Comtech Telecommunications Corp. — Q2 FY2014 Form 10-Q
Reporting period: Three and six months ended January 31, 2014. 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 and liquidity
| Metric | Three months ended Jan. 31, 2014 | Three months ended Jan. 31, 2013 | Six months ended Jan. 31, 2014 | Six months ended Jan. 31, 2013 |
|---|---|---|---|---|
| Net sales | $85.5 million | $74.6 million | $168.9 million | $165.5 million |
| Gross profit / margin | $37.4 million / 43.7% | $32.2 million / 43.2% | $73.7 million / 43.6% | $74.0 million / 44.7% |
| Operating income / margin | $11.2 million / 13.1% | $5.9 million / 7.9% | $21.3 million / 12.6% | $19.3 million / 11.7% |
| Net income | $6.0 million | $2.4 million | $11.3 million | $9.8 million |
| Diluted EPS | $0.32 | $0.14 | $0.60 | $0.51 |
- Quarterly revenue rose 14.6%, largely on higher over-the-horizon microwave system sales. First-half revenue rose 2.1%; gross profit declined $0.3 million as the gross margin contracted 1.1 percentage points, reflecting sales mix and lower-margin development work.
- Six-month operating cash flow was only $54,000, versus $11.4 million a year earlier, mainly due to working-capital needs and the timing of customer shipments, collections, billings and related payments. Investing used $3.4 million; financing used $35.3 million, including $29.1 million of share repurchases and $9.1 million of dividends.
- Cash and equivalents were $318.0 million at January 31, down $38.6 million from July 31, 2013. Current liabilities were $266.1 million, including $200.0 million of convertible notes classified as current. Stockholders’ equity was $379.9 million.
- The notes carry 3.0% interest. Holders could require cash repurchase on May 1, 2014; Comtech could call them on or after May 5. The notes’ January 31 fair value was $206.8 million. A $100 million secured revolving facility had no borrowings and $1.8 million of standby letters of credit outstanding; it expires October 31, 2014, with a conditional extension option.
- Comtech repurchased 935,992 shares during the half at an average $31.10 per share. The board raised its annual dividend target to $1.20 per share.
Material changes and segment performance
- Telecommunications transmission: Q2 sales increased 23.4% to $56.5 million; first-half sales increased 11.9% to $110.9 million. Growth was primarily from North African over-the-horizon microwave contracts. Q2 segment operating income was $10.3 million; first-half was $19.2 million.
- RF microwave amplifiers: Q2 sales rose 7.8% to $22.0 million, while first-half sales fell 7.7% to $42.2 million. First-half segment operating income declined to $1.7 million from $2.4 million.
- Mobile data communications: Q2 sales fell 17.9% to $6.9 million; first-half sales fell 24.5% to $15.7 million, mainly due to lower U.S. Army BFT-1 sustainment activity. Segment results also benefited from a $2.0 million SENS technology sale in the first quarter.
- Q2 2013 operating income included $1.1 million of unusual benefits from a Stampede earn-out revaluation and a microsatellite wind-down accrual reversal. First-half 2013 included a net $2.7 million benefit from those items; first-half 2014 included a $0.2 million Stampede earn-out benefit. Excluding these items, management reported stronger underlying year-over-year operating performance.
Outlook, commentary and risks
- Management expected FY2014 sales to exceed FY2013’s $319.8 million and operating income to exceed $34.5 million, with operating margin targeted at at least 11%. FY2014 gross profit dollars were expected to rise, with gross margin approximately comparable to FY2013. The effective tax rate, excluding discrete items, was expected to be about 36.5%.
- Management expected Q3 to be the fiscal year’s weakest quarter, with operating margin around 8%, and Q4 to be the peak. Q2 included revenue from microwave-system contracts originally expected later in the year, making the expected second-half pattern notably uneven.
- Management anticipated significant positive operating cash flow in the second half but could not reliably estimate the amount. Its FY2014 outlook assumed the $200 million notes would be converted, redeemed or repurchased in May, reducing interest expense; the cash impact depends on that outcome. Capital expenditures were forecast at $5–7 million.
- The outlook depends on continued performance and timing of large North African contracts, orders for satellite earth-station and RF products, and U.S. Army funding and contract awards. The Army had informally indicated an intention to award a new multi-year BFT-1 sustainment contract, but no draft contract had been received; failure to renew the contract or annual $10 million IP license could materially hurt the outlook.
- Defense-budget uncertainty, international economic and political conditions, order timing, customer acceptance, contract-cost estimates and product mix could cause significant fluctuations. International sales were 57.3% of first-half revenue; one prime contractor represented 13.0% of first-half sales and 17.9% of receivables at January 31.
- The DCAA recommended an $11.819 million price adjustment plus interest concerning the original BFT-1 contract. Comtech disputes the draft audit findings; it had been told a final report was issued but had not received it. A refund, if ultimately required, could materially affect results in the period recognized, though management did not expect a material adverse effect on consolidated financial condition.
- Goodwill was not impaired in the August 2013 annual test, but the RF microwave amplifiers reporting unit had only a 13.2% estimated fair-value cushion over carrying value and was identified as at risk of a future test failure. A future step-two test could result in a write-off of up to $42.8 million of goodwill and intangibles. Two U.S. government investigations involving the CEO and the company remained unresolved; management said it had not been contacted since September 2012 and did not believe proceedings were likely. Other legal matters were not expected to be material.
Key facts for investors to verify
- Whether the May 2014 convertible-note put, redemption or conversion occurred, and its effects on cash, debt and interest expense.
- Whether the Army awarded and funded the anticipated BFT-1 sustainment contract and renewed the annual IP license.
- Second-half execution, cash conversion and margin performance on the North African microwave contracts, including the expected Q3 slowdown.
- Final disposition and potential exposure from the DCAA audit recommendation and the pending government investigations.
- Whether RF microwave amplifier performance and valuation assumptions support the goodwill carrying value; monitor for impairment indicators.