Comtech Telecommunications Corp. — Q2 FY2012 Form 10-Q
Reporting period: Quarter and six months ended January 31, 2012; filed March 8, 2012. Comtech designs and sells communications products and systems through telecommunications transmission, RF microwave amplifiers, and mobile data communications segments. Results are unaudited.
Financial performance
| Metric | Three months ended Jan. 31, 2012 | Six months ended Jan. 31, 2012 |
|---|---|---|
| Net sales | $99.1 million, down 39.1% | $212.5 million, down 37.7% |
| Gross profit / margin | $41.4 million / 41.8% | $92.7 million / 43.6% |
| Operating income / margin | $10.7 million / 10.8% | $26.4 million / 12.4% |
| Net income | $5.8 million | $18.4 million |
| Diluted EPS | $0.27 | $0.75 |
| Operating cash flow | Not provided separately for the quarter | $11.2 million |
For comparison, prior-year quarter sales were $162.8 million, operating income $25.3 million, net income $16.1 million and diluted EPS $0.52. Prior-year six-month sales were $341.0 million, operating income $65.3 million, net income $41.8 million and diluted EPS $1.32. The prior-year six-month operating result included a $12.5 million merger termination fee.
Six-month gross margin rose from 36.7% to 43.6%; excluding a $5.6 million benefit from final pricing on MTS/BFT-1 orders, the current-period margin was 42.1%. Current six-month operating income included that pricing benefit and $2.6 million of costs related to a withdrawn proxy solicitation. Excluding both, management reported operating income of approximately $23.4 million, or 11.3% of sales.
Liquidity and debt: Cash and cash equivalents were $400.2 million at January 31, 2012, down from $558.8 million at July 31, 2011. Current assets were $557.0 million and current liabilities $70.0 million. The company had $200.0 million of 3.0% convertible senior notes outstanding and no revolving-facility borrowings; $1.7 million of standby letters of credit were outstanding under its $150 million facility, which expires January 31, 2014. Six-month interest expense was $4.3 million.
Six-month cash used in financing was $167.1 million, principally $157.7 million for share repurchases and $12.2 million for dividends. Investing cash outflow was $2.7 million. The notes mature in 2029, subject to conversion, redemption and holder put rights, including a put date in 2014.
Material changes and management commentary
- Mobile data communications sales fell 66.8% year over year in both the quarter and six-month period, primarily as MTS/BFT-1 sales to the U.S. Army declined. Telecommunications transmission quarterly sales fell 17.7%; RF microwave amplifier quarterly sales fell 6.3%.
- The BFT-1 contract ordering period expired December 31, 2011. Funded MTS/BFT-1 backlog was approximately $28.2 million at January 31, 2012. Management expected sales to the Army in each of the next two fiscal quarters to be below the Q2 level.
- Management said most product lines other than MTS/BFT-1 were expected to have higher bookings, sales and related profits in the second half than in the first half. It expected FY2012 net sales and profits to be materially below FY2011, primarily because of lower MTS/BFT-1 revenue. Based on backlog and anticipated bookings, it expected FY2012 operating margin of approximately 12%; FY2012 net profits and diluted EPS were expected to be slightly above the company’s estimate three months earlier. No specific full-year revenue or EPS forecast is stated in the provided filing text.
- Management expected RF microwave amplifier FY2012 sales to exceed FY2011, while telecommunications transmission sales and mobile microsatellite sales were expected to be lower than FY2011. A potential large North African government contract was anticipated late in Q4, but FY2012 revenue from it was expected to be nominal.
- The annual targeted dividend increased to $1.10 per share. The board declared a further $0.275 per-share dividend payable May 22, 2012, subject to the stated record date. At January 31, $72.9 million remained under the $250 million repurchase authorization. Management also indicated it may pursue acquisitions.
Risks, contingencies and unusual items
- U.S. Army contract uncertainty: The business outlook assumed at least one new sustainment award. Management was negotiating for a task order and potential multi-year IDIQ contract, but said neither award nor acceptable terms—including payment for intellectual-property use—were assured. The Army’s plans and funding could change.
- BFT-1 audit: DCAA and DCMA reviews are ongoing concerning pricing disclosures and Cost Accounting Standards coverage. A required price adjustment could mean repayment to the government with interest and could materially affect results and financial condition.
- Patent litigation: ViaSat claims that Comtech’s subsidiary infringed patents through products using licensed Carrier-in-Carrier technology. Trial was scheduled for September 2012; no potential settlement was accrued. An adverse judgment could materially affect the business.
- Government spending and demand: Defense budget reductions, potential sequestration, contract funding and customer order timing may adversely affect sales. Government contracts may be terminated, and IDIQ contracts do not require minimum purchases except where specified.
- Accounting and tax items: The six-month effective tax rate was 20.0%, including a $3.5 million discrete tax benefit; management estimated an approximately 35% FY2012 tax rate excluding discrete items. The research and experimentation credit expired December 31, 2011. Inventory provisions were $1.6 million for the six months, versus $0.9 million a year earlier.
- Management identified possible future goodwill impairment if reporting-unit performance falls short of expectations. Telecommunications transmission goodwill had only a 6% estimated fair-value cushion over book value in the August 2011 review; RF microwave amplifiers had a 78% cushion, down from 138% a year earlier.
Most important facts for investors to verify
- Whether and on what terms the Army awards new MTS/BFT-1 sustainment work, and the timing and conversion of the $28.2 million funded backlog.
- Results and potential financial exposure from the BFT-1 DCAA/DCMA audit, including any effects on contract negotiations.
- Whether the expected second-half bookings and approximately 12% FY2012 operating-margin outlook are achieved despite materially lower expected annual sales and profits.
- Underlying margins and earnings after considering the $5.6 million contract-pricing benefit, proxy-solicitation costs, prior-year merger termination fee, and discrete tax benefits.
- Cash generation and liquidity after substantial repurchases and dividends, while accounting for $200 million of convertible notes, lease commitments, contingent acquisition payments and possible legal or tax payments.
- Developments in ViaSat litigation, defense-budget reductions, and goodwill impairment indicators.