Edgar Filing: COMTECH TELECOMMUNICATIONS CORP /DE/

form10-q.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

T Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended October 31, 2008

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)

68 South Service Road, Suite 230, Melville, NY		11747
(Address of principal executive offices)		(Zip Code)

	(631) 962-7000
	(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.

T 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 T Accelerated filer o 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 T No

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of December 1, 2008, the number of outstanding shares of Common Stock, par value $.10 per share, of the registrant was 24,744,626 shares.

COMTECH TELECOMMUNICATIONS CORP.

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements

	Condensed Consolidated Balance Sheets – October 31, 2008 (Unaudited) and July 31, 2008	2

	Condensed Consolidated Statements of Operations – Three Months Ended October 31, 2008 and 2007 (Unaudited)	3

	Condensed Consolidated Statements of Cash Flows – Three Months Ended October 31, 2008 and 2007 (Unaudited)	4

	Notes to Condensed Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40

Item 4.	Controls and Procedures	40

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	41

Item 1A.	Risk Factors	41

Item 6.	Exhibits	42

	Signature Page	43

PART I

FINANCIAL INFORMATION

COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Item 1.	October 31, 2008			July 31, 2008
Assets	(Unaudited)
Current assets:
Cash and cash equivalents	$	211,472,000			410,067,000
Accounts receivable, net		113,014,000			70,040,000
Inventories, net		115,116,000			85,966,000
Prepaid expenses and other current assets		9,758,000			5,891,000
Deferred tax asset		15,986,000			10,026,000
Total current assets		465,346,000			581,990,000

Property, plant and equipment, net		39,188,000			34,269,000
Goodwill		147,566,000			24,363,000
Intangibles with finite lives, net		60,971,000			7,505,000
Deferred financing costs, net		1,221,000			1,357,000
Other assets, net		645,000			3,636,000
Total assets	$	714,937,000			653,120,000

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	33,243,000			31,423,000
Accrued expenses and other current liabilities		46,537,000			49,671,000
Customer advances and deposits		17,542,000			15,287,000
Current installments of other obligations		73,000			108,000
Interest payable		525,000			1,050,000
Income taxes payable		7,304,000			-
Total current liabilities		105,224,000			97,539,000

Convertible senior notes		105,000,000			105,000,000
Other liabilities		2,216,000			-
Income taxes payable		3,404,000			1,909,000
Deferred tax liability		22,907,000			5,870,000
Total liabilities		238,751,000			210,318,000

Commitments and contingencies (See Note 17)

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; issued 24,953,198 shares and 24,600,166 shares at October 31, 2008 and July 31, 2008, respectively		2,495,000			2,460,000
Additional paid-in capital		197,224,000			186,246,000
Retained earnings		276,652,000			254,281,000
		476,371,000			442,987,000
Less:
Treasury stock (210,937 shares)		(185,000	)		(185,000	)
Total stockholders’ equity		476,186,000			442,802,000
Total liabilities and stockholders’ equity	$	714,937,000			653,120,000

See accompanying notes to condensed consolidated financial statements.

COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three months ended October 31,
	2008			2007

Net sales	$	191,915,000			115,055,000
Cost of sales		104,936,000			64,577,000
Gross profit		86,979,000			50,478,000

Expenses:
Selling, general and administrative		28,978,000			20,399,000
Research and development		14,125,000			11,041,000
Amortization of acquired in-process research and development (See Note 6)		6,200,000			-
Amortization of intangibles		1,793,000			379,000
		51,096,000			31,819,000

Operating income		35,883,000			18,659,000

Other expenses (income):
Interest expense		666,000			677,000
Interest income and other		(1,277,000	)		(4,447,000	)

Income before provision for income taxes		36,494,000			22,429,000
Provision for income taxes		14,123,000			7,735,000

Net income	$	22,371,000			14,694,000

Net income per share (See Note 5):
Basic	$	0.91			0.61
Diluted	$	0.80			0.54

Weighted average number of common shares outstanding – basic		24,586,000			23,924,000

Weighted average number of common and common equivalent shares outstanding assuming dilution – diluted		28,537,000			28,208,000

See accompanying notes to condensed consolidated financial statements.

COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three months ended October 31,
	2008			2007
Cash flows from operating activities:
Net income	$	22,371,000			14,694,000
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization of property, plant and equipment		2,913,000			2,112,000
Amortization of acquired in-process research and development		6,200,000			-
Amortization of intangible assets with finite lives		1,793,000			379,000
Amortization of stock-based compensation		2,418,000			2,719,000
Amortization of fair value inventory step-up		760,000			-
Deferred financing costs		136,000			136,000
(Benefit from) provision for allowance for doubtful accounts		(29,000	)		75,000
Provision for excess and obsolete inventory		990,000			546,000
Excess income tax benefit from stock award exercises		(1,400,000	)		(505,000	)
Deferred income tax expense (benefit)		944,000			(12,000	)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable		(20,974,000	)		(16,007,000	)
Inventories		(455,000	)		(10,244,000	)
Prepaid expenses and other current assets		(3,519,000	)		(4,013,000	)
Other assets		-			49,000
Accounts payable		(3,894,000	)		1,866,000
Accrued expenses and other current liabilities		(17,014,000	)		(6,991,000	)
Customer advances and deposits		(959,000	)		1,564,000
Interest payable		(525,000	)		(525,000	)
Income taxes payable		12,902,000			4,425,000
Net cash provided by (used in) operating activities		2,658,000			(9,732,000	)

Cash flows from investing activities:
Purchases of property, plant and equipment		(4,537,000	)		(3,179,000	)
Purchases of other intangibles with finite lives		-			(193,000	)
Payments for business acquisitions, net of cash acquired		(205,146,000	)		(265,000	)
Net cash used in investing activities		(209,683,000	)		(3,637,000	)

Cash flows from financing activities:
Principal payments on other obligations		(35,000	)		(33,000	)
Excess income tax benefit from stock award exercises		1,400,000			505,000
Proceeds from exercises of stock options		6,826,000			3,166,000
Proceeds from issuance of employee stock purchase plan shares		239,000			219,000
Net cash provided by financing activities		8,430,000			3,857,000

Net decrease in cash and cash equivalents		(198,595,000	)		(9,512,000	)
Cash and cash equivalents at beginning of period		410,067,000			342,903,000
Cash and cash equivalents at end of period	$	211,472,000			333,391,000

Supplemental cash flow disclosures:
Cash paid during the period for:
Interest	$	1,052,000			1,063,000
Income taxes	$	387,000			3,450,000

Non cash investing activities:
Radyne acquisition transaction costs not yet paid (See Note 6)	$	488,000			-

See accompanying notes to condensed consolidated financial statements.

COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1)

General

The accompanying condensed consolidated financial statements of Comtech Telecommunications Corp. and Subsidiaries (the “Company”) as of and for the three months ended October 31, 2008 and 2007 are unaudited. In the opinion of management, the information furnished reflects all material 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 months ended October 31, 2008 and 2007, comprehensive income was equal to net income.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results may differ from those estimates.

These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the fiscal year ended July 31, 2008 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

The Company applies the provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No. 123(R), stock-based compensation for both equity and liability-classified awards 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 fair value of liability-classified awards is remeasured at the end of each reporting period until the award is settled, with changes in fair value recognized pro-rata for the portion of the requisite service period rendered. The Company used the modified prospective method upon adopting SFAS No. 123(R).

The Company recognized stock-based compensation for awards issued under the Company’s Stock Option Plans and the Company’s 2001 Employee Stock Purchase Plan (the “ESPP”) in the following line items in the Condensed Consolidated Statements of Operations:

	Three months ended October 31,
	2008			2007
Cost of sales	$	85,000			221,000
Selling, general and administrative expenses		1,884,000			2,020,000
Research and development expenses		449,000			478,000
Stock-based compensation expense before income tax benefit		2,418,000			2,719,000
Income tax benefit		(782,000	)		(941,000	)
Net stock-based compensation expense	$	1,636,000			1,778,000

Of the total stock-based compensation expense before income tax benefit recognized in the three months ended October 31, 2008 and 2007, $56,000 and $51,000, respectively, related to stock-based awards issued pursuant to the ESPP and $29,000 and $89,000, respectively, related to awards of stock appreciation rights (“SARs”).

Stock-based compensation that was capitalized and included in ending inventory at October 31, 2008 and July 31, 2008 was $374,000 and $215,000, respectively.

The Company estimates the fair value of stock-based awards using the Black-Scholes option pricing model. The Black-Scholes option pricing model includes assumptions regarding dividend yield, expected volatility, expected option term and risk-free interest rates. The assumptions used in computing the fair value of stock-based awards reflect the Company’s best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of its control. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive stock-based awards.

The per share weighted average grant-date fair value of stock-based awards granted during the three months ended October 31, 2008 and 2007 approximated $15.59 and $15.73, respectively. In addition to the exercise and grant-date prices of the awards, certain weighted average assumptions that were used to estimate the initial fair value of stock-based awards in the respective periods are listed in the table below:

	Three months ended October 31,
	2008			2007
Expected dividend yield		0	%		0	%
Expected volatility		40.36	%		43.11	%
Risk-free interest rate		2.82	%		4.55	%
Expected life (years)		3.61			3.55

Stock-based awards granted during the three months ended October 31, 2008 and 2007 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 stock-based awards 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. The Company settles employee stock option exercises with new shares. All SARs granted through October 31, 2008 may only be settled with cash.

The Company estimates expected volatility by considering the historical volatility of the Company’s stock, the implied volatility of publicly traded stock options in the Company’s stock and the Company’s expectations of volatility for the expected life of stock-based compensation awards. 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 life is the number of years that the Company estimates awards will be outstanding prior to exercise. The expected life of the awards issued after July 31, 2005 and through July 31, 2007 was determined using the “simplified method” prescribed in SEC Staff Accounting Bulletin (“SAB”) No. 107. Effective August 1, 2007, the expected life of awards issued was determined by employee groups with sufficiently distinct behavior patterns.

The following table provides the components of the actual income tax benefit recognized for tax deductions relating to the exercise of stock-based awards:

	Three months ended October 31,
	2008			2007

Actual income tax benefit recorded for the tax deductions relating to the exercise of stock-based awards	$	2,374,000			904,000
Less: Tax benefit initially recognized on exercised stock-based awards vesting subsequent to the adoption of SFAS No. 123(R)		(974,000	)		(399,000	)
Excess income tax benefit recorded as an increase to additional paid-in capital		1,400,000			505,000
Less: Tax benefit initially disclosed but not previously recognized on exercised equity-classified stock-based awards vesting prior to the adoption of SFAS No. 123(R)		-			-
Excess income tax benefit from exercised equity-classified stock-based awards reported as a cash flow from financing activities in the Company’s Condensed Consolidated Statements of Cash Flows	$	1,400,000			505,000

At October 31, 2008, total remaining unrecognized compensation cost related to unvested stock-based awards was $16,338,000, net of estimated forfeitures of $961,000. The net cost is expected to be recognized over a weighted average period of 2.1 years.

(4)	Fair Value Measurement

Effective August 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It establishes a fair value hierarchy that distinguishes between (a) Level 1 inputs which are based on quoted market prices for identical assets or liabilities in active markets at the measurement date; (b) Level 2 inputs which are observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; and (c) Level 3 inputs which reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date and which are both unobservable in the market and significant to the instrument’s valuation.

The only assets or liabilities measured at fair value on a recurring basis as of October 31, 2008 were investments owned by the Company that are classified as cash and cash equivalents. As of October 31, 2008, substantially all of the Company’s cash and cash equivalents consist of money market funds which were valued using Level 1 inputs.

(5)	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 equity-classified stock-based awards and convertible senior notes, if dilutive, outstanding during each period. Equity-classified stock-based awards to purchase 1,110,000 and 589,000 shares, for the three months ended October 31, 2008 and 2007, respectively, were not included in the EPS calculation because their effect would have been anti-dilutive. Liability-classified stock-based awards do not impact, and are not included in, the denominator for EPS calculations.

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 includes the impact of the assumed conversion of its 2.0% convertible senior notes in calculating diluted EPS.

