Comtech Telecommunications Corp (CMTL) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Comtech Telecommunications Corporation's first quarter of fiscal 2007 earnings conference 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 conference is being recorded Tuesday, December 5, 2006.

I would now like to turn the conference over to Ms. Vicki [Secaney] of Comtech Telecommunications. Please go ahead, ma'am.

Thank you and good morning. Welcome to the Comtech Telecommunications Corp. conference call for the first quarter of fiscal 2007.

With us on the call this morning are Fred Kornberg, President and Chief Executive Officer of Comtech, Robert Rouse, Executive Vice President and Chief Operating Officer, and Michael Porcelain, Chief Financial Officer.

A news release on the Company's results was issued yesterday afternoon. 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 am pleased to introduce the President of Comtech, Fred Kornberg. Fred?

Thank you, Vicky, and good morning, everyone, and thank you for joining us today.

This morning we will be discussing our results for the first quarter of fiscal 2007. We've provided a solid start to what we expect to be another record year for Comtech.

Our fiscal 2007 first quarter operating results and bookings exceeded our expect expectations and continue to reflect the strength of our product offerings and the health of the end markets that we serve. Rob Rouse, our Chief Operating Officer, will discuss recent developments in each of our three business segments and then I will update our guidance for fiscal 2007.

But first, Mike Porcelain, our Chief Financial Officer, will review our operating results for the first quarter. Mike?

Thanks, Fred. Good morning.

Let's begin by review some income statement items for the quarter ended October 31, 2006.

Q1 sales were $97.1 million compared to $106.6 million in the first quarter of fiscal 2006. The decrease reflects growth in the Telecommunications Transmission segment offset by lower sales as anticipated in our Mobile Data Communications and RF Microwave Amplifier segments.

Sales in our Telecommunications Transmission segment were $1.1 million higher in Q1 of fiscal 2007 than in Q1 of fiscal 2006. Sales in this segment reflect continued strong demand for our satellite earth station products offset by lower sales as we anticipated of our Over-the-horizon microwave systems. Rob will discuss this further in his remarks.

In our Mobile Data Communications segment sales decreased by $3.7 million, primarily due to the impact of our decision made in fiscal 2006 to significantly de-emphasize standalone sales of low margin, turnkey employee mobility solutions. Approximately $1.2 million of the Q1 Mobile Data Communications segment sales did result from a favorable adjustment to the estimated gross margin on the MTS contract due to increased funding and improved operating efficiencies.

Sales in our RF Microwave Amplifier segment decreased by $6.9 million, primarily as a result of lower sales as we anticipated of our amplifiers that are incorporated into IED jamming systems during this quarter compared to Q1 in fiscal 2006. Of the Company's Q1 fiscal 2007 sales 29.4% were to international end users, 56.3% were to the U.S. government, and 14.3% were to domestic commercial customers.

Gross profit decreased to $39.4 million in the first quarter of fiscal 2007 from $40.2 million in the first quarter of fiscal 2006. The decreased in gross profit during the quarter was primarily attributable to the decrease in sales, partially offset by an increase in the gross profit percentage from 37.7% to 40.6%.

Excluding the impact on sales and gross profit from favorable cumulative gross profit adjustments in both periods, gross margin would have been 39.9% in Q1 of fiscal 2007, and 37.2% in Q1 of fiscal 2006. This increase reflects a higher proportion of our consolidated net sales occurring in the Telecommunications Transmission segment which typically realizes higher margins than our other two segments.

It also reflects increased operating efficiencies in our Mobile Data Communications segment including the benefit of our decision to significantly de-emphasize standalone sales of low margin turnkey employee mobility solutions, and it includes the reduction in our estimated reserve for warranty obligations by half a million due to lower than anticipated claims received to date on a large Over-the-Horizon microwave system contract who's warranty period is nearing expiration.

SG&A expenses increased from $16 million in first quarter of fiscal 2006 to $16.6 million in the quarter. The increase during the first quarter of fiscal 2007 was primarily attributable to higher payroll related expenses including increased amortization of stock-based compensation expense, offset in part by lower expenses in our Mobile Data Communications segment as we continued to de-emphasize standalone sales of low margin turnkey employee mobility solutions.

Research and development expenses were $7.2 million in the first quarter of fiscal 2007, 7% higher than the $6.7 million in the first quarter of 2006. We expect R&D to continue to ramp-up in fiscal 2007.

Operating income for the three months ended October 31, 2006 was $15 million compared to $16.8 million in the prior year period. The first quarter of fiscal 2007 does include stock-based compensation expense of $1.8 million compared to $1.3 million in the first quarter of fiscal 2006.

