Business context and reporting period
Comtech Telecommunications Corp. designs and sells communications products, systems and services to commercial and government customers. This unaudited Form 10-Q covers the three and six months ended January 31, 2016; comparisons are with the same periods in 2015. Results for these periods exclude TeleCommunication Systems, Inc. (TCS), acquired on February 23, 2016.
Before the acquisition, Comtech reported three segments: telecommunications transmission, RF microwave amplifiers, and mobile data communications. It subsequently reorganized into commercial solutions and government solutions.
Key financial metrics
| Metric | Three months ended Jan. 31, 2016 | Prior-year quarter | Six months ended Jan. 31, 2016 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $70.3 million | $81.8 million | $134.4 million | $158.2 million |
| Gross profit / margin | $29.4 million / 41.8% | $37.9 million / 46.3% | $57.6 million / 42.9% | $73.2 million / 46.3% |
| Operating income / margin | $3.2 million / 4.6% | $10.6 million / 13.0% | $5.4 million / 4.0% | $18.8 million / 11.9% |
| Net income | $2.5 million | $7.6 million | $3.9 million | $12.8 million |
| Diluted EPS | $0.15 | $0.46 | $0.24 | $0.78 |
- For the six months, operating cash flow was $23.4 million, versus cash used of $8.2 million a year earlier. Capital expenditures were $1.5 million; dividends paid were $9.7 million.
- Cash and cash equivalents were $163.5 million at January 31, 2016, up from $151.0 million at July 31, 2015. Current assets were $281.6 million and current liabilities $60.0 million.
- At January 31, Comtech reported no drawn balance in the disclosed $15 million credit facility; $1.7 million of standby letters of credit were outstanding. The facility was terminated when the TCS-related financing was put in place.
- Comtech declared dividends of $0.30 per share in each of the first two fiscal quarters; its stated fiscal 2016 annual dividend target was $1.20 per share.
Material changes versus prior comparable periods
- Quarterly sales fell 14.1%; six-month sales fell 15.0%. Telecommunications transmission was the main source of weakness: segment sales declined 28.4% in the quarter and 29.8% for six months.
- Satellite earth-station demand and sales were hurt by difficult international market conditions, including lower oil prices, weaker purchasing power amid a strong U.S. dollar, and customer budget cuts or delayed purchases. Two large North African microwave-system contracts were nearing completion, reducing related sales.
- RF microwave amplifier sales grew 15.3% in the quarter and 17.8% for six months. Mobile data communications sales increased 7.9% and 4.0%, respectively.
- Gross margin contracted in both periods, principally because of lower sales and unfavorable product mix in telecommunications transmission. Operating income also reflected lower revenue and acquisition-plan expenses.
- Research and development expense declined 20.6% in the quarter and 20.8% for six months, reflecting cost reductions and completion of projects. Acquisition-plan expenses were $2.3 million for the quarter and $3.7 million for six months; there were no comparable costs in 2015.
Outlook, acquisition, risks and unusual items
- Management expected legacy-business fiscal 2016 revenue and operating income to be below fiscal 2015, while consolidated fiscal 2016 outlook was expected to improve with TCS. Management said fiscal 2017 results were expected to be significantly higher than fiscal 2016, but did not provide specific consolidated forecasts in this filing.
- Management expected satellite earth-station sales to decline in fiscal 2016, with the fourth quarter expected to be the peak. It anticipated strong second-half bookings for microwave systems, including potential international orders; these were expectations, not reported orders. RF amplifier sales and bookings were expected to grow, supported by new products and in-flight connectivity demand.
- TCS was acquired for $5.00 per share. Its unaudited revenue for the twelve months ended December 31, 2015 was approximately $360 million. The preliminary purchase price was approximately $340.4 million and enterprise value approximately $423.2 million. TCS had $61.4 million cash and approximately $144.1 million debt at closing.
- The new five-year secured credit facility provides a $250 million term loan and up to $150 million revolving facility. On a pro forma combined basis after assumed payment or repayment of transaction costs and TCS debt, Comtech reported more than $50 million cash and approximately $361.6 million debt. The acquisition is expected to materially increase annual interest and intangible amortization expense.
- Management estimated transaction and merger-related expenditures of approximately $48 million. It expected annual run-rate synergies of about $8 million over the next several quarters and $12 million in the second year. Management described the acquisition as expected to be accretive on a cash basis excluding transaction and merger expenditures; realization and timing remain uncertain.
- Risks include integration execution, retention of personnel and customers, realization of synergies, government funding and contract timing, international economic and currency conditions, and estimates on long-term contracts, warranties, inventory and receivables. TCS also has patent-indemnification litigation with losses difficult to estimate; acquisition-related shareholder suits remained pending in one Maryland court, while another court indicated it would dismiss related actions.
- The IRS notified Comtech of an intended audit of its fiscal 2014 federal return; fiscal 2012 and 2013 returns may also be audited. The six-month effective tax rate was 27.9%, including discrete benefits; management estimated a 33.5% fiscal 2016 rate excluding TCS and discrete items.
Important facts for investors to verify
- Final TCS purchase accounting, acquired-asset valuations, transaction-cost treatment and the resulting goodwill and amortization.
- Actual acquisition debt, interest costs, leverage, covenant headroom and availability under the new credit facility.
- Progress toward stated synergy targets and the total cash and earnings impact of integration and transaction costs.
- Whether expected microwave-system bookings convert to funded orders and whether legacy satellite demand stabilizes.
- Developments in TCS indemnification litigation and acquisition-related lawsuits, as well as the outcome of the IRS audit.
- Customer and receivables concentration: one U.S. prime contractor represented 17.2% of receivables at January 31, 2016; management also noted recent bad-debt expense tied to an international customer.