Securities and exchange commission


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NameSecurities and exchange commission
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(3) Inventories
Inventories consist of the following at July 31, 1999 and 1998:
1999 1998

---------- ----------
Raw materials and components $3,553,000 3,365,000

Work-in-process 5,798,000 4,932,000

---------- ----------

9,351,000 8,297,000

Less:

Progress payments 302,000 1,333,000

Reserve for anticipated losses on

contracts and inventory reserves 1,170,000 829,000

---------- ----------
Inventories, net $7,879,000 6,135,000

========== ==========
(4) Property, Plant and Equipment
Property, plant and equipment consists of the following at July 31, 1999

and 1998:

1999 1998

----------- -----------

Equipment $ 9,574,000 8,918,000

Leasehold improvements 427,000 352,000

Facilities financed by capital lease 3,365,000 3,365,000

Equipment financed by capital lease 4,219,000 3,802,000

----------- -----------

17,585,000 16,437,000
Less accumulated depreciation and amortization 13,275,000 12,123,000

----------- -----------
$ 4,310,000 4,314,000

=========== ===========
Depreciation and amortization expense on property, plant and equipment

amounted to approximately $1,152,000, $1,103,000 and $994,000 for

the years ended July 31, 1999, 1998 and 1997, respectively.

F-11
(5) Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following at

July 31, 1999 and 1998:
1999 1998

---------- ----------

Customer advances and deposits $2,798,000 652,000

Accrued wages and benefits 1,603,000 1,068,000

Accrued commissions 915,000 452,000

Other 710,000 608,000

---------- ----------
$6,026,000 2,780,000

========== ==========
(6) Short-Term Borrowings
In December 1998, the Company obtained an $8,000,000 secured credit

facility from Republic National Bank of New York. The line of credit

which is to be used for working capital requirements is for a term

of one year and bears interest on borrowings at 90 day LIBOR plus

1.50%. There were no borrowings outstanding at July 31, 1999.
(7) Long-Term Debt
Long-term debt consists of the following at July 31, 1999 and 1998:
1999 1998

---------- ----------
Obligations under capital leases $1,564,000 2,249,000

Less current installments 605,000 804,000

---------- ----------
$ 959,000 1,445,000

========== ==========
The obligations under capital leases relate to the Melville, New York

facilities, as well as certain equipment, the net carrying value of

which was $2,087,000 and $2,517,000 at July 31, 1999 and 1998,

respectively.
Future minimum lease payments under capital leases as of July 31, 1999

are:
Years ending July 31,:

2000 $ 725,000

2001 563,000

2002 315,000

2003 137,000

2004 51,000

----------
Total minimum lease payments 1,791,000
Less amounts representing interest

(at rates varying from 6.8% to 10.8%) 227,000

----------

1,564,000

Less current installments 605,000

----------
Obligations under capital leases, net

of current installments $ 959,000

==========

F-12
In December 1991, the Company and a partnership controlled by the

Company's Chairman, Chief Executive Officer and President entered

into an agreement in which the Company leases from the partnership

its corporate headquarters and Melville production facility. The

lease is for a ten-year period and provides for annual rentals of

approximately $448,000 for fiscal 1999, subject to annual

adjustments equal to the lesser of 5% or the change in the Consumer

Price Index. For financial reporting purposes, the Company has

capitalized this lease at inception in the amount of $2,450,000, net

of deferred interest of $1,345,000. The outstanding balance at July

31, 1999 and 1998 approximated $817,000 and $1,105,000,

respectively.
(8) Income Taxes
The provision (benefit) for income taxes on continuing operations

included in the accompanying consolidated statements of operations

consists of the following:
Year ended July 31,

-------------------

1999 1998 1997

----------- ----------- -----------

Federal -current $ 60,000 45,000 20,000

Federal -deferred (3,949,000) -- --
State and local - current 135,000 135,000 34,000

----------- ----------- -----------

$(3,754,000) 180,000 54,000

=========== =========== ===========
The provision (benefit) for income taxes on income from continuing

operations was ($3,754,000), $180,000 and $54,000 for fiscal 1999,

1998 and 1997, respectively and differed from the amounts computed

by applying the U.S. Federal income tax rate of 34% as a result of

the following:

