Comtech Telecommunications Corp. (CMTL) Q4 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Comtech Telecommunication Corp.'s Fourth Quarter Fiscal 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded this Thursday, September 27, 2012. I would now like to turn the conference over to Ms. Maria Salerno of Comtech Telecommunications. Please go ahead, ma'am.

Thank you, and good morning. Welcome to the Comtech Telecommunications Corp. conference call for the fourth quarter and fiscal year ended July 31, 2012. With us on the call this morning are Fred Kornberg, President and Chief Executive Officer of Comtech; and Michael Porcelain, Senior Vice President and Chief Financial Officer. Before we proceed, I need to remind you of the company's Safe Harbor language. Certain information presented in this call will include, but not be limited to, information relating to the future performance and financial condition of the company, the company's plans, objectives and business outlook; the plans, objectives and business outlook of the company's management, and the company's assumptions regarding such performance, business outlook and plans are forward-looking in nature and involve certain significant risks and uncertainties. Actual results could differ materially from such forward-looking information. Any forward-looking statements are qualified in their entirety by cautionary statements contained in the company's Securities and Exchange Commission filings. I am pleased now to introduce the President and Chief Executive Officer of Comtech, Fred Kornberg. Fred?

Thanks, Maria, and good morning, everyone, and thank you for joining us on this call. Yesterday afternoon, despite ongoing challenging market conditions, we reported a solid fourth quarter result of $112.8 million in revenue and a GAAP diluted EPS of $0.38. For the year, our revenues totaled $425.1 million of revenues and a GAAP diluted EPS of $1.42. Excluding a $2.6 million pretax restructuring charge related to the wind down of our microsatellite product line, our non-GAAP diluted EPS for the fourth quarter was $0.45. And excluding this charge and cost associated with a contested proxy that occurred early in the year, our non-GAAP EPS for the year was $1.55. Our adjusted EBITDA for the fourth quarter was $21.6 million and $76.2 million for the full fiscal year. As indicated in yesterday's press release, we enter fiscal 2013 with optimism. Based on our backlog and additional expected bookings, we believe we can achieve revenues of $375 million to $395 million and a GAAP diluted EPS between $1.40 to $1.50 in fiscal 2013. This guidance assumes virtually no revenue from our microsatellite product line, which in fiscal 2012 was $17.7 million. Our GAAP guidance also includes approximately an additional $1 million or $0.03 of diluted EPS of additional restructuring charges that we expect to record in the first quarter of fiscal 2013. Our adjusted EBITDA guidance is expected to be in the range of $70 million to $74 million for fiscal 2003 -- '13. In light of our expectations of generating solid operating cash flows in fiscal 2013 and beyond, our Board of Directors approved a dividend for our first quarter of fiscal 2013 of $0.275. This dividend is expected to be paid on November 20, 2012 to stockholders of record on October 19, 2012. To date, we have paid out approximately $47.5 million of dividends over the past 8 consecutive quarters, and believe our dividend program is an excellent way to return capital to our stockholders. Now let me turn it over to Mike Porcelain to provide a brief overview of our financial results. Mike?

