COMTECH TELECOMMUNICATIONS CORP /DE/ files 10-Q in a filing on December 04, 2019.
Sales to U.S. government customers include sales to the U.S. Department of Defense (“DoD”), intelligence and civilian agencies, as well as sales directly to or through prime contractors. Domestic sales include sales to commercial customers, as well as to U.S. state and local governments. Except for the U.S. government, there were no customers that represented more than 10.0% of consolidated net sales during the three months ended October 31, 2019 and 2018. International sales include sales to U.S. domestic companies for inclusion in products that are sold to international customers. Except for the U.S., no individual country (including sales to U.S. domestic companies for inclusion in products that are sold to a foreign country) represented more than 10.0% of consolidated net sales for the three months ended October 31, 2019 and 2018.
We believe the fair values of our operating lease liabilities and our finance lease and other obligations, which currently reflect weighted-average discount rates of approximately 4.05% and 4.21%, respectively, would not be materially different than their carrying values as of October 31, 2019. See Note (12) – “Leases” for further information.
As of October 31, 2019 and July 31, 2019, except for the U.S. government (and its agencies), which represented 35.4% and 27.8%, respectively, of total accounts receivable, there were no other customers which accounted for greater than 10.0% of total accounts receivable.
Interest expense related to our credit facilities, including amortization of deferred financing costs, recorded during the three months ended October 31, 2019 and 2018, was $1,753,000 and $2,542,000, respectively. The amount for the three months ended October 31, 2019 relates to our new Credit Facility; whereas, the amount for the three months ended October 31, 2018 relates to our Prior Credit Facility. During the three months ended October 31, 2019 and 2018, our blended interest rate approximated 4.70% and 6.00%, respectively.
Borrowings under the Credit Facility shall be either: (i) Alternate Base Rate borrowings, which bear interest from the applicable borrowing date at a rate per annum equal to (x) the greatest of (a) the Prime Rate (as defined) in effect on such day, (b) the Federal Funds Effective Rate (as defined) in effect on such day plus 1/2 of 1.00% per annum and (c) the Adjusted LIBO Rate (as defined) on such day (or, if such day is not a business day, the immediately preceding business day) plus 1.00% per annum, plus (y) the Applicable Rate (as defined), or (ii) Eurodollar borrowings, which bear interest from the applicable borrowing date at a rate per annum equal to (x) the Adjusted LIBO Rate for such interest period plus (y) the Applicable Rate. Determination of the Applicable Rate is based on a pricing grid that is dependent upon our Secured Leverage Ratio (as defined) as of the end of each fiscal quarter for which consolidated financial statements have been most recently delivered.
As of October 31, 2019, the aggregate number of shares of common stock which may be issued, pursuant to the Plan, may not exceed 10,362,500. At the Fiscal 2019 Annual Meeting of Stockholders held on December 3, 2019, stockholders approved an amendment to our Plan to increase the share reserve under the Plan by 600,000 shares, to a total 10,962,500 shares. Stock options granted may not have a term exceeding ten years or, in the case of an incentive stock award granted to a stockholder who owns stock representing more than 10.0% of the voting power, no more than five years. We expect to settle all outstanding awards under the Plan and employee purchases under the ESPP with the issuance of new shares of our common stock.
Our ESPP provides for the issuance of up to 1,050,000 shares of our common stock. Our ESPP is intended to provide our eligible employees the opportunity to acquire our common stock at 85% of fair market value at the date of issuance. Through October 31, 2019, we have cumulatively issued 797,186 shares of our common stock to participating employees in connection with our ESPP.
ESPP stock-based compensation expense primarily relates to the 15% discount offered to participants in the ESPP. During the three months ended October 31, 2019 and 2018, we recorded benefits of $310,000 and $130,000, respectively, which primarily represents the recoupment of certain share units.
Based on our quantitative evaluation, we determined that our Commercial Solutions and Government Solutions reporting units had estimated fair values in excess of their carrying values of at least 29.0% and 122.2%, respectively, and concluded that our goodwill was not impaired and that neither of our two reporting units was at risk of failing the quantitative assessment. It is possible that, during fiscal 2020 or beyond, business conditions (both in the U.S. and internationally) could deteriorate from the current state, our current or prospective customers could materially postpone, reduce or even forgo purchases of our products and services to a greater extent than we currently anticipate, or our common stock price could decline. A significant decline in our customers’ spending that is greater than we anticipate or a shift in funding priorities may also have a negative effect on future orders, sales, income and cash flows and we might be required to perform a quantitative assessment during fiscal 2020 or beyond. If assumed net sales and cash flow projections are not achieved in future periods or our common stock price significantly declines from current levels, our Commercial Solutions and Government Solutions reporting units could be at risk of failing the quantitative assessment and goodwill assigned to the respective reporting units could be impaired.