1999 1998 1997

---- ---- ----

Amount Rate Amount Rate Amount Rate

------ ---- ------ ---- ------ ----
Computed "expected" tax

expense $ 927,000 34.0% 437,000 34.0% 183,000 34.0%

Increase (reduction) in income

taxes resulting from:

Change in the beginning

of the year valuation

allowance for deferred

tax assets (4,544,000) (166.6) (93,000) (7.2) 264,000 49.6

Utilization of tax benefit

carryforward (223,000) (8.2) (299,000) (23.3) (430,000) (79.9)

State and local income tax,

net of Federal benefit 86,000 3.2 135,000 10.5 34,000 6.3

Other -- -- -- -- 3,000 --

----------- ------ ------- ---- ------ ----
Effective tax rate $(3,754,000) (137.6)% 180,000 14.0% 54,000 10.0%

=========== ====== ======= ==== ====== ====
As of July 31, 1999, the Company has net operating loss carryforwards

of approximately $10,260,000 for income tax purposes of which

$4,843,000 expires in 2004, $1,473,000 expires in 2005, $415,000

expires in 2009 and $3,529,000 expire in 2010 through 2012.

F-13
The tax effects of temporary differences that give rise to significant

portions of the deferred tax assets and liabilities at July 31, 1999

and 1998 are presented below.

1999 1998

---- ----
Deferred tax assets:

Allowance for doubtful accounts receivable $ 60,000 60,000

Inventory reserve 646,000 496,000

Plant and equipment, principally due to capitalized

leases and differences in depreciation (16,000) 27,000

Compensated absences, principally due to accrual

for financial reporting purposes 395,000 331,000

Deferred compensation 250,000 154,000

Net operating loss carryforwards 3,490,000 3,726,000

Investment tax credit carryforwards 440,000 440,000

Alternative minimum tax credit carryforwards 87,000 87,000

----------- -----------

Total gross deferred tax assets 5,352,000 5,321,000

Less valuation allowance (777,000) (5,321,000)

----------- -----------
Net deferred tax assets $ 4,575,000 --

=========== ===========
The Company provides for income taxes under the provisions of SFAS No.

109, "Accounting for Income Taxes". SFAS 109 requires an asset and

liability based approach in accounting for income taxes. In

assessing the realizability of deferred tax assets and liabilities,

management considers whether it is more likely than not that some

portion or all of them will not be realized. At July 31, 1998 the

Company had a 100% valuation allowance against these gross deferred

tax assets. During fiscal 1999, the Company concluded that a full

valuation allowance was no longer necessary given its estimates of

future earnings, which include substantial long-term contracts

entered into in the first and fourth quarters of fiscal 1999 and the

expected timing of temporary difference reversals. Accordingly, the

Company reduced the valuation allowance to $777,000 during fiscal

1999 and recorded deferred tax assets of $4,575,000 of which

$3,155,000 was recorded in the fourth quarter. The Company must

generate approximately $13,500,000 of taxable income to fully

utilize its deferred tax assets. Management believes it is more

likely than not that the results of future operations will generate

sufficient taxable income to realize the net deferred tax assets.
(9) Stockholders' Equity
(a) Option and Warrant Plans and Agreements
The Company has several option and warrant plans and agreements as

follows:
1982 Incentive Stock Option Plan - The 1982 Incentive Stock Option and

Appreciation Plan provided for the granting to key employees and

officers of incentive stock options to purchase up to 240,000 shares

of the Company's common stock through September 29, 1992 at prices

not less than the fair market value of such shares on the date the

option is granted. The plan expired on September 29, 1992. Options

granted to purchase an aggregate of 16,350 shares remain

outstanding.
1993 Incentive Stock Option Plan - The 1993 Incentive Stock Option Plan,

as amended, provides for the granting to key employees and officers

of incentive and non-qualified stock options to purchase up to

1,042,500 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, the exercise price cannot be less than 110% of the

fair market value. In addition, it provides formula grants to

non-employee members of the Board of Directors. The term of the

options may 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 may be no more than five years. The plan expires in

2002, unless terminated earlier by the Board of Directors under

conditions specified in the plan. As of July 31, 1999, the Company

had granted incentive stock options representing the right to

purchase an aggregate of 1,029,015 shares at prices ranging between

$1.50 - $7.50 per share, of which 69,600 options were canceled and

888,045 are outstanding at July 31, 1999. To date, 71,370 shares

have been exercised.

