Maria Ceriello - IR Fred Kornberg - President & CEO Michael Porcelain - SVP & CFO.

Alexander Spektor - BMO Capital Markets Mark Jordan - Noble Financial Stanley Kovler - Citigroup Mike Latimore - Northland Capital Kyle McNealy - Jefferies Glenn Mattson - Ladenburg Thalmann.

Welcome to the Comtech Telecommunications Corp.’s Second Quarter Fiscal 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Thursday, March 8, 2017.

I'd like now to turn the conference over to Ms. Maria Ceriello of Comtech Communications. Please go ahead, ma’am..

Thank you, and good morning. Welcome to the Comtech Telecommunications Corp. conference call for the second quarter of fiscal year 2018. With us on the call this morning are Fred Kornberg, Chief Executive Officer and President of Comtech; and Michael D. Porcelain, Senior Vice President and Chief Financial Officer.

Before we proceed, I need to remind you of the company’s Safe Harbor language.

Certain information presented in this call will include, but not be limited to information relating to the future performance and financial condition of the company, the company’s plans, objectives, and business outlook; and the plans, objectives, and business outlook of the company’s management.

The company’s assumptions regarding such performance, business outlook, and plans are forward-looking in nature and involve certain significant risks and uncertainties. Actual results could differ materially from such forward-looking information.

Any forward-looking statements are qualified in their entirety by cautionary statements contained in the company’s Securities and Exchange Commission filings. I am pleased now to introduce the Chief Executive Officer and President of Comtech, Fred Kornberg.

Fred?.

Thank you, Maria and good morning, everyone, and thank you for joining us on this call. As we announced yesterday afternoon, we reported our second quarter results of $133.7 million in revenues and operating profit of $4.9 million. Adjusted EBITDA of $14.5 million and bookings of $210.6 million.

We finished the quarter with a backlog of $567.3 million, which is close to the company's record. Our results for the quarter, obviously, exceeded our expectations and our business momentum remains strong and shows no signs of slowing down. So as such, we’ve increased our fiscal 2018 revenue target to a range of $570 million to $585 million.

Increased our GAAP diluted EPS target to a new range of $1.08 to $1.23, and increased our adjusted EBITDA guideline -- guidance to a range of $72 million to $76 million. As you can imagine, I'm pleased with our business and our accomplishments thus far.

I will talk more about our accomplishments later in this call, but first let me turn it over to Mike Porcelain, our CFO, who will provide a discussion of our financial results and update our fiscal 2018 guidance in more detail.

Mike?.

Thanks, Fred, and good morning, everyone. Consolidated net sales for Q2 were $133.7 million, of which approximately 31.5% were from the U.S government, 26.5% from international end customers, and 42% from domestic commercial end customers.

During Q2, we achieved a consolidated book-to-bill ratio of 1.57 with both segments achieving a book-to-bill ratio in excess of one-time sales. As many of you know, Comtech's reported backlog of $567.3 million only consist of funded and/or firm orders.

As such, some of the contracts that we have been awarded during fiscal 2018 and fiscal 2017 and even before have not yet been fully funded, hence they’re not reported as backlog.

So when you think about the strength of our backlog, you should be mindful that the total contracts that we have in place are actually higher than our backlog by a material amount. For example, our AT&T contract for $96.2 million have a multiyear ordering period and not all of it is in backlog.

Our SNAP contract for $123.6 million covers a 3-year period and has minimal funding to date. Because we’re the sole provider for many of our contracts, funding is generally assured and likely to occur. But when we report backlog, we believe to take -- we believe what we do is a conservative view.

Going forward, we are going to try to put some metrics out there for you to follow the contracts, but I figure I would mention it, because I do think it is relevant when understanding our current position of strength. Now let me turn it back to sales and give a sense by segment on what is happening.

Net sales in our Commercial Solutions segment for Q2 were $85.8 million, an increase of 4.5% when compared to last year. Sales in the segment represented approximately 64.2% of total net sales. This was a terrific quarter for bookings in the segment, which achieved a book-to-bill ratio of 1.81.

Net sales of our satellite earth station products which include our HEIGHTS product line or satellite modems, and solid-state power amplifiers were higher this quarter than Q2 of last year and market conditions overall for this product line continue to improve.

In fact, both bookings and sales for this quarter increased as compared to the respective amounts achieved in the first quarter of fiscal 2018.

We continue to see increased interest from customers across our entire customer base, most notably from U.S government customers as well as strengthening end market validation of our commercial HEIGHTS products.

Turning to our Enterprise Technology Solutions and Safety and Security Technology Solutions group, sales were higher this quarter as compared to Q2 fiscal 2017.

