Comtech Telecommunications Corp (CMTL) 2013 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Comtech Telecommunications Corp First Quarter Fiscal 2013 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 Friday, December 7, 2012. I would now like to turn the conference over to Ms. Maria Salerno 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 Year 2013. With us on the call this morning, are Fred Kornberg, President and Chief Executive Officer of Comtech, and Michael Porcelain, Senior Vice President and Chief Financial Officer.

Before we proceed, I need to remind you of the Company's Safe Harbor language. 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 Company's plans, objectives, and business outlook, the plans, objectives and business outlook of the Company's Management, and the Company's assumptions regarding such performance, business outlook, 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 filing.

I am pleased now to introduce the President and Chief Executive Officer of Comtech, Fred Kornberg. Fred?

Thanks Maria. Good morning everyone, and thank you for joining us on this call. Despite difficult market conditions, we reported solid first quarter results of $91 million in revenues, and a GAAP diluted EPS of $0.36. Our first quarter results include a pre-tax net charge of $800,000 related to a restructuring plan to wind down our microsatellite product line, and also includes a pre-tax benefit of $2.4 million related to a change in fair value of the earn-out liability associated with the acquisition of Stampede Technologies Inc.

Our adjusted EBITDA for the quarter was $18.5 million. Although our long term growth plans have not changed, we believe that the impending sequestration deadline and the looming fiscal cliff have resulted in increased uncertainty throughout our customer base. As such, we now believe revenues in fiscal 2013 will be in the range of $350 million to $365 million, and GAAP diluted EPS will be in the range of $1.26 to $1.34. Our adjusted EBITDA is expected to be in the range of $65 million to $68 million.

In light of our expectations of continuing solid operating cash flows, our Board of Directors approved a dividend for our second quarter of fiscal 2013 of $0.275 cents per common share. This dividend is expected to be paid on December 27, 2012 to stockholders of record on December 17, 2012. To date, we have paid out approximately $52.3 million of dividends over the past nine consecutive quarters, and continue to believe our dividend program is an excellent way to return capital to our stockholders. In addition, our Board of Directors authorized a new $50 million stock repurchase program, which will be effective upon the completion of our current $250 million stock repurchase program. And as of today, we have $61.3 million available to repurchase our common stock.

At this point, let me turn it over to Mike Porcelain to provide a brief overview of our first quarter financial results. Mike?

Thanks Fred, and good morning everyone. I'll walk you through the Q1 results. And as I normally do, I will provide some additional commentary on our expected financial results for fiscal 2013. During Q1, we generated revenues of $91 million, of which 43.4% were for US government end-users, 43.1% were for international end-users, with the remainder being for domestic commercial end customers. Let me provide some color on sales by segment.

Net sales on our Telecom Transmission segment were $53.3 million in Q1 of fiscal 2013, as compared to the $56.8 million we achieved in Q1 of last year, representing a decrease of 6.2%. This decline is attributable to lower sales of our satellite earth station products, which were partially offset by slightly higher sales in our over-the-horizon microwave system product line. During Q1 of fiscal 2013, our satellite earth station product line was negatively impacted by reduced spending by the US government, primarily as a result of budget pressures and the impending sequestration deadline, as well as continuing overall challenging global business conditions. These adverse conditions have continued into our second quarter of fiscal 2013, and we do not expect to see meaningful improvement until the second half of fiscal 2013. Ultimately, we do expect business conditions to improve. As such, we expect satellite earth station sales to increase slightly in fiscal 2013 as compared to the full year of fiscal 2012.

Sales of our over-the-horizon microwave systems increased slightly during Q1 of fiscal 2013 compared to last year, and reflect the benefit of shipments related to orders for our modular transportable troposcatter systems or MTTS. As well as our performance on our three year, $55 million contract to design and furnish a telecommunication system for use in the North African government's communications network. Although future orders are difficult to predict, we are expecting to receive significant additional MTTS orders that we do expect to ship during the fourth quarter of our fiscal 2013. As such, we do expect net sales for this product line in the fiscal 2013 to be significantly higher than the level we achieved last year.

Net sales in our RF Microwave Amplifier segment were $25.3 million, as compared to $21.1 million in Q1 of last year. This increase of 19.9% primarily reflects significantly higher sales of our traveling wave tube amplifiers. Overall market conditions in this end market also remains challenging, and the ability to predict the timing of additional awards remains difficult. Based on our current backlog and the anticipated timing of orders we do expect to receive, we now expect net sales in this segment in fiscal 2013 to be slightly lower than the level we achieved in fiscal 2012.

