Comtech Telecommunications Corp. — Q3 FY2014 Form 10-Q
Reporting period: Three and nine months ended April 30, 2014. Interim financial statements are unaudited. Comtech designs and sells communications products, systems and services through telecommunications transmission, RF microwave amplifiers, and mobile data communications segments.
Financial performance
| Metric | Three months ended April 30, 2014 | Year-over-year change | Nine months ended April 30, 2014 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $88.9 million | Up 27.2% | $257.8 million | Up 9.5% |
| Gross profit / margin | $38.3 million / 43.1% | Margin down from 44.9% | $112.1 million / 43.5% | Margin down from 44.8% |
| Operating income / margin | $10.6 million / 11.9% | Up from $5.4 million / 7.7% | $31.8 million / 12.3% | Up from $24.7 million / 10.5% |
| Net income | $5.9 million | Up from $2.9 million | $17.2 million | Up from $12.7 million |
| Diluted EPS | $0.32 | Up from $0.17 | $0.92 | Up from $0.69 |
| Operating cash flow | Not reported for quarter | — | $10.8 million | Down from $15.7 million |
Margins and drivers: Quarterly sales growth came mainly from telecommunications transmission and RF microwave amplifiers; mobile data communications sales declined. Gross margin contracted as sales mix shifted toward lower-margin over-the-horizon microwave systems and Navy development work. Nine-month operating income included a $0.2 million benefit from a Stampede earn-out fair-value change, compared with a $2.7 million net benefit in the prior-year period; excluding those items, operating income was $31.6 million versus $22.0 million.
Balance sheet, liquidity and capital allocation
- At April 30, cash and cash equivalents were $295.0 million, down from $356.6 million at July 31, 2013. Current assets were $447.7 million and current liabilities $262.7 million.
- Convertible notes of $191.5 million were classified as current at quarter-end. In May, holders converted another $41.5 million into shares and the remaining $150.0 million principal was redeemed for cash at par plus accrued interest. No notes remained outstanding as of May 5, 2014.
- After the May note redemption, $12.0 million of share repurchases and a $4.9 million dividend payment, management reported approximately $128.0 million of cash, before other cash flows.
- The company generated $10.8 million of operating cash flow and used $4.5 million for capital expenditures in the nine-month period. Working-capital needs, including higher receivables and inventory, contributed to lower operating cash flow.
- Financing activities used $67.9 million, including $58.1 million of share repurchases and $13.8 million of dividends. The company repurchased 1.85 million shares at an average $31.40 per share.
- A $100 million secured revolving credit facility had no borrowings and $1.3 million of standby letters of credit outstanding. It expires October 31, 2014, with a possible extension to December 31, 2016 subject to conditions and covenants.
Material changes and management outlook
- For the quarter, telecommunications transmission sales rose 34.8% to $61.2 million, RF microwave amplifier sales rose 38.9% to $22.5 million, and mobile data communications sales fell 37.3% to $5.2 million. International sales were 62.3% of quarterly revenue, versus 47.1% a year earlier; the North African customer market accounted for 22.4%.
- Management said quarterly bookings were the highest of the fiscal year and described the outlook as better than previously anticipated. For FY2014, it expects sales and operating income to exceed FY2013 levels ($319.8 million and $34.5 million, respectively), with operating income targeted at approximately 12.0% of sales. It expects full-year gross profit dollars to rise, with gross margin comparable to FY2013.
- Management expects FY2014 mobile data communications sales to be significantly lower than FY2013, while expecting telecommunications transmission and RF microwave amplifier sales to be slightly higher. It expects R&D expense to be lower than FY2013 and total operating expenses slightly higher in dollars. The estimated FY2014 effective tax rate, excluding discrete items, is approximately 36.5%.
- Timing matters: work on two North African over-the-horizon microwave contracts was performed earlier than expected, making Q3 sales unusually strong and Q4 sales in that product line expected to be significantly lower. Most of the quarter’s strong RF amplifier bookings were expected to ship in FY2015.
- Two new three-year Army BFT-1 contracts, with potential aggregate value of $68.2 million, began April 1; initial funded orders were $17.5 million. Options, additional funding and purchases are not assured, and the contracts can be terminated for convenience.
Risks, contingencies and unusual items
- Government spending, contract funding, customer order timing, international conditions and sales mix can materially affect results. U.S. government contracts may be terminated for convenience; IDIQ contracts do not guarantee purchases.
- RF microwave amplifiers goodwill was not impaired in the August 2013 annual test, but management said the reporting unit was at risk of failing the impairment test. A 160-basis-point increase in its assumed discount rate or a carrying-value increase above $13.2 million could likely trigger failure; up to $42.1 million of goodwill and intangibles could be written off if a subsequent test requires it.
- A DCAA audit recommended an $11.8 million price adjustment plus interest on a historic BFT-1 contract. The Army concluded the cost data was not defective but requested a voluntary refund; Comtech declined in May 2014 and considered the matter closed, though an Army claim remained possible.
- Separate U.S. government and SEC investigations relating to the CEO had not resulted in contact since September 2012. Management did not believe legal proceedings were likely, but an adverse proceeding could materially affect the company.
- Federal tax returns for FY2011–FY2013 remain subject to potential IRS audit. Unrecognized tax benefits were $2.9 million. Other ongoing legal matters were not expected by management to have a material adverse effect.
- Warranty obligations were $9.0 million at April 30, up from $7.8 million at July 31. Management also cited uncertainty in estimates for long-term contract costs, warranty expense, inventory reserves and customer collections.
Important facts for investors to verify
- Post-quarter cash and share count effects of the note conversions, $150 million cash redemption, subsequent repurchases and dividend payment.
- Whether anticipated FY2014 sales, operating income and approximately 12% operating margin were achieved, considering the North African contract timing shift and Q4 expectations.
- Funding, option exercise and termination status of the new Army BFT-1 contracts, and the durability of the segment’s license revenue.
- Collection and billing of the $19.9 million unbilled receivables balance; one prime contractor represented 28.4% of receivables at April 30.
- Developments in the DCAA/Army refund matter, government investigations, tax exposures and RF microwave amplifiers goodwill impairment assumptions.