COMTECH TELECOMMUNICATIONS CORP /DE/ — Interim / Quarterly Report 2006

Mar 8, 2006

10-Q 1 d67323_10-q.htm QUARTERLY REPORTS

| UNITED STATES SECURITIES AND EXCHANGE
COMMISSION |
| --- |
| Washington, D.C. 20549 |
| FORM 10-Q |

(Mark One)

| x | Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| --- | --- |
| For the quarterly period ended January 31,
2006 | |
| o | Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| Commission File Number: 0-7928 | |

(Exact name of registrant as specified in its charter)

Delaware	11-2139466
(State or other jurisdiction of incorporation
/organization)	(I.R.S. Employer Identification Number)
105 Baylis Road, Melville, New York	11747
(Address of principal executive offices)	(Zip Code)

(631) 777-8900
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer x Non-accelerated filer o

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes x No

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of February 28, 2006, the number of outstanding shares of Common Stock, par value $.10 per share, of the registrant was 22,786,915 shares.

COMTECH TELECOMMUNICATIONS CORP. INDEX

	Page
PART
I. FINANCIAL INFORMATION
Item
1. Financial Statements
Consolidated
Balance Sheets – January 31, 2006 (Unaudited) and July 31, 2005	2
Consolidated
Statements of Operations – Three and Six Months Ended January 31,
2006 and 2005 (Unaudited)	3
Consolidated
Statements of Cash Flows – Six Months Ended January 31, 2006 and
2005 (Unaudited)	4
Notes
to Consolidated Financial Statements	5
Item
2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations	14
Item
3. Quantitative and Qualitative Disclosures about Market Risk	23
Item
4. Controls and Procedures	23
PART
II. OTHER INFORMATION
Item
1. Legal Proceedings	23
Item
1A. Risk Factors	23
Item
4. Submission of Matters to a Vote of Security Holders	24
Item
6. Exhibits	24
Signature
Page	25

1

PART I FINANCIAL INFORMATION COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS

Item 1.

| | January
31, 2006 | | | |
| --- | --- | --- | --- | --- |
| | (Unaudited) | | | |
| Assets | | | | |
| Current assets: | | | | |
| Cash and cash
equivalents | $ 218,677,000 | | 214,413,000 | |
| Restricted
cash | 1,003,000 | | 1,034,000 | |
| Accounts
receivable, net | 75,989,000 | | 56,052,000 | |
| Inventories,
net | 53,920,000 | | 45,103,000 | |
| Prepaid
expenses and other current assets | 5,846,000 | | 4,387,000 | |
| Deferred tax
asset - current | 8,047,000 | | 8,092,000 | |
| Total current
assets | 363,482,000 | | 329,081,000 | |
| Property, plant and equipment,
net | 20,435,000 | | 18,683,000 | |
| Goodwill | 22,244,000 | | 22,244,000 | |
| Intangibles with definite
lives, net | 8,121,000 | | 9,123,000 | |
| Deferred financing costs,
net | 2,722,000 | | 2,995,000 | |
| Other assets, net | 315,000 | | 277,000 | |
| Total
assets | $ 417,319,000 | | 382,403,000 | |
| Liabilities
and Stockholders’ Equity | | | | |
| Current liabilities: | | | | |
| Accounts
payable | $ 21,951,000 | | 23,577,000 | |
| Accrued
expenses and other current
liabilities | 35,990,000 | | 34,497,000 | |
| Customer
advances and deposits | 5,093,000 | | 5,282,000 | |
| Deferred
service revenue | 10,245,000 | | 8,210,000 | |
| Current
installments of other obligations | 210,000 | | 235,000 | |
| Interest
payable | 1,050,000 | | 1,050,000 | |
| Income taxes
payable | 3,696,000 | | 1,540,000 | |
| Total current
liabilities | 78,235,000 | | 74,391,000 | |
| Convertible senior
notes | 105,000,000 | | 105,000,000 | |
| Other obligations, less current
installments | 306,000 | | 396,000 | |
| Deferred tax liability -
non-current | 6,592,000 | | 5,987,000 | |
| Total
liabilities | 190,133,000 | | 185,774,000 | |
| Commitments and contingencies
(See Note 13) | | | | |
| Stockholders’
equity: | | | | |
| Preferred
stock, par value $.10 per share;
shares authorized and unissued 2,000,000 | — | | — | |
| Common stock,
par value $.10 per share; authorized
100,000,000 shares and 30,000,000 shares at January 31, 2006 and July 31,
2005, respectively; issued 22,994,853 shares and 22,781,678 shares at January
31, 2006 and July 31, 2005, respectively | 2,299,000 | | 2,278,000 | |
| Additional
paid-in capital | 132,938,000 | | 127,170,000 | |
| Retained
earnings | 92,134,000 | | 67,366,000 | |
| | 227,371,000 | | 196,814,000 | |
| Less: | | | | |
| Treasury stock
(210,937 shares) | (185,000 | ) | (185,000 | ) |
| Total
stockholders’ equity | 227,186,000 | | 196,629,000 | |
| Total
liabilities and stockholders’ equity | $ 417,319,000 | | 382,403,000 | |

See accompanying notes to consolidated financial statements.

2

COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

| | Three
months ended January 31, — 2006 | 2005 | | 2006 | | 2005 | | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Net sales | $ 95,741,000 | | 78,087,000 | | 202,308,000 | | 134,209,000 | |
| Cost of sales | 54,650,000 | | 45,797,000 | | 121,013,000 | | 74,798,000 | |
| Gross
profit | 41,091,000 | | 32,290,000 | | 81,295,000 | | 59,411,000 | |
| Expenses (See Note
3): | | | | | | | | |
| Selling,
general and administrative | 15,809,000 | | 12,033,000 | | 31,857,000 | | 23,257,000 | |
| Research and
development | 6,007,000 | | 4,954,000 | | 12,756,000 | | 9,850,000 | |
| Amortization
of intangibles | 603,000 | | 568,000 | | 1,199,000 | | 1,137,000 | |
| | 22,419,000 | | 17,555,000 | | 45,812,000 | | 34,244,000 | |
| Operating income | 18,672,000 | | 14,735,000 | | 35,483,000 | | 25,167,000 | |
| Other expense
(income): | | | | | | | | |
| Interest
expense | 672,000 | | 667,000 | | 1,346,000 | | 1,336,000 | |
| Interest
income | (2,172,000 | ) | (905,000 | ) | (3,947,000 | ) | (1,548,000 | ) |
| Income before provision for
income taxes | 20,172,000 | | 14,973,000 | | 38,084,000 | | 25,379,000 | |
| Provision for income
taxes | 6,868,000 | | 4,791,000 | | 13,316,000 | | 8,121,000 | |
| Net income | $ 13,304,000 | | 10,182,000 | | 24,768,000 | | 17,258,000 | |
| Net income per share (See Note
4): | | | | | | | | |
| Basic | $ 0.59 | | 0.47 | | 1.09 | | 0.80 | |
| Diluted | $ 0.50 | | 0.39 | | 0.94 | | 0.68 | |
| Weighted average number of
common shares
outstanding – basic | 22,741,000 | | 21,486,000 | | 22,694,000 | | 21,441,000 | |
| Weighted average number of
common and
common equivalent shares outstanding assuming dilution – diluted | 27,354,000 | | 27,021,000 | | 27,367,000 | | 26,756,000 | |

See accompanying notes to consolidated financial statements.

3

COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

| | Six
months ended January 31, — 2006 | 2005 | | |
| --- | --- | --- | --- | --- |
| Cash
flows from operating activities: | | | | |
| Net
income | $ 24,768,000 | | 17,258,000 | |
| Adjustments
to reconcile net income to net cash provided by operating activities: | | | | |
| Depreciation
and amortization of property, plant, equipment and intangibles | 4,074,000 | | 3,666,000 | |
| Amortization
of stock-based compensation | 2,834,000 | | — | |
| Amortization
of deferred financing costs | 273,000 | | 274,000 | |
| Loss
on disposal of property, plant and equipment | 16,000 | | — | |
| Provision
for doubtful accounts | 99,000 | | 21,000 | |
| Provision
for excess and obsolete inventories | 987,000 | | 792,000 | |
| Deferred
income tax expense | 650,000 | | — | |
| Income
tax benefit from stock option exercises | — | | 526,000 | |
| Excess
income tax benefit from stock option exercises | (1,154,000 | ) | — | |
| Changes
in assets and liabilities: | | | | |
| Restricted
cash securing letter of credit obligations | 31,000 | | 3,010,000 | |
| Accounts
receivable | (20,036,000 | ) | 1,569,000 | |
| Inventories | (9,743,000 | ) | 426,000 | |
| Prepaid
expenses and other current assets | (1,459,000 | ) | (3,259,000 | ) |
| Other
assets | (38,000 | ) | (67,000 | ) |
| Accounts
payable | (1,626,000 | ) | 7,242,000 | |
| Accrued
expenses and other current liabilities | 1,493,000 | | 3,749,000 | |
| Customer
advances and deposits | (189,000 | ) | 3,755,000 | |
| Deferred
service revenue | 2,035,000 | | (3,468,000 | ) |
| Interest
payable | — | | (23,000 | ) |
| Income
taxes payable | 3,310,000 | | 5,073,000 | |
| Net
cash provided by operating activities | 6,325,000 | | 40,544,000 | |
| Cash
flows from investing activities: | | | | |
| Purchases
of property, plant and equipment | (4,643,000 | ) | (3,373,000 | ) |
| Purchase
of technology license | (197,000 | ) | — | |
| Net
cash used in investing activities | (4,840,000 | ) | (3,373,000 | ) |
| Cash
flows from financing activities: | | | | |
| Principal
payments on other obligations | (115,000 | ) | (140,000 | ) |
| Proceeds
from exercises of stock options and employee stock purchase plan shares | 1,740,000 | | 1,420,000 | |
| Excess
income tax benefit from stock option exercises | 1,154,000 | | — | |
| Net
cash provided by financing activities | 2,779,000 | | 1,280,000 | |
| Net
increase in cash and cash equivalents | 4,264,000 | | 38,451,000 | |
| Cash
and cash equivalents at beginning of period | 214,413,000 | | 163,292,000 | |
| Cash
and cash equivalents at end of period | $ 218,677,000 | | 201,743,000 | |
| Supplemental
cash flow disclosure: | | | | |
| Cash
paid during the period for: | | | | |
| Interest | $ 1,073,000 | | 1,073,000 | |
| Income
taxes | $ 9,447,000 | | 2,522,000 | |

See accompanying notes to consolidated financial statements.

