Comtech Telecommunications Earnings 2019-10-31
CMTL 10Q Quarterly Report
| Balance Sheet | Income Statement | Cash Flow |
|---|---|---|
| Comparables ($MM TTM) | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Ticker | M Cap | Assets | Liab | Rev | G Profit | Net Inc | EBITDA | EV | G Margin | EV/EBITDA | ROA |
| LORL | 1,191 | 394 | 33 | 0 | 0 | 123 | 94 | 933 | 10.0 | 31% | |
| CMTL | 718 | 888 | 353 | 672 | 247 | 25 | 64 | 838 | 37% | 13.1 | 3% |
| CASA | 545 | 436 | 366 | 227 | 170 | 20 | 57 | 600 | 75% | 10.5 | 5% |
| HLIT | 499 | 527 | 315 | 379 | 196 | -28 | -7 | 457 | 52% | -62.4 | -5% |
| GILT | 479 | 395 | 156 | 0 | 0 | 0 | 0 | 383 | 0% | ||
| MAXR | 443 | 5,083 | 4,352 | 1,490 | 0 | -863 | -701 | 3,518 | 0% | -5.0 | -17% |
| CAMP | 346 | 659 | 466 | 355 | 143 | -5 | 38 | 453 | 40% | 11.9 | -1% |
| CRNT | 289 | 283 | 123 | 0 | 0 | 0 | 0 | 254 | 0% | ||
| KVHI | 186 | 221 | 67 | 123 | 28 | 38 | 50 | 173 | 23% | 3.4 | 17% |
| AIRG | 145 | 56 | 8 | 62 | 27 | 3 | 4 | 131 | 44% | 32.0 | 5% |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q |
(Mark One)
 | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended October 31, 2019
 | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File Number: 0-7928
(Exact name of registrant as specified in its charter)
Delaware | 11-2139466 | |
(State or other jurisdiction of incorporation /organization) | (I.R.S. Employer Identification Number) | |
68 South Service Road, Suite 230, Melville, NY | 11747 | |
(Address of principal executive offices) | (Zip Code) | |
(631) 962-7000 |
(Registrant’s telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act: | ||
Title of each class | Trading Symbol(s) | Name of exchange on which registered |
Common Stock, par value $0.10 per share | CMTL | NASDAQ Stock Market LLC |
Series A Junior Participating Cumulative Preferred Stock, par value $0.10 per share | ||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes 
NoIndicate by check mark whether the registrant has submitted electronically, every Interactive Data file required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes NoIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | | Accelerated filer | | Emerging growth company | |
Non-accelerated filer | | Smaller reporting company | | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes NoAs of November 29, 2019, the number of outstanding shares of Common Stock, par value $0.10 per share, of the registrant was 24,389,774 shares.
COMTECH TELECOMMUNICATIONS CORP. INDEX | |||
Page | |||
PART I. FINANCIAL INFORMATION | |||
Item 1. | |||
Item 2. | |||
Item 3. | |||
Item 4. | |||
PART II. OTHER INFORMATION | |||
Item 1. | |||
Item 1A. | |||
Item 2. | |||
Item 4. | |||
Item 6. | |||
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
October 31, 2019 | July 31, 2019 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 46,873,000 | 45,576,000 | ||||
Accounts receivable, net | 161,044,000 | 145,032,000 | |||||
Inventories, net | 71,810,000 | 74,839,000 | |||||
Prepaid expenses and other current assets | 15,995,000 | 14,867,000 | |||||
Total current assets | 295,722,000 | 280,314,000 | |||||
Property, plant and equipment, net | 26,873,000 | 28,026,000 | |||||
Operating lease right-of-use assets, net | 34,148,000 | — | |||||
Finance lease right-of-use assets, net | 447,000 | — | |||||
Goodwill | 309,871,000 | 310,489,000 | |||||
Intangibles with finite lives, net | 256,684,000 | 261,890,000 | |||||