Interest expense, which primarily represents interest on our convertible notes, was consistent between the quarters at approximately $700,000. Interest income increased significantly from $1.8 million in the first quarter of fiscal 2006 to $3.2 million in the first quarter of fiscal 2007, primarily due to higher interest rates and additional investable cash since October 31, 2005.

The effective tax rate for Q1 of fiscal 2007 was 38% compared to 36% in the same period last year. The increase reflects the expiration of the Federal Research and Experimentation Credit in December of 2005 and the scheduled phase out of the [Extraterritorial] Income exclusion in December of 2006.

On a non-GAAP basis, excluding the impact of stock option expensing, the effective tax rate for Q1 of fiscal 2007 would be 37%.

Regarding our effective rate going forward, our stockholders have been asked to approve of an amendment to our 2007 stock incentive planned intended to permit us to claim tax deductions for cash incentive awards earned and paid under the plan without limitation under Section 162 of the Internal Revenue Code. If the amendment is adopted and we take cash incentive awards under the plan, our effective rate for fiscal 2007 could be lower.

GAAP net income for the first quarter of fiscal 2007 was $10.8 million, or $0.41per diluted share as compared to $11.5 million, or $0.43 per diluted share in the prior year period. Because we believe that many investors may continue 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 first quarter of fiscal 2007, excluding stock option expensing, would have been $12.1 million, or $0.45 per diluted share versus net income for the first quarter of fiscal 2006 of $12.5 million, or $0.47 per diluted share. Earnings before interest, taxes, depreciation and amortization, or EBITDA, was $19.2 million for the first quarter of fiscal 2007 versus $20.1 million for the first quarter of fiscal 2006.

Cash used in operating activities of $3.6 million in Q1 of fiscal 2007 primarily reflects a build up in our inventory that we currently anticipate to be delivered to our customers throughout fiscal 2007, as well as the timing of payments for accounts payable and certain accrued expenses during Q1 of this fiscal year.

Backlog as of October 31, 2006 was $210.4 million, a new record for Comtech. This compares to $186 million as of July 31, 2006 and $156.8 million as of October 31, 2005.

Before I turn it over to Rob, I would just like to make a few comments on the status of the Form 10-Q that we filed yesterday with the SEC. As disclosed on the 10-Q that we filed yesterday afternoon, KPMG our independent registered public accounting firm, advised us that it had obtained information that it believes one of its staff accountants, who worked on the engagement to one of our financial statements, has made an investment in our common stock and that this matter has raised a question whether KPMG's independence has been impaired.

Although we are not certain, we've been told that the amount invested by this individual was approximately $5,000 that the investment occurred in the December 2005, January 2006 timeframe. As of this morning, KPMG continues to assess whether or not there has been an impairment of its independence relating to Comtech.

Although we are hopeful that we will have some resolution of this matter as soon as possible, we are an innocent bystander here and we will have to allow this process to run its course. Despite this unfortunate matter involving the KPMG employee, neither Fred nor I have any basis for believing the financial statements require any changes and we have certified in accordance with Sarbanes-Oxley and the SEC rules and regulations the information in the Form 10-Q that we filed yesterday.

We simply hope that this unfortunate incident, that was completely out of the Company's control to prevent, and whose resolution is being driven by KPMG, will be resolved at the earliest time.

With that said, Rob will now discuss recent developments in our businesses. Rob?

Thanks, Mike. Good morning to all of you.

Let's begin a discussion with our Telecommunications Transmission segment. Representing approximately 54% of our first quarter fiscal 2007 sales, this remains our largest segment and has been a significant catalyst for growth in recent years.

Its sustained success has been the result of its well-established leadership positions in satellite earth station products and Over-the-Horizon microwave systems.

As a reminder, our largest product line in this segment is satellite earth station products. Comtech is well recognized as a one-stop shop for this important family of products.

We sell these products to a broad group of global communication service providers as well as to domestic and international satellite network integrators. The U.S. government, particularly, and also foreign governments are becoming an increasingly more important part of this product line for us.

Increased demand in this product line has been driven by the global development of information intensive economies, the need for developing countries to upgrade or build out their communications infrastructures and the emergence of information based network centric warfare.

All of these trends have placed a premium on the development of technology to increase the efficiency of satellite networks which can reduce overall operating costs and provide for more voice, video and data throughput.

Accordingly, our R&D efforts in this area are primarily focused on optimizing the efficiency of our end users networks. In fact, we believe that our satellite modem technology is the de facto standard for optimizing satellite bandwidth utilization.