4

COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(1)	General
	The accompanying consolidated financial statements
of Comtech Telecommunications Corp. and Subsidiaries (“the Company”) as of
and for the three and six months ended January 31, 2006 and 2005 are
unaudited. In the opinion of management, the information furnished reflects
all adjustments (which include normal recurring adjustments) necessary for a
fair presentation of the results for the unaudited interim periods. The
results of operations for such periods are not necessarily indicative of the
results of operations to be expected for the full fiscal year. For the three
and six months ended January 31, 2006 and 2005, comprehensive income was
equal to net income. All share and per share information in the consolidated
financial statements and notes thereto has been adjusted for a three-for-two
stock split, which was effected in the form of a 50% stock dividend in April
2005.
	These consolidated financial statements should be
read in conjunction with the audited consolidated financial statements of the
Company for the fiscal year ended July 31, 2005 and the notes thereto
contained in the Company’s Annual Report on Form 10-K, filed with the
Securities and Exchange Commission (“SEC”), and all of the Company’s other
filings with the SEC.
(2)	Reclassifications
	Certain reclassifications have been made to
previously reported financial statements to conform to the Company’s current
financial statement format.
(3)	Stock-Based
Compensation
	Effective August 1, 2005, the Company adopted the
provisions of Financial Accounting Standards Board (“FASB”) Statement of
Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payments,”
which establishes the accounting for employee stock-based awards. Under the
provisions of SFAS No. 123(R), stock-based compensation is measured at the
grant date, based on the calculated fair value of the award, and is
recognized as an expense over the requisite employee service period
(generally the vesting period of the grant). The Company adopted SFAS No.
123(R) using the modified prospective method and, as a result, periods prior
to August 1, 2005 have not been restated.
	The Company recognized stock-based compensation for
awards issued under the Company’s Stock Option Plans and Employee Stock
Purchase Plan in the following line items in the Consolidated Statement of
Operations:

| Cost of sales | Three
months ended
January 31, 2006 — $ 105,000 | | 181,000 | |
| --- | --- | --- | --- | --- |
| Selling, general and administrative expenses | 1,238,000 | | 2,323,000 | |
| Research and development expenses | 195,000 | | 330,000 | |
| Stock-based compensation expense before income tax
benefit | 1,538,000 | | 2,834,000 | |
| Income tax benefit | (351,000 | ) | (625,000 | ) |
| Net compensation expense | $ 1,187,000 | | 2,209,000 | |

| During the three and six months ended January 31,
2006, $61,000 of stock-based compensation was capitalized in inventory. |
| --- |
| During the three and six months ended January 31,
2005 (and for periods prior to August 1, 2005) the Company recorded
compensation expense for employee stock options based upon their intrinsic value
on the date of grant pursuant to Accounting Principles Board (“APB”) Opinion
No. 25, “Accounting for Stock Issued to Employees.” Since the exercise price
for such options was equal to the fair market value of the Company’s stock at
the date of grant, the stock options had no intrinsic value upon grant and,
therefore, no expense was recorded in the Consolidated Statements of
Operations. |

5

| Stock-based compensation expense, net of related
income taxes, resulted in a decrease of $0.05 and $0.04, respectively, in
basic and diluted earnings per share for the three months ended January 31,
2006 and a decrease of $0.10 and $0.07, respectively, in basic and diluted
earnings per share for the six months ended January 31, 2006. |
| --- |
| Had the compensation cost of the Company’s employee
stock award plans for the three and six months ended January 31, 2005 been
determined in accordance with SFAS No. 123, the Company’s pro forma net
income and net income per share would have been: |

| Net income, as
reported | | Three
months ended January 31, 2005 — $ 10,182,000 | | 17,258,000 | |
| --- | --- | --- | --- | --- | --- |
| Less: Total
stock-based employee compensation expense determined under fair value based
method for all awards, net of related tax effects | | (535,000 | ) | (1,077,000 | ) |
| Pro forma net
income | | $ 9,647,000 | | 16,181,000 | |
| Net income per
share: | | | | | |
| As reported | Basic | $ 0.47 | | 0.80 | |
| | Diluted | $ 0.39 | | 0.68 | |
| Pro forma | Basic | $ 0.45 | | 0.75 | |
| | Diluted | $ 0.37 | | 0.64 | |

| Under the modified prospective method, SFAS No.
123(R) applies to new awards and to awards outstanding on the effective date
that are subsequently modified or cancelled. Compensation expense for
outstanding awards for which the requisite service had not been rendered as
of July 31, 2005 is being recognized over the remaining service period using
the compensation cost calculated for pro forma disclosure purposes under SFAS
No. 123. The Company has elected to value graded vesting awards based on
vesting tranches. Prior to the adoption of SFAS No. 123(R), the Company
valued graded vesting awards based on the entire award for purposes of pro
forma disclosure. The Company amortizes the fair values of all awards on a
straight-line basis over the total requisite service period. Cumulative
compensation expense recognized at any date will at least equal the grant
date fair value of the vested portion of the award at that time.
Additionally, the Company includes the excess hypothetical tax benefit
related to stock options which were fully vested upon adoption of SFAS No.
123(R) when calculating earnings per share. |
| --- |
| The Company estimates the fair value of stock
options using the Black-Scholes option pricing model. The Company believes that
the valuation technique and the approach utilized to develop the underlying
assumptions are appropriate in calculating the fair values of the Company’s
stock options granted during the three and six months ended January 31, 2006.
Estimates of fair value are not intended to predict actual future events or
the value ultimately realized by the employees who receive equity awards. |
| The per share weighted average fair value of stock
options granted during the three months ended January 31, 2006 and 2005 was
$15.79 and $12.49, respectively. The per share weighted average fair value of
stock options granted during the six months ended January 31, 2006 and 2005
was $14.23 and $7.77, respectively. In addition to the exercise and grant
date prices of the awards, certain weighted average assumptions that were
used to estimate the fair value of stock option grants in the respective
periods are listed in the table below: |

2006	2005	2006	2005
Expected dividend yield	0 %	0%	0 %	0%
Expected volatility	50.90 %	62.37%	51.76 %	65.61%
Risk-free interest rate	4.43 %	3.60%	4.12 %	3.66%
Expected term (years)	3.63	5.00	3.63	5.00

6

| | Options granted during fiscal 2006 have exercise
prices equal to the fair market value of the stock on the date of grant, a
contractual term of five years and a vesting period of three years. All
options granted through July 31, 2005 had exercise prices equal to the fair
market value of the stock on the date of grant, a contractual term of ten
years and generally a vesting period of five years. As of January 31, 2006,
the weighted average estimated forfeiture rate was 8.2%. |
| --- | --- |
| | The Company estimates expected volatility based
primarily on historical daily price changes of the Company’s stock and other
factors. The risk-free interest rate is based on the United States (“U.S.”)
treasury yield curve in effect at the time of grant. The expected option term
is the number of years that the Company estimates that options will be
outstanding prior to exercise. The expected term of the awards issued after
July 31, 2005 was determined using the “simplified method” prescribed in SEC
Staff Accounting Bulletin (“SAB”) No. 107. |
| | The actual income tax benefit recorded relating to
the exercise of stock option awards was $1,154,000 for the six months ended
January 31, 2006 and is classified as a financing cash inflow in the
Company’s Consolidated Statement of Cash Flows. Prior to the adoption of SFAS
No. 123(R), the Company presented all tax benefits related to stock-based
compensation as an operating cash inflow. The actual income tax benefit
recorded relating to the exercise of stock option awards was $526,000 for the
six months ended January 31, 2005. |
| | At January 31, 2006, total remaining unrecognized
compensation cost related to unvested stock-based payment awards was
$14,408,000. That cost is expected to be recognized over a weighted average period
of 3.1 years. |
| (4) | Earnings
Per Share |
| | The Company calculates earnings per share (“EPS”) in
accordance with SFAS No. 128, “Earnings per Share.” Basic EPS is computed
based on the weighted average number of shares outstanding. Diluted EPS reflects
the dilution from potential common stock issuable pursuant to the exercise of
stock options and the conversion of convertible senior notes, if dilutive,
outstanding during each period. Stock options to purchase 702,000 and 11,000
shares for the three months ended January 31, 2006 and 2005, respectively,
were not included in the EPS calculation because their effect would have been
anti-dilutive. Stock options to purchase 663,000 and 89,000 shares for the
six months ended January 31, 2006 and 2005, respectively, were not included
in the EPS calculation because their effect would have been anti-dilutive. |
| | In accordance with Emerging Issues Task Force
(“EITF”) Issue No. 04-8, “The Effect of Contingently Convertible Instruments
on Diluted Earnings per Share,” the Company has included the impact of the
assumed conversion of its 2.0% convertible senior notes in calculating
diluted EPS commencing in the fiscal quarter ended January 31, 2005. |
| | The following table reconciles the numerators and
denominators used in the basic and diluted EPS calculations: |

| | Three
months ended January 31, — 2006 | 2005 | Six months
ended January 31, — 2006 | 2005 |
| --- | --- | --- | --- | --- |
| Numerator: | | | | |
| Net income
for
basic calculation | $ 13,304,000 | 10,182,000 | 24,768,000 | 17,258,000 |
| Effect of
dilutive securities: | | | | |
| Interest
expense
(net of tax) on convertible senior notes | 408,000 | 450,000 | 831,000 | 900,000 |
| Numerator for diluted
calculation | $ 13,712,000 | 10,632,000 | 25,599,000 | 18,158,000 |
| Denominator: | | | | |
| Denominator
for
basic calculation | 22,741,000 | 21,486,000 | 22,694,000 | 21,441,000 |
| Effect of
dilutive securities: | | | | |
| Stock
options | 1,280,000 | 2,202,000 | 1,340,000 | 1,982,000 |
| Conversion
of
convertible senior notes | 3,333,000 | 3,333,000 | 3,333,000 | 3,333,000 |
| Denominator for
diluted calculation | 27,354,000 | 27,021,000 | 27,367,000 | 26,756,000 |