Turning to our Mobile Data Communications segment, sales in Q1 of fiscal 2013 were $12.3 million, a substantial decrease of 65.4% from Q1 of last year. This anticipated decrease is attributable to a substantial decline in MTS and BFT1 sales to the US Army, as well as our fiscal 2012 decision to wind down our microsatellite product line. Sales related to the design of microsatellites were insignificant in Q1 of this year, compared to approximately $7.6 million in Q1 of last year.

Mobile Data Communications sales for the first quarter of fiscal 2013 includes $2.5 million of revenue related to our $10 million annual intellectual property licensing fee that we collected in fiscal 2012. Q1 fiscal 2013 sales also include sales of MTS mobile satellite transceivers of approximately $3.5 million, for which we currently have no additional orders in our backlog. We continue to expect that sales in our Mobile Data Communications segment will be materially lower this year as compared to last. As a reminder, effective June 30, 2012, we are no longer procuring or providing satellite transponder capacity to the US Army. We currently have $11.8 million of BFT1 orders in our backlog, and as Fred will discuss in a bit, we are expecting that the BFT1 sustainment contracts optional performance period will be exercised by the US Army.

Let me walk you through our gross margin and SG&A line items. Our gross profit in Q1 of fiscal 2013 as a percentage of net sales was 46%, as compared to 45.2% for Q1 of last year. The increase was attributable to a higher percentage of consolidated net sales occurring in our Telecom Transmission segment, which generally has a higher gross profit percentage than our other two reportable operating segments, and an overall better mix of products and services in both our RF Microwave Amplifiers and Mobile Data Communication segments. Our gross profit in Q1 of fiscal 2013 does reflect the $2.5 million of revenue from the IP fee I just mentioned. Our gross profit in Q1 of fiscal 2012 reflects the benefit of $5.6 million related to the finalization of MTS and BFT1 orders. Looking forward, we believe gross profit as a percentage of consolidated net sales for the full fiscal year 2013 will be higher than the percentage we achieved in fiscal 2012.

On the expense side, SG&A expenses were $16.8 million or 18.5% of Q1 of fiscal 2013 net sales, as compared to the 21.3% we achieved in Q1 of last year. Our SG&A expenses for Q1 of fiscal 2013 reflects a benefit of $2.4 million relating to a change in the fair value of a contingent earn-out liability associated with our acquisition of Stampede assets, offset in part by approximately the $800,000 worth of restructuring charges associated with the wind down of our microsatellite product line. Our SG&A expenses during Q1 of last year were impacted by $2.6 million of professional fees associated with the withdrawn contested proxy solicitation in connection with our fiscal 2011 annual meeting of stockholders. Excluding these amounts in each respective period, SG&A expenses decreased by $3.1 million primarily due to overall lower spending associated with lower consolidated net sales. Looking forward, total GAAP SG&A expenses in dollars are expected to decrease in fiscal 2013 as compared to fiscal 2012, and as a percentage of consolidated net sales are expected to be comparable.

Research and Development expenses were $10 million or 11% of consolidated net sales in Q1 of fiscal 2013, versus the $9.7 million or 8.6% in Q1 of fiscal 2012. Looking forward, despite challenging business conditions and notwithstanding our cost reduction efforts, we expect to continue to invest in R&D. As such, we expect that R&D expenses in dollars in fiscal 2013 will be comparable to the level we spent in fiscal 2012. As a percentage of consolidated net sales, we do expect that R&D expenses to increase.

Total stock based compensation expense in the first quarter of fiscal 2013, which is recorded in our unallocated segment, was $700,000 compared to $900,000 in the first quarter of fiscal 2012. Amortization of intangibles with finite lives in the first quarter of fiscal 2013 was $1.6 million, compared to $1.7 million in the first quarter of fiscal 2012. Consolidated operating income was 14.7% of consolidated net sales, as compared to 13.9% in the first quarter of last year. Because the pricing for various products and services we have agreed to provide to the US Army has not yet been finalized and it remains difficult to predict our overall sales and product mix, it is difficult to estimate future operate margins. Nevertheless, based on the orders currently in our backlog and orders we expect to receive, we do expect consolidated operating income in fiscal 2013 as a percentage of consolidated net sales to approximate 13%.

Interest expense was $2.1 million in the first quarter of both first quarter of fiscal 2013 and fiscal 2012. Interest income and other was $276,000 in the first quarter of fiscal 2013, compared to the $496,000 we reported last year in Q1. Interest income and other for both periods is primarily generated from interest earned on our cash and cash equivalents.