Deferred financing costs, net | 2,943,000 | 3,128,000 | |||||
Other assets, net | 4,334,000 | 3,864,000 | |||||
Total assets | $ | 931,022,000 | 887,711,000 | ||||
Liabilities and Stockholders’ Equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 29,380,000 | 24,330,000 | ||||
Accrued expenses and other current liabilities | 72,807,000 | 78,584,000 | |||||
Operating lease liabilities, current | 9,248,000 | — | |||||
Finance lease and other obligations, current | 567,000 | 757,000 | |||||
Dividends payable | 2,428,000 | 2,406,000 | |||||
Contract liabilities | 36,989,000 | 38,682,000 | |||||
Interest payable | 447,000 | 588,000 | |||||
Total current liabilities | 151,866,000 | 145,347,000 | |||||
Non-current portion of long-term debt | 169,000,000 | 165,000,000 | |||||
Operating lease liabilities, non-current | 27,725,000 | — | |||||
Income taxes payable | 2,298,000 | 325,000 | |||||
Deferred tax liability, net | 13,768,000 | 12,481,000 | |||||
Long-term contract liabilities | 11,457,000 | 10,654,000 | |||||
Other liabilities | 17,264,000 | 18,822,000 | |||||
Total liabilities | 393,378,000 | 352,629,000 | |||||
Commitments and contingencies (See Note 19) | |||||||
Stockholders’ equity: | |||||||
Preferred stock, par value $0.10 per share; shares authorized and unissued 2,000,000 | — | — | |||||
Common stock, par value $0.10 per share; authorized 100,000,000 shares; issued 39,402,226 shares and 39,276,161 shares at October 31, 2019 and July 31, 2019, respectively | 3,940,000 | 3,928,000 | |||||
Additional paid-in capital | 551,316,000 | 552,670,000 | |||||
Retained earnings | 424,237,000 | 420,333,000 | |||||
979,493,000 | 976,931,000 | ||||||
Less: | |||||||
Treasury stock, at cost (15,033,317 shares at October 31, 2019 and July 31, 2019) | (441,849,000 | ) | (441,849,000 | ) | |||
Total stockholders’ equity | 537,644,000 | 535,082,000 | |||||
Total liabilities and stockholders’ equity | $ | 931,022,000 | 887,711,000 | ||||
See accompanying notes to condensed consolidated financial statements.
2
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended October 31, | |||||||
2019 | 2018 | ||||||
Net sales | $ | 170,267,000 | 160,844,000 | ||||
Cost of sales | 106,700,000 | 103,075,000 | |||||
Gross profit | 63,567,000 | 57,769,000 | |||||
Expenses: | |||||||
Selling, general and administrative | 31,851,000 | 31,847,000 | |||||
Research and development | 14,861,000 | 13,210,000 | |||||
Amortization of intangibles | 5,206,000 | 4,289,000 | |||||
Acquisition plan expenses | 2,389,000 | 1,130,000 | |||||
54,307,000 | 50,476,000 | ||||||
Operating income | 9,260,000 | 7,293,000 | |||||
Other expenses: | |||||||
Interest expense | 1,804,000 | 2,669,000 | |||||
Write-off of deferred financing costs | — | 3,217,000 | |||||
Interest (income) and other | (77,000 | ) | 66,000 | ||||
Income before provision for (benefit from) income taxes | 7,533,000 | 1,341,000 | |||||
Provision for (benefit from) income taxes | 1,145,000 | (2,127,000 | ) | ||||
Net income | $ | 6,388,000 | 3,468,000 | ||||
Net income per share (See Note 6): | |||||||
Basic | $ | 0.26 | 0.14 | ||||
Diluted | $ | 0.26 | 0.14 | ||||
Weighted average number of common shares outstanding – basic | 24,555,000 | 23,999,000 | |||||
Weighted average number of common and common equivalent shares outstanding – diluted | 24,737,000 | 24,375,000 | |||||
See accompanying notes to condensed consolidated financial statements.
