CPI International Q2 2008 Earnings Call Transcript

| About: CPI International, (CPII)

CPI International

Q2 2008 Earnings Call (CPII)

May 8, 2008 11.00 am ET


Joe Caldarelli - Chief Executive Officer and President

Joel Littman - Chief Financial Officer

Bob Fickett, - Chief Operating Officer


Michael Collin - Wachovia Securities

Chris Quilty - Raymond James


Good day everyone, and welcome to today's CPI International Second Quarter 2008 Financial Results Conference Call. My name is Christina, and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session toward the end of today's presentation. (Operator Instructions). Just as a reminder, today's conference is being recorded for replay purposes.

Before we begin, the Company has asked me to read the following statement; today's presentation includes forward-looking statements within the meaning of the Securities Exchange Act of 1934. Forward-looking statements provide the Company's current expectations, beliefs or forecasts of future events. Forward-looking statements are subject to known and unknown risks and uncertainties which could cause actual results to differ materially from the results projected, expected, or implied by forward-looking statements.

These factors include, without limitation; competition in the Company's end-market; the Company's debt levels; significant changes or reductions in the U.S. Defense budget; currency fluctuations; U.S. government contracts; laws and regulations; changes in technology; the impact of unexpected cost; and inability to obtain raw materials and components. Further information on these risk factors and additional risks and uncertainties are included in the Company's filings with the Securities and Exchange Commission. The computations of EBITDA, adjusted EBITDA, adjusted EBITDA margin, free cash flow, free cash flow per share, free cash flow conversions, and adjusted free cash flow that will be discussed on today's call are non-GAAP financial measures under Securities and Exchange Commission rules.

A presentation of the most directly comparable GAAP measures and reconciliation's of each of these non-GAAP financial measures to the most directly comparable GAAP measures are available in yesterday's press release, which has been posted on the Company's website. Interested parties can access the press release by going to www.CPII.com and opening the press release entitled CPI International Announces Second Quarter 2008 Financial Results.

At this time, I would like to turn the presentation over to your host for today's conference, Mr. Joe Caldarelli. The Chief Executive Officer of CPI International. Please go ahead.

Joe Caldarelli – Chief Executive Officer and President

Thank you Christina; good morning and welcome to CPI's second quarter 2008 call. Today's call will have the following agenda; first, I'll provide an overview of Q2 for each of our markets, including our sales and order results in those markets. Joel Littman, our CFO, will then discuss some of our key financial metrics for the quarter. Next, I'll talk about our expectations for the rest of the year. We'll then open up the call for your questions. Bob Fickett, our Chief Operating Officer will join us for the question-and-answer session at the end of the call.

Q2 was quite a good quarter for CPI. Our operations are running smoothly, and we are executing well on our current programs. In comparison to the year-ago quarter, we grew our sales, increased our net income and earnings per share, generated positive cash flow, and continued to pay down our debt. Taking a look at our Q2 sales, we recorded $94.8 million in sales, our highest quarterly sales level to date. Our Malibu division, which we acquired last August, and therefore, was not included in our year-ago results, contributed $3.9 million in sales to our totals this quarter. Approximately one-third of Malibu's Q2 sales were in the radar market, and approximately two-thirds were in the communications market.

Even if we exclude the Malibu division sales, Q2 of fiscal '08 still represented our highest quarter of organic sales. In comparison to Q2 of '07, the recent quarter sales increased 7%. Ops in the Malibu division sales, we grew sales by 3% for the period. On the order side of things, in the first six months of fiscal '08, our orders were $105.2 million, an increase of 1% compare to the year-ago period. In the first half of '08, the Malibu division contributed 11.6 million orders to CPI, again approximately one-third of which was in the radar market, and two-thirds of which were in the communications market.