Turning to income taxes, our GAAP effective tax rate for the first quarter of fiscal 2013 was 35.5%, which does not include any benefit from Research and Development credits which expired on December 31, 2011. This rate does reflect an increase as compared to our earlier fiscal 2013 estimate of 34.5%. This new rate assumes no discrete tax adjustments, and reflects product and geographical mix changes in our fiscal 2013 business outlook. This change negatively impacted our earnings guidance by approximately $0.02 of diluted EPS. Despite the higher tax rate, as mentioned earlier, for the first quarter of fiscal 2013 we did deliver GAAP diluted EPS of $0.36.

Now, let me provide a few financial metrics to help provide additional color. Adjusted EBITDA as defined at the end of our press release that we issued yesterday was $18.5 million in Q1. At October 31, 2012, our backlog was $133.3 million, compared to $153.9 million at July 31, 2012. This backlog includes $11.8 million of orders related to our BFT1 sustainment activities.

Now let me turn to our balance sheet which remains very strong. As of October 31, 2012, we had $374.5 million of cash and cash equivalents. This balance does not reflect our Q1 dividend of $4.8 million, which was paid in November of 2012. We also generated $11.9 million of positive cash flows from operations during Q1. Based on the timing of expected orders and related collections, we do expect nominal cash flows from operations during our second and third quarter of fiscal 2013, but we do expect to generate significant cash flows from operations during our last quarter.

Finally, I want to highlight a few comments related to our fiscal 2013 guidance. As you know, we stopped providing quarterly guidance several years ago. However in light of current market conditions and the timing of expected orders, we do believe it is prudent to provide some comments on Q2. We expect that our sales in Q2 of fiscal 2013 will be approximately 15% lower than Q1 of 2013 before ramping back up in Q3 and even more so in Q4. As a result of our outlook, we expect that our 3% convertible notes in Q2 will not be dilutive. As such, for income statement modeling purposes you should consider excluding the shares from your diluted EPS ratio calculation and not adding back the interest expense to the numerator. From an EPS perspective, Q2 diluted EPS is expected to be somewhere between $0.10 and $0.12 with the rest of the year strengthening and Q4 being our peak. Of course as usual, our guidance does not reflect any stock purchases or one-time charges that may happen.

Now let me turn it back to Fred who will discuss our business strategies and outlook in further detail. Fred?

Thanks Mike. I'd like to provide a brief update on each of our core product lines, and then we'll go into a question and answer period. I'll start with the Telecommunications Transmission segment, which is the backbone of our current business.

Although total revenues in this segment decreased by approximately 6% from the first quarter of last year, the decrease is primarily the result of the weak macro-level economic environment worldwide, as well as the virtual paralysis in US government spending. Generally speaking, we can say that we do not believe we're losing market share, and we clearly remain the undisputed leader in both the satellite earth station equipment and over-the-horizon microwave system markets. Satellite earth station product bookings in the first quarter of fiscal 2013 were softer than we had expected. Having said that, we do see some catalysts that should make bookings in the second half of fiscal 2013 stronger than the first half.

On the international front, we believe softer bookings are primarily the result of delays in programs and projects. Our products are still the key enablers in making satellite networks more efficient and addressing severe bandwidth shortages. When new cellular networks are being rolled out, satellite for backhaul is the preferred solution to moving voice, video, and data back to central switching stations. And we remain the supplier of choice in providing maximum efficiencies to our broad customer base.

On the US government side of the satellite earth station product line, the ongoing paralysis in Washington continues to make the receipt of orders a challenge. We were hoping for some additional clarity once the Presidential election was over, but worry about the election has now been replaced by panic about the fiscal cliff. Despite that, we continue to be bullish as far as long term demand for our product goes. A few months ago, we received our first US government orders for modems containing our Carrier-in-Carrier technology. And earlier this week, we received government certification for two of our key government modem products. This is important since it allows us to sell our most attractive product feature to the various potential buyers within the US government. Although we continue to operate in a very uncertain economic and political environment, future emerging opportunities on the international side of the satellite earth station area combined with progress that is expected to be made on the fiscal cliff issue during the second half of 2013, make us believe that bookings in fiscal 2013 will be modestly higher than they were in 2012.

Turning to the other component of our Telecommunications Transmission segment, we remain bullish about our over-the-horizon microwaves product line. As you know, in the fourth quarter of fiscal 2012 we received a $55 million contract from a US prime contractor relating to the next phase of the major communications project with the North African end customer, which will generate nice revenue stream beginning in the second half of this fiscal year. Just as importantly, we understand that the prime contractor has already received its contract for the next phase of this same project, and is awaiting a down payment from the end customer. Although it is very difficult to predict the timing of large international orders, it is possible that we could receive an order for this next phase during fiscal 2013, and this order would be of the equivalent size. This end customer market is expected to provide additional revenue opportunities for us in the foreseeable future.