As Fred will discuss in more detail, we were awarded a strategic multiyear contract valued at a $134 million from one of the largest wireless carriers in the U.S for safety and security technology solutions.

On the Enterprise Solutions side, which consist of mapping and location applications, we're starting to see some of the revenue synergies that we contemplated with the TCS acquisition.

We've been working hard and are pleased to say that year-over-year sales for these products in our international markets where we have strong relationships with mobile carriers are expected to increase more than 10%. This is a trend we hope can continue.

Now let me turn to our Government Solutions segment, where net sales were $47.9 million as compared to $56.9 million in Q2 of last year, a decrease of approximately 15.8%. Sales in the segment represented approximately 35.8% of total net sales.

The period-over-period decline in net sales in the Government segment was expected and primarily reflects significantly lower sales over the over-the-horizon microwave system product line, the impact of our previously implemented tactical shift in strategy away from bidding on large commodity service contracts and the absence of $2.5 million of BFT intellectual property licensing fees that we earned in the second quarter of fiscal 2017, supporting the U.S.

Army's BFT program. Such declines were partially offset by increased sales of our high-power broadband amplifiers. We believe the impact of our previously implemented tactical shift is largely over and are optimistic that the government segment will start to grow.

During Q2, order activity in this segment was strong and our Government Solutions segment achieved a book-to-bill ratio of 1.15 for the quarter. This was the fourth quarter in a row that our book-to-bill ratio in our Government Solutions segment exceeded 1.0, and we believe this trend validates the strategy we initiated.

In fact, backlog for our Government Solutions segment is the highest it has been since our acquisition of TCS back in February 23, 2016. This is quite an accomplishment and we are optimistic that bookings can go even higher than our most recent quarter.

Given the booking strength for the first half of the year that we saw, we now expect net sales for our Government Solutions segment to be slightly higher than fiscal 2017. Just a few months ago, we were expecting to report year-over-year sales decline. Now let me give you some color on our operating metrics.

Gross profit in Q2 of fiscal 2018 as a percentage of consolidated net sales was 38% as compared to 38.3% we achieved in Q2 of last year. If you remove the BFT IP fee from last year, our gross profit would have been 37.1% last year.

So you can actually see that we're achieving gross margin improvement on an operational basis, despite the reported number. For the year, we still expect gross profit as a percentage of consolidated net sales to be slightly lower when compared to 2017.

On the operating expense side, SG&A expenses were $27.2 million in Q2 of fiscal 2018 or 20.3% of consolidated net sales as compared to 22.3% last year. Here you can see the benefit of our lower spending and the benefit of cost reductions that we previously initiated.

For the year, given our current spending and investment plans and second half revenue growth assumptions, we do expect SG&A expenses as a percentage of revenue for fiscal 2018 to be comparable to the 21.1% we achieved in fiscal 2017.

Research and development expenses were $13.4 million in Q2 or 10% of consolidated net sales being comprised of $11.4 million of spending in the Commercial segment, $2 million of spending related to the Government Solution segment with the rest constituting amortization of stock-based compensation.

We feel our historical and current R&D spending is starting to pay off and is contributing to the recent contract award wins we have announced. As such, we continue to invest significantly in new technologies across our entire product line and expect R&D to approximate 10% of revenues in fiscal 2018.

Total stock-based compensation expense was $1 million for Q2 of fiscal 2018. Like Q4 of fiscal 2017, we do expect a multimillion dollar spike in stock-based compensation in our Q4 2018 based on our current plan and the timing of incentive awards.

Given the increase in our stock price, the type of awards that are currently outstanding and awards expected to be issued during the year, we believe that total amortization of stock-based compensation in fiscal 2018 will be higher by several million dollars than the $8.5 million recorded in fiscal 2017.

Amortization of intangibles was $5.3 million in Q2 of fiscal 2018. And we expect this run rate to remain the same for the next two quarters. On a GAAP basis, our consolidated operating income was $4.9 million or 3.7% of net sales in Q2 of fiscal 2018.

For the year, we're targeting to achieve operating income as a percentage of consolidated net sales of approximately 5%.

This range which includes the impact of amortization of intangibles compares favorably to 3.3% of consolidated net sales in fiscal 2017, excluding the $18.8 million of favorable adjustments of operating income that we recorded in fiscal 2017 and which are discussed more in our 10-K filing from last year.

We believe that adjusted EBITDA is an important metric, and in this regard our adjusted EBITDA was $14.5 million in Q2 of fiscal 2018 or 10.9% of consolidated net sales.