The following table reconciles the numerators and denominators used in the basic and diluted EPS calculations:

	Three months ended October 31,
	2008		2007
Numerator:
Net income for basic calculation	$	22,371,000		14,694,000
Effect of dilutive securities:
Interest expense (net of tax) on convertible senior notes		416,000		416,000
Numerator for diluted calculation	$	22,787,000		15,110,000

Denominator:
Denominator for basic calculation		24,586,000		23,924,000
Effect of dilutive securities:
Stock options		618,000		951,000
Conversion of convertible senior notes		3,333,000		3,333,000
Denominator for diluted calculation		28,537,000		28,208,000

(6)	Acquisitions

The Radyne Acquisition

On August 1, 2008, the Company acquired Radyne Corporation (“Radyne”) for a preliminary aggregate purchase price of approximately $231,684,000 (including estimated transaction costs and liabilities assumed for outstanding share-based awards). The operating results of Radyne have been included in the consolidated statement of operations from August 1, 2008 (the beginning of the Company’s fiscal year 2009) through October 31, 2008. From an operational and financial reporting perspective, Radyne’s satellite electronics and video encoder and decoder product lines are now part of the Company’s telecommunications transmission segment; Radyne’s traveling wave tube amplifier (“TWTA”) and klystron tube power amplifier (“KPA”) product portfolios are now part of the Company’s RF microwave amplifiers segment; and Radyne’s microsatellites and Sensor Enabled Notification (“SENS”) Technology product lines are now part of the Company’s mobile data communications segment.

The unaudited pro forma financial information in the table below, for the three months ended October 31, 2007, combines the historical results of Comtech for the three months ended October 31, 2007 and, due to the differences in the Company’s reporting period, the historical results of Radyne from July 1, 2007 through September 30, 2007.

	Three months ended
	October 31, 2007
Total revenues	$	153,429,000
Net income		9,437,000
Basic net income per share		0.39
Diluted net income per share		0.35

The pro forma financial information is not indicative of the results of operations that would have been achieved if the acquisition and cash paid had taken place at the beginning of the three months ended October 31, 2007. The pro forma financial information includes adjustments for:

-	incremental amortization expense of $6,200,000 for the estimated fair value of acquired in-process research and development;

-	incremental amortization expenses of $883,000 associated with the increase in acquired other intangible assets;

-	incremental amortization of $760,000 related to the fair value step-up of certain inventory acquired;

-	lower interest income of $2,552,000 due to assumed cash payments relating to the Radyne acquisition; and

-	the net tax impact of all of these adjustments.

The Company accounts for business combinations in accordance with FASB Statement No. 141, “Business Combinations” (“SFAS No. 141”). Accordingly, the preliminary aggregate purchase price for Radyne was allocated as of August 1, 2008, as set forth below:

Preliminary fair value of Radyne net tangible assets acquired	$	68,689,000

Preliminary fair value adjustments to net tangible assets:
Acquisition-related restructuring liabilities (See Note 10)		(3,400,000	)
Inventory step-up		1,520,000
Deferred tax assets, net		696,000
Preliminary fair value of net tangible assets acquired		67,505,000

Preliminary adjustments to record intangible assets at fair value:				Estimated Useful Lives
In-process research and development		6,200,000		Expensed immediately
Customer relationships		29,600,000		10 years
Technologies		19,900,000		7 to 15 years
Trademarks and other		5,700,000		2 to 20 years
Goodwill		123,203,000		Indefinite
Deferred tax liabilities, net		(20,424,000	)
		164,179,000
Preliminary aggregate purchase price	$	231,684,000

The estimated fair value of technologies and trademarks was based on the discounted capitalization of royalty expense saved because the Company now owns the assets. The estimated fair value of customer relationships and other intangibles with finite lives was primarily based on the value of the discounted cash flows that the related intangible asset could be expected to generate in the future.

The estimated fair value ascribed to in-process research and development projects of $6,200,000 (which was expensed during the three months ended October 31, 2008) was based upon the excess earnings approach utilizing the estimated economic life of the ultimate products to be developed, the estimated timing of when the ultimate products were expected to be commercialized and the related net cash flows expected to be generated. These net cash flows were discounted back to their net present value utilizing a weighted average cost of capital. The following table summarizes the fair value allocated to each project acquired, as well as the significant appraisal assumptions used as of the acquisition date and the current project status:

	As of the Acquisition Date of August 1, 2008
Specific Nature of In-Process Research and Development Projects	Fair Market Value Allocated		% of Estimated Efforts Complete		Original Anticipated Completion Date	Discount Rate		Fiscal Year Cash Flows Projected To Commence	Project Status as of October 31, 2008

RF Microwave Amplifiers Segment
Technology #1	$	1,553,000		61%	November 2008		14%	2009	In-Process
Technology #2		971,000		54%	January 2009		14%	2009	In-Process
Technology #3		776,000		76%	October 2008		14%	2009	In-Process
Telecommunications Transmission Segment
Technology #4		2,900,000		75%	October 2008		14%	2009	Complete
Total	$	6,200,000

These purchased in-process research and development efforts are complex and unique in light of the nature of the technology, which is generally state-of-the-art. Risks and uncertainties associated with completing the projects in-process include the availability of skilled engineers, the introduction of similar technologies by others, changes in market demand for the technologies and changes in industry standards affecting the technology. The Company does not believe that a failure to eventually complete the acquired in process research and development projects will have a material impact on the Company’s consolidated results of operations.

The allocation of the purchase price for Radyne was based upon a preliminary valuation and estimates and assumptions that are subject to change within the purchase price allocation period (generally one year from the acquisition date). The primary areas of purchase price not yet finalized include restructuring costs, income taxes, certain pre-acquisition contingencies for Radyne’s export matters that existed as of the acquisition date (see “Notes to Condensed Consolidated Financial Statements – Note (17) Legal Matters and Proceedings”) and residual goodwill.

The Verso Acquisition

In July 2008, the Company acquired the network backhaul assets and the NetPerformer and AccessGate product lines and assumed certain liabilities of Verso Technologies (“Verso”) for $3,917,000. This operation was combined with the Company’s existing business and is part of the telecommunications transmission segment.

Sales and income related to the Verso acquisition were not material to the Company’s results of operation and the effects of the acquisition were not material to the Company’s historical consolidated financial statements. The Company allocated the aggregate purchase price of the Verso acquisition to net tangible assets and intangible assets with an estimated useful life of seven years.