A few years back, we refocused our marketing our over-the-horizon microwave products and systems to foreign countries that have challenges in communicating over difficult terrain, similar to our North African end customer. We've made significant head way with various new potential customers worldwide. In fact, in the first quarter of fiscal 2013, we received a $1.4 million order from the Swedish Military for the first of many of our mobile transportable communications troposcatter systems. We're also cautiously optimistic about some of the other international opportunities, some of which are quite large. In the intermediate to long term, all of these potential customers have a requirement for tropo. South America in particular looks like a strong market for tropo, while unrest in the Middle East, unfortunately, seems to be delaying potential projects in that region.

On the US government front, we continue to supply a prime contractor that is using its antennas and our modular transportable troposcatter systems to offer the US a military fly away configuration, which is capable of providing seamless compatibility with legacy fielded over-the-horizon microwave systems. We believe that additional orders for this project and this product may be forthcoming, as there are hundreds of potential units to be deployed. In addition, during the first quarter of fiscal 2013, we received an additional order for $2.7 million for the TRC-170 upgrade kits for the US Marine Corps. As you know, over the past five years our over-the-horizon microwave systems including upgraded TRC-170s have been fielded by the US military throughout the world, and have proven to be an important link in critical communications channels. Overall, we believe that our Telecommunications Transmission product lines are weathering the current adverse business and government spending environments, and are poised for growth as conditions improve and government funding frees up.

Moving to our Microwave Amplifier segment, our traveling wave tube amplifiers or TWTAs and solid state power amplifiers or SSPAs serve critical needs in both the commercial and defense markets. Our TWTAs are used extensively in the satellite communications market, enabling vital services such as traditional broadcast, direct to home broadcast, satellite news gathering, and the emerging satellite broadband communications area. Among our more recent TWTA wins are contracts for our industry leading 500 Watt Ka-band amplifiers, which are key components in the vast majority of North American and European high throughput broadband satellite systems. On the defense side, our TWTA products are used to support high capacity US military communication systems, such as the Wideband Global Satellite Constellation and the Milstar system. We also have products qualified for future FAB-T and WIN-T programs.

On the solid state amplifier side, in addition to commercial applications such as aviation, medical and instrumentation testing, our SSPAs are used in a number of electronic warfare applications including counter-IED systems. In fact during the past few years, a significant portion of our SSPA sales have come from our participation in counter-IED programs. We have now substantially completed work on our development contracts in support of the DoD's next generation counter-IED programs, most notably Crew 3.3. And believe that we will receive the lion's share of the related production orders. However, in light of technical issues experienced on this program which are unrelated to us and the uncertain funding environment, it's not clear where this program is heading and when the government and the prime contractor will be ready to place orders for our products.

In our Mobile Data Communications segment, as anticipated, revenues in the first quarter of fiscal 2013 relating to BFT1 and MTS programs were significantly lower. We are currently providing both MTS and BFT sustainment services pursuant to a three year IDIQ contract. We were awarded this contract in late March, and the contract has a not-to-exceed value of $80.7 million, and a base performance period that began on April 1, 2012 and ends on March 31, 2013. The contract provides for two 12 month option periods exercisable by the US Army, and includes an annual intellectual property license fee of $10 million. Payments of the annual IP license fees beyond the base year are contingent upon the Army's exercise of one or both of the optional performance periods. We expect that the US Army will exercise the first option period before the end of March of 2013.

As we reported on our last investor conference call, in the fourth quarter of fiscal 2012 we adopted a restructuring plan to wind out our microsatellite product line. We completed that plan in the first quarter of fiscal 2013, and have exited the microsatellite business. As of today, we have substantially completed our repositioning of our Mobile Data Communications segment, and are now solely focused on providing BFT1 related services to our legacy US Army customer, and seeking other government and international opportunities that our technology can be readily adapted to.

All in all, we believe we have reacted quickly and appropriately to the adverse business and government spending environments that we are operating in, and have made adjustments to our businesses accordingly. At the same time, we have continued to invest in new technologies and products, which should bode well for us once conditions improve. And finally before turning it over for questions, I would like to wish our Senior Management Team, our Board of Directors, all of our employees, all of our stockholders, and all those listening to this call a happy and safe holiday season.

Operator, we'll take some questions now.

Thank you.