Based on our quantitative evaluation, we determined that our Commercial Solutions and Government Solutions reporting units had estimated fair values in excess of their carrying values of at least 29.0% and 122.2%, respectively, and concluded that our goodwill was not impaired and that neither of our two reporting units was at risk of failing the quantitative assessment. It is possible that, during fiscal 2020 or beyond, business conditions (both in the U.S. and internationally) could deteriorate from the current state, our current or prospective customers could materially postpone, reduce or even forgo purchases of our products and services to a greater extent than we currently anticipate, or our common stock price could decline. A significant decline in our customers’ spending that is greater than we anticipate or a shift in funding priorities may also have a negative effect on future orders, sales, income and cash flows and we might be required to perform a quantitative assessment during fiscal 2020 or beyond. If assumed net sales and cash flow projections are not achieved in future periods or our common stock price significantly declines from current levels, our Commercial Solutions and Government Solutions reporting units could be at risk of failing the quantitative assessment and goodwill and intangibles assigned to the respective reporting units could be impaired.
Significant judgment is required in determining income tax provisions and tax positions. We may be challenged upon review by the applicable taxing authority and positions taken by us may not be sustained. We recognize all or a portion of the benefit of income tax positions only when we have made a determination that it is more likely than not that the tax position will be sustained upon examination, based upon the technical merits of the position and other factors. For tax positions that are determined as more likely than not to be sustained upon examination, the tax benefit recognized is the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The development of valuation allowances for deferred tax assets and reserves for income tax positions requires consideration of timing and judgments about future taxable income, tax issues and potential outcomes, and are subjective critical estimates. A portion of our deferred tax assets consist of federal research and experimentation tax credit carryforwards, most of which was acquired in connection with our acquisition of TCS. No valuation allowance has been established on these deferred tax assets based on our evaluation that our ability to realize such assets has met the criteria of “more likely than not.” We continuously evaluate additional facts representing positive and negative evidence in determining our ability to realize these deferred tax assets. In certain circumstances, the ultimate outcome of exposures and risks involves significant uncertainties. If actual outcomes differ materially from these estimates, they could have a material impact on our results of operations and financial condition.
•We are increasing our Adjusted EBITDA goal to a new range of $99.0 million to $103.0 million as compared to the prior range of $98.0 million to $102.0 million. Our Adjusted EBITDA goal reflects a target of approximately 14.0% of our expected fiscal 2020 consolidated net sales.
We are increasing our Adjusted EBITDA goal to a new range of $99.0 million to $103.0 million as compared to the prior range of $98.0 million to $102.0 million. Our Adjusted EBITDA goal reflects a target of approximately 14.0% of our expected fiscal 2020 consolidated net sales.
•Despite incurring $2.4 million of actual acquisition plan expenses and $0.2 million of estimated contract settlement costs in the first quarter of fiscal 2020, as well as an additional $2.4 million of such costs expected during the second quarter of fiscal 2020, GAAP operating income, as a percentage of the consolidated net sales, is still expected to approximate 7.0%. Excluding such expenses, operating income, as a percentage of fiscal 2020 consolidated net sales, is expected to approximate 7.7%.
Despite incurring $2.4 million of actual acquisition plan expenses and $0.2 million of estimated contract settlement costs in the first quarter of fiscal 2020, as well as an additional $2.4 million of such costs expected during the second quarter of fiscal 2020, GAAP operating income, as a percentage of the consolidated net sales, is still expected to approximate 7.0%. Excluding such expenses, operating income, as a percentage of fiscal 2020 consolidated net sales, is expected to approximate 7.7%.
•There is no change to our expected interest expense rate (including amortization of deferred financing costs) of approximately 4.6% or total interest expense of approximately $7.5 million. Our current and fiscal 2020 expected cash borrowing rate is approximately 4.0%.
There is no change to our expected interest expense rate (including amortization of deferred financing costs) of approximately 4.6% or total interest expense of approximately $7.5 million. Our current and fiscal 2020 expected cash borrowing rate is approximately 4.0%.
•Our effective income tax rate (excluding discrete tax items) for each of the remaining quarters of fiscal 2020 is expected to approximate 23.0%.
Our effective income tax rate (excluding discrete tax items) for each of the remaining quarters of fiscal 2020 is expected to approximate 23.0%.
Net Sales. Consolidated net sales were $170.3 million and $160.8 million for the three months ended October 31, 2019 and 2018, respectively, representing an increase of $9.5 million, or 5.9%. The period-over-period increase in net sales reflects significantly higher net sales in our Commercial Solutions segment, offset in part by a decrease in our Government Solutions segment. Net sales by operating segment are discussed below.