The valuation of Verso’s intangible assets was based primarily on the discounted capitalization of royalty expense saved because the Company now owns the assets.

(7)	Accounts Receivable

Accounts receivable consist of the following:

	October 31, 2008		July 31, 2008
Billed receivables from the U.S. government and its agencies	$	55,498,000		34,911,000
Billed receivables from commercial customers		51,632,000		31,758,000
Unbilled receivables on contracts-in-progress		7,149,000		4,672,000
		114,279,000		71,341,000
Less allowance for doubtful accounts		1,265,000		1,301,000
Accounts receivable, net	$	113,014,000		70,040,000

Unbilled receivables on contracts-in-progress include $3,523,000 and $2,854,000 at October 31, 2008 and July 31, 2008, respectively, due from the U.S. government and its agencies. There was $0 and $145,000 of retainage included in unbilled receivables at October 31, 2008 and July 31, 2008, respectively. In the opinion of management, substantially all of the unbilled balances will be billed and collected within one year.

(8)	Inventories

Inventories consist of the following:

	October 31, 2008		July 31, 2008
Raw materials and components	$	67,735,000		41,047,000
Work-in-process and finished goods		56,269,000		53,120,000
		124,004,000		94,167,000
Less reserve for excess and obsolete inventories		8,888,000		8,201,000
Inventories, net	$	115,116,000		85,966,000

Inventories directly related to long-term contracts, including the Company’s contracts for the U.S. Army’s Movement Tracking System (“MTS”) and the U.S. Army’s Force XXI Battle Command, Brigade-and-Below command and control systems (also known as Blue Force Tracking (“BFT”)), were $27,370,000 and $29,081,000 at October 31, 2008 and July 31, 2008, respectively.

At October 31, 2008 and July 31, 2008, $4,879,000 and $4,336,000, respectively, of the inventory balance above related to contracts from third party commercial customers who outsource their manufacturing to the Company.

(9)	Accrued Expenses

Accrued expenses and other current liabilities consist of the following:

	October 31, 2008		July 31, 2008
Accrued wages and benefits	$	16,296,000		23,680,000
Accrued warranty obligations		14,871,000		12,308,000
Accrued commissions and royalties		4,501,000		4,882,000
Accrued business acquisition payments		488,000		1,169,000
Accrued acquisition-related restructuring liabilities (See Note 10)		597,000		-
Other		9,784,000		7,632,000
Accrued expenses and other current liabilities	$	46,537,000		49,671,000

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. Some of the Company’s product warranties are provided under long-term contracts, the costs of which are incorporated into the Company’s estimates of total contract costs.

Changes in the Company’s product warranty liability during the three months ended October 31, 2008 and 2007 were as follows:

	Three months ended October 31,
	2008			2007
Balance at beginning of period	$	12,308,000			9,685,000
Provision for warranty obligations		2,231,000			3,072,000
Warranty obligations acquired from Radyne		1,975,000			-
Reversal of warranty liability		-			(156,000	)
Charges incurred		(1,643,000	)		(1,011,000	)
Balance at end of period	$	14,871,000			11,590,000

(10)	Acquisition-Related Restructuring Plan

In connection with the August 1, 2008 acquisition of Radyne, the Company immediately adopted a restructuring plan to achieve operating synergies. As of October 31, 2008, the Company has vacated and subleased Radyne’s Phoenix, Arizona manufacturing facility and has integrated Radyne’s satellite manufacturing and engineering operations into the Company’s high-volume technology manufacturing center located in Tempe, Arizona. In addition, Radyne’s corporate functions, which were co-located in Radyne’s manufacturing facility, have been moved to the Company’s Melville, New York corporate office. These actions were substantially complete as of October 31, 2008.

In connection with these activities, the Company recorded approximately $3,400,000 of restructuring costs, including $2,500,000 related to facility exit costs and $800,000 related to severance for Radyne employees who were informed they were terminated on August 1, 2008. In accordance with EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” the Company recorded these costs at fair value as assumed liabilities as of August 1, 2008, with a corresponding increase to goodwill. As such, these costs are not included in the Condensed Consolidated Statement of Operations for the three months ended October 31, 2008.

The facility exit costs of approximately $2,500,000 reflect the net present value of $13,054,000 for total non-cancelable lease obligations and related costs (for the period of November 1, 2008 through October 31, 2018) associated with the vacated manufacturing facility, less the net present value of estimated sublease income of $8,389,000. The Company estimated sublease income based on the terms of fully executed sublease agreements for the facility and its assessment of future uncertainties relating to the real estate market. The Company currently believes that it is not probable that it will be able to sublease the facility beyond the executed sublease terms which expire on October 31, 2015. Costs associated with operating the manufacturing facility through October 31, 2008 were expensed in the Condensed Consolidated Statement of Operations for the three months ended October 31, 2008.

The following represents a summary of the acquisition-related restructuring liabilities as of October 31, 2008:

	Accrued July 31, 2008		Initial Costs		Cash Payments		Accrued October 31, 2008		Total Costs Accrued to Date		Total Expected Program Costs
Facilities	$	-		2,500,000		-		2,500,000		2,500,000		2,500,000
Severance		-		800,000		587,000		213,000		800,000		800,000
Other		-		100,000		-		100,000		100,000		100,000
Total restructuring costs	$	-		3,400,000		587,000		2,813,000		3,400,000		3,400,000

Of the $2,813,000 acquisition-related restructuring liabilities accrued as of October 31, 2008, $597,000 is included in accrued acquisition-related restructuring liabilities and $2,216,000 is included in other liabilities.

(11)	2.0% Convertible Senior Notes

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 of $3,821,000.

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 if, during a 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. Upon conversion of the notes, in lieu of delivering common stock, the Company may, in its discretion, deliver cash or a combination of cash and common stock.

The notes can be converted, at the option of the noteholders, during the conversion period of September 15, 2008 through December 15, 2008. To date, no noteholders have exercised their conversion option. On the basis of the actual closing sale prices of the Company’s common stock through December 1, 2008, the Company also anticipates that the notes will be convertible during the conversion period of December 15, 2008 through March 16, 2009. Upon receiving notification of a noteholder’s intent to convert, the Company, in accordance with the provisions of the indenture, will inform the noteholder of its intention to deliver shares of common stock or cash, or a combination thereof.