(Operator Instructions)

Chris Quilty with Raymond James.

Thanks gentlemen. A couple of questions. First of all, on the Telecom business, can you remind us what the split between, I'm sorry not on Telecom but specifically on the earth station product line what the mix is between commercial and government?

Yes, the business is mostly from an international perspective. We don't really put it out for competitive reasons, but you could assume it's more than half the business is on the international side.

Okay, and what are you seeing in there competitively, either in the SCPC market or alternative technologies? Any changes that you've seen in the last six months to a year?

Chris, I don't think we see any changes as such. I think we just see just the market stall. As I tried to point out, we're not losing any contracts, they're not going to other technologies. The market just seems to be stalled, and so we still have the same market share but we just don't have the dollars.

And Chris, just to put some further comments around, the big slowdown that we saw in Q1 was really on the US government side. That's where they're just down significantly versus Q1 of last year. Our international business, for the most part, if you remember how strong it was last year, it was up double digits in our first quarter versus 2011 is basically flat in our Q1. But it's tough out there.

Okay. And any progress to announce on the recent relationship with Harris CapRock?

Not really, nothing's changed. The program is going forward on the scheduled basis, so everything is fine.

Okay. You also mentioned I think that you got your first government order for a Carrier-in-Carrier technology, and I think you've had that deployed for three or four years in the commercial sector. Can you comment on why it's taken this long for the government to adopt the technology?

Yes, this is really nothing new. We had the same problems I guess on the international side. As you know, the telecommunications industry and specifically also the government is really slow to change to a new technology. And so it was just a normal, let's say, length of time that you market it and you convince the government or the international side that the product has certain advantages over let's say your competitors projects.

Specifically what I mentioned today, was just this past couple of weeks. We did finally receive certification of our two of our modems using the Carrier-in-Carrier technology. That is really the key effort. The government does require certification of its products to be used on major programs. And although we had some sales to let me say to government three letter agencies, this will allow sales into major US Army, US Marine Corps programs.

Yes. And I think for your commercial customers, the adoption of that technology was driven by return on invested capital that could range in a matter of months.

Right.

Does the government think the same way, or is this probably a traditional slow government procurement process?

Well, it's always the government works in its fashion. I think they do appreciate the payback on this technology, and obviously they're beginning to use it. As you know, government bandwidth for satellite communications has always been an issue for the government. So one would have expected that this technology would have been I guess bought a little bit earlier, but it is what it is.

Okay. And can you also comment or estimate on of the 250,000 deployed modems, where you are in the upgrade cycle of modems deployed with the Carrier-in-Carrier technology?

I really don't think we want to mention the details in that area, but we're probably less -- certainly less than 30% of the way there.

Okay, great. Shifting gears on the RF business, can you remind us of what your status is on the WIN-T increment 2 program?

Yes, on the WIN-T increment 2 program we're working with Rockwell Collins as you know. They are the supplier for the WIN-T increment 2, and we have our products with Rockwell qualified. And in certain of our products, we're the sole supplier.

Great. And finally on the Mobile Data business, I think you had previously forecast around $27 million of revenue in that segment, you had obviously a strong Q1. Is it still fair to assume only around $6 million to $7 million of revenue per quarter through the balance of the year?

Yes, Chris I'm not sure we ever gave any specific color on the mobile data com revenue. But it is fair to assume that given our Q1 revenue of $12.3 million that that included $3.5 million worth of mobile satellite transceivers, for which we don't have backlog. Q2, Q3, Q4 sales are going to be down from that number. If you look at what we have in backlog and well as our expectation of the renewal of the BFT-1 optional performance period, you can kind of back into your own revenue number.

Okay. And given the lack of orders there, I know in past years, the Telecom business benefited from the manufacturing synergies in the factory in Arizona. Is it fair to assume that margins in the Telecom business are now sort of decoupled from the Mobile Data business and stand on their own?

Oh, yes, very much so.

And are you still looking for sustainable margins in the low 20%s in the Telecom?

Yes.

Okay. And finally on the Mobile Data business, I think with the waning of the MTS and BFT business and now the microsatellite business gone, I think when you originally lost the MTS BFT contracts, you had indicated that you thought there were commercial opportunities for that technology. Is that still part of the plan?

It's still part of the plan. As you can appreciate, these things take a long time to develop. We did just recently win a NATO program for a similar technology, as I think we released that information. And so given the economy, I think the expectation is that we will be booking some programs in the future.

Okay. And Mike, can you give us the backlog by segment?

