COMTECH TELECOMMUNICATIONS CORP quarterly report, Q1 FY2014

Comtech Telecommunications Corp. — Form 10-Q Summary

Reporting period: Fiscal first quarter ended October 31, 2013; comparisons are with the three months ended October 31, 2012 unless noted. The interim financial statements are unaudited. Comtech designs and sells advanced communications products, systems and services through telecommunications transmission, RF microwave amplifiers, and mobile data communications segments.

Financial performance

Metric	Q1 FY2014	Q1 FY2013	Change
Net sales	$83.4 million	$91.0 million	Down 8.4%
Gross profit / margin	$36.4 million / 43.6%	$41.8 million / 46.0%	Margin down 2.4 percentage points
Operating income / margin	$10.1 million / 12.1%	$13.4 million / 14.7%	Down 24.4%; margin down 2.6 points
Net income	$5.3 million	$7.4 million	Down 28.6%
EPS, basic / diluted	$0.32 / $0.28	$0.43 / $0.36	Both lower
Operating cash flow	$(1.2) million	$11.9 million	Decrease of $13.1 million

Segment sales: telecommunications transmission $54.4 million, up 2.1%; RF microwave amplifiers $20.2 million, down 20.2%; mobile data communications $8.8 million, down 28.5%.
The sales decline primarily reflected lower RF amplifier and mobile data sales. Consolidated gross margin fell mainly because of telecommunications transmission sales mix, including low-margin U.S. Navy development work and no MTTS hardware shipments in the quarter.
Cash and cash equivalents were $346.6 million at October 31, versus $356.6 million at July 31, 2013. Operating cash use reflected higher working-capital needs, notably increased receivables and inventory.
Capital expenditures were $1.0 million; operating cash flow less capital expenditures was approximately $(2.3) million. Financing cash use was $7.8 million, including $4.5 million of dividends and $3.6 million of share repurchases.

Debt, liquidity and capital allocation

The balance sheet included $200 million of 3.0% convertible senior notes, classified as current because holders may require cash repurchase on May 1, 2014. The notes are senior unsecured obligations. Their estimated fair value was $210.1 million.
Comtech had no revolving loans under its $100 million secured credit facility and had $1.9 million of standby letters of credit outstanding. The facility was amended December 6, 2013, after quarter-end; its stated expiry was October 31, 2014, with a conditional extension option to December 31, 2016.
Compliance with the facility’s maximum total-debt-to-adjusted-EBITDA covenant was waived as of October 31, 2013. Management said it believed it could meet or obtain waivers for applicable financial covenants. The facility also contains restrictions on dividends, repurchases and other actions.
In the quarter, Comtech repurchased 124,753 shares for $3.6 million at an average $28.73 per share. The repurchase authorization was increased from $50 million to $100 million on December 9, 2013; about $71 million remained available then.
The board raised the annual target dividend from $1.10 to $1.20 per share on December 9, 2013, and declared a $0.30 quarterly dividend payable February 19, 2014. Future dividends remain subject to board approval.

Outlook and management commentary

Management expected fiscal 2014 sales to be modestly above fiscal 2013’s $319.8 million and operating income to exceed fiscal 2013’s $34.5 million. Growth was expected to come from telecommunications transmission and RF microwave amplifiers, weighted toward the second half; management targeted GAAP operating margin of at least 11% for the year.
Management expected full-year consolidated gross margin to be comparable to fiscal 2013. Telecommunications transmission margin was expected to be slightly lower than fiscal 2013, while RF amplifier gross profit and margin were expected to be slightly higher. Mobile data communications sales were expected to be significantly lower, with operating income in dollars comparable to fiscal 2013.
Management expected fiscal 2014 R&D expense in dollars to be slightly below fiscal 2013 and total operating expenses slightly above fiscal 2013. The expected effective tax rate was approximately 36.5%, excluding discrete items; this estimate did not assume extension of the federal research credit beyond December 31, 2013.
Management anticipated positive operating cash flow for the remainder of fiscal 2014 but said the amount was difficult to predict. Fiscal 2014 capital expenditures were estimated at $5 million to $7 million. The company also said it might pursue acquisitions.
Bookings and sales remain sensitive to order timing, customer funding, contract performance and product mix. U.S. government budget uncertainty, sequestration, defense-spending reductions, global economic conditions and political volatility in international markets could adversely affect outlook. Approximately 22.5% of backlog at October 31 consisted of U.S. government end-customer orders.

Material risks, contingencies and unusual items

BFT-1 contract audit: The DCAA’s May 2013 draft audit recommended an $11.819 million price adjustment plus interest on the original BFT-1 contract. Comtech disputed the findings; it was verbally told a final report had been issued in October 2013 but had not received the report. A government demand could require repayment, although management did not believe the matter would ultimately materially affect consolidated financial condition.
Government investigations: The filing describes a U.S. Attorney investigation relating to the CEO and a separate SEC investigation of CPI stock trading. The company and CEO had cooperated and had not been contacted since September 2012. Management did not believe either was likely to result in a proceeding, but an adverse proceeding could materially affect business and results.
Goodwill impairment sensitivity: No impairment was recorded in the August 1, 2013 annual test. The RF microwave amplifiers reporting unit was considered at risk of failing the first impairment-test step in a future period; its estimated fair value exceeded carrying value by at least 13.2%. A 160-basis-point WACC increase or a carrying-value increase above $13.2 million could likely trigger failure; up to $43.4 million of goodwill and intangibles could then be written off.
Customer and contract concentration: One prime contractor associated with two North African over-the-horizon microwave contracts accounted for 20.3% of accounts receivable at quarter-end and 12.5% of quarterly sales. The Army’s BFT-1 sustainment contract and annual $10 million intellectual-property license renewal are important to mobile-segment results; a new sustainment award was anticipated but future funding and award timing were uncertain.
Other notable items included a $2.0 million high-margin SENS technology sale in mobile data communications, a $0.2 million reduction in the Stampede contingent earn-out liability, and no repeat of the prior-year $0.8 million microsatellite wind-down restructuring charge.

Important facts for investors to verify

Whether holders required cash repurchase of the $200 million convertible notes on May 1, 2014, and the resulting effect on cash, debt and credit-facility terms.
The final DCAA audit findings, any Contracting Officer decision, and the potential amount and timing of any BFT-1 repayment.
Whether the Army awarded and funded the anticipated BFT-1 sustainment contract and renewed the annual intellectual-property license.
Whether backlog conversion and second-half orders supported fiscal 2014 sales, operating-income and cash-flow expectations, particularly for the two North African contracts and RF amplifier segment.
Changes in defense budgets, customer purchasing decisions and RF reporting-unit assumptions that could affect goodwill impairment risk.
Developments in the government investigations, tax examinations and credit-facility covenant compliance.