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%. As such, interest expense on the 2.0% notes then outstanding may increase from 2.00% to 2.25%.

The Company may, at its option, redeem some or all of the notes for cash on or after February 4, 2009. If the Company redeems the notes for cash, on or after February 4, 2009, the Company will record an increase in interest expense for the unamortized portion of the deferred financing costs relating to the 2.0% convertible senior notes and, in the case of a cash redemption prior to February 1, 2011, an additional expense up to $600,000. As of October 31, 2008, unamortized deferred financing costs were $1,221,000. However, if, the noteholders are ultimately able to exercise their conversion option, and the Company elects to deliver shares of common stock in lieu of cash, the unamortized deferred financing costs will not be recorded as interest expense; rather, it will be recorded as reduction in additional paid-in-capital.

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 notes have substantive conversion features as defined by EITF No. 05-1, “Accounting for the Conversion of an Instrument that Became Convertible Upon the Issuer’s Exercise of a Call Option.” Accordingly, the Company will not recognize a gain or loss if it issues common stock upon the conversion and settlement of these notes.

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.

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 Comtech Telecommunications Corp.’s (the “Parent”) U.S. domiciled wholly-owned subsidiaries have issued full and unconditional guarantees in favor of the holders of the Company’s 2.0% convertible senior notes (the “Guarantor Subsidiaries”). These full and unconditional guarantees are joint and several. The Company’s foreign subsidiaries who have not issued guarantees are Memotec, Inc., Xicom Technology Europe, Ltd., Radyne Corporation Pte. Ltd. and Beijing Comtech EF Data Equipment Repair Service Co., Ltd. (the “Non-Guarantor Subsidiaries”). Other than supporting the operations of its subsidiaries, 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. Consolidating financial information regarding the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries can be found in Note (18) to the Condensed Consolidated Financial Statements.

(12)	Income Taxes

At July 31, 2008 and October 31, 2008, the total unrecognized tax benefits, excluding interest, were $4,467,000 and $4,958,000, respectively. At July 31, 2008 and October 31, 2008, the amount of unrecognized tax benefits that would impact the Company’s effective tax rate, if recognized, was $2,714,000 and $4,181,000, respectively. Unrecognized tax benefits result from income tax positions taken or expected to be taken on the Company’s income tax returns for which a tax benefit has not been recorded in the Company’s financial statements. Of the total unrecognized tax benefits, $1,909,000 and $3,404,000 were recorded as non-current income taxes payable in the Condensed Consolidated Balance Sheets of the Company at July 31, 2008 and October 31, 2008, respectively.

The Company’s policy is to recognize interest and penalties relating to uncertain tax positions in income tax expense. At July 31, 2008 and October 31, 2008, interest accrued relating to income taxes was $301,000 and $367,000, respectively, net of the related income tax benefit.

Tax years prior to fiscal 2003 are not subject to examination by the U.S. Federal tax authorities. In fiscal 2008, the Internal Revenue Service (“IRS”) completed its audit of the Company’s Federal income tax returns for fiscal 2004 and fiscal 2005. In addition, it has informed the Company that it will audit the Company’s Federal income tax return for fiscal 2006. The IRS audits for fiscal 2004 and 2005 were focused on the allowable amount of Federal research and experimentation (“R&E”) credits utilized and interest expense relating to the Company’s 2.0% convertible senior notes.

If the final outcome of the fiscal 2006 audit differs materially from the Company’s original income tax provision, the Company’s results of operations and financial condition could be materially impacted.

(13)	Stock Option Plans and Employee Stock Purchase Plan

The Company issues stock-based awards pursuant to the following plans:

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 Company’s 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 October 31, 2008, the Company had granted stock-based awards representing the right to purchase an aggregate of 2,016,218 shares (net of 428,441 canceled awards) at prices ranging between $0.67 - $5.31 per share. All 2,016,218 stock-based awards have been exercised as of October 31, 2008.

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, SARs, 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 6,587,500. The Stock Option Committee of the Company’s 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 awards may not have a term exceeding ten years or no more than five years in the case of an incentive stock award granted to a stockholder who owns stock representing more than 10% of the voting power.

As of October 31, 2008, the Company had granted stock-based awards representing the right to purchase an aggregate of 5,922,922 shares (net of 662,478 canceled awards) at prices ranging between $3.13 - $51.65, of which 2,654,037 are outstanding at October 31, 2008. As of October 31, 2008, 3,268,885 stock-based awards have been exercised. All stock-based awards granted through July 31, 2005 had exercise prices equal to the fair market value of the stock on the date of grant and a term of ten years. All stock-based awards granted since August 1, 2005 have had exercise prices equal to the fair market value of the stock on the date of grant and a term of five years.

The following table summarizes certain stock option plan activity during the three months ended October 31, 2008:

	Number of Shares Underlying Stock-Based Awards			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Outstanding at July 31, 2008		2,519,673		$	28.87
Granted		554,100			46.94
Expired/canceled		(72,400	)		31.72
Exercised		(347,336	)		19.65
Outstanding at October 31, 2008		2,654,037		$	33.77		3.71	$	38,920,000
Exercisable at October 31, 2008		1,147,022		$	27.79		3.22	$	23,660,000
Expected to vest at October 31, 2008		1,420,084		$	38.48		4.07	$	14,153,000

Included in the number of shares underlying stock-based awards outstanding at October 31, 2008, in the above table, are 36,000 SARs with an aggregate intrinsic value of $290,000.

The total intrinsic value of stock-based awards exercised during the three months ended October 31, 2008 and 2007 was $8,405,000 and $7,352,000, respectively.

2001 Employee Stock Purchase Plan – The ESPP was approved by the shareholders on December 12, 2000, and 675,000 shares of the Company’s common stock were reserved for issuance. The ESPP is intended to provide eligible employees of the Company the opportunity to acquire common stock in the Company at 85% of fair market value at the date of issuance through participation in the payroll-deduction based ESPP. Through the first quarter of fiscal 2009, the Company issued 290,439 shares of its common stock to participating employees in connection with the ESPP.