Sure, Chris. Our Telecom backlog as of Q1 was $75.8 million, RF Amplifiers backlog was $43.7 million and our Mobile Data Communications backlog was $13.8 million.

Great. Thank you guys.

Joe Nadol from JP Morgan.

Thanks, good morning. Just digging in a little bit more in the satellite earth station area and the government demand in particular, is it fair to say or do you believe that the length of time it took for certification that you've now received was a factor in delaying orders, or are those issues not really related?

No, they definitely are related. As I tried to indicate, where certification is not a problem, for instance, just as an example for the three letter agencies, we have started selling that Carrier-in-Carrier technology a bit earlier. But on the other hand for major programs, certification is a major issue. So I think we're very happy that this finally came through.

Okay. And then the orders that you're looking for, not this quarter but in the second half from the US government, are those largely DOD orders? Are they civil agencies? Are they lots and lots of one-off orders or are there two or three kind of big lot orders you're expecting? Just if you could help characterize those a little bit.

I think if we're talking about the Telecom segment, I think it's throughout. It's really throughout the DoD agencies, as well as international obviously.

Okay. And then you had indicated last quarter that share repurchase wasn't going to be -- you didn't intend to make that a major focus. And then now, you've re-upped the share authorization here. Is that a reflection of simply of the stock price, or is there something else with regard to the M&A outlook that's driving that?

I think I certainly don't remember, but I didn't think that I mentioned that we were stopping the buyback purchase program. I think what I intended to say at least was that we were taking a breather and at this time, not buying any more. I think we always, and our Board always discusses future buys of our stock back. Specifically, yes, we do have an acquisition program. But as we all look out there, we're selling at four or five times EBITDA. Some of the assets out there that we're looking at need to be paid for by eight to nine times EBITDA. So our stock looks very attractive to us right now.

Okay. And then finally, Fred, just looking at the fiscal cliff and sequestration and all that, I'm sure you guys have a pretty good bead on which line items in the budget are going to feed. Hopefully those orders you're expecting to rebound for satellite earth stations in the second half. We have CR as well going on. Is there a certain resolution that you need to this whole situation in the next month or two that will enable the critical agencies or critical customers that you're looking at to place those earth station orders? Or is the money funded and there, and you're not really worried about that part of it?

Well the irony of the situation is that certainly the '13 budget is approved, and has moneys in for various programs that we're on. I think it's more or less the paralysis that has set in in various government agencies where they're really in a mode of not being sure exactly what their future holds. And this is essentially stopping their funding that they have being let go, or because they don't know what the future funding is. So I think it's really the paralysis that has become a problem for us. We believe on a future basis that the programs and the Telecom products that we supply should not be really affected to a large degree on any funding shortfalls. We believe that Telecom is something that the government will spend money on. So I think it's more of the paralysis and when that will finally be overcome, and that's by resolution finally.

Okay, thank you.

Mark Jordan with Noble Financial.

Good morning gentlemen. Looking at the first quarter Telecom group on the operating margin, as you had 23%. That clearly was influenced by the clawback, and if you back that out I assume, it looks like you were at about 18.5% Op margin there. Looking out into the second quarter, is there any mix shift? To get to this the earnings numbers it looks like you're implying that you'd be down potentially somewhere in the 9% to 10% Op margin range in this group. Is this just a function of lower sales volumes and fixed overhead driving down that Op margin, or is there a mix shift that you see?

Sure Mark. I certainly don't think our operating margin is going to be below 10% for Q2. So I think that's a little too extreme. But yes, you are right. 18.5% or so in Q1 adjusting for the Stampede valuation, there are some big large mix issues that did occur in our Telecom segment. As you know, our over-the-horizon microwave product line, when it generates significant revenue, does bring us pretty high contribution margins. And we did ship a significant amount of MTTS sales. Again, that comes in at high contribution margins on the operating income line. We're not expecting anything to come in until Q4, so that will really be a big mix change to the segment.

Okay. And then back to the comments of longer term and the Telecom group being 20%-plus normalized operating margins. Just sort of generically, you've got to be in the low $60 million per quarter range to obtain that level given a normal mix?

For the Telecom segment?

Yes.

I mean it certainly is a reasonable number on average.

Okay. Final question, I know you'd had in the past some relatively modest amount of inventory exposure relative to your older MTS hardware. Has that been worked off, or what is the remaining exposure there?

It's virtually none. I would certainly say any inventory we have at this point related to the BFT-1 and MTS programs is certainly insignificant, immaterial.

Okay, thank you very much.

Richard Valera with Needham & Company.

