have reduced the vesting period from five years to three years.

I see it.

Those are automatically going to drive the estimated life down just mechanically given the shorter terms. The volatility as time has gone on particularly in light of the fact that we did the convertible debt offering back in January '04, our volatility in our stock has come down dramatically since then. You measure it over time. We continue to update that each quarter for changes in the volatility from the last measurement date.

But there is a financial impact in terms of the calculation of the cost. And that is what I'm trying to get at here is what the actual effect or impact was in terms of calculating these options or stock comp expense from having made that reduction which is pretty significant from 62% to 51% approximately.

These changes only apply to the new options and we're required as everyone is under FAS 123R to make the assessments on the date. I don't have a calculation of what the assumptions would have been or the calculation would have been under different assumptions. Those were the assumptions as of that date.

Okay, fair enough. Now with respect to the use of non-GAAP measures, I've noticed that you've more or less chosen to only pro forma, if you will, the impact of stock option expense under FAS 123R. Is there a reason why you have not also attempted to give us some pro forma adjustment even though you've given us information in the text of the press release, why haven't you also tried to pro forma or adjust for these cumulative gross profit adjustments and the impact? I mean I can more or less calculate the EPS effect based on the information you have given us. But why would you not treat that as some type of a pro forma or non-GAAP measure?

Because in reality what it suggests to me is that prior period results were more or less not properly recorded because of the assumptions used for percentage completion accounting and that while we have a big positive affect here in this quarter if it had been spread out or more properly calculated in prior periods, the prior periods were understated and then we're kind of overstating the affect here.

My question is, why wouldn't you want to try to give us some type of table or pro forma adjustment for that?

First of all I kind of take exception to suggesting that the prior periods were not properly stated.

Well because of misestimation.

-- well, that is just the application of percentage of completion accounting. But to answer your question specifically, we've tried to make it very simple as to what things we pro formaed out. The only things we pro formaed out in the past good and bad have been in process R&D charges and now the stock based compensation. Obviously with stock based compensation we have apples and oranges, the prior period doesn't have FAS 123 adopted. But most importantly these cumulative adjustments are our operating items. I think our disclosures are very transparent in terms of the impact on every line item that can be computed.

The problem, Andy, with going through and start pro formaing them is what do you decide to pro forma and what do you decide not to pro forma? Because the SEC will say well you pro formaed this and you didn't pro forma that. So what we have done is try to be very specific as to the types of things we pro forma in both directions and provide you guys with the information you need to do those calculations. I think if you do the duty calculations that you're talking about you'll see that our margins, our operating margins have improved with or without the adjustments.

Yes, yes. I mean my problem with this is the general inconsistencies across companies and industries. For example, you do not -- you've elected not to pro forma the amortization associated with purchased intangibles. I see 90% of the companies backing that out and pro formaing it and just saying it is a non-cash charge. Interesting that you have elected not to treat that as a non-GAAP measure. My understanding is the SEC really doesn't care as long as you reconcile. They don't make any determination as to what you should, or can or can't pro forma. That has been what I've observed.

Again, Andy, just in the interest of the call, we can talk about it more off-line if you'd like. We've tried to pro forma the 123R stuff, the in-process R&D charges. That is all we pro formaed consistently going back five to 10 years and we have tried to make the disclosures. If you look at our MD&A we have every --

I have.

-- every item broken out so you can figure the impact on every line item so --

I have no problem with that at all, Bob.

So if you'd like to call me off-line we could talk about it further. I think in the interest of the call --

Great. Thanks.

Tim Quillin.

That was a painful discussion to listen to.

We agree.

I just had a couple of follow-on questions. One regarding your large North African customer which I believe was 10.8% of revenue this quarter which would be about $10 million in revenue down from about $16 million. What is a sustainable on the current three-year $77 million contract, what is kind of a sustainable level for the remainder of the contract which I think takes you to the end of fiscal '07, right?

Yes, we're expecting, Tim, without going to the specific number that to continue to head down. It's one of the reasons Fred alluded to for the disparity between the beginning and the end of the year. I would expect it to be probably closer to 5 than 10 for the next two quarters.

Would that continue to go down without assuming there is no follow-on contract, does that continue to go down in fiscal '07 or kind of stay at that kind of maintenance level?

In total I would expect it to go down in '07, if you're looking at year-to-year and certainly toward the second part of '07 you're going to see depending on our performance on it wane off it additionally. But as Fred said, by that time we do have some very large opportunities with the same end customer that relates to the same overall projects. By that time I think you'd start to hopefully see the tick back up in terms of our revenues to that customer.

You partially answered but in terms of a follow-on contract can you try and quantify as much as possible kind of the magnitude of follow-on opportunities? And when you might receive follow on orders and when those might start to ramp up?

Again it's extremely difficult to kind of peg a date of when those orders would come. We understand that as a best guess and a wide range that they're going to happen in calendar '06.

Okay. That is helpful. And then can you just address the I guess specifically the receivables related to this contract? And does the bulk of it -- do you collect the bulk of it in your fiscal fourth quarter and what kind of cash flow impact should we be expecting then?

Tim, without again giving a specific cash number for the fourth quarter, I do expect, this isn't a direct contract we have with this end customer. We're working through a large U.S. prime. Certain milestones are beginning to kick in which will start flip this into a billed classification, if you will. And then once that is done it's the normal payment terms on that.

It's very difficult sitting here in March to say specifically what amount we expect to collect by the end of the fiscal year because a thirty-day flip in terms of when that milestone is met may impact whether we collect the cash at the end of '06 or the very beginning of '07. But I do expect by Q3 to start to see the unbilled coming down into a billed classification. And then start to see the collections in Q4.

Okay. In just lastly on the stock option expense. And I think I can back into this number based on your EPS guidance for the third quarter. I'm just wondering how we should model this going forward? There was a little bit of a quarter-to-quarter fluctuation I guess based on new stock option grants in the second quarter. Is the second quarter kind of good -- you know, in general and obviously it's fluctuating but in general kind of a good dollar amount about 1.5 million?

Yes, that is a reasonable amount, Tim. And the tax rate as it relates to stock options is a little bit quirky because you don't get any tax benefit on incentive stock options until they are exercised. That can change things around a little bit. It's not a bad baseline to use from a modeling point of view.

Okay, fair enough. Thanks gentlemen.

We have no further questions, sir.

Okay. If there are no further questions thank you very much for your interest in Comtech and we at look forward to speaking with you again in a couple of months. Thank you very much.

This concludes today's teleconference. You may disconnect at any time. Thank you for your participation.