7

(5)
Accounts receivable consist of the following:

Accounts receivable from commercial customers	January 31, 2006 — $ 31,191,000	30,967,000
Unbilled receivables (including retainages) on contracts-in-progress	27,136,000	8,811,000
Amounts receivable from the U.S. government and its
agencies	18,390,000	16,910,000
	76,717,000	56,688,000
Less allowance for doubtful accounts	728,000	636,000
Accounts
receivable, net	$ 75,989,000	56,052,000

| | There was no retainage included in unbilled
receivables at January 31, 2006. There was $2,684,000 of retainage included
in unbilled receivables at July 31, 2005. In the opinion of management,
substantially all of the unbilled balances will be billed and collected
within one year. |
| --- | --- |
| | The increase in unbilled receivables at January 31,
2006 primarily related to a large over-the-horizon microwave system contract
in our telecommunications transmission segment. We currently expect that a
significant portion of the total receivables (including unbilled receivables
at January 31, 2006) related to this contract will be collected during the
second half of fiscal 2006. |
| | As of January 31, 2006, a prime contractor
represented 24.0% of total net accounts receivable. |
| (6) | Inventories |
| | Inventories consist of the following: |

| Raw materials and components | January
31, 2006 — $ 33,501,000 | 26,816,000 |
| --- | --- | --- |
| Work-in-process and finished goods | 25,882,000 | 24,796,000 |
| | 59,383,000 | 51,612,000 |
| Less reserve for excess and obsolete inventories | 5,463,000 | 6,509,000 |
| Inventories, net | $ 53,920,000 | 45,103,000 |

| | Inventories directly related to long-term contracts
were $5,823,000 and $8,925,000 at January 31, 2006 and July 31, 2005,
respectively. At January 31, 2006, $4,882,000 of inventory related to a
contract from a third-party commercial customer to outsource its
manufacturing. The decrease in the reserve relates primarily to the write-off
of previously reserved for inventory. |
| --- | --- |
| (7) | Accrued
Expenses |
| | Accrued expenses and other current liabilities
consist of the following: |

| Accrued wages and benefits | January
31, 2006 — $ 11,966,000 | 14,439,000 |
| --- | --- | --- |
| Accrued commissions | 4,673,000 | 5,049,000 |
| Accrued warranty | 10,817,000 | 7,910,000 |
| Accrued hurricane related costs (See Note 13) | 2,250,000 | 2,331,000 |
| Accrued business acquisition payments | 500,000 | 1,000,000 |
| Other | 5,784,000 | 3,768,000 |
| | $ 35,990,000 | 34,497,000 |

The Company provides warranty coverage for most of its products for a period of at least one year from the date of shipment. The Company records a liability for estimated warranty expense based on historical claims, product failure rates and other factors.

8

Changes in the Company’s product warranty liability during the six months ended January 31, 2006 and 2005 were as follows:

| | Six months
ended January 31, — 2006 | 2005 | | |
| --- | --- | --- | --- | --- |
| Balance at beginning of period | $ 7,910,000 | | 4,990,000 | |
| Provision for warranty obligations | 4,735,000 | | 1,926,000 | |
| Charges incurred | (1,828,000 | ) | (1,241,000 | ) |
| Balance at end of period | $ 10,817,000 | | 5,675,000 | |

| (8) |
| --- |
| On January 27, 2004, the Company issued $105,000,000
of its 2.0% convertible senior notes in a private offering pursuant to Rule
144A under the Securities Act of 1933, as amended. The net proceeds from this
transaction were $101,179,000 after deducting the initial purchaser’s
discount and other transaction costs. |
| The notes bear interest at an annual rate of 2.0%
and, during certain periods, the notes are convertible into shares of the
Company’s common stock at an initial conversion price of $31.50 per share (a
conversion rate of 31.7460 shares per $1,000 original principal amount of
notes), subject to adjustment in certain circumstances. The notes may be
converted during a conversion period if, during the 30 consecutive trading
days ending on the first day of the conversion period, on each of at least 20
trading days, the closing sale price of the Company’s common stock exceeds
120% of the conversion price in effect. The notes are convertible during the
conversion period from December 15, 2005 through March 14, 2006. As of March
7, 2006, none of the notes have been converted. Upon conversion of the notes,
in lieu of delivering common stock, the Company may, at its discretion,
deliver cash or a combination of cash and common stock. The Company
anticipates that with respect to the conversion period from December 15, 2005
through March 14, 2006, the Company would deliver shares of common stock to
note holders who exercise the right to convert. The Company may, at its
option, redeem some or all of the notes on or after February 4, 2009. Holders
of the notes will have the right to require the Company to repurchase some or
all of the outstanding notes on February 1, 2011, February 1, 2014 and
February 1, 2019 and upon certain events, including a change in control. If
not redeemed by the Company or repaid pursuant to the holders’ right to
require repurchase, the notes mature on February 1, 2024. |
| The 2.0% interest is payable in cash, semi-annually,
through February 1, 2011. After such date, the 2.0% interest will be accreted
into the principal amount of the notes. Also, commencing with the six month
period beginning February 1, 2009, if the average note price for the
applicable trading period equals 120% or more of the accreted principal
amount of such notes, the Company will pay contingent interest at an annual
rate of 0.25%. |
| The notes are general unsecured obligations of the
Company, ranking equally in right of payment with all of its other existing
and future unsecured senior indebtedness and senior in right of payment to
any of its future subordinated indebtedness. All of the Company’s
subsidiaries have issued full and unconditional guarantees in favor of the
holders of the Company’s 2.0% convertible senior notes, except for the
subsidiary that purchased certain assets and assumed certain liabilities of
Memotec (the “Memotec Subsidiary”). The Memotec Subsidiary’s total assets,
equity, net sales, income from continuing operations before income taxes and
cash flows from operating activities were less than 3.0% of the corresponding
consolidated amounts. These full and unconditional guarantees are joint and
several. Other than supporting the operations of its subsidiaries, Comtech
Telecommunications Corp. (the “Parent”) has no independent assets or operations
and there are currently no significant restrictions on its ability, or the
ability of the guarantors, to obtain funds from each other by dividend or
loan. |
| The net proceeds of the offering are being used for
working capital and general corporate purposes and potentially may be used
for future acquisitions of businesses or technologies or repurchases of the
Company’s common stock. The Company filed a registration statement with the
SEC, which has become effective, for the resale of the notes and the shares
of common stock issuable upon conversion of the notes. |

9

| (9) |
| --- |
| The Company has stock option
plans as follows: |
| 1993 Incentive Stock Option Plan – The 1993 Incentive Stock Option
Plan, as
amended, provided for the granting to key employees and officers of incentive
and non-qualified stock options to purchase up to 2,345,625 shares of the
Company’s common stock at prices generally not less than the fair market
value at the date of grant with the exception of anyone who, prior to the
grant, owns more than 10% of the voting power, in which case the exercise
price cannot be less than 110% of the fair market value. In addition, it provided formula grants to
non-employee members of the Board of Directors. The term of the options could be no more than ten years. However, for
incentive stock options
granted to any employee who, prior to the granting of the option, owns stock
representing more than 10% of the voting power, the option term could be no
more than five years. As of January
31, 2006, the Company had granted stock options representing the right to
purchase an aggregate of 2,070,218 shares (net of 374,441 canceled options)
at prices ranging between $0.67 - $5.31 per share, of which 207,262 are
outstanding at January 31, 2006. To date, 1,862,956 shares have been
exercised. Outstanding awards have
been transferred to the 2000 Stock Incentive Plan. The terms applicable to these awards prior to the transfer
continue to apply. The plan was
terminated by the Board of Directors in December 1999 due to the approval by
the shareholders of the 2000 Stock Incentive Plan. |
| 2000 Stock Incentive Plan – The 2000 Stock Incentive Plan, as
amended,
provides for the granting to all employees and consultants of the Company
(including prospective employees and consultants) non-qualified stock options,
stock appreciation rights, restricted stock, performance shares, performance
units and other stock-based awards.
In addition, employees of the Company are eligible to be granted
incentive stock options. Non-employee
directors of the Company are eligible to receive non-discretionary grants of
nonqualified stock options subject to certain limitations. The aggregate number of shares of common
stock which may be issued may not exceed 5,737,500 plus the shares that were
transferred to the Plan relating to outstanding awards that were previously
granted under the 1982 Incentive Stock Option Plan and the 1993 Incentive
Stock Option Plan. The Stock Option
Committee of the Board of Directors, consistent with the terms of the Plan,
will determine the types of awards to be granted, the terms and conditions of
each award and the number of shares of common stock to be covered by each
award. Grants of incentive and
non-qualified stock options may not have a term exceeding ten years or no
more than five years in the case of an incentive stock option granted to a
stockholder who owns stock representing more than 10% of the voting
power. As of January 31, 2006, the
Company had granted stock options representing the right to purchase an
aggregate of 4,612,200 shares at prices ranging between $3.13 - $41.51 of
which 361,325 options were canceled and 2,716,970 are outstanding at January
31, 2006. As of January 31, 2006,
1,533,905 stock options have been exercised. |
| The following table summarizes
stock option activity during the six months ended January 31, 2006: |

| Outstanding at July 31,
2005 | 2,566,882 | $ | 9.87 | | Aggregate Intrinsic Value |
| --- | --- | --- | --- | --- | --- |
| Granted | 606,000 | | 35.89 | | |
| Forfeited | (57,625 | ) | 8.62 | | |
| Expired | — | | — | | |
| Exercised | (132,155 | ) | 7.24 | | |
| Outstanding at October 31,
2005 | 2,983,102 | | 15.30 | | |
| Granted | 19,500 | | 37.66 | | |
| Forfeited | (9,150 | ) | 12.85 | | |
| Expired | — | | — | | |
| Exercised | (69,220 | ) | 6.76 | | |
| Outstanding at January 31,
2006 | 2,924,232 | $ | 15.66 | 6.42 | $ 47,345,000 |
| Options exercisable at
January 31, 2006 | 663,382 | $ | 9.37 | 6.86 | $ 14,913,000 |