At this time, I'd like to take a look at what is happening in each of our end markets. Within each market, I'll discuss our sales and orders for sales for the most recent period. Please note that we will discuss our sales on a quarterly basis, and our orders on a year-to-date basis. I'll start with our radar and our electronic warfare markets, which together we call our defense market. On our Q1 call, we indicated that we were experiencing a lengthening of order timelines in our defense markets. These delays have continued in Q2, and we are now projecting these delays to continue for the foreseeable future. We continue to see demand in the system for the expected products, and our customers continue to engage us in discussions about new orders for our radar and our electronic warfare products. They assure us that our products are still necessary for their systems, but customers appear to be taking longer to issue RFQs, place orders, and finalize orders. As you know, delays in order placements result in corresponding delays in the ensuing sales for those programs.

In Q2 our defense sales increased 12% to 45.5 million in comparison the prior year's quarter. There were two main factors that drove this sales increase; first, our radar product sales to support the HAWK missile system increased in Q2, and second, we are now including the Malibu division's radar sales in our defense segment. As you may remember from last quarter's call, our participation in the HAWK program is expected to be larger than normal this year, but several significant orders for this program had been delayed over the past several months.

In Q1, we had expected to receive a $3.9 million HAWK order and record subsequent sales of approximately $1 million during the quarter However, the order was delayed, pushing it out of Q1, which as you'll recall, contributed to our Q1 shortfall. Instead, we received the order in the first week of Q2, and we moved quickly during the quarter to provide our customers with the long-awaited product in a compressed timeframe. As a results, we shipped approximately $2.7 million in HAWK radar products in Q2. In April, again after the end of the quarter, we received another large order for radar products to support the HAWK system.

This order was valued at approximately $2 million, most from a different customer, but had also had been delayed and pushed out to the right. Shipments for this order have already started in Q3. In the first half of fiscal '08, our defense orders decreased 7% to $70.7 million in comparison to last year's period. The main factors in this decrease were the delays in the timing of orders, such as the ones I just mentioned, and a reduction in demand for radar products to support the ship board Aegis weapon system. We discussed this program on last quarter's call, so I won't go into too much detail here.

Let me just reconfirm that this decrease was not unanticipated, as we have now received all expected orders for our products to support the building of the remaining approved new ships for the Aegis weapon system. We have enjoyed high demand for products to support the system in the past several years to these new ship builds, as wells as spares and repairs, of course, and expect demand for our Aegis products to eventually increase again, as the new ships currently built will gradually join our installed base of existing ships, and will require spare and repair products from CPI.

It bears mentioning, however, that orders for spare and repair products to support the Aegis weapon system are among the group of defense orders that have been delayed in the first half of the year. Notwithstanding these order delays, the defense market continues to be a sizeable important market, and a solid performer for CPI. In the medical market, our sales were essentially unchanged at $17.1 million in Q2 and our orders were essentially unchanged at $36.7 million in the first six months of '08.

But that doesn't tell the whole story. The stability of our sales and order levels massed decreases in some unusual programs and growth in our core medical business. In 2006 and 2007, we participated in two annual increments of a Russian medical infrastructure program, for which we provided x-ray generators. We have discussed the Russian tender on previous calls, and I would like to remind you that we do not consider the program to be part of our core medical business. It is a periodic large program that took place in '06 and '07. Based on the information that we currently have, we now do not expect there to be an annual increment of this program in '08.

There may be other increments in future years, but as we have previously indicated, the planning of future increments is unpredictable. Last year, for the entire fiscal year, we booked orders and recorded sales of approximately $6 million Russian tender program, including $0.6 million of sales in Q2 and $1.4 million in orders in the first six months of the year. This year, our Q2 sales and our year-to-date orders included no products for this program. As you can tell from these statistics, the bulk of the shipments for the Russian program were made in Q3 and Q4 of fiscal '06 and '07; hence the challenging comps are still ahead of us.

In addition, one of our medical customers inadvertently double ordered MRI products from us last year. We shipped a significant portion of this customer's order in fiscal '07 before the oversight was realized. As a result orders and sales were unusually strong last year, at more than ($8) million each for the year. Our orders for MRI products consequently were approximately $2.2 million lower in the first six months of '08 than in the year-ago period, and our MRI sales in Q2 of '08 were approximately $0.4 million lower than a year ago.