3
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE MONTHS ENDED OCTOBER 31, 2019 AND 2018
(Unaudited)
Common Stock | Additional Paid-in Capital | Retained Earnings | Treasury Stock | Stockholders' Equity | ||||||||||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||||||||||||
Balance as of July 31, 2018 | 38,860,571 | $ | 3,886,000 | $ | 538,453,000 | $ | 405,194,000 | 15,033,317 | $ | (441,849,000 | ) | $ | 505,684,000 | |||||||||||||
Equity-classified stock award compensation | — | — | 1,046,000 | — | — | — | 1,046,000 | |||||||||||||||||||
Proceeds from exercises of stock options | 6,100 | 1,000 | 173,000 | — | — | — | 174,000 | |||||||||||||||||||
Proceeds from issuance of employee stock purchase plan shares | 8,861 | 1,000 | 240,000 | — | — | — | 241,000 | |||||||||||||||||||
Issuance of restricted stock | 10,386 | 1,000 | (1,000 | ) | — | — | — | — | ||||||||||||||||||
Net settlement of stock-based awards | 52,926 | 5,000 | (2,059,000 | ) | — | — | — | (2,054,000 | ) | |||||||||||||||||
Cash dividends declared ($0.10 per share) | — | — | — | (2,381,000 | ) | — | — | (2,381,000 | ) | |||||||||||||||||
Accrual of dividend equivalents, net of reversal ($0.10 per share) | — | — | — | (82,000 | ) | — | — | (82,000 | ) | |||||||||||||||||
Net income | — | — | — | 3,468,000 | — | — | 3,468,000 | |||||||||||||||||||
Balance as of October 31, 2018 | 38,938,844 | $ | 3,894,000 | $ | 537,852,000 | $ | 406,199,000 | 15,033,317 | $ | (441,849,000 | ) | $ | 506,096,000 | |||||||||||||
Balance as of July 31, 2019 | 39,276,161 | $ | 3,928,000 | $ | 552,670,000 | $ | 420,333,000 | 15,033,317 | $ | (441,849,000 | ) | $ | 535,082,000 | |||||||||||||
Equity-classified stock award compensation | — | — | 879,000 | — | — | — | 879,000 | |||||||||||||||||||
Proceeds from exercises of stock options | 10,600 | 1,000 | 305,000 | — | — | — | 306,000 | |||||||||||||||||||
Proceeds from issuance of employee stock purchase plan shares | 10,135 | 1,000 | 245,000 | — | — | — | 246,000 | |||||||||||||||||||
Issuance of restricted stock | 21,510 | 2,000 | (2,000 | ) | — | — | — | — | ||||||||||||||||||
Net settlement of stock-based awards | 83,820 | 8,000 | (2,781,000 | ) | — | — | — | (2,773,000 | ) | |||||||||||||||||
Cash dividends declared ($0.10 per share) | — | — | — | (2,428,000 | ) | — | — | (2,428,000 | ) | |||||||||||||||||
Accrual of dividend equivalents, net of reversal ($0.10 per share) | — | — | — | (56,000 | ) | — | — | (56,000 | ) | |||||||||||||||||
Net income | — | — | — | 6,388,000 | — | — | 6,388,000 | |||||||||||||||||||
Balance as of October 31, 2019 | 39,402,226 | $ | 3,940,000 | $ | 551,316,000 | $ | 424,237,000 | 15,033,317 | $ | (441,849,000 | ) | $ | 537,644,000 | |||||||||||||
See accompanying notes to condensed consolidated financial statements.