10

| | The total cash received from
stock option exercises for the three months ended January 31, 2006 and 2005
was $467,000 and $1,043,000, respectively.
Total cash received from stock option exercises for the six months
ended January 31, 2006 and 2005 was
$1,425,000 and $1,253,000, respectively. The Company settles employee stock
option exercises with new shares. The
total intrinsic value of stock options exercised during the three months
ended January 31, 2006 and 2005 was $1,869,000 and $4,435,000,
respectively. The total intrinsic
value of stock options exercised during the six months ended January 31, 2006
and 2005 was $5,766,000 and $4,901,000, respectively. |
| --- | --- |
| (10) | Customer
and Geographic Information |
| | Sales by geography and
customer type, as a percentage of consolidated net sales, are as follows: |

2006	2005	2006	2005
United
States
U.S.
government	47.5%	51.8%	47.4%	46.4%
Commercial
customers	15.3%	10.6%	14.5%	12.1%
Total
United States	62.8%	62.4%	61.9%	58.5%
International
North
African country	10.8%	12.4%	13.2%	10.8%
Other
international customers	26.4%	25.2%	24.9%	30.7%
Total
International	37.2%	37.6%	38.1%	41.5%

| | International sales include sales to U.S. domestic
companies for inclusion in products that will be sold to international
customers. For the three and six months ended January 31, 2006, except for
sales to the U.S. government, one customer, a prime contractor, represented
12.0% and 12.1%, respectively, of consolidated net sales. For the three and six months ended January
31, 2005, except for sales to the U.S. government, no other customer
represented more than 10% of consolidated net sales. |
| --- | --- |
| (11) | Segment
Information |
| | Reportable operating segments are determined based
on the Company’s management approach.
The management approach, as defined by SFAS No. 131, is based on the
way that the chief operating decision-maker organizes the segments within an
enterprise for making operating decisions and assessing performance. While the Company’s results of operations
are primarily reviewed on a consolidated basis, the chief operating
decision-maker also manages the enterprise in three segments: (i) telecommunications transmission, (ii)
mobile data communications and (iii) RF microwave amplifiers.
Telecommunications transmission products include analog and digital modems,
frequency converters, power amplifiers, satellite very small aperture
terminal (“VSAT”) transceivers and antennas, voice gateways and
over-the-horizon microwave communications products and systems. Mobile data
communications provide satellite-based mobile location, tracking and
messaging hardware and related services, as well as turnkey employee mobility
solutions. RF microwave amplifier products include solid-state high-power
amplifier products that use the microwave and radio frequency spectrums. |
| | Unallocated expenses result from such corporate
expenses as legal, accounting and executive compensation. In addition, for the three and six months
ended January 31, 2006, unallocated expenses include $1,538,000 and
$2,834,000, respectively, of stock-based compensation expense. There was no
stock-based compensation expense recorded for the three or six months ended
January 31, 2005. Interest expense associated with the Company’s 2.0%
convertible senior notes is not allocated to the operating segments. Unallocated assets consist principally of
cash, deferred financing costs and deferred tax assets. Substantially all of the Company’s
long-lived assets are located in the U.S. |
| | Corporate management defines and reviews segment
profitability based on the same allocation methodology as presented in the
segment data tables below. |

11

| (in thousands) | Three
months ended January 31, 2006 — Telecommunications Transmission | Mobile
Data Communications | | RF
Microwave Amplifiers | Unallocated | | Total | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Net sales | $ 49,029 | | 36,209 | | 10,503 | — | | 95,741 |
| Operating income
(expense) | 13,032 | | 7,648 | | 2,069 | (4,077 | ) | 18,672 |
| Interest income | (7 | ) | 4 | | — | 2,175 | | 2,172 |
| Interest expense | 9 | | — | | 2 | 661 | | 672 |
| Depreciation and
amortization | 1,498 | | 262 | | 320 | 27 | | 2,107 |
| Expenditure for long-lived
assets,
including intangibles | 1,315 | | 126 | | 355 | 18 | | 1,814 |
| Total assets at January 31,
2006 | 124,386 | | 39,504 | | 22,095 | 231,334 | | 417,319 |
| | Three months ended January 31, 2005 | | | | | | | |
| (in
thousands) | Telecommunications Transmission | Mobile Data Communications | | RF Microwave Amplifiers | Unallocated | | Total | |
| Net sales | $ 39,650 | | 29,807 | | 8,630 | — | | 78,087 |
| Operating income
(expense) | 9,247 | | 6,697 | | 912 | (2,121 | ) | 14,735 |
| Interest income | 63 | | 1 | | — | 841 | | 905 |
| Interest expense | 2 | | — | | 3 | 662 | | 667 |
| Depreciation and
amortization | 1,333 | | 178 | | 318 | 23 | | 1,852 |
| Expenditure for long-lived
assets,
including intangibles | 1,092 | | 209 | | 270 | 7 | | 1,578 |
| Total assets at January 31,
2005 | 84,624 | | 26,888 | | 21,615 | 208,655 | | 341,782 |
| | Six months
ended January 31, 2006 | | | | | | | |
| (in thousands) | Telecommunications Transmission | Mobile
Data Communications | | RF
Microwave Amplifiers | Unallocated | | Total | |
| Net sales | $ 99,913 | | 75,643 | | 26,752 | — | | 202,308 |
| Operating income
(expense) | 25,270 | | 11,849 | | 6,277 | (7,913 | ) | 35,483 |
| Interest income | (38 | ) | (9 | ) | — | 3,994 | | 3,947 |
| Interest expense | 20 | | — | | 3 | 1,323 | | 1,346 |
| Depreciation and
amortization | 2,928 | | 504 | | 590 | 52 | | 4,074 |
| Expenditure for long-lived
assets,
including intangibles | 3,975 | | 360 | | 464 | 41 | | 4,840 |
| Total assets at January 31,
2006 | 124,386 | | 39,504 | | 22,095 | 231,334 | | 417,319 |
| | Six months ended January 31, 2005 | | | | | | | |
| (in
thousands) | Telecommunications Transmission | Mobile Data Communications | | RF Microwave Amplifiers | Unallocated | | Total | |
| Net sales | $ 77,152 | | 39,487 | | 17,570 | — | | 134,209 |
| Operating income
(expense) | 19,220 | | 7,905 | | 2,027 | (3,985 | ) | 25,167 |
| Interest income | 79 | | 1 | | — | 1,468 | | 1,548 |
| Interest expense | 6 | | — | | 7 | 1,323 | | 1,336 |
| Depreciation and
amortization | 2,650 | | 348 | | 631 | 37 | | 3,666 |
| Expenditure for long-lived
assets,
including intangibles | 2,222 | | 703 | | 423 | 25 | | 3,373 |
| Total assets at January 31,
2005 | 84,624 | | 26,888 | | 21,615 | 208,655 | | 341,782 |

12

| | Intersegment sales for the three months ended
January 31, 2006 and 2005 by the telecommunications transmission segment to
the RF microwave amplifiers segment were $2,462,000 and $2,735,000,
respectively. Intersegment sales for
the six months ended January 31, 2006 and 2005 by the telecommunications
transmission segment to the RF microwave amplifiers segment were $3,307,000
and $4,525,000, respectively. For the
three months ended January 31, 2006 and 2005, intersegment sales by the
telecommunications transmission segment to the mobile data communications
segment were $10,115,000 and $8,812,000, respectively. For the six months
ended January 31, 2006 and 2005, intersegment sales by the telecommunications
transmission segment to the mobile data communications segment were
$28,401,000 and $11,439,000, respectively. Intersegment sales have been
eliminated from the tables above. |
| --- | --- |
| (12) | Intangible Assets |
| | Intangible assets with definite lives as of January
31, 2006 and July 31, 2005 are as follows: |

| | January
31, 2006 — Gross Carrying Amount | Accumulated Amortization | July 31,
2005 — Gross Carrying Amount | Accumulated Amortization |
| --- | --- | --- | --- | --- |
| Existing
technology | $ 12,456,000 | 8,618,000 | 12,456,000 | 7,741,000 |
| Technology
license | 2,351,000 | 488,000 | 2,154,000 | 422,000 |
| Proprietary and
core technology | 2,794,000 | 801,000 | 2,794,000 | 610,000 |
| Other | 834,000 | 407,000 | 834,000 | 342,000 |
| Total | $ 18,435,000 | 10,314,000 | 18,238,000 | 9,115,000 |

| Amortization expense for the six months ended January
31, 2006 and 2005 was $1,199,000 and $1,137,000, respectively. The estimated amortization expense for the
twelve months ending January 31, 2007, 2008, 2009, 2010 and 2011 is
$2,389,000, $1,566,000, $980,000, $914,000 and $761,000, respectively. |
| --- |
| The carrying amount of goodwill, by segment, at both
January 31, 2006 and July 31, 2005 is as follows: |