As a result, sales in Q3 and Q4 of fiscal '08 are also expected to be lower than last year for this product line. In other words, our reported medical sales included a decrease of approximately $1 million in products from the Russian tender program, and for MRI applications.

Our reported medical orders for the first half of the year included a decrease of $2.6 million in products attributable to the Russian tender program and MRI applications. However, sales in our core medical business, excluding these two unusual items, therefore grew by approximately $1.1million, or 6% primarily driven by growth in sales of x-ray generators to our other international customers.

The $3.6 million decrease in medical orders from the Russian tender and MRI applications was offset by growth in orders for x-ray generators for other international customers, and in orders for products for radiation therapy applications. One of our large medical customers typically places a significant annual order for radiation therapy products in the second quarter of each year. That order came in as expected in Q2 of '08, and I am delighted to report that our radiation therapy business remains strong.

In general, our medical business is healthy and stable. It is worth noting, however, that a subset of our medical customers, specifically some of our U.S. customers for x-ray generators, appears to be becoming concerned about some market challenges that they may be facing and may be holding back on upgrade or expansion plans.

First, as you all know, the U.S. credit markets have tightened over the past year, which makes it more difficult for privately-owned, independent clinics and small community hospitals to arrange the financing required to upgrade or enhance their diagnostic imaging practices.

Second, the Deficit Reduction Act of 2005, or the DRA, which was intended to reduce Medicaid and Medicare spending is being phased in. The DRA includes provisions, which, if fully implemented, will result in reductions to the reimbursement that these clinics will receive for certain services.

As a result, some of these U.S. customers have become more cautious about their own outlook, and as a result of that caution, we are beginning to see some softening in demand for our products destined to these customers.

Year-to-date, our sales for x-ray generators from some of our U.S. customers were down approximately $0.7 million from the $4.2 million in sales that were made to those same customers in the first half of fiscal '07. This is a relatively small subset of our medical business. We do not expect our core medical business to shrink over the long term as a result of these factors, but our short-term growth rate in the medical market may be impacted somewhat. In the communications market, sales and orders each increased 2%. Our Q2 communications sales totaled $27.6 million, and our year-to-date communication orders totaled $55.9 million. The inclusion of the Malibu division sales and orders result in fiscal '08 was a contributor to our communication sales and order increases.

We are now moving into full production mode for Increment One of the Army's WIN-T communications program. . WIN-T is a very large and very important program for CPI, and it could bring us up to $50 million in sales over a four-year period. Last fall, as we were designated as the sole supplier of Ku-Band satellite communication amplifiers for this program, which was a significant win for us and helped, establish us as a key player in the military communications industry. This program is progressing very smoothly. In the first six months of '08, we received approximately $3 million in orders for the program. These were our first production orders. Our products and the system have now been fully qualified. In Q2, we made our first production sales for WIN-T, shipping approximately $1.7million. In the corresponding period of fiscal '07, we had not yet been awarded the WIN-T program; however, we did participate in its predecessor program, which was called JNN. JNN was also a significant program for us last year, but it has now been completed.

In other words, our '07 results included JNN, but not WIN-T, while our '08 results include WIN-T but not JNN six months of '08, we received approximately $3 million in orders for WIN-T, while our orders for the predecessor program decreased $3.1 million in comparison to the '07 period. In the most recent quarter, we shipped 1.7 million in products for WIN- T; in the year-ago quarter, we shipped an equal amount for JNN. So, so far these programs have largely balanced. The WIN-T program is continuing to ramp up, however, and in aggregate, it is expected to give much greater opportunity for CPI that its predecessor program. In fact, we've recently received approximately $8.5 million in follow-on orders for WIN-T from our customer. Products from these follow-on orders will be shipped over a period of approximately three quarters.