Adjusted EBITDA on our Commercial Solutions segment was $15.8 million or 18.4% of related net sales and our Government Solutions segment was $1.1 million or 2.4% of related net sales.

This quarter, our adjusted EBITDA on our Government Solutions segment was impacted by the lower level of sales contributions from our over-the-horizon microwave product lines as well as the absence of the $2.5 million of BFT IP license fees that we earned last year.

Given the strength, however, our backlog and expected performance, we expect a big pickup in adjusted EBITDA during the second half with a peak in Q4 in this segment. Let me now talk about our interest expense, taxes and our balance sheet.

Interest expense was $2.5 million in the second quarter and primarily reflects interest on our secured credit facility. Our total interest expense including the amortization of deferred financing cost is expected to reflect an effective rate of approximately 5.3% for the year. Our actual cash borrowing rate currently approximates 4%.

On the tax side, during Q2, we recorded a gain related to Tax Reform of $14 million or $0.59 per diluted share. The gain resulted from a re-measurement of our deferred tax assets and liabilities of the new tax rates.

Excluding discrete tax benefits, we currently expect our fiscal 2018 effective income tax rate to approximate 27.7% -- 27.75% as compared to our prior estimate of 34.5%.

Our fiscal rate in 2018 will only reflect seven months of benefit related to Tax Reform in fiscal 2019 before any discrete items and although we're still performing our assessment, we expect our effective tax rate to range from 24.5% to 26%. On the balance sheet side, at January 31, 2018 we had $40.5 million of cash and cash equivalents.

And in Q2, we generated cash flow from operating activities of $2.7 million. As of January 31, 2018, we had total debt excluding unamortized deferred financing cost of $198.3 million, our leverage ratio was 2.78 as compared to a maximum allowable of 3.35 EBITDA.

So we have pretty good balance sheet flexibility at the moment and given our fiscal 2018, we anticipate being in compliance with our credit facility for the foreseeable future. Looking forward for the rest of the year, we expect Q3 cash flow to be similar to Q2 with the large majority of fiscal 2018 operating cash flow recurring in Q4.

This is largely due to the timing of expected collections and timing of vendor payments. At the end of the day, it was a great quarter for Comtech, and it surpassed our original expectations.

On the bottom-line, GAAP diluted EPS was $0.60 -- $0.66 per diluted share, excluding the $0.59 tax gain, GAAP net income would have been approximately $1.8 million for the quarter or $0.07 per diluted share. Now let me give you some more color on our consolidated guidance.

We are increasing our revenue targets to a new range of $570 million to $585 million as compared to a prior range of $550 million to $575 million. Despite the absence of $6.7 million of BFT-1 intellectual property licensing fees, the midpoint of this range represents a year-over-year growth rate of close to 5%. We think that is pretty impressive.

In addition, we are increasing our adjusted EBITDA target to a new range of $72 million to $76 million as compared to our prior range of $69 million to $73 million. Again, despite the absence of the $6.7 million BFT-1 fee, the midpoint of our guidance represents a year-over-year growth rate close to 5%.

On a GAAP basis, we are increasing our GAAP diluted EPS target to a new range of $1.8 to $1.23, including the $0.59 net benefit from Tax Reform better than expected operating performance, some of which were offset by an anticipated increase in stock-based compensation.

From a timing sequence and consistent with our original business outlook for fiscal 2018, on a consolidated basis, our fourth quarter was expected to be the peak quarter by far for consolidated net sales, GAAP operating income, excluding the tax charge -- tax gain, and adjusted EBITDA.

Based on our backlog expected deliveries and product mix, we currently expect third quarter consolidated net sales and adjusted EBITDA to be sequentially higher than the second quarter of fiscal 2018 by approximately 10%.

We expect consolidated GAAP operating income and adjusted EBITDA as a percentage of consolidated third quarter net sales to approximate 4% and 11% respectively, with significant increases in each metric in the fourth quarter of fiscal 2018. Almost all of this is supported by our strong backlog position.

We expect GAAP EPS to approximate $0.10 to $0.12 in Q3 as compared to $0.07 per share we did in Q2 when adjusting for Tax Reform. Of course, Q4 will be significantly higher than the amount we report in Q3 on a tax Adjusted basis.

Finally, our Board of Directors declared a dividend for the third quarter of fiscal 2018 of $0.10 per common share payable on May 18, 2018 to shareholders of record at the close of business on April 18, 2018. Future dividends remain subject to Board approval as well as compliance with financial covenants under our senior secured credit facility.

Now let me turn it back to Fred, who will discuss our businesses in further detail.

Fred?.