Thanks, Fred, and good morning, everyone. As Fred mentioned, I'll walk you through Q4 and make a few comments about the full year, and as I normally do, I will provide some additional commentary on our expected financial results for fiscal 2013. During Q4, we generated revenues of $112.8 million, of which 51.8% were for U.S. government end users, 35.4% were for international end users, with the remainder being for domestic commercial end customers. For the full year fiscal 2012, we finished at $425.1 million of revenue, with nearly 50% being generated from the U.S. government and approximately 39% being generated from international end users. Looking forward, we expect that U.S. government sales, as a percentage of total expected sales, will significantly decline from the levels we achieved in Q4 due to a change in overall segment sales mix as a result of lower expected sales on our mobile data communication segment. Now let me walk you through sales by each segment. Net sales from our telecom transmission were $53.8 million in Q4 of fiscal 2012 as compared to $58.1 million we achieved in Q4 of last year, representing a decrease of 7.4%. This decline is attributable to lower sales of both Satellite Earth Station products and over-the-horizon microwave system products. During the quarter, we began recording some nominal revenue related to our $55 million over-the-horizon microwave system contract, and we do expect to record revenue related to this contract over the next 3 years. For the full year fiscal 2012, net sales on our telecom transmission segment were $210 million. As Fred will discuss in a bit more detail, we expect sales in this segment to increase in fiscal 2013 driven by increased sales of both Satellite Earth Station and over-the-horizon microwave system products. Net sales on our RF microwave amplifier segment were $30.8 million as compared to $22.2 million in Q4 of fiscal 2011. This increase of 38.7% reflects higher sales of both our traveling wave tube amplifiers and solid-state high-power amplifiers. For the full year fiscal 2012, net sales on our RF microwave amplifier segment were $102.5 million, and we expect fiscal 2000 sales on this segment to be comparable to this number. Turning to our mobile data communications segment. As expected, sales in Q4 of fiscal 2012 substantially declined, and were $28.1 million as compared to $60 million, a decrease of 53.2% from Q4 of fiscal 2011. This decline is attributable to both a substantial decline in MTS and BFT-1 sales to the U.S. Army and lower sales related to the design and manufacture of microsatellites. As we announced yesterday, we adopted a restructuring plan to wind down our microsatellite product line. Sales in microsatellites approximated $2.9 million in Q4, and were $17.7 million for fiscal 2012. For the full year of fiscal 2012, net sales in our mobile data communication segment were $112.6 million. We do expect that sales in this segment will be materially lower in fiscal 2013 as compared to fiscal 2012. As a reminder, we are no longer procuring or providing satellite transponder capacity to the U.S. Army. We currently have $16.6 million of BFT-1 orders in our backlog, and we are expecting that our contracts optional performance period will be exercised by the U.S. Army in March 2013. Let me walk you through our gross margin and SG&A line items now. As disclosed in yesterday's press release, our Q4 and year-to-date results and related line items were impacted by restructuring charges associated with our decision to wind down the microsatellite product line. Given the disclosure in our press release of this impact on each P&L line item directly on the face of the income statement, I will not repeat line by line the impact of such charges, rather, I will just walk you through our GAAP results. Our gross profit in Q4 of fiscal 2012, as a percentage of net sales, was 43.6% as compared to 42% during the comparative period of last year. The increase was attributable to a higher percentage of consolidated net sales occurring in our telecom transmission segment, which generally has a higher gross profit percentage than our other 2 reportable operating segments. Looking forward, based on the nature and type of orders that are currently in our backlog and anticipated orders that we expect to receive, we do believe that gross profit as a percentage of consolidated