Business context and reporting period
Comtech Telecommunications Corp. designs and supplies advanced communications products, systems and services through three segments: telecommunications transmission, RF microwave amplifiers, and mobile data communications. This Form 10-K covers the fiscal year ended July 31, 2014; fourth-quarter figures are unaudited.
Management said fiscal 2014 marked a return to revenue and operating-income growth after several years of declines. The company serves commercial and government customers, with satellite and over-the-horizon communications among its principal markets.
Financial and operating highlights
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Net sales | $347.2 million | $319.8 million |
| Gross profit / gross margin | $151.4 million / 43.6% | $140.8 million / 44.0% |
| Operating income / margin | $43.9 million / 12.6% | $34.5 million / 10.8% |
| Net income | $25.2 million | $17.8 million |
| Diluted EPS | $1.37 | $0.97 |
| Operating cash flow | $34.6 million | $37.7 million |
| Cash and cash equivalents at year-end | $154.5 million | $356.6 million |
| Working capital at year-end | $224.7 million | $220.6 million |
| Backlog at year-end | $133.4 million | $189.7 million |
Annual sales increased 8.6%. Gross margin eased 0.4 percentage points, while operating margin increased 1.8 points. Net income improved 41.2%. Operating cash flow declined by $3.1 million, principally amid higher working-capital needs and the timing of customer shipments, billings and receipts.
Fourth-quarter FY 2014 sales were $89.4 million, gross profit was $39.3 million, net income was $8.0 million and diluted EPS was $0.48. In Q4 FY 2013, the corresponding reported figures were $84.4 million, $35.4 million, $5.2 million and $0.28.
Segment sales in FY 2014 were $231.5 million for telecommunications transmission, $88.0 million for RF microwave amplifiers and $27.7 million for mobile data communications. Compared with FY 2013, those results represented growth of 19.0% and 1.3% in the first two segments, respectively, and a 27.5% decline in mobile data communications.
Material changes, liquidity and capital allocation
- Telecommunications transmission growth was driven mainly by higher over-the-horizon microwave system sales on large North African customer contracts. RF microwave amplifier sales rose modestly; mobile data communications sales fell with lower U.S. Army BFT-1 work and no FY 2014 mobile-transceiver shipments.
- Cash fell by $202.1 million, mainly reflecting $150.0 million of convertible-note principal redeemed or repurchased for cash, $70.7 million of share repurchases and $18.7 million of dividends paid. The remaining approximately $50.0 million of notes converted into common shares. No borrowed-money debt remained at July 31, 2014.
- The company had a $100 million revolving credit facility, with no borrowings and $1.4 million of standby letters of credit outstanding at year-end. It said it did not intend to renew the facility when it expired October 31, 2014.
- FY 2014 share repurchases totaled 2.25 million shares at an average $31.45 per share. The board’s targeted annual dividend was raised to $1.20 per share; future payments remain subject to board approval.
- Backlog declined by $56.3 million year over year. Management expected a majority of the year-end backlog to be recognized as FY 2015 sales; orders are generally subject to customer cancellation or modification.
Outlook, commentary and risks
- Management expected FY 2015 consolidated sales and operating income to exceed FY 2014 levels, with growth led by telecommunications transmission and RF microwave amplifiers and weighted toward the second half. It expected Q1 FY 2015 to be the lowest quarter for sales and operating income, targeted an operating margin of approximately 13%, and forecast an effective tax rate of approximately 35%, excluding discrete items.
- Management expected FY 2015 gross margin to be slightly below FY 2014, while forecasting slightly higher R&D expense in dollars and capital expenditures of approximately $5 million to $7 million. Expected FY 2015 operating cash flow was described as significant but below FY 2014 and weighted toward the second half.
- The U.S. Army BFT-1 support and intellectual-property license contracts have a base period ending March 31, 2015, with two annual options. Funding and options are at the Army’s discretion. The annual $10 million license fee is a material contributor to mobile-segment profitability; if the Army pays $30 million in fees through March 2017, it receives a limited non-exclusive right to use the IP thereafter without further license fees.
- In August 2014, the board confirmed it was exploring strategic alternatives, including a possible merger or sale. No transaction was assured; the review could divert management attention, incur costs or affect employees and customers. FY 2015 guidance excluded costs or impacts of the review.
- Key risks include government budget reductions, sequestration and contract delays; reliance on international markets and a North African end-customer; customer financing and collection risk; long and variable sales cycles; contract cost overruns and cancellations; technology and competitive change; and possible impairment of goodwill and intangible assets.
- A DCAA post-award audit of a former BFT-1 contract led to an $11.8 million recommended price adjustment plus interest. The Army said the cost or pricing data was not defective but requested a voluntary refund based on its view that some costs were overstated. Comtech disputed the assertion and declined; the company considered the matter closed but disclosed that the Army could pursue a claim.
- Separate U.S. government and SEC investigations involving the CEO were not reported as resolved formally, but the company said it had not been contacted since September 2012 and did not believe legal proceedings were likely. A proceeding could materially affect the company.
Most important facts for investors to verify
- Whether FY 2015 sales and operating-income growth materialized, particularly in the second half, and whether the targeted approximately 13% operating margin was achieved.
- New order flow, backlog conversion and customer concentration: one prime contractor represented 15.4% of FY 2014 sales, almost all associated with the North African end-customer; that end-customer accounted for 19.8% of year-end receivables.
- U.S. Army funding and option exercises for BFT-1, and the timing and prospects for BFT 2.5 or replacement work.
- Cash generation and liquidity after the note settlement, share repurchases and dividend payments, including the status of the credit facility after its October 2014 expiry.
- Any developments in the Army contract audit matter, the CEO-related investigations, and the board’s strategic-alternatives review.