Telecommunications transmission	8,817,000
Mobile data communications	5,005,000
RF microwave amplifiers	8,422,000
$	22,244,000

| (13) |
| --- |
| During the first quarter of fiscal 2005, two of the
Company’s leased facilities located in Florida experienced hurricane damage
to both leasehold improvements and personal property. As of January 31, 2006,
the Company has substantially completed all restoration efforts relating to
the hurricane damage and has received $2,787,000 in advances from its
insurance carrier. At January 31, 2006, the Company has recorded an $816,000
insurance recovery receivable and has accrued a total of $2,250,000 for
hurricane related costs. The Company has a written agreement with its general
contractor, which the Company believes limits its liability to the amount of
insurance proceeds ultimately received. The Company is in a dispute with the
general contractor and a certain subcontractor. As a result, in May 2005, the
Company deposited approximately $1,422,000 in trust with its attorneys, which
represents the amount of insurance proceeds that may be payable to the
general contractor, and filed a complaint for declaratory judgment with the
9th Judicial Circuit Court in Orange County, Florida. The Company is awaiting
the Court’s determination as to entitlement to these funds. The
insurance carrier has also been made a party to the Orange County proceedings
by the subcontractor. The Company does not expect that the outcome of this
matter will have a material effect on its consolidated financial position or
results of operations. |
| The Company is subject to certain other legal
actions, which arise in the normal course of business. Although the outcome of litigation is
difficult to accurately predict, the Company believes that the outcome of
these actions will not have a material effect on its consolidated financial
position or results of operations. |

13

(14)	Recent Accounting Pronouncement
	In February 2006, the FASB issued FASB Staff
Position (“FSP”) No. FAS 123(R)-4, “Classification
of Options and Similar Instruments Issued as Employee Compensation That Allow
for Cash Settlement upon the Occurrence of a Contingent Event,” which amends SFAS No. 123(R) to require that options issued
with
a cash settlement feature that can be exercised upon the occurrence of a
contingent event that is outside the employee’s control should not be
classified as liabilities until it becomes probable that the event will
occur. For companies that adopted SFAS No. 123(R) prior to the issuance of
the FSP, application is required in the first reporting period beginning
after February 3, 2006. Currently, the Company has no stock options
outstanding with contingent cash settlement features, and as a result, the
FSP will not impact the Company’s consolidated financial statements.
ITEM 2.	MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We design, develop, produce and market innovative products, systems and services for advanced communications solutions. We conduct our business through three complementary segments: telecommunications transmission, mobile data communications and RF microwave amplifiers. We sell our products into commercial and government markets where we believe we have technological, engineering, systems design or other expertise that differentiate our product offerings. We believe we are leaders in the market segments that we serve.

Our telecommunications transmission segment, our largest business segment, provides specialized products and systems for satellite, over-the-horizon microwave and wireless line-of-sight microwave telecommunications systems. Our mobile data communications segment provides satellite-based mobile location, tracking and messaging services and mobile satellite transceivers primarily for defense applications, including logistics, support and battlefield command and control, as well as turnkey employee mobility solutions. Our RF microwave amplifiers segment designs, manufactures and markets solid-state, high-power, broadband RF microwave amplifier products.

A substantial portion of our sales may be derived from a limited number of relatively large customer contracts, the timing of revenues from which cannot be predicted. Quarterly sales and operating results may be significantly affected by one or more of such contracts. In addition, our gross profit is affected by a variety of factors, including the mix of products, systems and services sold, production efficiencies, estimates of warranty expense, price competition and general economic conditions. Our gross profit may also be affected by the impact of any cumulative adjustments to contracts that are accounted for under the percentage-of-completion method. Accordingly, we can experience significant fluctuations in sales and operating results from quarter-to-quarter and period-to-period comparisons may not be indicative of future performance.

Revenue from the sale of our products is generally recognized when the earnings process is complete, upon shipment or customer acceptance. Revenue from contracts relating to the design, development or manufacturing of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts is recognized using the percentage-of-completion method. Revenue from contracts that contain multiple elements that are not accounted for under the percentage-of-completion method are accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Revenue from these contracts is allocated to each respective element based on the element’s relative fair value and is recognized when the respective revenue recognition criteria for each element are met.

Our contract with the United States (“U.S.”) Army for the Movement Tracking System (“MTS”) is for an eight-year period ending in July 2007 and revenue recognition is based on the percentage-of-completion method. The gross margin is based on the estimated sales and expenses for the entire eight-year contract. The amount of revenue recognized has been limited to the amount of funded orders received from the U.S. Army. Through the end of our fiscal quarter ended October 31, 2004, we recognized revenue on the portion of such orders that relate to prepaid service time when the time was used by the customer. As a result of changes to the manner in which our technology is being deployed and used, commencing November 1, 2004, we are recognizing service time revenue based on a network availability method which recognizes prepaid service time on a straight-line basis from the date of shipment through the end of the contract term in July 2007.

14

In February 2005, we acquired certain assets and assumed certain liabilities of Tolt Technologies, Inc. (“Tolt”) for an aggregate purchase price of $3.7 million, including transaction costs of $0.2 million. Based on Tolt’s achievement of fiscal 2006 sales goals, we may be required to pay an earn-out of $0.5 million. Tolt’s results of operations have been included in our mobile data communications segment.

As more fully described above in “Notes to Consolidated Financial Statements – Note (3) Stock-Based Compensation, ” we were required to recognize non-cash compensation expense for previously issued and new stock-based compensation awards beginning in the first quarter of fiscal 2006. For the three and six months ended January 31, 2006, $1.5 million and $2.8 million, respectively, of stock-based compensation expense was recorded, of which $1.2 million and $2.3 million, respectively, was included in selling, general and administrative expenses in the Consolidated Statement of Operations with the remaining expense recorded in cost of sales and research and development expenses. There was no stock-based compensation expense included in the reported amounts for the three or six months ended January 31, 2005.

CRITICAL ACCOUNTING POLICIES

We consider certain accounting policies to be critical due to the estimation process involved in each.

Revenue Recognition on Long-Term Contracts. Revenues and related costs from long-term contracts relating to the design, development or manufacturing of complex electronic equipment to a buyer’s specification or to provide services relating to the performance of such contracts are recognized using the percentage-of-completion method. Revenue is recognized based on the relationship of total costs incurred to total projected costs, or, alternatively, based on output measures, such as units delivered. Profits expected to be realized on such contracts are based on total estimated sales for the contract compared to total estimated costs, including warranty costs, at completion of the contract. These estimates are reviewed and revised periodically throughout the lives of the contracts, and adjustments to profits resulting from such revisions are made cumulative to the date of the change. The impact of any such adjustments discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” represents the cumulative impact of the adjustment on the relevant financial statement amount as of the beginning of the period being discussed. Estimated losses on long-term contracts are recorded in the period in which the losses become evident.

Some of our largest contracts, including our MTS contract with the U.S. Army, are accounted for using the percentage-of-completion method. We have been engaged in the production and delivery of goods and services on a continual basis under contractual arrangements for many years. Historically, we have demonstrated an ability to accurately estimate revenues and expenses relating to our long-term contracts. However, there exist inherent risks and uncertainties in estimating revenues, expenses and progress toward completion, particularly on larger or longer-term contracts. If we do not accurately estimate the total sales, related costs and progress towards completion on such contracts, the estimated gross margins may be significantly impacted or losses may need to be recognized in future periods. Any such resulting changes in margins or contract losses could be material to our results of operations and financial position.

In addition, most government contracts have termination for convenience clauses that provide the customer with the right to terminate the contract at any time. Such terminations could impact the assumptions regarding total contract revenues and expenses utilized in recognizing profit under the percentage-of-completion method of accounting. Changes to these assumptions could materially impact our results of operations and financial position. Historically, we have not experienced material terminations of our long-term contracts.

We also address customer acceptance provisions in assessing our ability to perform our contractual obligations under long-term contracts. Our inability to perform on our long-term contracts could materially impact our results of operations and financial position. Historically, we have been able to perform on our long-term contracts.

Accounting for Stock-Based Compensation. As discussed further in “Notes to Consolidated Financial Statements – Note (3) Stock-Based Compensation, ” we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R) on August 1, 2005 using the modified prospective method. Through July 31, 2005, we accounted for our stock option and employee stock purchase plans under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, and as a result no compensation costs had been recognized in our historical consolidated statements of operations.

We have used and expect to continue to use the Black-Scholes option-pricing model to compute the estimated fair value of stock-based awards. The Black-Scholes option pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. The assumptions used in computing the fair value of stock-based awards reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. We estimate expected volatility based primarily on historical daily price changes of our stock and other factors. As a result, if other assumptions or estimates had been used, the stock-based compensation expense that was

15

recorded for the three and six months ended January 31, 2006 could have been materially different. Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially impacted in the future.

Impairment of Intangible Assets. As of January 31, 2006, our intangible assets, including goodwill, aggregated $30.4 million. In assessing the recoverability of goodwill and other intangibles, we must make various assumptions regarding estimated future cash flows and other factors in determining the fair values of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets in future periods. Any such resulting impairment charges could be material to our results of operations.

Provisions for Excess and Obsolete Inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based on historical and future usage trends. Several factors may influence the sale and use of our inventories, including decisions to exit a product line, technological change and new product development. These factors could result in a change in the amount of excess and obsolete inventory on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if we determine that our inventory was overvalued, we would be required to recognize such costs in our financial statements at the time of such determination. Any such charges could be material to our results of operations and financial position.

Warranty Reserves. We provide warranty coverage for most of our products, including products under long-term contracts, for a period of at least one year from the date of shipment. We record a liability for estimated warranty expense based on historical claims, product failure rates and other factors. There exist inherent risks and uncertainties in estimating warranty expenses, particularly on larger or longer-term contracts. As such, if we do not accurately estimate our warranty costs, any such changes to our original estimates could be material to our results of operations and financial position.