net sales in fiscal 2013 will increase from the level we achieved in 2012. This increase is a result of anticipated growth in our telecom transmission segment and anticipated lower sales in our mobile data communications segment, which has relatively lower gross margins. On the expense side, SG&A expenses were $23.4 million or 20.7% of Q4 fiscal 2012 net sales as compared to 17.4% we achieved in Q4 of last year. Given the lower level of expected sales in fiscal 2013, we do expect that SG&A expenses in dollars will decline in fiscal 2013 as compared to fiscal 2012. R&D expenses were $9.9 million or 8.8% of consolidated net sales in Q4 of fiscal 2012 versus the $12 million or 8.5% in Q4 of fiscal 2011. For the year, R&D expenses were 9.1% of consolidated net sales. We expect to continue to invest in R&D. As such, despite the expected decline in sales, we anticipate that R&D expenses in dollars in fiscal 2013 will be comparable to the level we spent in fiscal 2012. As a percentage of consolidated net sales, both our SG&A and R&D expenses are expected to increase. Amortization of intangibles with finite lives in the fourth quarter of fiscal 2012 was $1.6 million. This was a decrease of $400,000 as compared to the fourth quarter of last year. Consolidated operating income in Q4 of fiscal 2012 was $14.3 million or 12.7% of consolidated net sales as compared to $20.5 million or 14.6% in the fourth quarter of last year. Although always difficult to predict based on our expected consolidated sales level and expected product mix, we anticipate that our consolidated operating income in fiscal 2013, as a percentage of consolidated net sales, will range between 13% and 14%. Total stock-based compensation in the fourth quarter of fiscal 2012, which is recorded in our unallocated segment, was $900,000 compared to $1.4 million in the fourth quarter of fiscal 2011. Interest expense in the fourth quarter of fiscal 2012 was $2.3 million as compared to $2.1 million in the fourth quarter of fiscal 2011. Interest expense in Q4 of fiscal 2012 includes accelerated amortization of deferred financing cost related to the lowering of our borrowing capacity on a revolving credit facility from $150 million to $100 million. Interest income and other was $295,000 in the fourth quarter of fiscal 2012 as compared to $544,000 in the fourth quarter of fiscal 2011. The decrease is primarily attributable to lower cash balances as a result of the significant repurchases of our common stock, as well as our dividend payments. Turning to income taxes. Our GAAP effective tax rate for the fourth quarter of fiscal 2012 was 35.5%. We expect that our GAAP tax rate in fiscal 2013, including any discrete items, will approximate -- excluding any discrete items, will approximate 34.5% due to anticipated changes in our overall tax components, primarily the expected geographic mix of our earnings. Finally, as mentioned earlier, for the fourth quarter of fiscal 2012, we delivered GAAP diluted EPS of $0.38 as compared to $0.42 for the fourth quarter of fiscal 2011. For the year, we delivered GAAP diluted EPS of $1.42 as compared to $2.22 for fiscal 2011. Now let me provide some additional financial metrics. Adjusted EBITDA, as defined at the end of our press release that we issued yesterday, was $21.6 million in Q4 and $76.2 million for fiscal 2012. We finished the year with backlog of $153.9 million compared to $145 million as of July 31, 2011. This is our highest level of backlog as of any quarter in fiscal 2012, and includes the benefit of our $55 million over-the-horizon microwave system contract and $16.6 million of orders related to our BFT-1 sustainment activities. Now let me turn to our balance sheet, which remains very strong. As of July 31, 2012, we had $367.9 million of cash and cash equivalents. This cash balance does not reflect our Q4 dividend payment, which occurred in August of 2012, for approximately $4.8 million. During the year, we generated $53.5 million of positive cash flows from operations, and we do expect to continue to generate strong cash flows from operations in fiscal 2013. In fiscal 2012, we repurchased 217.4 million of our common stock and we have 11.3 million left for repurchases that we can make pursuant to our existing authorization. Now let me turn it back to Fred, who will discuss our business strategies and outlook in further detail. Fred?