The indoor H-Plus Remote Gateway; the H-Plus outdoor Remote Gateway, and the H-Pro outdoor Remote Gateway. Our H-Plus Remote Gateway products give our customers the flexibility to choose between hub and spoke VSAT connectivity, plus the option to run in true SCPC efficient mode.

Our products also allow service providers and end users to move the entire VSAT system outdoors mounted onto an antenna and out of the remote environmentally controlled shelters. This fiscal year, we've started marketing HEIGHTS to various U.S government customers.

We believe the U.S government total addressable market for these products is quite large. But for the moment, the government still continues to be very interested in continuing with our SCPC product line.

For example, we expect to receive in next -- in the quarter -- this quarter -- the third quarter of our fiscal year, a large multiyear contract from the Space and Naval Warfare Systems Command to procure our SLM-5650 satellite modems for a special SCPC application, using our protected communications waveform.

There are over 800 older generation modems currently utilized by the multiple Navy programs, which will be replaced by these new modems. As many of you know we have been also working on the ATIP, or Advanced Time Division Multiple Access, TDMA, Interface Processor Terminal Program for the Navy for many, many years.

Here during our second quarter, we received a multiyear follow-on contract for $19.1 million to continue work in this very important area. Another area we continue to be excited about is the IFEC market or the in-flight satellite based connectivity market.

Our solid-state power amplifiers enable commercial airlines to provide in-flight connectivity services to their passengers. Also during second quarter, we announced the receipt of two new orders totaling $10.7 million for our solid-state power amplifiers to be used in an airborne in-flight connectivity application.

We believe this product line will continue to contribute solid revenues for the company over the next few years.

We are also seeing continued demand for our satellite communications amplifiers and recently announced the expansion of our series of high-powered GaN solid-state power amplifiers to fill out the top frequency spectrum end of our industry-leading SSA -- SSPA product line.

Just last week we introduced our new compact highly efficient GaN-based Ku Band solid-state power amplifier. This amplifier packs a tremendous amount of power into a very small compact 48 pound or 22 kilogram antenna mounted outdoor unit.

We believe this is the lightest and most efficient 200 watt linear Ku Band SSPA available in the marketplace, with linear performance equal to or better than much more expensive larger and heavier competitor products.

Additionally, last week we announced the new breakthrough 250 watt V Band TWT amplifier for use with high throughput satellite gateway services. This product is targeted towards the V Band ecosystem which is expected to grow significantly in the future at this higher frequency spectrum.

Now let me turn to our Safety and Security Technology product line, where our solutions include 911 call routing for wireless, 911 routing for voice over Internet networks, and next generation 911 solutions for state and local public safety operations.

During the quarter, we announced we were awarded a large strategic multiyear contract valued at approximately $134 million to provide one of the largest wireless carriers in the U.S with enhanced E911 services, supporting both current 911 infrastructure and the next generation NG911 networks, which enable text messaging, image, data and video processing.

This was a major contract win for Comtech, which increased our market share significantly. Under this competitively awarded contract, this U.S wireless carrier is expected to migrate existing and planned new cell sites from a competitive solution to Comtech's more advanced secure and reliable 911 called routing technology.

As a result, more than 150 million U.S mobile cell phone users will benefit from a more reliable 911 call routing solution. We believe that the safety and security market will grow for many years ahead and that the current political environment will be helpful in facilitating this growth.

Turning to our Enterprise and Trusted Location Solution product line, here our solutions include GPS enabled software where we support products such as Verizon's Navigator Services and Text Messaging Solutions.

In the second quarter, this product line showed positive momentum with our location and mapping services being increasingly integrated into our new virtual platforms offerings. We have deployed virtual network functions and micro services into our seamless indoor and outdoor location messaging solutions.

We believe the importance of both location and messaging for the mobile network operator and large enterprise markets is increasing as exemplified by deployments of business models in machine to machine and industrial Internet of things applications.

We believe this market is also poised for growth with enterprise customers not only in the U.S., but also internationally. For example, in the second quarter, we received a $3.8 million of orders from a major Middle East service provider for a complete suite of our location-based services.

For fiscal year 2018, we are actually expecting international sales for these products to grow over 10%. At this point let me talk about the government markets and our Government Solutions segment where we serve large government end users that require mission critical technologies and systems.

Our Government Solutions are sold to the U.S Department of Defense agencies and international government agencies, and primarily consist of C4ISR applications or what we call command-and-control technologies.

Our solutions include satellite, line of sight, and tropospheric scatter ground terminals, management and sale of satellite bandwidth, information technology outsourced services, and RF power and switching technologies. Like our Commercial segment our Government Solutions segment is showing positive momentum.