4
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) | |||||||
Three months ended October 31, | |||||||
2019 | 2018 | ||||||
Cash flows from operating activities: | |||||||
Net income | $ | 6,388,000 | 3,468,000 | ||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||||
Depreciation and amortization of property, plant and equipment | 2,651,000 | 2,851,000 | |||||
Amortization of intangible assets with finite lives | 5,206,000 | 4,289,000 | |||||
Amortization of stock-based compensation | 879,000 | 1,046,000 | |||||
Amortization of deferred financing costs | 185,000 | 548,000 | |||||
Estimated contract settlement costs | 230,000 | — | |||||
Write-off of deferred financing costs | — | 3,217,000 | |||||
Changes in other liabilities | (1,033,000 | ) | — | ||||
(Gain) loss on disposal of property, plant and equipment | (3,000 | ) | 32,000 | ||||
Benefit from allowance for doubtful accounts | (343,000 | ) | (7,000 | ) | |||
Provision for excess and obsolete inventory | 373,000 | 747,000 | |||||
Deferred income tax expense | 2,286,000 | 2,273,000 | |||||
Changes in assets and liabilities, net of effects of business acquisitions: | |||||||
Accounts receivable | (15,947,000 | ) | (12,267,000 | ) | |||
Inventories | 2,656,000 | (15,240,000 | ) | ||||
Prepaid expenses and other current assets | 930,000 | 3,054,000 | |||||
Other assets | (44,000 | ) | 64,000 | ||||
Accounts payable | 4,299,000 | (9,180,000 | ) | ||||
Accrued expenses and other current liabilities | (1,095,000 | ) | 8,526,000 | ||||
Contract liabilities | (822,000 | ) | (2,947,000 | ) | |||
Other liabilities, non-current | 3,000 | 275,000 | |||||
Interest payable | (133,000 | ) | (455,000 | ) | |||
Income taxes payable | (1,221,000 | ) | (4,424,000 | ) | |||
Net cash provided by (used in) operating activities | 5,445,000 | (14,130,000 | ) | ||||
Cash flows from investing activities: | |||||||
Purchases of property, plant and equipment | (1,250,000 | ) | (1,645,000 | ) | |||
Net cash used in investing activities | (1,250,000 | ) | (1,645,000 | ) | |||
Cash flows from financing activities: | |||||||
Net borrowings of long-term debt under Credit Facility | 4,000,000 | 193,400,000 | |||||
Net payments under Revolving Loan portion of Prior Credit Facility | — | (48,603,000 | ) | ||||
Repayment of debt under Term Loan portion of Prior Credit Facility | — | (120,121,000 | ) | ||||
Remittance of employees' statutory tax withholdings for stock awards | (4,560,000 | ) | (5,017,000 | ) | |||
Cash dividends paid | (2,692,000 | ) | (2,615,000 | ) | |||
Payment of deferred financing costs | — | (1,771,000 | ) | ||||
Repayment of principal amounts under finance lease and other obligations | (198,000 | ) | (454,000 | ) | |||
Proceeds from issuance of employee stock purchase plan shares | 246,000 | 241,000 | |||||
Proceeds from exercises of stock options | 306,000 | 174,000 | |||||
Net cash (used in) provided by financing activities | (2,898,000 | ) | 15,234,000 | ||||
Net increase (decrease) in cash and cash equivalents | 1,297,000 | (541,000 | ) | ||||
Cash and cash equivalents at beginning of period | 45,576,000 | 43,484,000 | |||||
Cash and cash equivalents at end of period | $ | 46,873,000 | 42,943,000 | ||||
See accompanying notes to condensed consolidated financial statements. (Continued) | |||||||
5
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited) | |||||||
Three months ended October 31, | |||||||
2019 | 2018 | ||||||
Supplemental cash flow disclosures: | |||||||
Cash paid during the period for: | |||||||
Interest | $ | 1,701,000 | 2,470,000 | ||||
Income taxes, net | $ | 79,000 | 25,000 | ||||
Non-cash investing and financing activities: | |||||||
Reclass of finance lease right-of-use assets to property, plant and equipment | $ | 295,000 | — | ||||
Cash dividends declared but unpaid (including dividend equivalents) | $ | 2,484,000 | 2,463,000 | ||||
Accrued additions to property, plant and equipment | $ | 692,000 | 795,000 | ||||
Accrued deferred financing costs | $ | — | 41,000 | ||||
See accompanying notes to condensed consolidated financial statements.