We believe that our R&D efforts and new product offerings are allowing to us continue to take market share from our competitors. And the record level of bookings in Q1 in our satellite earth station family of products is further validation of our strategy.

An update on the new products that are coming on line. First the CDM-Qx modem which employs carrier and carrier technology. This innovative technique allows end users to transmit both the forward and return sides of a satellite link concurrently using the same amount of satellite bandwidth, resulting in transmission of a full duplex link in up to half the satellite transponder bandwidth.

This translates to a potential of up to 50% power and bandwidth savings which is incremental to other operational savings from other techniques we offer such as our patented forward error correction technology. A recent example is General Communications Inc., a regional integrated communications provider serving the state of Alaska who is utilizing our CDM-Qx modems.

Jimmy Sipes, Vice President of Network Services at General Communications notes, "that carrier and carrier technology is doubling our transponder throughput and enabling delivery of new services without any additional transponder cost or operational expenses."

Another new product is the CDM-700 and 710 series of modems. These high-speed satellite modems operate at data rates of up to 155 megabits per second and include the latest DVBS-2 digital broadcasting standards. This new product offering leapfrogs the previous throughput rates of about 20 megabits per second available in prior generation modems.

We also recently introduced the SLM-5650 satellite modem for the government market, which as I mentioned earlier, is a market with very strong growth dynamics. This new modem meets the requirements of mill standard 188, 165-A, and includes extended data rates, a wide range of modulation options and advanced forward error correction.

The SLM-5650 has been well received and should enable us to take additional market share on the government side of this product line. We intend to continue to increase our technology investments in the satellite earth station product line with an ongoing focus on bandwidth optimization solutions for our commercial and government customers.

Now on to our Over-the-Horizon microwave product line. Here we have been and continue to be the world leader in providing equipment and systems which use the troposphere as the transmission medium.

The troposphere is a layer of the earth's atmosphere approximately seven miles above the earth's surface that is used to reflect signals to transmit voice, video and data. One of the major differences between troposcatter and satellite systems is that the use of the troposphere is free. This type of channel is also very secure and not prone to jamming from enemy territory.

Advancements that we have made in recent years have increased data rates by more than eight fold, thereby opening the door for a variety of new applications including the transmission of color video, video from unmanned aerial vehicles and IP over this type of channel for the first time. The higher data rates and the related applications that have been enabled by them have in turn opened up new markets for our troposcatter systems.

Among the more significant of such markets is U.S. Department of Defense which is reincorporating tropo systems back into its infrastructure. As you may know, the first major tropo program related to the DoD is the TRC-170 modem upgrade program.

Since May of this year, we have received orders totaling approximately $34 million to supply 220 modem upgrade kits for this important program. And we are actively speaking to the DoD about additional modem upgrade kit purchases as well as installation and support services.

In addition to the TRC-170 modem upgrade program, there are other tropo opportunities with the U.S. DoD including TRC-175, beyond line-of-sight terminal, or, BLOS, for which we have already provided our Over-the-Horizon equipment. There's also the Theater Deployable Communications, or TDC program, which we believe is a much longer term opportunity since the role of tropo is less clearly defined and the program needs additional funding.

We believe that the clear DoD priority as supported by its spending habits is the TRC-170 modem upgrade program. We also believe that the backward compatibility of the upgraded TRC-170 terminal modem kits that we are delivering with any non-upgraded TRC-170 terminals, the TRC-175 terminals and any additional programs puts us in a very strong position for any future U.S. government tropo awards since these terminals have to be able to speak to each other.

In addition to the exciting new U.S. government market, our traditional markets remain platforms for growth.

On the international front, revenues relating to our $77 million contract with a North African country were significantly lower in Q1 of fiscal 2007 compared to fiscal 2006. As you know, we anticipated this trend more than a year ago based on the production schedule for this contract which was in its peak production phase in late fiscal 2005 and early fiscal 2006.

We are expecting to receive a large follow-on contract relating to this program which represents the next phase of the current project. We believe we are simply in between major phases of this large program as the timing of the award has moved to the right.

We also believe that there are new program opportunities developing with the same end customer. And although the timing of contract awards from international customers is difficult to predict, we continue to expect to receive at least one meaningful award related to this end customer during fiscal 2007.

We also believe that having the U.S. government as a key reference customer has put us in a better position to market the utility of our technology to existing and potential international customers who may or may not be familiar with this unique and useful platform. In fact, we are approaching and reapproaching other potential international customers who have similar needs and geographic terrain, including some countries in the same general area as our North African customer, where Over-the-Horizon microwave technology is the logical solution.

In summary, our Telecom Transmission segment continues to lead the way in developing leading edge solutions for our customers and driving our strong operating results.

