Comtech Telecommunications Corp. — Q2 FY2015 Form 10-Q
Reporting period: Fiscal quarter and six months ended January 31, 2015. The interim financial statements are unaudited. Comtech designs and sells communications equipment, systems and services through telecommunications transmission, RF microwave amplifiers, and mobile data communications segments.
Financial performance
| Metric | Three months ended Jan. 31, 2015 | Six months ended Jan. 31, 2015 |
|---|---|---|
| Net sales | $81.8 million | $158.2 million |
| Gross profit / margin | $37.9 million / 46.3% | $73.2 million / 46.3% |
| Operating income / margin | $10.6 million / 13.0% | $18.8 million / 11.9% |
| Net income | $7.6 million | $12.8 million |
| Diluted EPS | $0.46 | $0.78 |
For the quarter, sales fell 4.3% year over year, while gross profit increased 1.4%; operating income declined 4.9% and net income rose 26.8%. For the six months, sales declined 6.3%, gross profit declined 0.7%, operating income declined 11.4%, and net income increased 13.5%. Gross margins improved from 43.7% to 46.3% in the quarter and from 43.6% to 46.3% year to date. Reported net income benefited from a discrete tax benefit of approximately $0.6 million in the six-month period.
Six-month segment sales were $105.2 million for telecommunications transmission, $40.4 million for RF microwave amplifiers, and $12.6 million for mobile data communications. Compared with the prior year, sales decreased in each segment. Segment operating income was $19.2 million, $2.0 million, and $5.6 million, respectively; unallocated operating expenses were $8.0 million.
Cash, liquidity and capital
- Cash and cash equivalents were $135.1 million at January 31, 2015, down from $154.5 million at July 31, 2014. Current assets were $292.7 million and current liabilities $58.9 million.
- Operating cash flow was negative $8.2 million for the six months, versus positive $0.1 million a year earlier. Management attributed the outflow primarily to working-capital timing, including receivables, inventory, and customer advances on large microwave-system contracts.
- Capital expenditures were $2.1 million; cash dividends paid were $9.7 million. No shares were repurchased in the period. Approximately $13.7 million remained authorized under the $100 million repurchase program.
- The $200 million 3.0% convertible notes were settled or repurchased in May 2014; the filing reports no outstanding borrowings at January 31, 2015. A new uncommitted, secured $15 million facility expires October 31, 2015; $2.3 million of standby letters of credit were outstanding.
- Management expected FY2015 capital expenditures of $5–$7 million and said existing cash and expected operating cash flows should cover anticipated cash requirements. It expected positive FY2015 operating cash flow, weighted toward the latter half of the year.
Material changes and management outlook
- Management lowered its FY2015 outlook: consolidated sales and operating income are expected to be below FY2014 levels. It targets an FY2015 operating margin of approximately 11%, with an estimated effective tax rate of approximately 34.75%, excluding discrete tax items. The filing does not provide a clear numerical full-year sales or operating-income forecast.
- Satellite earth-station bookings slowed significantly, particularly in Russia and parts of the Middle East, amid lower oil prices, a stronger U.S. dollar, and volatile economic conditions. Management described the slowdown as potentially temporary and cited a strong opportunity pipeline, while expecting FY2015 product sales below FY2014.
- Expected large over-the-horizon microwave orders and associated revenue and operating income shifted from FY2015 to FY2016. Management expected second-half telecommunications transmission sales roughly comparable to first-half sales, weighted toward the fourth quarter; third-quarter segment operating income was expected to decline significantly from Q2 before recovering in Q4.
- Management expected RF microwave amplifiers sales and operating income to exceed FY2014, with growth concentrated late in the second half. Mobile data communications sales and operating income were expected below FY2014, despite the Army’s stated intent to exercise the first option year of the BFT-1 sustainment and license contracts.
- FY2015 R&D expense was expected to exceed FY2014, though quarterly spending was expected to ease slightly from Q2. Total operating expenses were expected to be slightly higher than FY2014. FY2015 guidance includes approximately $1.0 million of incremental leadership-change costs and $0.6 million for the strategic alternatives review; the review concluded with the board deciding the company should remain independent.
- The company named Stanton D. Sloane CEO and President effective January 26, 2015; Fred Kornberg became Executive Chairman. The board declared a $0.30-per-share dividend payable May 21, 2015, subject to the stated record date.
Risks, contingencies and unusual items
- Q2 telecommunications transmission gross profit included approximately $1.0 million from better-than-expected performance on a large North African contract and approximately $0.5 million from lower warranty claims. These benefits may not recur.
- Receivables from one U.S. prime contractor were 37.1% of total accounts receivable at January 31, 2015; that customer represented approximately 14.4% of sales for the quarter and six-month period. Most relates to a North African end customer. Unbilled receivables on two large contracts rose to $21.2 million.
- Goodwill was $137.4 million. The company’s August 2014 qualitative assessment found no likely impairment, but management warned that weaker-than-assumed revenue, adverse business conditions, or defense spending changes could put telecommunications and RF amplifier goodwill at risk of impairment.
- Other key exposures include U.S. government contract funding, cancellation and deployment decisions; international political and economic conditions, potential sanctions, oil prices, exchange rates, and access to financing; contract estimates and customer acceptance; and warranty, inventory, and credit-loss estimates.
- Unrecognized tax benefits totaled $3.1 million; federal returns for FY2011–FY2014 are subject to potential IRS audit. The company disclosed prior SEC and U.S. government investigations involving Fred Kornberg and CPI stock trading; it reported no government contact since September 2012 and said it did not believe proceedings were likely, while acknowledging a possible material adverse effect if proceedings arise. Other ordinary-course matters were not expected to materially affect results or financial condition.
- Future cash payments on the Radyne restructuring plan were estimated at approximately $4.8 million, including future interest accretion. Net operating lease commitments were $24.4 million after contractual sublease payments.
Important facts for investors to verify
- Whether satellite earth-station bookings recover and whether expected large microwave orders arrive on the revised schedule.
- Conversion of contract-related receivables and inventory into cash, given negative first-half operating cash flow and concentration in one prime contractor.
- Actual FY2015 sales, operating margin, cash generation, and segment performance versus management’s outlook, including the timing of expected second-half activity.
- Army exercise and funding of the BFT-1 option year, and the durability of the associated license and sustainment revenue.
- Whether changing business conditions, revenue assumptions, or defense spending lead to goodwill impairment or further revisions to guidance.
- Developments in tax audits, investigations, legal matters, and the company’s ability to sustain dividends and any future share repurchases.