Allowance for Doubtful Accounts. We perform ongoing credit evaluations of our customers and adjust credit limits based upon customer payment history and current creditworthiness, as determined by our review of our customers’ current credit information. Generally, we will require cash in advance or payment secured by irrevocable letters of credit before an order is accepted from an international customer that we do not do business with regularly. In addition, we seek to obtain insurance for certain international customers. We continuously monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the allowances established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and the financial health of specific customers. Changes to the estimated allowance for doubtful accounts could be material to our results of operations and financial position.

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31, 2005

Net Sales. Consolidated net sales were $95.7 million and $78.1 million for the three months ended January 31, 2006 and 2005, respectively, representing an increase of $17.6 million, or 22.5%. The increase in net sales occurred in all three business segments.

Net sales in our telecommunications transmission segment were $49.0 million and $39.7 million for the three months ended January 31, 2006 and 2005, respectively, an increase of $9.3 million, or 23.4%. The growth in this segment resulted primarily from an increase in demand for our satellite earth station products and incremental sales of our over-the-horizon microwave systems (including sales related to a $77.0 million contract that we received in September 2004). Net sales for the three months ended January 31, 2005 included $1.3 million of sales related to an adjustment to the estimated gross margin at completion on two large over-the-horizon microwave contracts. We anticipate that quarterly sales for the balance of fiscal 2006 relating to over-the-horizon microwave systems will be lower than the sales for the three months ended January 31, 2006 unless we receive another substantial contract. Sales in this product line can fluctuate dramatically from quarter-to-quarter based on the receipt of large contracts and our performance thereon. Our telecommunications transmission segment represented 51.2% and 50.8% of consolidated net sales for three months ended January 31, 2006 and 2005, respectively.

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Net sales in our mobile data communications segment were $36.2 million and $29.8 million for the three months ended January 31, 2006 and 2005, respectively, an increase of $­­­6.4 million, or ­­­­21.5%. The increase in net sales was due to (i) higher sales on the MTS contract, including $6.7 million of net sales relating to the gross profit adjustment discussed below, (ii) the acquisition of Tolt in February 2005 which contributed $5.0 million of net sales for the three months ended January 31, 2006 and (iii) higher sales of battlefield command and control applications to the U.S. military. Net sales for the three months ended January 31, 2005 were positively impacted by a favorable cumulative adjustment associated with the aforementioned change from the usage method to the straight-line method of accounting for MTS prepaid service time revenue which contributed $4.6 million to net sales. Our mobile data communications segment represented 37.8% and 38.2% of consolidated net sales for the three months ended January 31, 2006 and 2005, respectively.

Quarterly sales and profitability in our mobile data communications segment can fluctuate dramatically due to quarterly funding fluctuations and the continued rollout of our new MTS transceiver. In addition to these normal quarter-to-quarter fluctuations in this segment, we also expect a decline in net sales associated with lower margin Tolt products. To date, we have not been satisfied with Tolt’s penetration into the commercial satellite-based mobile data application market. As a result, in February 2006 we revamped the incentive compensation plan for Tolt salespeople in order to better focus their efforts on selling commercial satellite-based mobile data applications. Our new plan is expected to result in a reduction in net sales of lower margin Tolt products; and we do not expect to see an immediate increase in commercial satellite-based mobile data applications. Tolt is expected to remain a net cost center during the transition period which is expected to last no longer than six months. The new incentive compensation plan may not be successful in accomplishing its objectives. As such, we may need to refine our strategy. However, we continue to believe that our technology is well-suited for certain vertical commercial markets, particularly those requiring near real-time communications.

Net sales in our RF microwave amplifiers segment were $10.5 million for the three months ended January 31, 2006, compared to $8.6 million for the three months ended January 31, 2005, an increase of $1.9 million, or 22.1%. The increase in net sales was primarily the result of increased demand for our defense related products. In particular, we experienced an increase in demand for our RF microwave amplifiers that are incorporated into improvised explosive device jamming systems. The sustainability of the defense related revenue base in this segment will be dependent upon the receipt of additional orders for improvised explosive device jamming system amplifiers or participation in additional large electronic warfare programs. Our RF microwave amplifiers segment represented 11.0% of consolidated net sales for both the three months ended January 31, 2006 and 2005.

International sales (which include sales to domestic companies for inclusion in products which are sold to international customers) represented 37.2% and 37.6% of consolidated net sales for the three months ended January 31, 2006 and 2005, respectively. Domestic commercial sales represented 15.3% and 10.6% of consolidated net sales for the three months ended January 31, 2006 and 2005, respectively. Sales to the U.S. government (including sales to prime contractors to the U.S. government) represented 47.5% and 51.8% of consolidated net sales for the three months ended January 31, 2006 and 2005, respectively.

During the three months ended January 31, 2006, except for sales to the U.S. government, one customer, a prime contractor, represented ­­­­­12.0% of consolidated net sales. For the three months ended January 31, 2005, except for sales to the U.S. government, no other customer represented more than 10% of consolidated net sales. Direct and indirect sales to a North African country (including certain sales to the prime contractor mentioned above) during the three months ended January 31, 2006 and 2005 represented 10.8% and 12.4% of consolidated net sales, respectively.

Gross Profit. Gross profit was $41.1 million and $32.3 million for the three months ended January 31, 2006 and 2005, respectively, representing an increase of $8.8 million, or 27.2%. Our gross profit percentage was 42.9% for the three months ended January 31, 2006 as compared to 41.4% for the three months ended January 31, 2005.

Excluding the impact of adjustments to both net sales and gross profit, as discussed below, our gross profit as a percentage of sales for the three months ended January 31, 2006 would have been 39.9% as compared to 39.6% for the three months ended January 31, 2005. This increase was primarily the result of a higher percentage of satellite earth station product sales, which have higher gross margins than any of our other product lines, partially offset by an increase in Tolt sales which have lower gross margins than any of our other product lines.

During the three months ended January 31, 2006, we recorded favorable cumulative gross profit adjustments of $7.3 million relating to our ongoing review of total estimated contract revenues and costs, and the related gross margin at completion, on long-term contracts (of which $6.5 million relates to the mobile data communications segment and $0.8 million relates to the RF microwave amplifiers segment). These favorable adjustments were partially offset by a $1.7 million warranty provision discussed below. During the three months ended January 31, 2005, we recorded favorable

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cumulative adjustments with an aggregate impact of $3.7 million on gross profit (of which $2.4 million relates to the mobile data communications segment and $1.3 million relates to the telecommunications transmission segment).

In our mobile data communications segment, during the three months ended January 31, 2006, we increased the estimated gross profit at completion on the MTS contract, which resulted in a $6.5 million cumulative increase to the gross profit recognized in prior periods. The adjustment was the result of increased funding from the U.S. Army, as well as improved operating efficiencies. At the request of the U.S. Army, we continue to rollout our next generation satellite transceiver, known as the MT 2012, and enhance our network and related software to provide increased speed and performance. We currently expect to complete the new product transition during fiscal 2006. If the current funding levels of MTS and battlefield command and control applications are maintained or increased, we may experience additional increased operating efficiencies.

Unrelated to the next generation MTS technology upgrade, we recently determined that certain of our firmware needs to be modified. This effort will require additional field personnel and other costs. Included in cost of sales for the three months ended January 31, 2006 is a $1.7 million warranty provision related to modifying units previously shipped to non-MTS customers. An additional $0.8 million is included in the MTS estimated costs at completion relating to the same firmware modification. We are currently in the early stages of planning and rolling out these modifications and continue to work closely with our customers. The ultimate amount of warranty expense could differ from our initial estimate and we may incur additional unanticipated costs or delays.

In our RF microwave amplifiers segment, during the three months ended January 31, 2006, we increased the estimated gross profit at completion on a military contract as it was substantially completed. This adjustment resulted in an aggregate $0.8 million cumulative increase to the gross profit recognized on the contract in prior periods.

As part of our strategy to further leverage our high-volume manufacturing center and further develop a diversified customer base, we currently have on-hand $4.9 million of inventory relating to a contract from a third-party commercial customer to outsource its manufacturing. Although sales relating to this inventory have been nominal to date, we expect sales to this customer to increase during the second half of fiscal 2006.

Included in cost of sales for the three months ended January 31, 2006 and 2005 are provisions for excess and obsolete inventory of $0.5 million and $0.4 million, respectively. As discussed under “Critical Accounting Policies – Provisions for Excess and Obsolete Inventory,” we regularly review our inventory and record a provision for excess and obsolete inventory based on historical and projected usage assumptions.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $15.8 million and $12.0 million for the three months ended January 31, 2006 and 2005, respectively, representing an increase of $3.8 million, or 31.7%. The increase in expenses was primarily attributable to (i) expenses associated with Tolt which was acquired in February 2005 and (ii) the increased level of net sales and activity in all three of our business segments. In addition, selling, general and administrative expenses for the three months ended January 31, 2006 included $1.2 million of stock-based compensation expense. There was no stock-based compensation expense included in selling, general and administrative expenses for the three months ended January 31, 2005. As a percentage of consolidated net sales, selling, general and administrative expenses were 16.5% and 15.4% for the three months ended January 31, 2006 and 2005, respectively.

Research and Development Expenses. Research and development expenses were $6.0 million and $5.0 million for the three months ended January 31, 2006 and 2005, respectively. Approximately $4.5 million and $4.4 million of such amounts, respectively, related to our telecommunications transmission segment. As an investment for the future, we are continually enhancing our existing products and developing new products and technologies. Whenever possible, we seek customer funding for research and development to adapt our products to specialized customer requirements. During the three months ended January 31, 2006 and 2005, customers reimbursed us $0.6 million and $1.1 million, respectively, which is not reflected in the reported research and development expenses, but is included in consolidated net sales with the related costs included in cost of sales.