Net sales in our Commercial Solutions segment were $94.3 million for the three months ended October 31, 2019, as compared to $78.0 million for the three months ended October 31, 2018, a significant increase of $16.3 million, or 20.9%. Our Commercial Solutions segment represented 55.4% of consolidated net sales for the three months ended October 31, 2019 as compared to 48.5% for the three months ended October 31, 2018. As further discussed below, demand for our products appears strong and looking forward, we believe this segment will grow in fiscal 2020.
Net sales in our Government Solutions segment were $76.0 million for the three months ended October 31, 2019 as compared to $82.9 million for the three months ended October 31, 2018, a decrease of $6.9 million, or 8.3%. Our Government Solutions segment represented 44.6% of consolidated net sales for the three months ended October 31, 2019, as compared to 51.5% for the three months ended October 31, 2018. As further discussed below, our business remains strong and demand for our solutions still appears robust. Looking forward, we believe that sales in our Government Solutions segment will be similar or slightly higher than the level we achieved in fiscal 2019, with the ultimate level largely determined by the timing of orders and sales.
Domestic sales include sales to commercial customers, as well as to U.S. state and local governments. Except for the U.S. government, there were no customers that represented more than 10.0% of consolidated net sales during the three months ended October 31, 2019 and 2018.
International sales for the three months ended October 31, 2019 and 2018 (which include sales to U.S. domestic companies for inclusion in products that are sold to international customers) were $39.4 million and $39.3 million, respectively. Except for the U.S., no individual country (including sales to U.S. domestic companies for inclusion in products that are sold to a foreign country) represented more than 10.0% of consolidated net sales for the three months ended October 31, 2019 and 2018.
Gross profit, as a percentage of consolidated net sales, for the three months ended October 31, 2019 was 37.3% as compared to 35.9% for the three months ended October 31, 2018. This increase was almost entirely driven by product mix changes as a result of the significant period-over-period increase in net sales in our Commercial Solutions segment. This segment historically achieves higher gross margins than our Government Solutions segment. Gross profit, as a percentage of related segment net sales, is further discussed below.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $31.9 million and $31.8 million for the three months ended October 31, 2019 and 2018, respectively, representing an increase of $0.1 million, or 0.3%. As a percentage of consolidated net sales, selling, general and administrative expenses were 18.7% and 19.8% for the three months ended October 31, 2019 and 2018, respectively. The decrease, as a percentage of consolidated net sales, is primarily attributable to the increase in our consolidated net sales.
During the three months ended October 31, 2018, we incurred $1.4 million of facility exit costs in our Government Solutions segment. Excluding such costs, our selling, general and administrative expenses would have been $30.4 million, or 18.9% of consolidated net sales for the three months ended October 31, 2018.
Based on our current spending plans, we expect total fiscal 2020 selling, general and administrative expenses, in dollars, to be higher and, as a percentage of consolidated net sales, to be slightly lower than the 19.1% recorded in fiscal 2019.
Research and Development Expenses. Research and development expenses were $14.9 million and $13.2 million for the three months ended October 31, 2019 and 2018, respectively, representing an increase of $1.7 million, or 12.9%. As a percentage of consolidated net sales, research and development expenses were 8.7% and 8.2% for the three months ended October 31, 2019 and 2018, respectively.
We continue to invest in enhancements to existing products as well as in new products across almost all of our product lines. Based on our current spending plans, we expect fiscal 2020 research and development expenses, in dollars, to be higher and, as a percentage of consolidated net sales, to be slightly lower than the 8.4% achieved in fiscal 2019.
The increase in our Commercial Solutions segment’s operating income for the three months ended October 31, 2019, both in dollars and as a percentage of related segment net sales, was due primarily to the significant increase in this segment’s net sales offset, in part, by a slight decrease in this segment’s gross profit percentage, higher research and development expenses and increased amortization of intangibles, as discussed above. Looking forward, given expected sales and product mix assumptions, as discussed above, we expect fiscal 2020 operating income, both in dollars and as a percentage of related segment net sales, to be higher than the 10.1% achieved in fiscal 2019.
The increase in our Government Solutions segment’s operating income for the three months ended October 31, 2019, both in dollars and as a percentage of related segment net sales, was due primarily to the $1.4 million of facility exit costs that we incurred during the three months ended October 31, 2018, as discussed above. Excluding such facility exit costs, operating income in our Government Solutions segment for the three months ended October 31, 2018 would have been $8.0 million, or 9.7% of related segment sales. The decrease, both in dollars and as a percentage of related segment net sales, in the three months ended October 31, 2019 was due primarily to the decrease in net sales, as discussed above. Looking forward, given expected sales and product mix assumptions, as discussed above, we expect fiscal 2020 operating income, in dollars, to be comparable to the amount achieved in fiscal 2019, and as a percentage of related segment net sales, to be slightly lower than the 9.2% achieved in fiscal 2019.
