Comtech Telecommunications Corp. — Q2 FY2011 Form 10-Q
Reporting period: Three and six months ended January 31, 2011. The quarter is the second quarter of Comtech’s fiscal year. Financial statements are unaudited; dollar amounts below are in millions unless otherwise noted.
Business context
Comtech develops communications products and services through three segments: telecommunications transmission, mobile data communications, and RF microwave amplifiers. Sales include substantial U.S. government business, particularly U.S. Army Movement Tracking System (MTS) and Blue Force Tracking (BFT-1) programs.
Financial performance and liquidity
| Metric | Three months ended Jan. 31, 2011 | Prior-year quarter | Six months ended Jan. 31, 2011 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $162.8 | $171.1 | $341.0 | $304.9 |
| Gross profit | $60.9 | $63.5 | $125.1 | $113.3 |
| Gross margin | 37.4% | 37.1% | 36.7% | 37.1% |
| Operating income | $25.3 | $27.4 | $65.3 | $42.4 |
| Net income | $16.1 | $16.3 | $41.8 | $25.4 |
| Diluted EPS | $0.52 | $0.51 | $1.32 | $0.81 |
- Quarterly sales declined 4.9% and operating income declined 7.8%; net income was down 1.5%. Six-month sales rose 11.8%, while net income increased 64.6%.
- Six-month operating income included a $12.5 million net merger termination fee from the terminated CPI International merger. Excluding the fee, operating income increased approximately $10.5 million, or 24.8%, year over year.
- Cash provided by operations was $44.2 million for the six months, versus $28.0 million a year earlier. Capital spending on property and equipment was $3.4 million. Cash and cash equivalents declined $14.3 million to $593.3 million, principally after $46.8 million of share repurchases and $6.9 million of dividends.
- At January 31, current assets were $775.3 million and current liabilities $97.8 million. The company had $200.0 million of 3.0% convertible notes outstanding and no revolving-credit borrowings; $1.9 million of standby letters of credit were outstanding. Cash exceeded notes by approximately $393.3 million. The $150 million unsecured revolving facility expires January 31, 2014 and requires at least $100 million of unrestricted cash.
- The company repurchased 1.63 million shares for $46.8 million at an average $28.73 per share, with $53.2 million remaining under the authorization. It targeted annual dividends of $1.00 per share, subject to Board approval; a $0.25-per-share dividend was declared for payment in May 2011.
Material changes and segment trends
- Telecommunications transmission: Quarterly sales increased 6.7% to $62.3 million, supported by over-the-horizon microwave contracts. Six-month sales increased 6.0% to $111.4 million.
- Mobile data communications: Quarterly sales fell 8.9% to $76.7 million as MTS deliveries declined; six-month sales rose 32.2% to $182.9 million on timing of backlog deliveries. MTS and BFT-1 together represented 47.7% of consolidated six-month sales.
- RF microwave amplifiers: Quarterly sales declined 16.1% to $23.9 million; six-month sales declined 24.1% to $46.7 million. Management cited weaker demand, government procurement delays and lower government spending.
- Quarterly consolidated gross margin edged up to 37.4%, principally because a greater share of sales came from the higher-margin telecommunications transmission segment. Six-month gross margin declined to 36.7%, primarily reflecting sales mix.
Outlook, commentary and risks
- Management expected FY2011 consolidated sales to be significantly below FY2010, but operating income to be comparable, supported by cost reductions, product mix and the $12.5 million termination fee. The filing gives no specific FY2011 revenue or operating-income forecast. Backlog at January 31 was approximately $199.6 million, a substantial portion expected to be recognized in FY2011.
- Management expected mobile data communications sales to decline significantly in the second half of FY2011, with the fourth quarter the lowest. It also expected future annual sales and operating income from MTS and BFT-1 to materially decline from current levels. The current MTS and BFT-1 contracts expire July 12 and December 31, 2011, respectively; Army purchases under these IDIQ contracts are not guaranteed.
- The Army selected another vendor for BFT-2, reportedly at an evaluated price approximately 50% below Comtech’s proposal. A proposed transition to the Joint Battle Command-Platform could affect future MTS opportunities. Comtech was discussing possible future BFT-1 contract arrangements with the Army.
- Management expected FY2011 telecommunications transmission sales to increase, while RF microwave amplifier sales were expected to be significantly lower than FY2010. It expected gross margin to improve year over year, SG&A dollars to be slightly lower, and the effective tax rate excluding discrete items to be approximately 35%.
- Risks include dependence on large and potentially timing-sensitive government contracts, government funding and termination decisions, international political and economic conditions, contract-cost and warranty estimates, and the possibility that customer delays or cancellations exceed expectations. The RF microwave amplifiers unit had $29.6 million of goodwill; management warned that continued weak performance could lead to impairment, although its August 2010 review found no impairment.
- The independent ITAR audit reported no violations and noted improvements; the Department of State was still reviewing the report. Patent litigation remains pending, with a settlement in principle with one defendant and a trial scheduled for April 2012 against remaining defendants. IRS audits of FY2007 and FY2008 remain open and could result in a material assessment, according to the filing.
Most important facts for investors to verify
- Subsequent MTS/BFT-1 orders, contract extensions or replacement awards, and the pace and financial effect of the Army’s transition to BFT-2/JBC-P.
- Whether the FY2011 sales decline and comparable operating-income outlook are achieved, particularly after excluding the one-time $12.5 million termination fee.
- RF microwave amplifier bookings, margins and goodwill impairment indicators, as well as the performance and timing of large international microwave contracts.
- Operating cash generation and working-capital movements, covenant compliance, and the cash effects of further repurchases, dividends or acquisitions.
- Outcomes of the IRS audits, Department of State ITAR review and pending patent litigation.