Our sales for satellite communication products for certain foreign broadcast network applications and other military communication programs also increased during Q2. To date, we have not seen any indications that the weakening economy is having any impact on the communications market. In summary, our Q2 sales were our highest quarterly sales in CPI's history. Our recent sales benefited from increased activity in programs such as HAWK, WIN-T, x-ray imaging applications for international customers, various international, various industrial applications, and large scientific programs, programs such as the ship builds for Aegis, the Russian medical tender, and the JNN military communications program have now been completed, resulting in decreased activity in these programs in the most recent periods. We are continuing to see delays in order placements and ensuing sales in our defense markets.

And lastly, some of our U.S. medical customers appear to be facing a challenging environment, leading to a decrease in, or postponement of big demand for our x-ray generator products. However, in the long term, we do expect our core medical business to continue to grow. We'll discuss (inaudible) to our expectation for the second half of the year later in this morning's call.

this point, I'd like to turn the call over the Joel for discussion of some of our financial highlights for Q2.

Joel A. Littman – Chief Financial Officer

Thanks, Joe. This morning, my discussion of CPI's second quarter of fiscal 2008 results will focus on several of our key financial metrics, including EBITDA, adjusted EBITDA, net income, cash and cash flow. In addition, this quarter we are introducing two new cash flow metrics; cash flow per share and cash flow conversion. You can find definitions and reconciliations for our non-GAAP metrics in the financial tables at the back of yesterday's press release.

In the second quarter of fiscal 2008, CPI generated EBITDA of $15.8 million, or approximately 17% of sales. This is a slight decrease from the $16.3 million, or approximately 18% of sales generated in the same quarter of fiscal 2007. This decrease is primarily the result of an increase in the number of development programs we had underway during the most recent quarter. As you know, development programs typically have lower margins than manufacturing programs, and our increased development activity resulted in higher Company-funded research and development expenses and increased revenue from lower margin customer-funded development programs. These factors lowered our EBITDA by $1.4 million in the most recent quarter, as compared to the second quarter of the previous year. Partially offsetting this decrease our EBITDA was positively impacted by the additional gross profit generated by our increased sales during the quarter. Our adjusted EBITDA differed from EBITDA in the most recent quarter by excluding approximately 600,000 in non-cash stock-based compensation expenses, and approximately 400,000 in non-recurring expenses related to debt extinguishment. We generated 16.8 million in a adjusted EBITDA during the second quarter of fiscal 2008, essentially unchanged from the $16.6 million in adjusted EBITDA generated in the same quarter of the previous year.

In the second quarter of fiscal 2008, our net income totaled $6.2 million, or $0.35 per share on a diluted basis, an increase from the $5.8 million, or $0.32 per share on a diluted basis generated in generated in the same quarter of last year, and significantly higher than our guidance for the quarter. In comparison to the second quarter of fiscal 2007, our net income in the most recent quarter was positively impacted by the additional gross profit generated by the increase in our sales, as well as lower interest expense attributable to our successful debt refinancing last August. In addition, our effective tax rate in the second quarter of fiscal 2008 included a discreet tax benefit of approximately 400,000 related to foreign tax filing for fiscal 2007, resulting in a lower effective tax rate of approximately 26% in the quarter as compared to 35% in the year ago quarter.

Next I will discuss the changes in our cash and cash flow in the past 12 months. This is an important metric for CPI, and one that we watch very closely as we manage our business. Our cash position as of the end of the second quarter was 20.2 million, approximately equal to the 20.5 million we had as of the end of fiscal 2007. During the current six month period, we generated cash flow from operating activities of 10.4 million, and used this to redeem 6 million in principal amount of our floating rate senior notes, and to repay $# million of our senior term loan.

In addition, in April after the quarter ended, we made an additional optional pre-payment of 2 million on our senior term loan. In aggregate, we have repaid 12 million of our debt in fiscal 2008 to-date. Debt repayment continues to be a high priority for us. For the 12 month period ended in March 2008, we generated 20.3 million in free cash flow. On a diluted basis, our free cash flow for this period equates to $1.14 per share.

Our net income for the same period totaled $19.6 million. In other words, our free cash flow was higher than our net income for this period. As a result, our free cash flow conversion, which is the ratio of free cash flow to net income, was 104 %. Our adjusted free cash flow for the same period equaled 22.1 million, meeting our expectations for adjusted free cash flow of 20 million to 24 million in fiscal 2008.