During the second quarter, we received a 3-year $123.6 million contract from the U.S. Army to provide ongoing sustainment support services for the AN/TSC 198 SNAP terminals.

SNAP terminals provide quick and mobile satellite communications capability to personnel in the field and we will continue to be the sole provider in these sustainment support services for at least the next three years. Importantly, as previously announced, we were also awarded an $11.7 million contract to provide the U.S.

Army with several thousand of our next generation MT-2025 mobile satellite transceivers to support the Blue Force Tracking 2 or BFT-2 system. The BFT-2 system provides global real-time situational awareness and network capabilities for U.S war fighters and is the successor to the Blue Force Tracking BFT-1 system.

As you know, Comtech was the original developer of the BFT-1 system and we have continued to provide support for BFT-1 since its inception more than 15 years ago. In fiscal 2010, a lower-priced competitor was selected by the U.S. Army to develop next generation BFT-2 system.

Although we were disappointed in that decision and believe that our technology was superior, we work cooperatively with the U.S. Army and informed them that we would stand committed to assist them in any way possible. Today we're pleased that our efforts over the years have resulted in the U.S.

Army now selecting our MT-2025 transceiver to meet their immediate and future operational needs. The MT-2025 also known as the Blue Force Tracker 2 High-Capacity or BFT-2-HC satellite transceiver meets the original BFT-2 protocols, provides best-in-class reliability and is fully backward compatible with the BFT-1 system.

Initial shipments of the MT-2025 transceivers are expected to start during our fourth quarter. As you remember, we probably -- we previously shipped over 100,000 BFT-1 mobile satellite transceivers and believe that this current BFT-2 opportunity is likely at least that large or more.

Additionally, we're working on a more long-range successor program with the Army referred to as the BFT-3. In simple terms, we are excited after seven years finally to be back in the game. Another area we're excited about is on the cyber training front.

Since its inception, we have taught over 6,000 students and have over 300 classes with more than 4,000 graduates. We continue to see interest from the DoD and select National Intelligence Agency for our Cyber Training solutions. We’ve also started our plan to work with some blue-chip companies such as among others J.P.

Morgan Chase, Booz Allen Hamilton and various universities on various commercial training programs. Our pipeline of the Government segment opportunities is clearly growing.

We're working on many large multiyear solicitations, including the final RFP for the supply of tropospheric communications equipment, which will replace hundreds of the AN/TRC-170 troposcatter terminals in the DoD inventory. This multiyear opportunity we believe is literally going to be valued in the hundreds of millions of dollars.

As you know, we've been a supplier of over-the-horizon troposcatter systems to the U.S government agencies and to international customers for many, many years. We've a large worldwide installed base and our system can transmit video and other broadband voice and data applications at throughputs of over 50 megabits per second.

We are pleased that the final RFP has now been issued and believe it is a positive sign that the U.S government is moving ahead with this program. Although an award of the TRC-170 troposcatter program to us will not affect the 2000 -- fiscal 2018 revenues, we would expect to make significant contributions to revenues in subsequent years.

In the near-term, business activity in our over-the-horizon microwave systems product line is again starting to pick up. During the second quarter, we received multi-million dollar contract awards from two international customers and expect sales of this product line to significantly increase in the second half of fiscal 2018.

All in all, we came to see very positive signs and broad opportunities for future growth across all of our businesses. I believe that fiscal 2018 will be a strong year and given the opportunities we see ahead, I’m confident that 2019 could even be better. Now I'd like to proceed to the question-and-answer part of conference call.

Operator?.

Thank you. [Operator Instructions] And we will go first to the line of Tim Long from BMO. Please go ahead..

Good morning. This is Alex Spektor for Tim Long. A question on your international business. It's been fairly stable as a percent of revenue, but generally declining in absolute dollar terms. Fred, you just talked about some of that enterprise solutions gaining traction in the Middle East and two international customers for troposcatter.

As we think about the $570 million of backlog, is the international contribution showing a good trajectory there? Thank you..

Yes, I think we can say that the international business will start to accelerate much more. As I mentioned and as Mike mentioned, a part of the problem is always been the tropospheric scatter business is a lumpy business, and that's international business for the most part.

That has been in a kind of a downward trend for the last, let me say, 18 months or thereabouts. But I think as I mentioned, I think we see the trend now going up, again, we’ve received a couple of programs. These programs really have a long, long marketing cycle, and -- but there's lots in the pipeline.

And besides that, besides the international, obviously, we're now pursuing the government, the TRC-170 replacement..

Thank you..

Thank you. We will go next to the line of Mark Jordan from Noble. Please go ahead..