Thank you, good morning. Couple questions on BFT MTS as it relates to some of the risk language in the Q. First on the sustainment contract, is there any reason to assume that it's other than routine to get the prices finalized for that? You sounded pretty confident about it in your prepared remarks, but you had some risk language in there that suggested that there might be some risk to that not happening.

Well, Rich we've had that language for several quarters since we've had the order. That was just the nature of the last minute negotiations. You might have to go back to the quarter that we first got the contract. But really, the government had some difficulty figuring out exactly what contract it was, and at the end of the day it was all rushing around to finalize the current BFT-1 contract.

But in our case, we just think it's a matter of finalizing everything associated with the post order audit from the BFT1 program, and they're just taking it step-by-step. And we're just walking through. But there's not anything unusual that we know related to the current set of contracts, and we've been able to finalize stuff. It's a cost-plus type of a contract, so we have a good sense of what it's going to be. But given the SEC filing, we put in the cautionary language as we should appropriately do so.

Fair enough. And then similarly on the DCAA exit audits, you haven't mentioned so I assume you're expecting that to be pretty routine as well, but again some language in there that suggests you could end up owing money. Any reason to suspect at this point that you would end up owing money on that exit audit for MTS BFT?

Rich, I don't know if you had caught in our 10-Q, but in late November of 2012, we actually received what we would a consider positive notification from the DCMA that the DCAA had actually determined that our BFT-1 large contract had the commercial item pricing in there. And so that notification did occur in late November. We view that as a pretty positive development.

Notwithstanding that, the DCAA has to complete their audit, finish, issue us a report. We're not privy to what their findings are yet. But we do think that the first piece was a very successful resolvement for us, that our mobile satellite transceivers were commercial, and that's what we always thought. And that we thought was a large piece of what they were looking at. We're expecting to hear from them within the next quarter as to the resolvement of the remaining part of the audit, and obviously we just can't predict it. We just don't know what they have. And certainly anything that we have, we'll report to you.

No, that's great. And on the over-the-horizon, just wondered if you could give a little color. It sounds like you have a great opportunity for another major follow on with your North African customer. Wondering if you'd give any color on what might make that not happen? It sounds like you're reasonably comfortable that happens maybe in your fiscal fourth quarter. What are the potential obstacles? And then, any color on some of the additional deals? It sounds like you had other stuff in the pipeline perhaps beyond that very large follow on. So just any other color on that OTH pipeline if you will, of potential orders.

Obviously, Rich, we're kind of reticent to predict timing on the over-the-horizon products and programs. However, what we can say about the North African situation is that our US prime contractor has now signed an additional phase with this end customer, and has actually provided that customer performance bonds. And usually, that's the next step. And then the final step is that the end customer provides the US prime with a down payment.

Their expectation is for the down payment to occur in a matter of the next 60 days. What could happen? Things can always get delayed for one reason or another. Specifically, the only worry that I could see out there is what's happening in the Mid East, specifically in Egypt, that could spill over to our North African customers by giving them some reason to delay providing a down payment. But the contract is official, the bonds are in place.

Okay. That's helpful color. Thank you.

Tyler Hojo with Sidoti & Company.

Yes, hello. First, thanks for providing the additional color on the JCREW program. Was just wondering if your customer had given you any sort of visibility in regards to when volumes could potentially start on that program?

Well, as I tried to mention during my presentation, the program had run into some technical difficulties, specifically on the software side. As I also mentioned, it's not our piece of the product line that we supply. We've actually finished our development program fully and qualified. So the software technical difficulties have resulted in kind of a stalling of the program with the US Navy.

The customer and the Navy are in discussions of how to solve or resolve this particular program. And this has moved our expectations and the funding that was in the palm in the government budget programs was originally scheduled for '13. However, it now looks like the program's technical difficulties will probably push it out further, where the actual first orders do not look like they're going to happen in '13 and probably will happen in '14. So we've kind of finished our portion of it, and we really don't know the extent of the technical difficulties. We just know that the program is on hold.

Okay, that's very helpful. And Fred, another question for you. I'm just kind of curious, maybe if you could discuss some of the challenges, or lack there -- basically what I'm curious about is how do you handle basically running these defense businesses without having a security clearance in place?

I don't think I have a problem as far as security clearances are concerned. We have security clearance on all of our facilities that require it, and the people that run it. We're structured on a subsidiary basis with independent units, with independent Presidents running those operations. So as far as clearances are concerned, we've always -- I happen to have had the clearance because of many, many years where I actually was involved in some of the operations.