Amortization of Intangibles. Amortization of intangibles for both the three months ended January 31, 2006 and 2005 was $0.6 million. The amortization primarily relates to intangibles with definite lives that we acquired in connection with various acquisitions.

Operating Income. Operating income for the three months ended January 31, 2006 and 2005 was $18.7 million and $14.7 million, respectively. The $4.0 million, or 27.2% increase, was the result of higher sales and gross profit, discussed above, partially offset by higher operating expenses.

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Operating income in our telecommunications transmission segment increased to $13.0 million for the three months ended January 31, 2006 from $9.2 million for the three months ended January 31, 2005 as a result of increased net sales and gross profit, partially offset by increased operating expenses. In addition, operating income for the three months ended January 31, 2005 included a $1.1 million positive impact on operating income from the cumulative gross margin adjustments (discussed above under “ Gross Profit ”) related to two large over-the-horizon microwave contracts.

Our mobile data communications segment generated operating income of $7.6 million for the three months ended January 31, 2006 compared to $6.7 million for the three months ended January 31, 2005. The three months ended January 31, 2006 and 2005 included positive impacts on operating income from the cumulative adjustments, net of the warranty provision in the second quarter of fiscal 2006 (discussed above under “ Gross Profit ”) of $4.1 million and $2.2 million, respectively. Tolt, which we acquired in February 2005, incurred an operating loss of $0.8 million during the three months ended January 31, 2006 and will continue to remain a net cost center for the next three to six months as we transition to our new sales incentive compensation plan and refine our commercial marketing strategy.

Operating income in our RF microwave amplifier segment increased to $2.1 million for the three months ended January 31, 2006 from $0.9 million for the three months ended January 31, 2005 primarily as a result of the increase in net sales, as well as an increase in the gross profit percentage (including a $0.7 million benefit from a positive gross margin adjustment as discussed above under “Gross Profit” ).

Unallocated operating expenses increased to $4.1 million for the three months ended January 31, 2006 from $2.1 million for the three months ended January 31, 2005 due primarily to the recording of $1.5 million of stock-based compensation expense associated with SFAS No. 123(R) and increased incentive compensation costs in connection with the significant increase in pre-tax income.

Interest Expense. Interest expense was $0.7 million for both the three months ended January 31, 2006 and 2005. Interest expense primarily represents interest associated with our 2.0% convertible senior notes issued in January 2004.

Interest Income. Interest income for the three months ended January 31, 2006 was $2.2 million, as compared to $0.9 million for three months ended January 31, 2005. The $1.3 million increase was due primarily to an increase in interest rates and additional investable cash.

Provision for Income Taxes. The provision for income taxes was $6.9 million and $4.8 million for the three months ended January 31, 2006 and 2005, respectively. The increase in the tax provision was primarily attributable to the increased level of pre-tax profit and the expiration, in December 2005, of the Federal research and experimentation credit. During the three months ended January 31, 2006, we recorded a net benefit of $0.6 million primarily relating to the favorable settlement of a state tax matter. In addition, the expensing of stock-based compensation resulted in an increase to our effective tax rate of approximately 1.0% due to the nondeductibility of compensation expense relating to incentive stock options. As a result of our increased operating income, we now estimate that our effective tax rate for fiscal 2006, excluding the favorable settlement, will approximate 36.5%.

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JANUARY 31, 2006 AND JANUARY 31, 2005

Net Sales. Consolidated net sales were $202.3 million and $134.2 million for the six months ended January 31, 2006 and 2005, respectively, representing an increase of $68.1 million, or 50.7%. The increase in net sales occurred in all three business segments.

Net sales in our telecommunications transmission segment were $99.9 million and $77.1 million for the six months ended January 31, 2006 and 2005, respectively, an increase of $22.8 million, or 29.6%. The growth in this segment resulted primarily from incremental sales of our over-the-horizon microwave systems (including sales related to a $77.0 million contract that we received in September 2004) and an increase in demand for our satellite earth station products. Net sales for the six months ended January 31, 2005 included $3.6 million (including the portion recorded in the first quarter of fiscal 2005) related to adjustments to the estimated gross margin at completion on two large over-the-horizon microwave contracts. Sales in such product line can fluctuate dramatically from quarter-to-quarter based on the receipt of large contracts and our performance thereon. We anticipate that quarterly sales for the balance of fiscal 2006 relating to over-the-horizon microwave systems will be lower than the quarterly sales for the first half of the year unless we receive another substantial contract. Our telecommunications transmission segment represented 49.4% and 57.5% of consolidated net sales for the six months ended January 31, 2006 and 2005, respectively.

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Net sales in our mobile data communications segment were $75.6 million and $39.5 million for the six months ended January 31, 2006 and 2005, respectively, an increase of $­­­­­­­­­36.1 million, or ­­­­91.4%. The increase in net sales was due to (i) the acquisition of Tolt in February 2005 which contributed $11.5 million of net sales for the six months ended January 31, 2006, (ii) higher sales on the MTS contract, including $5.6 million of net sales relating to the gross profit adjustment discussed above and (iii) higher sales of battlefield command and control applications to the U.S. military. See the three month comparison above for further discussion regarding Tolt. Net sales for the six months ended January 31, 2005 were positively impacted by a favorable cumulative adjustment associated with the aforementioned change from the usage method to the straight-line method of accounting for MTS prepaid service time revenue which contributed $3.8 million to net sales. Our mobile data communications segment represented 37.4% and 29.4% of consolidated net sales for the six months ended January 31, 2006 and 2005, respectively.

Net sales in our RF microwave amplifiers segment were $26.8 million for the six months ended January 31, 2006, compared to $17.6 million for the six months ended January 31, 2005, an increase of $9.2 million, or 52.3%. The significant increase in net sales was primarily the result of increased demand for our defense related products. In particular, we experienced an increase in demand for our RF microwave amplifiers that are incorporated into improvised explosive device jamming systems. The sustainability of the defense related revenue base in this segment will be dependent upon the receipt of additional orders for improvised explosive device jamming system amplifiers or participation in additional large electronic warfare programs. Our RF microwave amplifiers segment represented 13.2% and 13.1% of consolidated net sales for the six months ended January 31, 2006 and 2005, respectively.

International sales (which include sales to domestic companies for inclusion in products which are sold to international customers) represented 38.1% and 41.5% of consolidated net sales for the six months ended January 31, 2006 and 2005, respectively. Domestic commercial sales represented 14.5% and 12.1% of consolidated net sales for the six months ended January 31, 2006 and 2005, respectively. Sales to the U.S. government (including sales to prime contractors to the U.S. government) represented 47.4% and 46.4% of consolidated net sales for the six months ended January 31, 2006 and 2005, respectively.

During the six months ended January 31, 2006, except for sales to the U.S. government, one customer, a prime contractor, represented ­­­­­12.1% of consolidated net sales. For the six months ended January 31, 2005, except for sales to the U.S. government, no other customer represented more than 10% of consolidated net sales. Direct and indirect sales to a North African country (including certain sales to the prime contractor mentioned above) during the six months ended January 31, 2006 and 2005 represented 13.2% and 10.8% of consolidated net sales, respectively.

Gross Profit. Gross profit was $81.3 million and $59.4 million for the six months ended January 31, 2006 and 2005, respectively, representing an increase of $21.9 million, or 36.9%. Our gross profit percentage was 40.2% for the six months ended January 31, 2006 as compared to 44.3% for the six months ended January 31, 2005.

Excluding the impact of adjustments to both net sales and gross profit, as discussed below, our gross profit as a percentage of sales for the six months ended January 31, 2006 would have been 39.1% as compared to 42.3%. This decline was due to a higher proportion of our consolidated net sales being in the mobile data communications segment, which typically realizes lower gross margins than sales in our other two segments. In addition, the six months ended January 31, 2006 includes sales related to Tolt which has lower gross margins than any of our other product lines.

During the six months ended January 31, 2006, we recorded favorable cumulative gross profit adjustments of $6.1 million (of which $5.5 million relates to the mobile data communications segment and $0.6 million relates to the RF microwave amplifiers segment) as discussed above. The favorable adjustments were partially offset by a $1.7 million warranty provision also discussed above. During the six months ended January 31, 2005, we recorded cumulative adjustments related to two large over-the-horizon microwave system contracts and the MTS contract with an aggregate impact of $5.8 million on gross profit (of which $2.2 million relates to the mobile data communications segment and $3.6 million relates to the telecommunications transmission segment).

Included in cost of sales for the six months ended January 31, 2006 and 2005 are provisions for excess and obsolete inventory of $1.0 million and $0.8 million, respectively. As discussed under “Critical Accounting Policies – Provisions for Excess and Obsolete Inventory,” we regularly review our inventory and record a provision for excess and obsolete inventory based on historical and projected usage assumptions.

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Selling, General and Administrative Expenses. Selling, general and administrative expenses were $31.9 million and $23.3 million for the six months ended January 31, 2006 and 2005, respectively, representing an increase of $8.6 million, or 36.9%. The increase in expenses was primarily attributable to (i) the increased level of net sales and activity in all three of our business segments and (ii) expenses associated with Tolt which was acquired in February 2005. In addition, selling, general and administrative expenses for the six months ended January 31, 2006 included $2.3 million of stock-based compensation expense. There was no stock-based compensation expense included in selling, general and administrative expenses for the six months ended January 31, 2005. As a percentage of consolidated net sales, selling, general and administrative expenses were 15.8% and 17.4% for the six months ended January 31, 2006 and 2005, respectively.

Research and Development Expenses. Research and development expenses were $12.8 million and $9.9 million for the six months ended January 31, 2006 and 2005, respectively. Approximately $9.6 million and $8.6 million of such amounts, respectively, related to our telecommunications transmission segment. As an investment for the future, we are continually enhancing our existing products and developing new products and technologies. Whenever possible, we seek customer funding for research and development to adapt our products to specialized customer requirements. During the six months ended January 31, 2006 and 2005, customers reimbursed us $1.1 million and $1.9 million, respectively, which is not reflected in the reported research and development expenses, but is included in consolidated net sales with the related costs included in cost of sales.