Good morning, gentlemen. First question is on the new BFT terminals that you are going to be producing. Noticed that the first award came through ADS, which is a logistics company servicing the Army. Was that down to expedite and not have to go through a formal RFP type of -- an award process.

And do you expect that vehicle to be used for successive purchases?.

The answer to the first part, Mark, yes, it was done for expedited purposes to get us on order. The second part of it, I think the Army does not intend to go that route in the future, if they can avoid it and go directly to us..

Okay. In terms of sizing this, you’ve mentioned that there's 100,000 terminals out there that could be upgraded.

And is it correct, if my memory serves, that those were -- your prior transceivers were about $2,500 a piece, is that a reasonable estimate in terms of value and over what timeframe do you think they might upgrade those 100,000 units out in the field?.

To the best of our information right now and discussions with the Army, they're looking to immediately field as fast as they can about 100,000 transceivers. The $2,500 price that you mentioned is roughly in the ballpark, I think, what we're talking about here.

And I think as far as the delivery cycle and the ordering cycle, it obviously depends upon the funding that they have and so forth. But we believe that they really are behind schedule on the fielding of the BFT-2 system. So we anticipate that to occur pretty rapidly.

As you can imagine, the first order that we've gotten, the Army is exactly being very careful again just to make sure that they get a good product. We believe this is a product we've had -- seven years ago, we had the product to have that solution, but seven years later we're finally getting there..

Okay.

The SNAP re-compete, what was the pricing on this current contract versus the prior one from a margin standpoint? And how linear should the revenues be on this award? And given the fact that, would you expect all the feelings to be consumed over the 3-year timeframe?.

I think we would rather not talk about the pricing obviously. But I think it is a 3-year program depending upon -- its really a support contract with sustainment services. So it really depends upon how many of these terminals are sent back by the Army to us for refurbishment and upgrading.

Not knowing exactly their schedule it's difficult, but it is three years and we're assuming a linear revenue stream..

Okay. Final question for me, with the large 911 contract of $100 million plus won, where you’ve displaced West. Given the fact that you’re picking up incremental volume, what impact does that have for your margins in that segment, given I think it's a hosted service.

So would this enhance the overall margins of that business in addition to just the revenue growth?.

I think the short answer is, yes. For that specific program there would be some margin pickup there..

Okay. Thank you..

Thank you. We will go next to the line of Stanley Kovler from Citi. Please go ahead..

Hi. Good morning. Thanks for taking the question. So, you talked about your government book-to-bill has been above 1 for the past four quarters. And when we look at the revenue, it's been flattish recently.

Can you help us understand the duration of the backlog that you’re building there to better assess how that will trend not just over the next two quarters, but perhaps some visibility over '19? I appreciate all the discussion about the orders and trends. Just wanted to get a little bit more color on those two items..

Sure. I think a very simple way to think about our backlog, it's kind of aligns with our percentage of sales. So, we’re seeing the Commercial segment being about 60 some odd percent of our sales, you could think about backlog being of that nature.

And certainly on the government side, the backlog number is less representative of the total contract value that we have in place and as I mentioned in the call, the $125 million SNAP program, there's virtually none in backlog and that’s really a 3-year program.

So when we think about visibility, I guess, to use that phrase, I think we’re gaining visibility in terms of let's say 9 to 12 to even maybe 18 months that we have pretty good visibility in terms of a base set of business.

There is that -- there's certainly the book to ship type business in our government business that does occur, but we’re starting to get pretty good visibility, I would say beyond 12 months in terms of a base set of business that we have..

Thanks. And when we look at the operating cash flow outlook for fiscal '18, how close will that be to where you wind up with your adjusted EBITDA outlook? And then, as you think about the cash you will generate in the second half of this year, and going into '19, in the past you adjusted your dividend now with a lower tax rate and better visibility.

How should we think about your dividend policy and use of cash there? Thanks..

In terms of the cash cycle and the total amount of cash, I would point you to 2017.

I think our operating cash flow on a free cash flow basis that we’re going to do in 2018 is going to be similar, maybe even slightly lower than 2017, that really is just a function of the waiting of the quarter in Q4, but it's going to be real close to 2017 is the way we’re thinking about total cash -- free cash flow and obviously that will come in 2019 in Q1 for whatever doesn't come in Q4.

So that’s how we’re thinking about it. I think from a strategic perspective, I think the dividend still is an important component of our capital deployment. At the same time, we want additional balance sheet flexibility and right now with our current facility, I think you'll see us reduce the revolver with no other changes in our capital structure.