Thanks, Mike. I'd like to provide a brief update on each of our current product lines, and I'll start with our telecommunications segment, which is the backbone of our current business. The solid Satellite Earth Station product bookings in the second and third quarters contributed to our fourth quarter being the strongest revenue quarter of fiscal 2012 for this product line. Bookings also increased slightly in the fourth quarter as compared to the third quarter. The increase in the fourth quarter bookings was primarily attributable to continued strength in the international part of this product line. As we've discussed before, our products are key enablers in making satellite networks more efficient in addressing severe bandwidth shortages in the satellite area. Today, satellite for backhaul is the preferred solution to moving voice, video and data back to central switching stations when new cellular networks are being rolled out in less developed parts of the world. Despite challenging economic conditions, we continue to invest heavily in R&D, resulting in new product introductions such as our advanced VSAT product line. In fiscal 2012, we were awarded a $3.5 million order from Harris CapRock for our advanced VSAT products, which will be used by Harris CapRock maritime customers, including their Royal Caribbean Cruise lines. This was a significant order, as it enters us into the large market for maritime communication solutions, and positions us to take market share from some of the entrenched players in the market. On the U.S. government side of the Satellite Earth station product line, the current paralysis in Washington and the threat of sequestration continues to make bookings a challenge. That said, a few months ago, we received our first U.S. government order for modems using our Carrier-in-Carrier technology. This is important since it allows us to sell our most attractive product technology to the various potential buyers within the U.S. government. We're hopeful that we can displace some of our competitors by offering this industry-leading capability. Although we continue to operate in very uncertain economic and political environments, the continued strength in our international bookings, combined with our expectations of a bit more clarity on the U.S. government side once the presidential election is over, make us believe that sales and bookings in fiscal 2013 for our Satellite Earth Station products will be meaningfully higher than they were in fiscal 2012. Turning to the other component of our telecommunications transmission segment. We remain very bullish about our over-the-horizon microwave product line. On the international front, after a long wait, we finally received a $55 million contract from a U.S. prime contractor relating to the next phase of a North African customer's communication project. Just as important, the end customer has already asked our prime contractor for a proposal on the next phase of the same project, and both we and our customer have already submitted our proposals. As I've said before, it is very difficult to predict the timing of large over-the-horizon awards. However, we have been told that the end customer's intent is to issue another large award during our fiscal 2013. There are also other substantial opportunities relating to separate projects, which we're also engaged with the end customer on directly and through prime contractors. We believe this end customer could provide our company additional revenue opportunities for the foreseeable future. We have also refocused on marketing our products and systems to foreign countries that have challenges in communicating over difficult terrain. For example, we have also made headway with various new potential customers in the Middle East, Northern Europe, Africa and Asia. We understand that political unrest in certain regions may make lead times longer than usual, and we are cautiously optimistic about these opportunities in the intermediate to long-term. All of these potential customers have a requirement for tropo, and are either preparing specifications, negotiating with us or waiting for government approval for their projects. We're confident that we will receive an order from at least one new international customer in fiscal 2013. On the U.S. government front, we continue to supply a prime contractor that is using its antennas and our radios to offer a troposcatter system in a transportable flyaway configuration, which is capable of providing seamless compatibility with legacy-fielded, government, over-the-horizon microwave systems. To date, we have received orders for over 48 systems with additional funding for long-lead items for another 20 systems. We believe that additional orders for this product may be forthcoming, as there are hundreds of potential units to be deployed. Also, over the past 5 years, our over-the-horizon microwave systems, including upgraded TRC-170s, have been fielded by the U.S. Military in Iraq, Afghanistan and other parts of the world, and have proven to be an important link in critical communications channels. Overall, we believe that our telecom transmission product lines are weathering the current adverse economic geopolitical and government spending environments and are poised for growth as conditions improve and government funding frees up. Moving to our RF microwave amplifiers segment, our traveling wave tube amplifiers or TWTAs and solid-state power amplifiers or SSPAs serve critical needs in both the commercial and defense markets. Our TWTAs are used extensively in the satellite communications market, enabling vital services such as traditional broadcast, Direct to Home broadcast, satellite news gathering and the emerging satellite broadband communications area. Among our more recent commercial TWTA wins are contracts for our new industry-leading 500-watt Ka-band amplifiers, which are key components in the vast majority of North American and European high throughput satellite systems. On the defense side, our TWTA products are used to support high capacity U.S. Military communication systems such as wideband global satellite or WGS, Milstar system, and we've also supplied products for both the FAB-T and WIN-T programs. Our SSPA products are used in commercial applications such as aviation, medical and instrumentation testing, and also used in a number of electronic warfare applications, including counter-IED systems. In fact, during the past few years, a significant portion of our SSPA sales have come from our participation in counter-IED programs. This past year, we have substantially completed work on development contract in support of the DoD's next-generation counter-IED program, most notably CREW 3.3, and believe that we will receive the lion's share of the related production orders. However, based on recent discussions, it appears that orders relating to CREW 3.3 may slip further to the right than we were anticipating, and as such, the contribution to revenue from CREW 3.3 will most probably slip into fiscal 2014. We believe -- we also believe that our RF microwave amplifier segment is navigating through this difficult environment more effectively than most of our competitors. In our mobile data communications segment, revenues in fiscal 2012 relating to BFT-1 and MTS were substantially lower than those reported in the past few years, and that trend is expected to continue into fiscal 2013. On a positive note, some of the short-term uncertainty relating to BFT-1 and MTS was resolved in connection with the sustainment of airtime contracts that we received in the third quarter. We're currently providing both MTS and BFT-1 sustainment services pursuant to a 3-year IDIQ contract that we were awarded in March. This contract has a not to exceed value of $80.7 million and a base performance period that began on April 1, 2012, and ends on March 31, 2013. The contract provides for 2 12-month exercisable option periods, and payments of our $10 million annual IP license fees beyond the base year are contingent upon the U.S. Army's exercise of one or both of those optional performance periods. In our guidance, we have assumed that the U.S. Army will exercise the first option period before the end of March 2013. During the year, our microsatellite product line continued to be impacted by U.S. government budget pressures, and we saw no signs of such pressures moderating anytime soon. As a result in the fourth quarter, we adopted a restructuring plan to wind down our microsatellite product line. As of today, we have substantially completed the repositioning of our mobile data communication segment, and are now focused on providing BFT-1-related services to our legacy U.S. Army customer and seeking other government opportunities that our technology can be readily adopted to. Finally, we continue to believe that we have struck the right balance between returning significant cash to our stockholders and retaining the ability to be opportunistic in pursuing acquisitions, which will create stockholder value. We have a long history of being both disciplined and diligent in pursuing our acquisition strategy. As such, we continue to be focused on the right deal, and not necessarily on the one that is available at the moment. At this point, I'd like to proceed to the question-and-answer part of our conference call. Operator?