(14)	Customer and Geographic Information

Sales by geography and customer type, as a percentage of consolidated net sales, are as follows:

	Three months ended October 31,
	2008			2007
United States
U.S. government		61.6	%		60.6	%
Commercial customers		9.9	%		8.8	%
Total United States		71.5	%		69.4	%

International		28.5	%		30.6	%

International sales include sales to U.S. domestic companies for inclusion in products that will be sold to international customers. For the three months ended October 31, 2008 and 2007, except for sales to the U.S. government, no other customer represented more than 10% of consolidated net sales.

(15)	Segment Information

Reportable operating segments are determined based on the Company’s management approach. The management approach, as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”) is based on the way that the chief operating decision-maker organizes the segments within an enterprise for making decisions about resources to be allocated and assessing their 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 operating segments: (i) telecommunications transmission, (ii) mobile data communications and (iii) RF microwave amplifiers.

Telecommunications transmission products include satellite earth station products (such as analog and digital modems, frequency converters, power amplifiers, voice gateways, HDTV video encoders and decoders) and over-the-horizon microwave communications products and systems. Mobile data communications products include satellite-based mobile location, tracking and messaging hardware and related services and the design and production of microsatellites. RF microwave amplifier products include traveling wave tube amplifiers, klystron tube power amplifiers and solid-state, high-power broadband 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 months ended October 31, 2008 and 2007, unallocated expenses include $2,418,000 and $2,719,000, respectively, of stock-based compensation expense. Interest expense (which includes amortization of deferred financing costs) associated with the Company’s 2.0% convertible senior notes is not allocated to the operating segments. Depreciation and amortization includes amortization of stock-based compensation. Unallocated assets consist principally of cash and cash equivalents, deferred financing costs and deferred tax assets. Substantially all of the Company’s long-lived assets are located in the U.S.

The August 1, 2008 acquisition of Radyne did not result in any change to the Company’s management approach and management defines and reviews segment profitability based on the same allocation methodology as presented in the segment data tables below.

	Three months ended October 31, 2008
(in thousands)	Telecommunications Transmission		Mobile Data Communications		RF Microwave Amplifiers			Unallocated			Total
Net sales	$	74,561		81,906		35,448			-		$	191,915
Operating income (loss)		19,272		24,454		(81	)		(7,762	)		35,883
Interest income and other		28		-		74			1,175			1,277
Interest expense		5		-		-			661			666
Depreciation and amortization		6,058		769		4,787			2,470			14,084
Expenditure for long-lived assets, including intangibles		129,532		7,291		49,641			18			186,482
Total assets at October 31, 2008		293,729		70,870		120,528			229,810			714,937

	Three months ended October 31, 2007
(in thousands)	Telecommunications Transmission		Mobile Data Communications		RF Microwave Amplifiers		Unallocated			Total
Net sales	$	48,852		53,046		13,157		-		$	115,055
Operating income (loss)		10,891		12,753		1,035		(6,020	)		18,659
Interest income and other		49		1		-		4,397			4,447
Interest expense		6		9		-		662			677
Depreciation and amortization		1,667		516		259		2,768			5,210
Expenditure for long-lived assets, including intangibles		2,884		475		239		39			3,637
Total assets at October 31, 2007		130,065		63,703		38,275		345,263			577,306

Intersegment sales for the three months ended October 31, 2008 and 2007 by the telecommunications transmission segment to the mobile data communications segment were $34,381,000 and $21,019,000, respectively, and to the RF microwave amplifiers segment were $2,472,000 and $2,168,000, respectively.

Intersegment sales for the three months ended October 31, 2008 by the RF microwave amplifiers segment to the telecommunications transmission segment were $145,000. There were no intersegment sales by the RF microwave amplifiers segment to the telecommunications transmission segment for the three months ended October 31, 2007.

All intersegment sales have been eliminated from the tables above.

Because historical segment results do not include Radyne, period-to-period comparisons should not be relied upon as an indicator of the Company’s future performance because these comparisons may not be meaningful.

(16)	Intangible Assets

Intangible assets with finite lives as of October 31, 2008 and July 31, 2008 are as follows:

	October 31, 2008
	Weighted Average Amortization Period		Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Technologies		10.5	$	42,211,000		16,004,000	$	26,207,000
Customer relationships		10.0		29,931,000		923,000		29,008,000
Trademarks and other		17.3		6,344,000		588,000		5,756,000
Total			$	78,486,000		17,515,000	$	60,971,000

	July 31, 2008
	Weighted Average Amortization Period		Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Technologies		7.3	$	22,252,000		15,086,000	$	7,166,000
Customer relationships		7.6		331,000		172,000		159,000
Trademarks and other		4.6		644,000		464,000		180,000
Total			$	23,227,000		15,722,000	$	7,505,000

Amortization expense for the three months ended October 31, 2008 and 2007 was $1,793,000 and $379,000, respectively. The estimated amortization expense related to intangible assets with finite lives for the fiscal years ending July 31, 2009, 2010, 2011, 2012 and 2013 is $7,143,000, $7,028,000, $6,567,000, $5,652,000 and $5,445,000, respectively.

The changes in carrying amount of goodwill by segment for the three months ended October 31, 2008 are as follows:

	Telecommunications		Mobile Data		RF Microwave
	Transmission		Communications		Amplifiers		Total
Balance at July 31, 2008	$	8,817,000		7,124,000		8,422,000	$	24,363,000
Acquisition of Radyne (See Note 6)		98,400,000		4,346,000		20,457,000		123,203,000
Balance at October 31, 2008	$	107,217,000		11,470,000		28,879,000	$	147,566,000

(17)	Legal Matters and Proceedings

Export Matters

In October 2007, the Company’s Florida-based subsidiary, Comtech Systems, Inc. (“CSI”), received a customs export enforcement subpoena from the U.S. Immigration and Customs Enforcement (“ICE”) branch of the Department of Homeland Security. The subpoena relates to CSI’s $1,982,000 contract with the Brazilian Naval Commission (the “Brazil contract”) and it required the production of all books, records and documents, including copies of contracts, invoices and payments related to agreements between CSI, its agent, its subcontractor and the Brazilian government. Customs officials originally detained certain inventory related to the Brazil contract pending resolution of this matter.