In our Mobile Data Communications segment Q1 was a good start to what we expect will be another fantastic year. On the government side of this business, funding for the logistic communities MTS program continues to be on the rise.

Approximately $85 million is included in the fiscal 2007 defense budget for this important program. By far the highest amount of line item funding in the history of the program.

As you well know, the MTS contract expires in July 2007. At this point, no request for proposal has been issued by the program office in preparing for a recompete process.

With just eight months left before the contract expires, it is possible that the program office may request that the contract be extended for some period of time until the recompete process is completed. In light of the critical nature of this program, however, we believe that the Army will continue to rollout the technology irrespective of whether the contract is expected or recompeted.

However, the lack of clarity regarding what will happen in this final year of the initial contract does present some additional uncertainty as to how much and when funding will be received and how related deliveries will be affected.

Having said that, we have begun to receive initial funding from the government's fiscal 2007 budget as evidenced by the $24.3 million in new orders we received in late October.

In addition to the core MTS funding we are also continuing to receive orders pursuant to the National Guard supplemental funding bill. As a reminder, MTS was the second highest priority identified in this National Guard bill which allocated $113 million to be spent on MTS systems.

Although the MTS program office and National Guard will retain a portion of the amount for their own expenses and peripheral equipment, we expect to receive the lion's share of this funding. To date, we have received approximately $56 million of orders from the National Guard and are awaiting additional orders once the Guard determines how and when to field its additional requirements.

We also continue to provide hardware satellite services and other support to the warfighter community, most notably for the FBCB2, or Blue Force Tracking program. Our technology is critical to this high profile program as it provides for communications when forces are spread out beyond line-of-sight range on the battlefield.

Since our last conference call, we have received a request for proposal from our Blue Force Tracking customer to provide continuing satellite service and hardware pursuant to a five-year, IDIQ contract. This proposed contract is expected to be in the range of $200 million and is tangible evidence of the important role our technology continues to play and will play over the next few years.

We are also continuing to work with this customer in addressing future operational needs, and in connection with such efforts, are in investing in significant upgrades to both our network and hardware offerings to favorably position us for the next-generation of Blue Force Tracking.

During Q1 of fiscal 2007 we completed the acquisition of Insite Consulting. Insite allows us our Mobile Data Communications segment to offer additional software applications to the logistics and warfighter communities within the U.S. DoD as well as to allied military forces.

In fact, Insite is currently working on a project to incorporate its geoOps software platform into a multinational, satellite-based friendly force tracking system being deployed by NATO. We also believe that Insite will be very helpful to us in penetrating some of the vertical commercial markets that may be subject to Department of Homeland Security mandates regarding the hauling of hazardous and flammable materials.

During Q1 we also fully integrated the operations of Tolt into our Germantown, Maryland facility and sales of low margin standalone Tolt products were virtually a zero for the first quarter. All in all despite the loss of approximately $15 million of Tolt sales, we expect that fiscal 2007 will be another record year for our Mobile Data Communications segment.

Now on to our third segment, RF Microwave Amplifiers. This segment's first quarter results were in line with our expectations. We expect sales and earnings in the second half of fiscal 2007 to be stronger than the first half as a result of deliveries on orders received in fiscal 2006 and so far in fiscal 2007.

In fact, the $55.2 million of record annual bookings in this segment in fiscal 2006 were followed up in Q1 of fiscal 2007 by a solid $13.2 million in new orders.

This business is not just about one program or one application. Our opportunities in this segment are broad-based.

Our high-power broadband amplifiers are of particular importance in many electronic warfare applications. Among such applications are communications jamming, IED jamming, radar and IFF.

Accordingly, the majority of this business currently is defense related. However, our amplifiers also play an important role in a variety of sophisticated commercial applications such as oncology treatment systems and air to satellite to ground communications for commercial aircraft.

Demand for our high-power amplifier products for the commercial aviation market have been particularly strong. And we are continuing to invest heavily in the latest solid-state technologies and incorporating these innovations into new products for existing and potential customers.

Now back to Fred who will update our guidance for fiscal 2007. Fred?

Thanks, Rob.

As I've said on numerous times in the past, it continues to remain very difficult for us to provide revenue and EPS guidance due to many factors including the timing of bookings and related revenues and large contracts, the uncertainty, particularly in today's environment regarding U.S. government funding priorities, and obviously, economic conditions in general. These factors are an inherent part of our business.

Having said that again, 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. Please note that our earnings releases and quarterly investment presentations reconcile the GAAP and non-GAAP information, as I said, on our releases and on our Web site.