6
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) General
The accompanying condensed consolidated financial statements of Comtech Telecommunications Corp. and its subsidiaries ("Comtech," "we," "us," or "our") as of and for the three months ended October 31, 2019 and 2018 are unaudited. In the opinion of management, the information furnished reflects all material adjustments (which include normal recurring adjustments) necessary for a fair presentation of the results for the unaudited interim periods. Our results of operations for such periods are not necessarily indicative of the results of operations to be expected for the full fiscal year.
The preparation of our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the condensed consolidated financial statements, and the reported amounts of net sales and expenses during the reported period. Actual results may differ from those estimates.
Our condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements, filed with the Securities and Exchange Commission ("SEC"), for the fiscal year ended July 31, 2019 and the notes thereto contained in our Annual Report on Form 10-K, and all of our other filings with the SEC.
As disclosed in more detail in Note (15) - "Segment Information," we manage our business in two reportable segments: Commercial Solutions and Government Solutions.
(2) Acquisitions
Solacom Technologies Inc.
On February 28, 2019, we completed our acquisition of Solacom Technologies Inc. ("Solacom"), pursuant to the Arrangement Agreement, dated as of January 7, 2019, by and among Solacom, Comtech and Solar Acquisition Corp., a Canadian corporation and a direct, wholly-owned subsidiary of Comtech. Solacom is a leading provider of Next Generation 911 ("NG-911") solutions for public safety agencies. The acquisition of Solacom was a significant step in our strategy of enhancing our public safety and location technologies.
The acquisition has an aggregate purchase price for accounting purposes of $32,934,000, of which $27,328,000 was settled in cash and $5,606,000 was settled with the issuance of 208,669 shares of Comtech’s common stock at a volume weighted average stock price of $26.86. The fair value of consideration transferred in connection with this acquisition was $31,489,000, which was net of $1,445,000 of cash acquired. The cash portion of the purchase price was funded principally through borrowings under our Credit Facility.
We are accounting for the acquisition of Solacom under the acquisition method of accounting in accordance with FASB ASC 805, "Business Combinations" ("ASC 805"). The purchase price was allocated to the assets acquired and liabilities assumed, based on their fair value as of February 28, 2019, pursuant to the business combination accounting rules. Acquisition plan expenses were not included as a component of consideration transferred and were expensed in the period incurred. Pro forma financial information is not disclosed, as the acquisition is not material.
7
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The following table summarizes the fair value of the assets acquired and liabilities assumed in connection with the Solacom acquisition:
Purchase Price Allocation (1) | Measurement Period Adjustments | Purchase Price Allocation (as adjusted) | ||||||||||
Settled in cash | $ | 27,328,000 | — | $ | 27,328,000 | |||||||
Settled in common stock issued by Comtech | 5,606,000 | — | 5,606,000 | |||||||||
Aggregate purchase price at fair value | $ | 32,934,000 | — | $ | 32,934,000 | |||||||
Allocation of aggregate purchase price: | ||||||||||||
Cash and cash equivalents | $ | 1,445,000 | — | $ | 1,445,000 | |||||||
Current assets | 9,896,000 | 1,000 | 9,897,000 | |||||||||
Property, plant and equipment | 777,000 | — | 777,000 | |||||||||
Deferred tax assets | 5,059,000 | 419,000 | 5,478,000 | |||||||||
Accrued warranty obligations | (1,431,000 | ) | — | (1,431,000 | ) | |||||||
Current liabilities | (4,477,000 | ) | — | (4,477,000 | ) | |||||||
Contract liabilities, non-current | (1,604,000 | ) | — | (1,604,000 | ) | |||||||
Net tangible assets at fair value | $ | 9,665,000 | 420,000 | $ | 10,085,000 | |||||||
Identifiable intangibles, deferred taxes and goodwill: | Estimated Useful Lives | |||||||||||
Technology | $ | 6,779,000 | — | $ | 6,779,000 | 10 years | ||||||
Customer relationships | 7,007,000 | — | 7,007,000 | 20 years | ||||||||
Trade name | 1,828,000 | — | 1,828,000 | 20 years | ||||||||
Deferred tax liabilities | (4,153,000 | ) | — | (4,153,000 | ) | |||||||
Goodwill | 11,808,000 | (420,000 | ) | 11,388,000 | Indefinite | |||||||
Allocation of aggregate purchase price | $ | 32,934,000 | — | $ | 32,934,000 | |||||||
(1) As reported in the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 2019.