Amortization of Intangibles. Amortization of intangibles for the six months ended January 31, 2006 and 2005 was $1.2 million and $1.1 million, respectively. The amortization primarily relates to intangibles with definite lives that we acquired in connection with various acquisitions.

Operating Income. Operating income for the six months ended January 31, 2006 and 2005 was $35.5 million and $25.2 million, respectively. The $10.3 million, or 40.9% increase, was the result of higher sales and gross profit, discussed above, partially offset by higher operating expenses.

Operating income in our telecommunications transmission segment increased to $25.3 million for the six months ended January 31, 2006 from $19.2 million for the six months ended January 31, 2005 as a result of increased net sales and gross profit, partially offset by increased operating expenses, including increased research and development expenses. In addition, the six months ended January 31, 2005 included a $3.1 million positive impact on operating income from the cumulative gross margin adjustments discussed above under “ Gross Profit ” related to two large over-the-horizon microwave contracts.

Our mobile data communications segment generated operating income of $11.8 million for the six months ended January 31, 2006 compared to $7.9 million for the six months ended January 31, 2005 due primarily to the significant increase in net sales, partially offset by increased operating costs, including expenses associated with Tolt, which incurred an operating loss of $1.5 million for the six months ended January 31, 2006. In addition, the six months ended January 31, 2006 and 2005 included positive impacts on operating income from the cumulative gross margin adjustments, net of the warranty provision in the fiscal 2006 period, discussed above of $3.3 million and $2.0 million, respectively.

Operating income in our RF microwave amplifier segment increased to $6.3 million for the six months ended January 31, 2006 from $2.0 million for the six months ended January 31, 2005, primarily as a result of the significant increase in net sales, as well as an increase in the gross profit percentage (including a $0.5 million benefit from a positive gross margin adjustment on a contract as discussed above under “Gross Profit” ).

Unallocated operating expenses increased to $7.9 million for the six months ended January 31, 2006 from $4.0 million for the six months ended January 31, 2005 due primarily to the recording of $2.8 million of stock-based compensation expense associated with SFAS No. 123(R) and increased incentive compensation costs in connection with the significant increase in pre-tax income.

Interest Expense. Interest expense was $1.3 million for both the six months ended January 31, 2006 and 2005. Interest expense primarily represents interest associated with our 2.0% convertible senior notes issued in January 2004.

Interest Income. Interest income for the six months ended January 31, 2006 was $3.9 million, as compared to $1.5 million for six months ended January 31, 2005. The $2.4 million increase was due primarily to an increase in interest rates and additional investable cash primarily provided by our operating cash flow.

Provision for Income Taxes. The provision for income taxes was $13.3 million and $8.1 million for the six months ended January 31, 2006 and 2005, respectively. The increase in the tax provision was primarily attributable to the increased level

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of pre-tax profit and the expiration, in December 2005, of the Federal research and experimentation credit. During the six months ended January 31, 2006, we also recorded a net benefit of $0.6 million primarily relating to the favorable settlement of a state tax matter. In addition, the expensing of stock-based compensation resulted in an increase to our effective tax rate of approximately 1.0% due to the nondeductibility of compensation expense relating to incentive stock options. As a result of our increased operating income, we now estimate that our effective tax rate for fiscal 2006, excluding the favorable settlement, will approximate 36.5%.

LIQUIDITY AND CAPITAL RESOURCES

Our unrestricted cash and cash equivalents increased to $218.7 million at January 31, 2006 from $214.4 million at July 31, 2005.

Net cash provided by operating activities was $6.3 million for the six months ended January 31, 2006. Such amount reflects net income of $24.8 million, the impact of depreciation and amortization and the provisions for doubtful accounts and inventory reserves aggregating $5.4 million and stock-based compensation expense of $2.8 million, offset by changes in working capital balances, most notably an increase in accounts receivable and inventory. The increase in accounts receivable was driven, in part, by increased unbilled receivables related to a large over-the-horizon microwave system contract in our telecommunications transmission segment. We currently expect that a significant portion of the total receivables (including unbilled receivables at January 31, 2006) related to this contract will be collected during the second half of fiscal 2006.

Net cash used in investing activities for the six months ended January 31, 2006 was $4.8 million, primarily representing capital expenditures.

Net cash provided by financing activities was $2.8 million for the six months ended January 31, 2006, due primarily to proceeds from stock option exercises and employee stock purchase plan shares aggregating $1.7 million and a $1.2 million excess income tax benefit from the exercise of stock options.

FINANCING ARRANGEMENT

On January 27, 2004, we issued $105.0 million of our 2.0% convertible senior notes in a private offering pursuant to Rule 144A of the Securities Act of 1933, as amended. The net proceeds from this transaction were $101.2 million after deducting the initial purchaser’s discount and other transaction costs. For further information concerning this financing, see “Notes to Consolidated Financial Statements – Note (8) 2.0% Convertible Senior Notes .”

COMMITMENTS

In the normal course of business, we routinely enter into binding and non-binding purchase obligations primarily covering anticipated purchases of inventory and equipment. We do not expect that these commitments as of January 31, 2006 will materially adversely affect our liquidity.

At January 31, 2006, we had contractual cash obligations to repay our 2.0% convertible senior notes, capital lease and operating lease obligations (including satellite lease expenditures relating to our mobile data communications segment contracts) and the financing of a purchase of proprietary technology. Payments due under these long-term obligations are as follows:

| | Obligations
due by fiscal year (in thousands) — Total | Remainder of 2006 | 2007 and 2008 | 2009 and 2010 | After 2010 |
| --- | --- | --- | --- | --- | --- |
| 2.0% convertible senior notes | $ 105,000 | — | — | — | 105,000 |
| Operating lease commitments | 21,529 | 7,206 | 10,115 | 3,417 | 791 |
| Other obligations | 581 | 138 | 330 | 113 | — |
| Total contractual cash obligations | $ 127,110 | 7,344 | 10,445 | 3,530 | 105,791 |

We have entered into standby letter of credit agreements with financial institutions relating to the guarantee of our future performance on certain contracts. At January 31, 2006, the balance of these agreements was $1.2 million. Cash we have pledged against such agreements aggregating $1.0 million has been classified as restricted cash in the consolidated balance sheet as of January 31, 2006.

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We believe that our cash and cash equivalents will be sufficient to meet our operating cash requirements for the foreseeable future. In the event that we identify a significant acquisition that requires additional cash, we would seek to borrow funds or raise additional equity capital.

FORWARD-LOOKING STATEMENTS

Certain information in this Quarterly Report on Form 10-Q contains forward-looking statements, including but not 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 that are forward-looking in nature and involve certain significant risks and uncertainties. Actual results could differ materially from such forward-looking information.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

Our earnings and cash flows are subject to fluctuations due to changes in interest rates primarily from our investment of available cash balances. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. If the interest rate we receive on our investment of available cash balances were to change by 10%, our annual interest income would be impacted by approximately $0.9 million.

Our 2.0% convertible senior notes bear a fixed rate of interest. As such, our earnings and cash flows are not sensitive to changes in interest rates on our long-term debt. As of January 31, 2006, we estimate the fair market value of our 2.0% convertible senior notes to be $120.0 million based on recent trading activity.

ITEM 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out by the Company under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures have been designed and are being operated in a manner that provides reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. There have been no changes in the Company’s internal controls over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II OTHER INFORMATION

ITEM 1. Legal Proceedings

See Note 13 of the Notes to Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for information regarding legal proceedings.

Item 1A. Risk Factors

There have been no material changes from the risk factors previously disclosed in the Company’s Form 10-K for the fiscal year ended July 31, 2005.

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ITEM 4. Submission of Matters to a Vote of Security Holders

At the Company’s Annual Stockholders’ Meeting, held on December 6, 2005, Mr. Gerard R. Nocita and Mr. Ira Kaplan were elected as Directors for a three-year term. The votes were as follows: Mr. Gerard R. Nocita – shares for 19,317,832; shares withheld 1,893,255. Mr. Ira Kaplan – shares for 19,980,795; shares withheld 1,230,292. Mr. Fred Kornberg and Mr. Edwin Kantor continued on as Directors for terms expiring in two years and Dr. George Bugliarello and Mr. Richard L. Goldberg for terms expiring in one year.

The stockholders approved an amendment to the Company’s Certificate of Incorporation increasing the number of authorized shares of the Company’s Common Stock from 30,000,000 to 100,000,000 by a vote of 17,543,125 shares for and 3,638,171 shares against, with 29,790 shares abstaining.

The stockholders ratified the selection of KPMG LLP as the Company’s auditors for its 2006 fiscal year by a vote of 21,035,056 shares for and 165,913 shares against, with 10,117 shares abstaining.

The stockholders approved the adoption of the amendment to the Company’s 2000 Stock Incentive Plan by a vote of 10,802,949 shares for and 5,297,976 shares against, with 38,245 shares abstaining.

ITEM 6. Exhibits

| (a) |
| --- |
| Exhibit 3.1
- Amendment to the Certificate of
Incorporation |
| Exhibit 31.1
- Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| Exhibit 31.2
- Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| Exhibit 32.1 - Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 |
| Exhibit
32.2 - Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 |

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

COMTECH TELECOMMUNICATIONS CORP. (Registrant)

Date: March 8, 2006	By:	/s/ Fred Kornberg
		Fred Kornberg
		Chairman of the Board
		Chief Executive Officer and
President
		(Principal Executive Officer)
Date: March 8, 2006	By:	/s/ Robert G. Rouse
		Robert G. Rouse
		Executive Vice President and
		Chief Financial Officer
		(Principal Financial and
Accounting Officer)

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