With that in mind, excluding the impact of stock option expensing, we're raising our non-GAAP diluted EPS guidance for fiscal 2007 by $0.12 from a range of $1.93 to $1.95 to a new range of $2.05 to $2.07. This equates to a GAAP diluted EPS range from $1.86 to $1.88.

This EPS guidance assumes a non-GAAP effective tax rate of 37% and a GAAP effective tax rate of 38% and does not anticipate reinstatement of the R&E tax credit by Congress this year.

Fiscal 2007 revenues are now expected to be between $440 million and $450 million for the year. As you can see from our outlook for the remainder of fiscal 2007, we expect the average quarterly sales will continue to increase as our businesses remain very strong and we expect solid organic growth once again this year.

In addition with our strong cash position and expected cash growth for the year, we're able to continue to seek appropriate acquisitions and consider deploying cash flow in a stock buy back program as deemed appropriate. Q1of 2007 was a good start to what we expect will be another fantastic year and we remain optimistic about delivering another record year in fiscal 2007, our fifth in a row.

Thank you very much. Now we will take your questions. Operator?

[OPERATOR INSTRUCTIONS] We'll take our first question from Mark Jordan with A.G. Edwards. Go ahead, please.

Good morning, gentlemen.

I was wondering if you could give us a break down on backlog by the three operational segments, please?

Sure, Mark.

In our Telecom Transmission segment backlog for the quarter was $79.4 million. In our Mobile Data Communications segment, $88.1 million. And RF Microwave Amplifiers it was at $42.9 million for a total backlog of 210.4.

Back to the tax question again. Your guidance for GAAP earnings included a 38% tax rate which does not assume, or the potential impact of passing the action by shareholders. If that is passed would that be retroactive to the start of the year or to the point of the day of passage, and when is that meeting?

Sure.

Mark, this has been an area that's been kind of bogged down in Congress with a lot of other tax initiatives that have been attached to it. I think there's pretty bipartisan support to it.

It appears at this point in time what they would like to do is make it retroactive so in addition to whatever benefit we would have on this year's P&L if you remember last year we actually had half a year's worth of non-R&E credit environment.

So you don't know until they pass the bill but it's got pretty bipartisan support in Congress. So forgetting about the impact from prior years, we think that that could lower our effective tax rate for this year by itself anywhere from let's say 1% to 1.5%.

And as Mike mentioned in his comments, also, our shareholder are voting today on this proposal regarding Section 162M of the code which could further reduce our tax rate. So if the R&E credit gets passed and the proposal before our shareholders gets passed today, we could see our tax rate drop in the, let's say, 2% range if both happened.

Okay. Thank you.

Also talking about the TRC-170, you've got $34 million in orders. Have you delivered anything meaningful on that yet and what is the delivery timeframe for the $34 million that you have backlog?

Sure. We have delivered some amounts in the first quarter. We do expect those to ramp-up in the second quarter and the vast majority of it will most likely be delivered by the end of the third quarter.

As I said in my comments, we are working with the end customer on receiving additional orders and we are also hopeful that we'll receive some support services for installation and training and the like as well.

Final question.

With Tolt being assimilated into the Company what is your strategy for addressing the potential to commercial marketplace and what are you putting in place to work in that direction?

Sure. As I mentioned briefly during my comment, Mark, regarding Insite, we really have tried to focus our efforts on the vertical markets that have some type of Homeland Security mandate dynamic to them rather than the much broader market, whereas Tolt was more of a attack all sides of the market. So we're hoping to focus on customers who are going to really have, what I call either an economic or a regulatory mandate to use a real-time tracking using satellite.

If we have a potential customer that can get by with a terrestrial solution that's not a market we really want to play in because satellite's not going to be cost competitive. But if we have a customer that needs satellite tracking in real-time, we think our qualifications from the Iraq war are very compelling in terms of reliability and that's where we are going to focus our market efforts.

Thank you very much.

Sure.

Thank you. We'll take our next question from Tim Quillin with Stephens Incorporated. Go ahead, please.

Good morning. Nice results.

Rob, on the TRC-170 sales in the quarter could you just give a little better sense, bigger than a bread box?

All I can tell you, Tim, is it will ramp-up in Q -- I don't want to get into product line revenues but we expect revenues in that segment, in that product line to increase for the rest of the year.

In the 10-Q it said that you expect the average of the next, the remainder of the year, the next three quarters to be above the first quarter. Does that, is that based on the $33.8 million in backlog or do you assume additional orders on top of that?