The Company engaged outside counsel to assist CSI in its response to the subpoena and related matters and to conduct its own investigation into whether or not CSI was in compliance with export-related laws and regulations, including the International Traffic in Arms Regulations (“ITAR”) and the Export Administration Regulations. The Company believes that CSI made a good faith effort to comply with applicable regulations.

In November 2008, the U.S. Customs and Border Protection Agency of the Department of Homeland Security informed the Company that it was seizing the detained inventory under the provisions of Title 22 U.S.C. Section 401, in that exportation was attempted without presentation of a Department of State license. CSI has decided not to dispute the ruling. The inventory remains officially seized; however, it has been returned to CSI’s facility in Orlando, Florida. CSI has petitioned the U.S. Customs and Border Protection Agency for relief from forfeiture and has requested that the goods be officially released. In addition, CSI believes there are a number of circumstances, including the good faith effort that it took to comply with applicable regulations, that may mitigate against the forfeiture of and the imposition of any potential fines or penalties in connection with the seized goods. CSI has also filed an amended license (referred to as a Technical Assistance Agreement (“TAA”)) with the U.S. Department of State and has requested a license for the hardware. If successful in its efforts, CSI is hopeful that it may be able to shortly reship the Brazil inventory to the end-customer.

In addition to its review of the Brazil contract, in March 2008, the Enforcement Division of the U.S. Department of State informed the Company that it sought to confirm the Company’s company-wide ITAR compliance for the five-year period ended March 2008. In response, the Company expanded its ongoing investigation and provided detailed information and a summary of its findings to the U.S. Department of State. The Company’s findings to date indicate that there were certain instances of exports and defense services during the five-year period for which it did not have the appropriate authorization from the U.S. Department of State; however, none of those instances involved Proscribed Countries as defined by ITAR.

In connection with the Company’s August 1, 2008 acquisition of Radyne, the Company is continuing and expanding its export internal control assessment. To date, the Company has noted opportunities for improving its procedures to comply with laws and regulations relating to exports, including at its newly acquired Radyne subsidiaries. Violations, discovered by the Company as part of its internal control assessment, including those by Radyne that occurred prior to August 1, 2008, have been reported to the U.S. Department of State. In December 2008, the Company was requested to provide additional information to the U.S. Department of State. In addition, the Company has decided to have an independent export compliance audit performed and submit the results to the U.S Department of State. The Company intends to continue to cooperate with the U.S. Department of State’s review.

Since the receipt of the original Brazil subpoena in October 2007, the Company has engaged outside counsel and export consultants to help it assess and improve, as appropriate, its internal controls with respect to U.S. export control laws and regulations and laws governing record keeping and dealings with foreign representatives. The Company continues to take numerous steps to significantly improve its export control processes, including the hiring of additional employees who are knowledgeable and experienced with ITAR and the engagement of an outside export consultant to conduct additional training. The Company is also in the process of implementing enhanced formal company-wide ITAR control procedures, including at its newly acquired Radyne subsidiaries. Because the Company’s assessments are continuing, the Company expects to remediate, improve and enhance its internal controls relating to exports throughout fiscal 2009.

Because the above matters are ongoing, the Company cannot determine the ultimate outcome of these matters.

Violations of U.S. export control-related laws and regulations could result in civil or criminal fines and/or penalties and/or result in an injunction against the Company, all of which could, in the aggregate, materially impact its business, results of operations and cash flows. Should the Company identify a material weakness relating to its compliance, the ongoing costs of remediation could be material.

Inventory related to the Brazil contract (including the inventory that has been seized but returned to CSI’s facility) had a net book value of $1,110,000 as of October 31, 2008. If this inventory is permanently seized or not released to the Company in a timely manner, or the Company cannot resell the inventory to other customers, the Company would be required to write-off the value of this inventory in a future accounting period.

Verso Antitrust Inquiry

In November 2008, the Telecommunications and Media Enforcement Section of the Antitrust Division of the United States Department of Justice (“Antitrust Division”) informed the Company that it opened an inquiry into Comtech EF Data Corp.’s $3,917,000 acquisition of the network backhaul assets and certain product lines of Verso Technologies in July 2008. The acquired products include NetPerformer and AccessGate product lines which primarily serve enterprises and mobile carriers. The network backhaul assets and related products are now owned by Comtech EF Data Corp.’s Canadian subsidiary, Memotec, Inc. Given the small size of the acquisition, there was no mandatory notification or reporting requirements of the Company. The Antitrust Division has not served a subpoena in connection with its inquiry, and to date, the Company has only had preliminary discussions with the Antitrust Division concerning its inquiry. The Company intends to voluntarily meet with the Antitrust Division in December 2008 to further discuss the matter. Worldwide sales of Verso and Memotec combined for the three months ended October 31, 2008 were approximately $5,600,000. Although this matter is at an early stage, the Company is unable to predict the outcome of the Antitrust Division’s inquiry or the remedy the Antitrust Division might seek if it determined to challenge the transaction.

U.S. Department of Defense Investigation

In December 2008, Comtech PST Corp. (“Comtech PST”), a wholly-owned subsidiary of the Company, and Hill Engineering (“Hill”), a division of Comtech PST, each received a subpoena from the U.S. Department of Defense (“DoD”) requesting a broad range of documents and other information relating to a third party’s contract with the DoD and related subcontracts for the supply of specific components by Hill to the third party. The Company has begun an internal investigation and intends to fully cooperate with the DoD’s investigation and provide requested documents and other information. The Company has had preliminary discussions with the DoD concerning its investigation, but at this early stage, the Company is unable to predict the outcome of the DoD’s investigation.

Other Legal Proceedings

The Company is party to certain other legal actions, which arise in the normal course of business. Although the ultimate 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 condition or results of operations.

(18)	Condensed Consolidating Financial Information

The consolidating financial information presented below reflects information regarding the Parent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries of the Company’s 2.0% convertible senior notes. The Parent’s expenses associated with supporting the operations of its subsidiaries are allocated to the respective Guarantor Subsidiaries and the Non-Guarantor Subsidiaries. The consolidating financial information presented herein is not utilized by the chief operating decision-maker in making operating decisions and assessing performance.