Excluding the $2.4 million of acquisition plan expenses and $0.2 million of estimated contract settlement costs, consolidated operating income for the three months ended October 31, 2019 would have been $11.9 million, or 7.0% of consolidated net sales. Excluding the $1.1 million of acquisition plan expenses and $1.4 million of facility exit costs in the three months ended October 31, 2018, consolidated operating income would have been $9.8 million, or 6.1% of consolidated net sales. The increase from 6.1% to 7.0% reflects the benefit of incremental sales growth and changes in overall spending, as discussed above.
Despite the incurrence of $2.4 million of acquisition plan expenses and $0.2 million of estimated contract settlement costs in the first quarter of fiscal 2020 as well as an additional $2.4 million of such costs expected during the second quarter of fiscal 2020, our fiscal 2020 GAAP consolidated operating income (in dollars) is anticipated to be higher than the $41.4 million we achieved in fiscal 2019, and as a percentage of consolidated net sales, to approximate 7.0% as compared to the 6.2% we achieved in fiscal 2019.
Interest Expense and Other. Interest expense was $1.8 million and $2.7 million for the three months ended October 31, 2019 and 2018, respectively. The amount for the three months ended October 31, 2019 primarily relates to our new Credit Facility. The amount for the three months ended October 31, 2018 primarily relates to our Prior Credit Facility. Our effective interest rate (including amortization of deferred financing costs) in the three months ended October 31, 2019 was approximately 4.7%.
Looking forward, we expect our fiscal 2020 interest expense rate to approximate 4.6% and total interest expense to approximate $7.5 million. Our current and expected fiscal 2020 cash borrowing rate (which excludes the amortization of deferred financing costs) is approximately 4.0%.
Provision for (Benefit from) Income Taxes. The provision for income taxes during the three months ended October 31, 2019 was $1.1 million as compared to a benefit from income taxes of $2.1 million for the three months ended October 31, 2018. Our effective tax rate (excluding discrete tax items) for the three months ended October 31, 2019 was 23.0% as compared to 22.75% for the three months ended October 31, 2018. The increase from 22.75% to 23.0% is primarily due to expected product and geographical mix changes reflected in our Business Outlook for Fiscal 2020.
Looking forward, based on the mix and anticipated timing of shipments and performance related to orders currently in our backlog and the mix and timing of expected new orders and related sales, we are targeting consolidated Adjusted EBITDA (in dollars) to be higher in fiscal 2020 as compared to the $93.5 million we achieved in fiscal 2019. As a percentage of consolidated net sales, Adjusted EBITDA is expected to approximate 14.0% in fiscal 2020. If order flow remains strong and we are able to achieve all of our fiscal 2020 business goals, it is possible that our fiscal 2020 Adjusted EBITDA could be higher than our targeted amount.
Borrowings under the Credit Facility shall be either: (i) Alternate Base Rate borrowings, which bear interest from the applicable borrowing date at a rate per annum equal to (x) the greatest of (a) the Prime Rate (as defined) in effect on such day, (b) the Federal Funds Effective Rate (as defined) in effect on such day plus 1/2 of 1.00% per annum and (c) the Adjusted LIBO Rate (as defined) on such day (or, if such day is not a business day, the immediately preceding business day) plus 1.00% per annum, plus (y) the Applicable Rate (as defined), or (ii) Eurodollar borrowings, which bear interest from the applicable borrowing date at a rate per annum equal to (x) the Adjusted LIBO Rate for such interest period plus (y) the Applicable Rate. Determination of the Applicable Rate is based on a pricing grid that is dependent upon our Secured Leverage Ratio (as defined) as of the end of each fiscal quarter for which consolidated financial statements have been most recently delivered.
Our earnings and cash flows are subject to fluctuations due to changes in interest rates primarily from borrowings under our Credit Facility. Based on the amount of outstanding debt under our Credit Facility, a hypothetical change in interest rates by 10% would change interest expense by approximately $0.6 million over a one-year period. Although we do not currently use interest rate derivative instruments to manage exposure to interest rate changes, we may choose to do so in the future in connection with our Credit Facility.
Our earnings and cash flows are also subject to fluctuations due to changes in interest rates on our investment of available cash balances. As of October 31, 2019, we had cash and cash equivalents of $46.9 million, which consisted of cash and highly-liquid money market deposit accounts. Many of these investments are subject to fluctuations in interest rates, which could impact our results. Based on our investment portfolio balance as of October 31, 2019, a hypothetical change in interest rates of 10% would have a nominal impact on interest income over a one-year period. Ultimately, the availability of our cash and cash equivalents is dependent on a well-functioning liquid market.
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