It's primarily, keep in mind that that disclosure, Tim, relates to that segment so that segment includes not only our Over-the-Horizon microwave line but also the Telecom, also the satellite earth station product line. So at the end of the day most of it's in backlog but we are expecting some additional orders and we do expect other recurring orders that we have in the smaller parts of that business.

But certainly, when you look at the two product lines in the business the earth station product lines tends to be more steady. The lumpiness tends to be on the Over-the-Horizon microwave side.

And I guess to answer the question more specifically, when you look at that $34 million in orders the first quarter doesn't have as much as it will for the rest of the year, would be a fair way to answer it.

Okay. And maybe another.

I guess what I'm trying to get a sense of and if you can give me specific numbers great, if not but I'm trying to get a sense of the growth rate in the earth satellite station business and maybe if you can talk about any areas of strength, particular areas of strength or weakness in that business.

Sure. I think in the satellite earth station business, the two areas that are very hot right now are first the cellular back haul market that we've talked about before, not only our EF data products, but our Memotec products that we acquired a few years ago, are really in the sweet spot of many applications that satellite are being used for.

As you go throughout the world and get into the less developed parts of the world, there's a lot of demand for cell service and all kinds of applications but you've got to get that information back to central headquarters, so to speak. So cellular back haul is really driving demand.

As well as the military market has been an area that we haven't been as strong in historically as the commercial market in that product line and our new SLM-5650 modem is coming on very nicely and we think we're taking market share in that area.

Okay. Very good.

And lastly, then, and this is I'm sure even hard for you to determine, but I have a little troubling modeling stock options expense. Could you give me a sense of how you expect that to trend over the course of this year and then to the extent you can, talk about where you expect that to go in the future?

Sure.

Tim, most of our option grants for the year have been made already so the guidance that you see and you can calculate there's about a $0.19 difference between GAAP and non-GAAP, that we don't expect that differential to really change dramatically at all, maybe by a penny or so the rest of the year.

And in our guidance we even have, if I'm correct, Mike, have a few miscellaneous option grants built in there for new hires and the like. So we don't really see it changing going forward for this year, Tim.

Obviously, looking into the future the way the calculations are done, they're based on the Black-Scholes model, as you know, and there's a lot of factors that go into that calculation including what our stock price is that make going forward very difficult to predict. But for this year, we don't expect the impact of stock option expensing to change materially from what we've indicated in our guidance.

Okay. Helpful. Thank you.

Sure.

Thank you. We'll take our next question from Richard Valera with Needham & Company. Go ahead, please.

Thank you. Good morning.

Rob, I know you guys don't want to be giving specific quarterly guidance but is there anything you can say about the contour of the remaining three quarters, how we should think about it? Should we just think about it sort of flattish for the remaining three quarters, figuring an average based on the remaining revenue in the year or is there any help you could give us in terms of that contour?

Rich, as we've said on the calls before, our hesitancy on the guidance is just based on the large contracts we have shifting between quarters, you know, this quarter was a bit stronger than we thought. We've said in our Q that we expect the average quarterly sales to increase and given the size of some of the items that we're dealing with, I wouldn't want to go much further than that.

Obviously, in our balance sheet we have a build up in inventory. So there's a lot of things in Q2 that we have in backlog that we know we're shipping, we know the dates and we're doing that now. But I'm just very reticent to kind of back door into quarterly guidance when we still really feel strongly this is the right answer that looking at our business quarterly is more confusing than anything else and you really have to look at it on an annual basis.

And we can have fluctuations between quarters for the rest of the year and that's why we've kind of said the average quarterly amounts we see for the rest of the year will increase because I'm just sensitive to something shifts between Q2, Q3, and the year itself is still intact and it's still meeting our expectations and exceeding our expectations. So we would like to avoid getting into much more granularity on the quarters.

Understood. Thought it would be worth a try.

On, you mentioned, Rob, that there's potential for a roughly $200 million, five-year contract in the Blue Force Tracking area which would imply about a $40 million annual run rate over the term of that yield. Can you give us a sense of where your current run rate is with the Blue Force Tracking program? It's sort of in the $30ish million range?

I would say, Rich, it's not significantly different than that. It can fluctuate from year-to-year but it's not out of line with historically where they've been.

So you wouldn't see that as really representing a material increase in the run rate of your Blue Force Tracking business?

Again, at this point in time, we're just responding to the RFP. It doesn't mean that there can't be other dynamics of Blue Force Tracking that we serve, as well, but it's not substantially above the current run rate that we're at. That's a fair way of saying it.

Okay. That's helpful.

Just to point out there, Rich, one of the reasons we believe that they want to put this contract in place is, as you probably know, some of the hardware purchases that they make in this program they're making under the MTS contract. And I think from a program office point of view they like the idea of having their own contract vehicle in place.