But for instance, our Board of Directors runs the Company, and they don't typically have clearances. And so, there are exclusions that are fine with the US government as long as any specific sensitive information is not brought to the attention of either the Board of Directors or in this case myself. So my security clearance is has not been taken away. It's just been suspended for the time being.

Tyler, just to put some financial commentary around it, the number of contracts that we have that require any type of security clearance for the Company in aggregate is really immaterial. And that's sort of why we don't even disclose it, in the sense of never have talked about it. And Comtech Telecom, the parent Corporation, to Fred's point that he just made, has always been what's referred to as an excluded parent. So therefore again, it was never really required by the government, and there's not a contract that does require Fred's specific security clearance.

Like would you care to provide the percentage of contracts that do require a security clearance? You said it was small, but could you maybe give a little color on that?

Less than 10%.

Less than 10%. Okay, great. Thanks so much for the color guys. Appreciate it.

Tim Quillin with Stephens.

Hello, good morning. The revenue, the quarter-to-quarter revenue decline of 15% in the second quarter, I understand how much the Mobile Data segment would decline. But are there different rates at which the Telecom transmission business would decline versus the Amplifier business? In other words, do you expect the steeper decline to come in the Telecom Transmission business?

Yes, the way I would describe it, it's just a blend. We do see 15% down quarter-to-quarter, and it is in all three of our segments. So I would just leave it at that. And given that it's very difficult to predict a specific order, our RF segment as you know is only $25.3 million. So an order that is a $2 million order that could shift one quarter-to-quarter could swing the actual percentage pretty high. So just assume it's in all three segments.

Right, okay. And then on the MTTS opportunity that you expect to come in and drive a relatively strong fourth quarter and shipments there, can you help us size that up and how that might be a swing factor in the guidance?

Well we did ship, and I used the phrase a significantly large amount in Q1. We are expecting almost double the amount to ship in Q4, but I don't want to put a number on that.

Okay, okay. And maybe just qualitatively, what is the risk to the new guidance if an order like that or maybe if you can highlight anything else that potentially could slip?

Well, certainly orders that we're expecting in Q4, of which that one is, could slip. And if nothing else changed, yes that would impact our guidance. But at the same time, we're trying to look at all different aspects. And things could happen. Pluses or minuses, our satellite earth station business could get a little bit better in terms of the US government and stuff freeing up. So when you add it all in, we try to give you the best shot that we have. But certainly, the MTTS orders that we're expecting in Q4 are a big swing to our outlook.

Okay. Are there any other big chunks like that or would that be kind of the biggest one that we should think about?

In terms of orders, that would be. But as we also mentioned we are expecting the optional performance period on our MTS our BFT-1 sustainment contract to be exercised in March, and we feel pretty good about that.

Right, right. And then Mike, I think you had said that in the second quarter would the convertible note be anti-dilutive then we should back out those shares and also lower the interest expense, is that right?

Yes, I mean you basically if you go to our 10-Q, you just look at the numbers that we use in the anti-dilutive numbers, the dilutive share calculation, and just remove them from the calculation.

But that would be the GAAP number or the GAAP share count for 2Q?

Yes, effectively assuming at the current stock price that we're at, you could kind of look at our dilutive shares being pretty close to equaling our basic shares.

Right, right. And then in the Mobile Data business, outside of BFT, I think BFT was something like $10 million in revenue in the quarter. And so you had $2.3 million of other revenue. What does that consist of?

We have a small business that is chunking along called the [Sense] business. It's similar to the government tracking business, but on a commercial basis. And it's small right now, but it is growing.

Okay, okay. And then just lastly, on the buybacks, is there a certain net cash threshold that you would think about? Or so in other words, would you think about the $200 million convertible note as debt and then try to have a cash balance that's meaningfully above that so that you can support your business and letters of credit and things like that?

Well right now, obviously, we have more than enough cash to pay off that note, should that happen and it's not converted. And also the buyback, even some more shares in the future. So I think we certainly have sufficient cash to not to worry about it until the notes are due I guess roughly -- in May 14. So, I think we'll make a decision appropriate at that point.

Okay. Well maybe just the easiest way to try and ask that question is there -- how low of a cash balance would you want to maintain, or how big of a cash balance would you want to not to go lower than?

I think that's difficult for us to tell you at this point, because we don't know what the business base will be at that point in time. But certainly, we also have $100 million credit line. So, I think it's a matter of looking at the business at that point in time.

Okay, brilliant. Thank you very much.

And now I'd like to turn it back to the Company for any closing remarks.

Okay, I guess I would like to thank everyone for joining us today and we look forward to speaking with you again in March.

This does conclude today's teleconference. You may now disconnect, and have a great day.