Comtech Telecommunications Corp. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2011, the three months ended October 31, 2010. The unaudited results are compared with the three months ended October 31, 2009; balance-sheet amounts are compared with July 31, 2010.
Business context and results
Comtech designs and sells communications products, systems and services through telecommunications transmission, mobile data communications, and RF microwave amplifiers. U.S. government business is a major driver: it represented 73.6% of quarterly sales, while the MTS program alone contributed approximately 43.5% and BFT approximately 10.3%.
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| Net sales | $178.2 million | $133.8 million | Up 33.2% |
| Gross profit / margin | $64.2 million / 36.1% | $49.8 million / 37.2% | Profit up; margin down 1.1 percentage points |
| Operating income | $40.1 million | $15.0 million | Up $25.1 million |
| Net income | $25.7 million | $9.0 million | Up approximately 184% |
| Diluted EPS | $0.79 | $0.30 | Up $0.49 |
| Operating cash flow | $19.3 million | $13.0 million | Up $6.3 million |
Segment sales were $49.1 million in telecommunications transmission, $106.2 million in mobile data communications and $22.8 million in RF microwave amplifiers. Their year-over-year changes were up 5.1%, up 96.3% and down 30.9%, respectively. Mobile data growth reflected shipment timing for MTS and BFT orders and higher microsatellite sales. RF amplifier sales and profitability fell amid delayed programs, budget constraints, lower volume and product-mix effects.
Operating income included a $12.5 million net merger termination fee from CPI after the proposed merger was ended. Excluding that unusual benefit, reported operating-income growth would have been materially lower. Gross margin also declined, principally because mobile data communications became a larger share of sales and product mix shifted.
Cash, debt and liquidity
Cash and cash equivalents were $602.7 million at October 31, down $4.9 million from July 31. Operating activities provided $19.3 million; investing activities used $4.4 million, including capital spending and acquisition-related payments; financing activities used $19.8 million, mainly for share repurchases. Accounts receivable fell to $90.4 million from $135.8 million, while net inventory rose to $84.9 million from $73.6 million.
Total current assets were $800.3 million and current liabilities were $113.3 million. The company reported $200 million of 3.0% convertible senior notes and no borrowings under its $150 million unsecured revolving facility; approximately $2.0 million of standby letters of credit were outstanding. The facility runs to January 31, 2014, requires at least $100 million of unrestricted cash, and includes financial and capital-allocation covenants. Management said it expected to meet the covenants for the foreseeable future.
The company repurchased 720,996 shares for approximately $20.2 million at an average $28.01 per share, with $79.8 million remaining under its authorization. It began quarterly dividends of $0.25 per share, targeting $1.00 annually, subject to Board approval. A $0.25 dividend was declared for payment in February 2011.
Outlook, risks and other material items
- Fiscal 2011 outlook: Management expected consolidated sales to be significantly below fiscal 2010, largely because MTS sales were expected to decline from the prior-year level. It expected full-year operating income to be comparable to fiscal 2010, including the $12.5 million termination fee and cost reductions. Gross margin as a percentage of sales was expected to improve year over year, partly because fewer lower-margin ruggedized computers were expected to ship.
- Segment outlook: Telecommunications transmission sales were expected to rise; mobile data communications sales were expected to decline significantly; and RF microwave amplifier revenue was expected to be slightly lower. Management anticipated quarterly consolidated sales to decline from current levels, with Q4 FY2011 the lowest quarter. Backlog at October 31 was approximately $267.4 million, a substantial portion expected to ship during fiscal 2011.
- Contract exposure: MTS and BFT are U.S. Army indefinite-delivery/indefinite-quantity contracts, so the Army is not obligated to order. The company had received $669.2 million of orders against the $899.1 million MTS ceiling and $290.9 million against the $384.0 million BFT-1 ceiling. MTS III competition, a possible MTS/BFT program combination, contract ceilings and future funding create material uncertainty. Comtech was not selected as BFT-2 program manager and vendor.
- Other risks: Government contract timing, termination rights and budget decisions can cause significant sales and margin volatility. The company also flagged inventory and purchase-commitment risk for MTS/BFT parts, long-term contract estimates, warranty reserves, goodwill impairment and customer credit exposure. RF microwave amplifiers goodwill was $29.6 million; management cited delays and budget constraints and said impairment could arise if expected recovery does not occur.
- Contingencies and unusual events: Comtech acquired Stampede WAN optimization technology for approximately $5.3 million, including $3.8 million of expected contingent earn-out payments. The prior CPI merger was terminated, generating the fee described above. A consolidated securities class action was dismissed with prejudice in November 2010. The State Department had closed its review of reported export-control violations without further administrative action but required an independent ITAR compliance audit; potential findings or reopening could result in penalties or remediation costs. The IRS was auditing fiscal 2007 and 2008 returns, including research-credit and domestic-production-deduction issues.
- Controls: Management concluded disclosure controls were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether MTS and BFT orders, contract extensions, funding and delivery schedules support the company’s assumed future revenue, especially following the MTS III and BFT-2 developments.
- How much of reported operating-income growth and fiscal 2011 expectations depends on the one-time $12.5 million CPI termination fee and cost-reduction actions.
- Whether mobile data mix, ruggedized-computer shipments and RF amplifier demand affect realized gross margins and the expected full-year margin improvement.
- Liquidity and covenant headroom after dividends, the remaining share-repurchase authorization, acquisitions and the $200 million convertible-note obligations.
- Results of the ITAR audit and IRS examinations, along with any changes in legal, tax or other contingent exposures.