So I wouldn't read too much into either direction the analyzed amount. I think they want to have a contract in place where they're able to buy product by themselves without having to go trough another command's contract vehicle.

Moving over to MTS you mentioned there's no formal RFP yet. Have you gotten any sort of feedback about what that next generation system might look like at this point? Is there things you're working on towards a possible re-bid or is it just sort of radio silence as far as what that might look like at this point?

I think radio silence is probably a good way to describe it, Rich. Obviously, it's a sensitive process because they're going through a procurement process and we're the incumbent. So we're continuing to focus our efforts on supplying them what they need and we have ongoing discussions with them.

I'll use RFID as an example. That was a technology that they told us they wanted and we incorporated it into our device so we're trying to anticipate what their needs are from an operational point of view, But in terms of their specific plans for the recompete process, it's not something that's within our purview at this point in time.

Great. Just one final one if I could.

With respect to cash flow you had kind of some unusual payments on the payable side this quarter which seems sort of one-time. I would expect going forward, though, as you potentially work down this inventory and don't have that big payables outlay that you should start seeing positive cash flow again. Is that fair to assume?

Absolutely. If you think about it the first quarter has a couple of things. It's got the build up of our inventory investment, which is going to fuel our growth for the rest of the year and, for example, things like year-end bonuses get paid out in the first quarter so you really have an entire year's worth of incentive compensation being paid in one quarter.

So you had our lowest quarter of the year with inventory build up and some of the accrued expense fluctuations that Mike referred to. Absolutely, we would expect the cash flow to turn in Q2 in the balance of the year.

Great. That's helpful. Thanks, guys.

Sure.

Thank you. We'll take our next question from Jim McIlree with Unterberg, Towbin. Go ahead, please.

Thank you. Good morning.

You talked about an increase in R&D for the rest of the year. Is that an increase in dollar amounts or is that an increase as a percent of revenues?

Both, Jim. You might recall my comments at the end of, I guess, for our year-end conference call, we were thinking that R&D would probable drift towards the 7% range.

In the first quarter it was probably a little bit higher than that just because our revenues were lower. But if you're thinking about it for the year, Jim, in the 7% range is probably a good point estimate.

Okay.

And SG&A, is that similar amounts in terms of percent of sales for the year that we saw in the first quarter? Kind of around that 17% area or is that?

I would expect it, Jim, to be somewhat lower because some of our G&A expenses are fixed. Other than things like commissions, certain forms of compensation there are a lot of fixed expenses so I would expect the SG&A percentage to decrease -- the dollars will go up but the percentage I would expect to decrease for the full-year.

Assuming that the shareholders approve the tax issue that you mentioned, does that signal a change in your policy of cash compensation versus option compensation?

No. The proposal that's in front of the shareholders, Jim, primarily relates to the deductability of cash compensation. With stockholder approval it would affectively enable us to take the full tax deduction for any cash incentive awards because currently there are limitations based on Section 162M of the code.

It doesn't necessarily indicate any change in strategy, it's just trying to fully maximize our tax position.

And, I'm sorry, but did you say expect the timing of the $200 million IDIQ?

We're currently in the process of responding to it, Jim. Again, this is another area where the timing is largely outside of our control, but we would expect this to not drag on for too long, hopefully within the next quarter or so.

Historically, if you remember what [we've] done in the beginning of each calendar year is we've done a large undefinitized contract for satellite time. Whether or not we're going to have to do that again is going to be dependent on whether or not this other contract vehicle would get in place which, given that we're in December, we'll probably have that scenario happen again,

But in terms of the $200 million contract, it's going to really be up to them in terms of assessing our proposal.

Terrific. Okay. Thank you very much.

Sure.

Thank you. We'll take our next question from Tyler Hojo with Sidoti. Go ahead, please.

Hi. Good morning.

I was wondering if you could talk about the guidance. Does that include, I know you've mentioned in the past, Rob, $40 million and up for a potential addition to the North African customer. Is that included in the guidance at all?

No, it's not. Tyler, in my commentary when I said that we're optimistic that we'll receive a contract, it would be in the latter part of the year.

And even if we were to receive it, given the nature of those types of contracts which do have some design and planning up front, it wouldn't be a meaningful revenue contributor unless we received it in the very near future which I don't think is the case at this point in time so it's not in our revenue or earnings guidance.

Okay. And you mentioned that there were several people that you were speaking with, was that correct?

In addition to the add on phase of the contract that we're currently involved in, there are other opportunities with the customer that we're speaking about but those are obviously less mature because they're not related to an existing program.