The following reflects the condensed consolidating balance sheet as of October 31, 2008:

	Parent			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Consolidating Entries			Consolidated Total
Assets
Current assets:
Cash and cash equivalents	$	210,726,000			-		2,039,000		(1,293,000	)	$	211,472,000
Accounts receivable, net		-			106,562,000		6,452,000		-			113,014,000
Inventories, net		-			113,449,000		1,667,000		-			115,116,000
Prepaid expenses and other current assets		740,000			7,043,000		1,975,000		-			9,758,000
Deferred tax asset		1,406,000			14,580,000		-		-			15,986,000
Total current assets		212,872,000			241,634,000		12,133,000		(1,293,000	)		465,346,000

Property, plant and equipment, net		706,000			37,795,000		687,000		-			39,188,000
Investment in subsidiaries		554,225,000			5,830,000		-		(560,055,000	)		-
Goodwill		-			146,619,000		947,000		-			147,566,000
Intangibles with finite lives, net		-			57,934,000		3,037,000		-			60,971,000
Deferred tax asset		-			-		206,000		(206,000	)		-
Deferred financing costs, net		1,221,000			-		-		-			1,221,000
Other assets, net		56,000			553,000		36,000		-			645,000
Intercompany receivables		-			171,433,000		-		(171,433,000	)		-
Total assets	$	769,080,000			661,798,000		17,046,000		(732,987,000	)	$	714,937,000

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	834,000			33,427,000		275,000		(1,293,000	)	$	33,243,000
Accrued expenses and other current liabilities		7,802,000			37,491,000		1,244,000		-			46,537,000
Customer advances and deposits		-			15,350,000		2,192,000		-			17,542,000
Current installments of other obligations		-			73,000		-		-			73,000
Interest payable		525,000			-		-		-			525,000
Income taxes payable		6,535,000			-		769,000		-			7,304,000
Total current liabilities		15,696,000			86,341,000		4,480,000		(1,293,000	)		105,224,000

Convertible senior notes		105,000,000			-		-		-			105,000,000
Other liabilities		-			2,216,000		-		-			2,216,000
Income taxes payable		3,404,000			-		-		-			3,404,000
Deferred tax liability		4,097,000			19,016,000		-		(206,000	)		22,907,000
Intercompany payables		164,697,000			-		6,736,000		(171,433,000	)		-
Total liabilities		292,894,000			107,573,000		11,216,000		(172,932,000	)		238,751,000

Commitments and contingencies

Stockholders’ equity:
Preferred stock		-			-		-		-			-
Common stock		2,495,000			4,000		2,000		(6,000	)		2,495,000
Additional paid-in capital		197,224,000			295,296,000		5,187,000		(300,483,000	)		197,224,000
Retained earnings		276,652,000			258,925,000		641,000		(259,566,000	)		276,652,000
		476,371,000			554,225,000		5,830,000		(560,055,000	)		476,371,000
Less:
Treasury stock		(185,000	)		-		-		-			(185,000	)
Total stockholders’ equity		476,186,000			554,225,000		5,830,000		(560,055,000	)		476,186,000
Total liabilities and stockholders’ equity	$	769,080,000			661,798,000		17,046,000		(732,987,000	)	$	714,937,000

(18)	Condensed Consolidating Financial Information (continued)

The following reflects the condensed consolidating balance sheet as of July 31, 2008:

	Parent			Guarantor Subsidiaries		Non-Guarantor Subsidiary		Consolidating Entries			Consolidated Total
Assets
Current assets:
Cash and cash equivalents	$	408,065,000			-		4,056,000		(2,054,000	)	$	410,067,000
Accounts receivable, net		-			67,777,000		2,263,000		-			70,040,000
Inventories, net		-			84,032,000		1,934,000		-			85,966,000
Prepaid expenses and other current assets		1,953,000			3,209,000		1,404,000		(675,000	)		5,891,000
Deferred tax asset		1,243,000			8,783,000		-		-			10,026,000
Total current assets		411,261,000			163,801,000		9,657,000		(2,729,000	)		581,990,000

Property, plant and equipment, net		740,000			32,763,000		766,000		-			34,269,000
Investment in subsidiaries		318,292,000			5,721,000		-		(324,013,000	)		-
Goodwill		-			23,416,000		947,000		-			24,363,000
Intangibles with finite lives, net		-			4,388,000		3,117,000		-			7,505,000
Deferred tax asset		-			-		206,000		(206,000	)		-
Deferred financing costs, net		1,357,000			-		-		-			1,357,000
Other assets, net		3,266,000			352,000		18,000		-			3,636,000
Intercompany receivables		-			171,277,000		-		(171,277,000	)		-
Total assets	$	734,916,000			401,718,000		14,711,000		(498,225,000	)	$	653,120,000

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,597,000			30,874,000		1,006,000		(2,054,000	)	$	31,423,000
Accrued expenses and other current liabilities		12,241,000			36,551,000		879,000		-			49,671,000
Customer advances and deposits		-			13,254,000		2,033,000		-			15,287,000
Current installments of other obligations		-			108,000		-		-			108,000
Interest payable		1,050,000			-		-		-			1,050,000
Income taxes payable		-			-		675,000		(675,000	)		-
Total current liabilities		14,888,000			80,787,000		4,593,000		(2,729,000	)		97,539,000

Convertible senior notes		105,000,000			-		-		-			105,000,000
Income taxes payable		1,909,000			-		-		-			1,909,000
Deferred tax liability		3,437,000			2,639,000		-		(206,000	)		5,870,000
Intercompany payables		166,880,000			-		4,397,000		(171,277,000	)		-
Total liabilities		292,114,000			83,426,000		8,990,000		(174,212,000	)		210,318,000

Commitments and contingencies

Stockholders’ equity:
Preferred stock		-			-		-		-			-
Common stock		2,460,000			4,000		-		(4,000	)		2,460,000
Additional paid-in capital		186,246,000			81,410,000		5,187,000		(86,597,000	)		186,246,000
Retained earnings		254,281,000			236,878,000		534,000		(237,412,000	)		254,281,000
		442,987,000			318,292,000		5,721,000		(324,013,000	)		442,987,000
Less:
Treasury stock		(185,000	)		-		-		-			(185,000	)
Total stockholders’ equity		442,802,000			318,292,000		5,721,000		(324,013,000	)		442,802,000
Total liabilities and stockholders’ equity	$	734,916,000			401,718,000		14,711,000		(498,225,000	)	$