And I don’t -- Fred, if you wanted to add any more comments to that?.

No, that’s fine..

Okay. Thanks. And if I can just squeeze in a follow-up on government side. I just wanted to understand sort of the margin profile of the BFT-2 business that you have, you were getting a license fee for number of years and so now this is going to transition to more of a product business.

I’m curious what impact that will have on your gross margin as we head into late this year, next year? Thanks a lot and good luck..

Sure. We’ve said it before this way, we were obviously optimistic, we were going to get some of the BFT-2 transceivers, which we're so pleased to have received. Last year when you look at the adjusted EBITDA margin on the Government segment, it was about 8% in total which included the BFT-2 -- a BFT-1, which do not include the BFT-1 IP fee in Q4.

So if you look at Q4 of last year, we did 8.7% without that. So if I could this way, I think that’s where we’re going to wind up being for the year in 2017, that’s sort of a good proxy of where we’re going to be and we want to get higher and total.

So, but we don’t want to give out specific margin statistics on the BFT-1, on the BFT-2 transceiver, but our hope is to get the segment to 9% to 10% adjusted EBITDA margin, relatively quickly and we will see where it goes from there.

But we are taking it in steps and right now we think 8.5% -- 8.7% or something like that is going to be the margin this year. Just like that was on Q4 last year, but we want to get higher..

Thanks a lot, and good luck guys..

Thank you. And we will go next to the line of Mike Latimore with Northland..

Yes, thanks. Congratulations, boy. Great to see the organic business and TCS assets come to fruition here. I guess on -- just on the PFT opportunity, you talked obviously about sort of upgrading a 100,000 units to BFT-2 is the opportunity. But then he also said, long range, you’re planning on BFT-3.

So it's a fact that they’ve upgraded sort of 100,000 to BFT-2 and then there's another 100,000 opportunity to go up the BFT-3, is that the way to think about the long-term?.

Yes, I think definitely I mean what we’re seeing now is finally after many, many years as I mentioned, our BFT-1 system is 15 years old. And so, still being used by the Army as the main system, because the BFT -- excuse me, the BFT-2 was never really, let me say, worked out. So BFT-2 will replace BFT-1, and BFT-3 will replace BFT-2.

Timing wise, I think we should be thinking in terms of BFT-3 being in the call that the 20 timeframe or 2021..

Got it. Okay, great. Thanks. Then on the -- you talked about this tropo opportunity with U.S government.

I think you described it as hundreds of millions of dollars, is that -- would that be the opportunity for a single vendor in terms of if you were to win that, that would be your opportunity or would that be an opportunity of which you get a segment of the business?.

Well, that's -- the numbers that I quoted was really our opportunity. And as far as the competition there are two parties bidding on this program and the outcome will be winner takes all..

Got it. Okay. Yes, great.

And then just last on the big sort of the new 911 deal that you announced this quarter, how long till that sort of fully implemented? And also can you just try little more clarity on sort of the reason to be -- sort of exclusive vendor here? It's kind of unusual to see sort of an exclusive vendor in this category, at least historically?.

I think, again, we can't speak for our customers. And as you know prior to this most of the carriers wanted two suppliers. We managed to convince this particular carrier that our product was superior and superior enough and the price was attractive enough that we can handle it to make them -- get more comfortable with a single supplier..

And Mike, we think that the transition is going to take at least 9 to 12 months, before that occur. So there will be some incremental revenue down the road. But it's going to take about 9 to 12 months for the migration to occur..

Okay, great. And then just last question. The tax rate, I know you’ve given sort of tax rate guidance here.

Is that the rate we should also use in the third and fourth quarter or what specific ratio would you use in the third and fourth quarter?.

Yes, it would be -- again, without any of these one-time type things that could occur, its 27.75% for Q3 and Q4, that’s right..

Okay, great. Thank you..

Thanks..

Thank you. And we will take our next question from the line of Kyle McNealy from Jefferies..

Hi. Good morning. Thanks for the question. A few items on backlog.

Is there an aged backlog number that you can give us for expectation over the 12 months that convert to revenue?.

The short answer is no. I think we have pretty good visibility out 9 to 12 months in both the commercial and the government segment is the way to think about it. There is some backlog that goes out to 2020, no doubt.

But it is the total contract value number that we will tell you to think about, because there's things again like the AT&T $96 million contract, not all of that is in our backlog number. The 125 SNAP is not in our backlog number.

So, from a visibility perspective, again I would say its 9 to 12 months, if not pushing beyond that is what we have in place, and then obviously we expect to record pretty solid bookings in Q3 and Q4, that will add to our visibility length, but I think the overall good news is the level and strength of our bookings here and our backlog is, we’re getting more visibility into the business perhaps than we've ever had before and that that's really a good thing to have..