And since we have attained the U.S. government as one of our customers, we've tried to reinvigorate some of our contacts in other areas of the world where having the U.S. government as a customer, we think, could be helpful to us. Because in the past without the U.S. government as a customer, many of our potential customers would say, well, why doesn't your own government use the technology?

So we're trying to reapproach, as I said during my comments, some of those contacts to let them know that we've answered that question and may have a better opportunity to sell to those end customers in the future.

Okay. Terrific. Maybe moving to something else.

As far, I know on some of the past calls you've mentioned additional IED opportunities on the RF side of the business. Maybe if you could update us as far as what's going on there?

Sure. Currently, there's four or five different IED jamming programs that are underway at the DoD. The Warlock program as relates to us if you recall, Tyler, we've been kind of downplaying our involvement in that for over a year now because we just didn't see the order flow there and saw them going in another direction.

There is another application that's being rolled out now and there's three other ones that are in the process of development and, again, we would like to play on the higher power side of the world and we have samples of our modules with most of the players in this market. But to be quite frank about it, it's a very cloudy picture in terms of what's happening and where the funding's going and in our guidance we have no additional IED jamming revenues for the rest of the year.

Not because we don't think that we have a good product that's well positioned with certain customers, it's just impossible to predict at this point what's going to ultimately end up happening.

Now, I know you probably won't tell me, but would you say, would you think it's reasonable without the return of IED coming back that you guys could do breakeven revenues in RF this year?

When you say -- what do you mean by breakeven?

Breakeven with fiscal '06.

Yes, I think our goal is, I think we said on the last call we believe this business has found a new foothold in the $40 million range and that's certainly, this year with a nominal amount of IED related revenue, that it just speaks to the strength of the other electronic warfare and other applications that we have here.

So, yes, that is implicit in our guidance is a run rate in the mid $40 million range for this segment.

Okay. Great. And maybe just a couple more here.

Were there any wind down costs from Tolt in the quarter and if so what were they?

Not anything of size. A lot of the cost had been accrued for, Tyler, in the fourth quarter. There were some severance payments for some folks that we had to keep on board during the transition.

But as of last Thursday, I guess it was, Mike, there's no one left in that facility. We're just looking to sublease it and all the operations have been moved to Maryland. So from an operational point of view it's behind us.

I guess somebody asked but I know one of the strategies was hoping to get some new product sales stemming from Tolt. Any timing on that or maybe if you could just talk a little bit about what the expectation is there?

Yes, I think, Tyler, maybe you were referring to Insite. The Tolt commercial activities have been merged into our Germantown, Maryland facility and, again, we're trying to focus on the areas that have a specific need for real-time satellite communications.

Given all the goings on that we have this year in the government side of the business we're taking that somewhat slow. As you could probably imagine with the opportunities before us on the government side, we don't want to get too distracted.

But we are hoping towards the latter part of this year, beginning of next year to land a couple of opportunities in that area. But I don't want to over estimate or over emphasize where our focus is at this point in time.

Okay. That's fine. And just one last one, maybe for Jerome if he's on the call.

Just if you guys could characterize what you're seeing as far as acquisitions go. I mean, obviously, you're sitting on a good deal of cash here.

I think the more important than what we're seeing is just the way we're approaching our acquisition strategy. We've become very methodical at looking at all opportunities that we think align with our two key drivers which is companies with leading markets positions and companies with very strong management teams that we think would thrive under the Comtech umbrella.

I would say that the number of opportunities has increased as I think we've become more recognized as a potential buyer of companies. And I think because we have more resources devoted to this effort, I think we're able to more quickly make decisions and able to move on and look at a broad number of opportunities.

What are you seeing, Jerome, as far as valuations right now?

Depends. I mean I don't think it's very varied and it's not something -- there's no kind of theme at this point. It's all really dependant on a particular situation.

Thank you very much, guys.

Sure.

Thank you. We'll take our next question from Tim Quillin of Stephens Incorporated. Go ahead, please.

Just a real quick question.

On the last conference call you mentioned the, least discussions internally and at the Board level about a share repurchase program. Could you just talk about what your current thinking is?

I guess, Tim, we've got a cash accumulation that's becoming a pretty large number and we're discussing ways of using it, whether it be an acquisition or whether it be a stock buy back. It all depends what's appropriate at a given time and so we will just continue to monitor it, discuss it, and we'll make a decision when we need to. Thank you.

Okay. Thanks, Fred.

We appear to have no further questions at this time.

Okay.

Well, thank you very much for your interest in Comtech and we look forward to speaking with you again very soon. Thank you very much for attending.

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