In summary, we continue to generate solid cash flow, and to use it to reduce our debt. Now I'd like to turn the call back over to Joe to discuss our updated guidance and our expectations for the rest of the year. Joe?

Joe Caldarelli – Chief Executive Officer and President

As we have indicated in our comments today and in yesterday's press release, we had a solid second quarter. However, the balance of fiscal '08 may turn out to be somewhat more challenging then we previously anticipated. We continue to pursue additional opportunities in development programs. We are confident that this is the right approach for the long-term growth of our business, but it will result in short-term financial pressures, such as increased costs and lower margins, which will impact our results from the second half of the year.

We expect our current development programs to produce profitable products and increase CPI's growth potential across our markets and businesses. In addition, although we had hoped to tell you otherwise today, we are continuing to experience delays in the placement of certain defense orders. In Q1, defense orders starting shifting off to the right. In Q2, that shift continued, and we currently do not see the situation changing in the second half of the year. As a result, our sales for these programs are shifting to the right as well. This is expected to negatively impact our sales and profit margins in the second half of the year.

In the medical market, which I've said before has been our fastest growing market, our short-terms growth rate is somewhat dampened by the challenges facing our U.S. customers, namely the DRA and the tight credit markets. If our U.S. medical customers continue to be reimbursed on lower levels, have difficulty gaining access to timely and affordable funding necessary to upgrade the expansion, demand for our products, for our x-ray products, could be softer in the back half of the year.

However, notwithstanding the intermittent nature of the Russian tender program, and this potential softening of our U.S x-ray business, we are continuing to see growth in our core medical business, as our radiation therapy and international x-ray business continues to thrive. Furthermore, the continued weakness of the U.S. dollar is an ongoing challenge for us. We have hedged approximately 70% of our estimated Canadian dollar expenses for the rest of the fiscal year, and we continue to implement cost savings initiatives, including some headcount reduction and offshoring, but we are unable to offset all of the increased costs associated with the unfavorable exchange rate.

We will persevere in our efficiency and cost-saving initiatives and their beneficial impact to our business will continue to grow, but it will take time. We are maintaining our expectation of an average effective exchange rate, including hedging, of US$0.98, CAN$1.00, in the last six months of the year.

Therefore, as a result of the combined impact of these various factors, we are updating our guidance for fiscal 2008. We are now projecting total sales of between $365 million and $375 million; net income of between 20.3 million and 22.1 million, or $1.15 to $1.25 per share on a diluted basis. Adjusted EBITDA of between 64.5 million and 67 million; and we are maintaining our previous guidance for adjusted free cash flow of between 20 million and 24 million. We currently expect that our fourth quarter financial results will be the strongest of looking out at the second half of the year and beyond, we continue to be optimistic about our business. Operationally, we are performing and executing well on the business that has come in. Demand for our types of defense products continues to be delayed, but we have not lost overall market share to competitors or been replaced on any significant programs.

Despite the periodic timing of the Russian tender program and the challenges facing some of our U.S. medical customers, our core medical business continues to grow in the areas of radiation therapy and international demand for x-ray generators. Our communications business is growing and gaining traction in military communications applications, and with foreign broadcast customers.

Although a small part of our total business, our industrial and scientific businesses are withstanding the weak U.S. economy, and in fact have grown somewhat. Additionally, we remain highly profitable as a Company. We are converting our net income to free cash flow at an excellent rate, and are therefore continuing to generate significant positive cash flow. As evidence of this, in fiscal '08 to date, we have already paid down our debt by another 12 million.

I'd like to thank you for your time and attention this morning. At this time, Christina, let's open up the call for questions.

Question-and-Answer Session


Thank you. (Operator Instructions). And our first question will come from Michael Collin with Wachovia Securities.

Michael Collin

Hi good morning. Can you guys provide us with an update on the active denial system work that you spoke about a few months back? I just want to see where you stood.