Right. Great.

And is there a number you can give us for the backlog including unfunded?.

Yes, I think as I mentioned Alex (sic) [Kyle], we’re going to try to do that. Right now we just don’t have a good number to give you.

I mean, you could go o back and pull the press releases results and kind of do that, but we’re going to try to put some out there for folks and we thought it was a good number, but we’re just not ready to do that today..

Okay, great. Should we expect to see that -- I know TCS had disclosed the unfunded backlog in some of their Ks and Qs.

Do you intend to do that?.

We’re going to look at it. So, short answer is yes, we are looking at doing that..

Okay, great. And circling back to the BFT transceivers, I know there has been a lot of talk about it on the call, but just one last point.

Do you expect that, there's going to be a share on split for those new BFT-2 transceivers or do you expect to get a majority of those new orders?.

I think as far as the army is concerned, if our units perform, we will get the total share..

Okay, great. And one last question on gross margin. Can you talk a little bit about margin [ph] trajectory for the remainder of the year? I know that you mentioned I think the government solutions business transition towards -- away from lower margin revenue is, it's largely -- you’re largely past that transition.

Do you expect [technical difficulty] start to pickup in the back half of the year and I know it's still in a downward trajectory, but once we start to see the benefit from that transition in Government Solutions?.

We think it's going to happen in Q3. In total, our gross margin in Q2 was 38%, which was a decline in from the Q1 number of 39%. The way I would tell you think about is we'd like to get back to the Q1 number for the year in total on -- in average, so if we can hit the 39% in total, that would be great.

What is going to -- what is -- it’s not a challenge, it's sort of a good news, right. As the government segment business grows which is now recurring, those margins are lower than the commercial segment. So the good news is the total values may -- will increase, but it becomes a little bit more challenged to increase the percentage of revenue.

So I think our immediate goal is can we get the 40% in total, that would be a great thing for us to do. We are not one percentage point change from where we are today in our minds to where we need to be. So that, I think we'd like to take it in steps, let's get to 41st, but we think we're headed up..

Okay, great. Thanks. That’s it for me. Congrats on the quarter, guys..

Thank you. And we will take our last question from Glenn Mattson with Ladenburg Thalmann. Please go ahead..

Yes. Hi, guys. Most of my questions have been asked.

I’m just curious, obviously, you’re not giving anything remotely close to 2018 guidance, but just the cadence of the last couple of years with a very large Q4 number versus the prior three quarters, is that kind of how to expect to think about the business going forward given whatever information we have now is just that -- is that the natural cadence of the quarterly -- the way the quarters fall?.

Yes, I think -- I will answer the question in a little bit more broader sense. I think when you look at our year-over-year guidance, the growth rate that we’re seeing on revenue is a little under 5%. The way we see adjusted EBITDA is a little under 5%.

So when we are thinking about next year, with all of the puts and takes, I would say that's probably the right way to think about the years in total. Again, these large contracts that we have are difficult to predict. So even the BFT-2 opportunities that we see -- we are not expecting that in 2019 to come into that big lumpy kind of a thing.

It's just not the way we do our business planning. We'll take it if it comes, but we’re not thinking about it. So I think close to that 5% on the top and close to 5% on the bottom, again, could we get to 600 next year? I don’t know, that’s -- it's kind of tough to see given the difficulty of predicting these large contracts.

That all being said, if we can get close to 600 and close to that 5% growth rate, then I think, yes, it will be sequentially back end loaded in Q4 because that's just what we’ve seen in the last three or four years both in the Comtech legacy business and in the TCS business. So, we’re thinking about it in the same way.

And if we are able to level it out a little bit, that would be great. But from a pure modeling perspective and the way we do or plan our business, yes, we would expect Q1 and Q2 to be the lower quarters with a pop in Q3 and the big ramp up in 4%, just like we’ve done for the last several years..

Okay. Thanks. That’s helpful.

And then just being that the TCS acquisition is pretty well digested at this point and everything is working pretty well on the balance sheet as you know repaired, is the company -- how aggressively are you looking at other acquisitions or anything like that?.

I think the best way to answer that one is, we’re looking..

Okay. All right. Great. Thanks, guys and good luck..

Okay. Thanks..

At this time, I’d like to turn it back over to the company for any closing remarks..

Okay. Well, thanks very much for joining us today and we look forward to seeing you or speaking with you again in June. Thank you very much..

We would like to thank everybody for their participation on today’s conference call. Please feel free to disconnect your line at any time..