[Operator Instructions] We can go first to the side of Joe Nadol with JPMorgan.

It's actually Chris Sands, in for Joe this morning. A quick question, and Fred, you touched on at the end there regarding capital deployment. The share repurchase authorization is down to a level that's well below where you've been running the last few years, which I guess gives you less optionality on that front. Can you just discuss, is it more M&A opportunities you're seeing or what the strategy there might be?

I think to answer both, I think, both questions. I think at this time, our Board of Directors believes that we have purchased an appropriate amount of shares. And as far as the M&A opportunities, we're always looking, but there's nobody on the -- let's say, on the target area right now.

Your next is Mark Jordan with Noble Financial.

Question relative to mobile data. With the wind down of the microsat business and that you're just focused on the sustainment of BFT-1, in short, for a proxy to -- or an estimate of that group, should we just take the $80.7 million and divide it by 3, and assume that that's a reasonable guesstimate of the revenue that could be derived from that segment in fiscal '13?

Yes, we do have some lingering orders that are not -- were not in that $85 million order, which we'll kind of ship out in Q1, but if you do look out beyond Q1, I think that is the right way to look at it.

Okay. And should one assume that, that -- say, $27 million would be spread equally because, I guess, you're taking the property rights equally one fold every month, and that the service is being linear also?

Yes, I think, right now, that's how we're looking at it. Obviously, the specific orders on that could come in, could change the mix of work, but right now, we do see pretty much a level workload once we get beyond Q2.

Okay. Do you have a CapEx, expected CapEx, number for, say, '13 and what might be a reasonable range for '14?

We haven't really taken a look at '14. Although, I wouldn't expect it to be much different than '13 at this point. We're looking at somewhere between $8 million and $10 million for the company as a whole.

Okay. Could you fill in the backlog? I think you gave mobile data had, what, a $16.1 million backlog, but the other 2 components would comprise the 153.9?

Sure, the $16.6 million number, Mark, was just the mobile data comm backlog related to BFT-1 business activities. So the mobile data comm backlog, as a whole, is $19.9 million. Our RF amplifier segment was $46.2 million, and our telecom transmission segment, which includes the benefit of the large Algerian contract was $87.8 million.

Okay. Final question relative to the overall tropo business, you did state a goal or expectation for having at least one large contract that could be received in fiscal '13. If you look at your pipeline, that one -- how many opportunities do you have out there to fulfill that one slot that you've expected?