Joe Caldarelli

It continues to follow the path we described a few months back, which is that our customer hopes to get some orders later this fiscal year, and there is still expectation of significant business in the 2010 to 2012 timeframe as we pointed out before. So it continues to be on track; we haven't seen any additional tangible movement recently, but there is still the indication that it should happen some time later this year.

Michael Collin

And regarding R&D do you look at a greater than 3% of sales as a more appropriate run rate going forward of your R&D spend?

Joe Caldarelli

We will probably running at a somewhat higher than expected rate long term, Mike. I don't think we will need to run quite at this rate in the long term, but I would expect us to run at a rate higher than we have historically, which as you know has been extremely low. So certainly with respect to customer-funded R&D, we will take all we can get. With respect to Company-funded R&D, I think we indicated some time ago that we expected numerically that number to get upwards the $10 million range, and I think that's still a good number for us -- per year.

Michael Collin

Great thank you.


(Operator Instructions) And our next question will come from Chris Quilty with Raymond James.

Chris Quilty

Thanks gentlemen a follow up on that R&D question. Can you just give us a sense of where exactly you're spending the money, both in terms of major programs, as well as how that money is being spent either on engineering activities or whether you're actually doing core hardware work?

Joe Caldarelli

Yeah the company funded R&D is generally focused on our commercial businesses which would be the communications and medical businesses, and there much of the effort is to continue to advance the product lines that we sell into next-generation products, more features, more performance and so on. So that's really just a product line maintenance and expansion, which includes, in some cases, some reasonably revolutionary new ideas.

Our defense business has consumed relatively modest amounts of in-house R&D, and the in-house R&D that we do spend in those areas tends to be used more to do sort of fundamental development of new circuits, new ideas, new concepts. But then we generally are able to get money from external sources to develop further into specific product applications. So the externally-funded R&D is primarily aimed at the defense side of things, or government applications I should say; in some cases, of course, it's for scientific-type applications. And ultimately all of that work that goes on with the externally-funded R&D we generally look for opportunities to fold the ideas back into the broader product lines. I think as we've indicated before, we don't sell our R&D for its own sake; we only accept customer-funded R&D if it allows us to do things that we think will generally be beneficial to us in developing new products, and therefore new business in the long run.

Chris Quilty

Okay, and I don't want you to give away any trade secrets here, but in terms of some of the future development work, I mean clearly you've done in the last several years a lot of development work on Ka-Band; is there another major trend out there beyond Ka-Band that we should be thinking about in terms of longer term opportunity?

Joe Caldarelli

Well, Ka-Band itself is still relatively imbionic, so there should be a good deal of work going on in Ka-Band for different power levels, and so on. In our solid state product amplifier areas, we are developing solid state products now to handle a variety of frequencies. We just recently at a trade show introduced what's called high-power block up converter, high-power block, which is a new product for CPI and which we think is very attractive to the market. That was entirely developed in-house with our money. And that was at Ku-Band, and we expect in the future to be able to offer a wider variety of Ka-Band products, both solid state as well as the VED-based ones. Some of the other work that's going on, I'll ask Bob Fickett maybe to describe those because he knows better which ones we're allowed to talk about or not. So Bob, maybe you can describe some of the work you're dong down there.

Bob Fickett

Well, in a couple of different areas, first just want to mention the Malibu area, that we are on several different development programs with TCDL where we do, we have real great technology on our advanced antennas, so in several different programs with new customers there, and making very good gains at trying to move into production areas. On the control components, which is being done out of our Beverly division, there's actually -- we're making great gains, as we mentioned, over the last couple of years. That was a new area that we were trying to make strides in, and we've received and qualified and have been qualified on a couple significant programs recently. So that's another area of good gains for us. In the VED area, there are some areas what we are hoping are leapfrog technologies that were sort of, we're still in the midst of approving grounds with such as sheeting technology, which it's still early but again, depend and some investment is going there, mainly customer-funded. But assuming we get the results that we're hoping to get, these could be very good for us, and there's several other areas, but these are just a few of them.

Chris Quilty

Presumably, no animals are hurt in the shipping process right?

