Comtech Telecommunications Corp. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended January 31, 2013. Amounts are in U.S. dollars; financial figures below are in millions unless stated otherwise.
Business context
Comtech designs and sells communications equipment, systems and services through telecommunications transmission, RF microwave amplifiers, and mobile data communications. Results are affected by uneven contract and order timing, U.S. government funding decisions, and global economic and political conditions. The mobile data segment is especially dependent on U.S. Army MTS and BFT-1 programs. Comtech has completed its wind-down of the microsatellite product line.
Financial performance
| Metric | Three months ended Jan. 31, 2013 | Year-over-year change | Six months ended Jan. 31, 2013 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $74.6 | Down 24.7% | $165.5 | Down 22.1% |
| Gross profit / margin | $32.2 / 43.2% | Margin up from 41.8% | $74.0 / 44.7% | Margin up from 43.6% |
| Operating income / margin | $5.9 / 7.9% | Down from $10.7 / 10.8% | $19.3 / 11.7% | Down from $26.4 / 12.4% |
| Net income | $2.4 | Down from $5.8 | $9.8 | Down from $18.4 |
| Diluted EPS | $0.14 | Down from $0.27 | $0.51 | Down from $0.75 |
- Margins and unusual items: Higher consolidated gross margins reflected sales mix, including a larger share from telecommunications transmission. Six-month 2012 gross margin included a $5.6 million benefit from finalized MTS/BFT-1 pricing; excluding it, the prior-period margin was 42.1%. Fiscal 2013 operating income included a $3.3 million benefit from reducing the Stampede earn-out estimate, partly offset by $0.6 million of microsatellite wind-down charges for the six-month period. Q2 also included a $0.9 million earn-out benefit and a $0.3 million restructuring-cost reversal. Excluding the cited items, management reported six-month operating margin of approximately 10.0% and Q2 operating margin of approximately 6.4%.
- Segment sales, six months: Telecommunications transmission $99.1 million, down 8.3%; RF microwave amplifiers $45.7 million, up 4.8%; mobile data communications $20.8 million, down 65.8%. The mobile data decline reflected lower Army MTS/BFT-1 business and the discontinued microsatellite line.
- Cash flow: Operating cash flow was $11.4 million, compared with $11.2 million a year earlier. Capital expenditures were $2.5 million. Cash declined $15.0 million during the half-year, to $352.9 million, principally reflecting $10.5 million of share repurchases and $14.3 million of dividends, partly offset by operating cash generation.
- Liquidity and debt: Cash and cash equivalents were $352.9 million; convertible senior notes were $200.0 million, bearing 3.0% interest. The notes are due in 2029, with holder repurchase dates beginning May 1, 2014. The $100.0 million secured revolver had no borrowings; $1.9 million of standby letters of credit were outstanding. Management said existing cash and expected operating cash flow should meet anticipated requirements.
- Capital returns: The company declared quarterly dividends of $0.275 per share and declared another $0.275 dividend in March 2013. It repurchased 397,798 shares for $10.5 million during the six months. The $250 million repurchase program was completed in February 2013; $45.1 million remained available under a separate $50 million authorization as of March 6, 2013.
Outlook, risks and contingencies
- Management expects fiscal 2013 sales to be significantly below fiscal 2012 sales of $425.1 million, with lower sales expected in all three segments. It expects Q3 sales and operating income to fall below Q2 levels, followed by a Q4 that may be near or at the fiscal-year quarterly revenue peak. Management’s fiscal 2013 operating-margin estimate was approximately 10%; consolidated gross margin was expected to be slightly higher than fiscal 2012.
- The outlook assumes the Army exercises the first option period of the BFT-1 sustainment contract and places additional funded orders. The Army notified Comtech on March 6 of its intent to exercise that option, but orders remain subject to funding; some contract pricing remains unsettled and the IDIQ contract does not guarantee purchases.
- Management cited U.S. defense budget uncertainty and sequestration, delayed or reduced customer spending, weak European economies, and political volatility in international markets. U.S. government customers represented 38.6% of six-month sales. These factors could further reduce orders, revenue, profits and cash flow.
- Goodwill sensitivity: No impairment was recorded, but the RF microwave amplifiers reporting unit was considered at risk of failing the first step of a future goodwill test. Its estimated fair value exceeded carrying value by at least 5%. A further 50-basis-point increase in the discount rate or a carrying-value increase above $5 million could likely cause a step-one failure; up to $29.6 million of goodwill could then be written off.
- Government audit: In a DCAA draft audit, the agency proposed an $11.9 million price adjustment plus $2.3 million interest related to the original BFT-1 contract. Comtech disputed the findings; in February 2013, the DCAA said it was awaiting information and expected to issue a new draft. The company said the outcome and any eventual adjustment were uncertain.
- Investigations: The company and its CEO received subpoenas in a U.S. government investigation and an SEC investigation concerning CPI International securities trading. Comtech said it was cooperating and did not believe either investigation was likely to result in a legal proceeding, while acknowledging a proceeding could materially affect the business.
- Other exposures include uncertain tax positions of $3.1 million, potential future IRS audits, warranty and contract-estimate risks, operating leases, and possible future payments under the convertible notes. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether U.S. Army funding and orders materialize under the BFT-1 option period, and how unresolved pricing affects revenue and margins.
- Whether expected order flow supports management’s fiscal 2013 sales and approximately 10% operating-margin outlook, particularly the projected Q3 weakness and Q4 recovery.
- Whether deteriorating customer demand or revised assumptions trigger an RF microwave amplifiers goodwill impairment.
- The outcome of the DCAA audit and any resulting government claim, as well as developments in the U.S. government and SEC investigations.
- Cash generation and capital returns relative to the $200 million convertible notes and other contractual obligations.