We have a number of opportunities. As I mentioned, with the current North African end user, we, obviously, we and our prime contractor have just submitted another proposal, which is equivalent to the contract that we just got. The customer is saying that this could happen in our fiscal 2013, but as we all know, things take a long time and necessarily those timelines are not necessarily met. Having said that, we also have a number of other opportunities in other parts of the world that are in the pipeline that vary anywhere from $20 million to $40 million. We expect that out of the 5 or more opportunities that we have that we'll land one.

[Operator Instructions] We'll go next to the side of Chris Quilty with Raymond James.

Just, first, a quick question for Mike. With regard to the over-the-horizon order, do you take the entire $55 million into the backlog even though it's a 3-year performance period?

Yes.

Okay. And how about with reference to the BFT, MTS contracts, is that just the one year without the option periods?

Yes. Whatever we have is in terms of a funded order goes in our backlog for mobile data comm, so that would be correct, and so it will come up to about $16.6 million of MTS and BFT-1 backlog as of 7/31, and a piece of that is related, like I say, to some lingering orders that we had gotten outside of our first BFT-1 sustainment contract. And just a real quick note, on the $55 million, not all of that's in backlog because we did record some nominal revenue in Q4, so it's not exactly that full number.

Got you. And again, on the OTH percentage of completion accounting and you tend to be fairly conservative in the early years of that, and then based upon performance, you take in incremental profits or losses towards the back end of the contract?

That's the right way to look at it.

Okay. Focusing on the telecom business, I think you mentioned that the strength you saw was international. Can you identify particular end market applications where the strength was coming from?

It's primarily in the backhaul area, and it's pretty well around the world, Asia, Africa. Europe is down a bit from our prior numbers, but in general, it's really spread around.

Okay. And by backhaul, you mean cellular backhaul?

Cellular backhaul, yes.

Okay. And in terms of new products in that area, the new contract with Harris for some of the maritime and mobility applications, was that based upon an existing product? Or is that an entirely new product that you won that contract with?

That's a product that we developed in the past, call it 12 months. So it's relatively a new product for us, and we're really entering a new market area for us.

Okay. And it's different than you had an effort back 1 year, 2 years ago focused on Terraria [ph]. I haven't heard any announcement associated with that particular effort. Is that still ongoing?

Yes. The 2 are different, and I think we can say that we dropped the other one.

Okay. And when you look at the market opportunity here in terms of maritime and mobility, where you really haven't had a presence, I think most of that dominated by iDirect, how big of an addressable market?

It's hard to quantify because, as you mentioned, iDirect is a major player in that market, and a lot of the market is so-called TDMA. Our technology in the area is not necessarily TDMA, but another version of the SCPC version. We think that our SCPC version today is extremely competitive with the TDMA versions, and so that we believe we can attack this market and capture a good deal, but it's really hard to quantify.

Okay. RF amplifier business, I mean, you hit the sort of EBIT margins you were targeting in the long-term. Should we see that as sustainable? Or were there onetime items in the quarter that boosted the margin performance?

Yes. It was definitely a good quarter, no doubt about it. I mean, we got over 11%. That's probably not a number to look at next year, but other than that, I will say a lot of the Q4 was product mix, and we'd like to see some of the CREW orders come into bring that margin up a little bit, but that's not going to happen until '14. So I would expect our margin profile in '13 to look very similar to what we did in '12 for the year.

Okay, and you have retired all of those money-losing development programs in the RF segment?

Well, not retired, but we did shift the development products out the door. So I mean, those are very good active programs for us, and some of them relate to the CREW 3.3 activity. So retire wouldn't be the right word, but shipped and accepted by the customer would be better.

Okay. I meant retired the losses and moved on to profitability?

Yes, that would be fair.

And I'm showing no further questions in queue at this time.

No other questions? Okay, thanks, again, for joining us today, and we look forward to speaking with you again in December.

And this concludes today's program. Have a great day. You may disconnect at this time.