Bob Fickett

It's sheet -- s-h-e-e-t.

Chris Quilty

Okay thank you. On the medical side of the business, are there any opportunities in terms of competitive retaking market share or going out into new product areas, or forward integrating into a larger component role with those customers?

Joe Caldarelli

We're currently the largest player in the segment that we're in, and so for us to take additional market share from competitors is challenging; however, what we have been doing is growing the size of addressable markets by going to different parts of the world, so one of the more attractive areas for us today, for example, is China, and we actually have a sheet-guide person residing in China handling medical for us because it's a great opportunity. So I think it's more of a market expansion there than it is taking market share. But I guess in a way, it's for competitors, because in the past they would do it internally, and now some of the products are being built by us as well as our competitors. Yes, we are looking at ways to provide more content to our customers. These are electronic products, and the way we do that is to try and take over some of the functionality that traditionally our customers have done themselves. So over time, we have been providing an increasing portion of the electronics that goes into a typical x-ray room, and that will continue going forward in the future. So those are the ways, I guess, that we will grow that part of the business.

In the area of the radiation therapy business, we will largely grow with our customers in that area, so as our customers do, so will we basically.

Chris Quilty

Okay, and shifting gears back to defense part of the business, this is just a very general generic question; is your sense that the delays you've encountered are in any way related to the delays that Congress is having in both passing the baseline budget and/or the supplementals? And the second part of the question is do you have a sense of how much of your exposure lays in the two budgets, and thing that are getting pushed out?

Joe Caldarelli

We don't think we have a lot of exposure to the budgets because our products will ultimately be needed, but I do believe that as the budgeting process drags on, it creates an environment with the agencies where it's difficult for them to be aggressive about placing orders. So we've said in the past that we can't point to a specific trigger mechanism as to what's causing the delays, but I think in aggregate, if you look at the fact that there clearly is some de-emphasis of our presence in the Middle East, there is some tightness in the budget, there are some delays in budget approvals. You put all that together and I think that translates to the people at the agencies clearly, directly or indirectly, had reason to drag their heels a bit. So I think in aggregate, all those things are contributing to the delays. Again, we've seen no indication of a reduced demand for our products other than the fact, of course, that we're in a less active mode than we were three years ago, so clearly, consumption of some of the products that get worn out in a more active mode, in the Middle East that consumption has slowed down. But that' s been the case now for quite a while, of course we haven't seen any further reduction, but there is still probably opportunity at the agency for them to take down their spares quantity somewhat without hurting the service overall.

Chris Quilty

And final question; I think I've asked this one before but just humor me. On the Ka-Band side, most of your work there with WIN-T, military oriented, are you looking at any of the proposed commercial activity that's starting to happen in Ka-Band?

Joe Caldarelli

Yes, just to be clear, on WIN-T, we're in the Ku-Band portion; on the Ka-Band portion. And yes, all of our Ka-Band work is in fact -- most of our Ka-Band work has been actually on the commercial side, and we have participated in all of the key programs that have used it so far in significant quantity, and we think we're well positioned with many of the opportunities that are being discussed going forward. So yes, we do believe that we, and our competitors, will see continued solid activity in Ka-Band going forward. Having said that, just to be clear, we do expect that business to be lumpy because most of the opportunities that are being discussed tend to be relatively discreet, and so you'll see significant sized lumps that will come along followed by some weight in between until the next lump comes along. So just so we're clear on that.

Chris Quilty

Okay, and do you do any space-qualified hardware?

Joe Caldarelli

Very, very small amount, so we do some -- very small amount. And not for the communications type satellites; we do it for scientific and sort of unique applications.

Chris Quilty

Okay great. Thank you, gentlemen.

Joe Caldarelli

Thank you.


(Operator’s Instruction) And at this time, there appear to be no further questions in the queue.

Joe Caldarelli

All right, well thank you very much folks for joining in, and we'll talk to you all next quarter. Thank you.


That does conclude our teleconference for today. We'd like to thank everyone for your participation and have a wonderful day.

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