F-14
Warrant Issued Pursuant to Acquisition of CMDC - As part of the asset

purchase agreement for the acquisition of Mobile Datacom Corp. (see

Note 12), which was incorporated into the Company as a wholly-owned

subsidiary, Comtech Mobile Datacom Corp., the Company issued

warrants to the owners and creditors to purchase 150,000 shares of

the Company's common stock at an exercise price of $6.57. The

warrants, which contain transferability restrictions, are

exercisable for a period of five years commencing September 24,

1998, and shares purchased through the exercise of these warrants

contain voting restrictions. Due to the transferability and voting

restrictions and other conditions, no value was ascribed to these

warrants for purposes of determining the cost of the acquisition.
(b) Option Activity
The following table sets forth summarized information concerning the

Company's stock options:
Number Weighted

of average exercise

shares price

------ -----
Outstanding at July 31, 1996 363,870 $ 2.42

Granted 43,500 2.16

Expired/canceled (21,810) 2.85

Exercised (64,590) 1.65

--------
Outstanding at July 31, 1997 320,970 2.55

Granted 583,125 2.99

Expired/canceled (13,500) 2.13

Exercised (32,400) 2.00

--------
Outstanding at July 31, 1998 858,195 2.65

Granted 140,250 6.08

Expired/canceled (5,688) 5.90

Exercised (88,362) 2.43

-------- --------

Outstanding at July 31, 1999 904,395 $ 3.40

======== ========
Options exercisable at

July 31, 1999 367,437 $ 2.93
Options available for

grant at July 31, 1999 83,085
The options outstanding as of July 31, 1999 are summarized in ranges as

follows:
Weighted Number of Weighted

Range of average options average

exercise price exercise price outstanding remaining life

-------------- -------------- ----------- --------------
$ 1.50 - 2.50 $ 2.08 123,870 6 years

2.51 - 4.99 3.09 663,525 8 years

5.00 - 7.50 6.55 117,000 7 years

F-15
(c) Stock-Based Compensation Plans
The Company has two stock option plans, the 1982 Incentive Stock Option

and Appreciation Plan and the 1993 Incentive Stock Option Plan. The

Company accounts for these plans under APB Opinion No. 25, under

which no compensation cost has been recognized. Had compensation

cost for these plans been determined consistent with SFAS No. 123,

the Company's net income and income per share would have been

reduced to the following pro forma amounts:
1999 1998 1997

----------- ----------- -----------

Net income As reported $ 5,255,000 1,104,000 484,000

Pro forma $ 4,836,000 817,000 475,000
Net income

per share As reported Basic $ 1.27 0.28 0.13

Diluted $ 1.15 0.27 0.12
Pro forma Basic $ 1.17 0.21 0.12

Diluted $ 1.06 0.19 0.12
The full impact of calculating compensation cost for stock options under

SFAS No. 123 is not reflected in the pro forma net income and net

income per share amounts presented above because compensation cost

is reflected over the option's vesting period and compensation cost

for options granted prior to August 1, 1995 was not considered.
The per share weighted-average fair value of stock options granted

during 1999 and 1998 was $3.19 and $2.30, respectively, on the date

of grant using the Black Scholes option-pricing model with the

following weighted-average assumptions:
1999 - expected dividend yield of 0%, risk-free interest rate of 5.86%,

expected volatility of 69.5% and an expected option life of 10

years.
1998 - expected dividend yield of 0%, risk-free interest rate of 6%,

expected volatility of 63.32% and an expected option life of 10

years.
1997 - expected dividend yield of 0%, risk-free interest rate of 6%,

expected volatility of 64.49% and an expected option life of 10

years.
(d) Restricted Common Stock
In February 1994, a total of 180,000 (after effect of three-for-two

stock split - see Note 9(e)) restricted shares of the Company's

common stock were granted by the Board of Directors to the principal

officers of one of the Company's operating units, Comtech

Communications Corp, ("CCC"), at a cost of $.10 per share. The award
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