The acquired identifiable intangible assets are being amortized on a straight-line basis, which we believe approximates the pattern in which the assets are utilized over their estimated useful lives. The fair value of customer relationships was estimated primarily based on the value of the discounted cash flows that the related intangible asset could be expected to generate in the future. The fair value of technology and trade name was estimated based on the discounted capitalization of royalty expense saved because we now own the assets. Among the factors contributing to the recognition of goodwill, as a component of the purchase price allocation, were synergies in products and technologies and the addition of a skilled, assembled workforce. This goodwill has been assigned to our Commercial Solutions segment based on specific identification and is generally not deductible for income tax purposes.
GD NG-911 Business
On April 29, 2019, we completed the acquisition of a state and local government NG-911 business pursuant to the Asset Purchase Agreement, dated as of April 29, 2019, by and among General Dynamics Information Technology, Inc., Comtech and Comtech NextGen LLC, a Delaware limited liability company and indirect, wholly-owned subsidiary of Comtech. The acquisition of this NG-911 business from GD (the "GD NG-911 business") has a preliminary cash purchase price of $10,000,000 (which is subject to a net working capital adjustment). In connection with this acquisition, we also announced an award of a five-year contract to develop, implement and operate a NG-911 emergency communications system for a Northeastern state. Immediately after our announcement of this acquisition, we hired approximately sixty GD NG-911 employees and completed the integration of this business into our Commercial Solutions segment’s public safety and location technologies product line. The acquisition, contract award and hiring of talented employees are expected to strengthen Comtech’s position in the growing NG-911 solutions market.
8
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
We are accounting for the acquisition of this business under the acquisition method of accounting in accordance with FASB ASC 805. The purchase price, which is subject to a pending closing date balance sheet adjustment process under the purchase agreement, was allocated to the assets acquired and liabilities assumed, based on their preliminary fair value as of April 29, 2019, pursuant to the business combination accounting rules. Acquisition plan expenses were not included as a component of consideration transferred and were expensed in the period incurred. Pro forma financial information is not disclosed, as the acquisition is not material.
The following table summarizes the preliminary fair value of the assets acquired and liabilities assumed in connection with the acquisition of the GD NG-911 business:
Purchase Price Allocation (1) | Measurement Period Adjustments | Purchase Price Allocation (as adjusted) | ||||||||||
Aggregate purchase price at fair value | $ | 10,000,000 | — | $ | 10,000,000 | |||||||
Allocation of aggregate purchase price: | ||||||||||||
Current assets | $ | 4,460,000 | 180,000 | $ | 4,640,000 | |||||||
Property, plant and equipment | 646,000 | — | 646,000 | |||||||||
Deferred tax assets | 3,426,000 | (50,000 | ) | 3,376,000 | ||||||||
Accrued warranty obligations | (5,000,000 | ) | — | (5,000,000 | ) | |||||||
Current liabilities | (3,162,000 | ) | 68,000 | (3,094,000 | ) | |||||||
Net tangible assets at preliminary fair value | $ | 370,000 | 198,000 | $ | 568,000 | |||||||
Identifiable intangibles, deferred taxes and goodwill: | Estimated Useful Lives | |||||||||||
Customer relationships | $ | 20,300,000 | — | $ | 20,300,000 | 10 years | ||||||
Technology | 3,500,000 | — | 3,500,000 | 15 years | ||||||||
Other liabilities | (21,700,000 | ) | — | (21,700,000 | ) | |||||||
Deferred tax liabilities | (518,000 | ) | — | (518,000 | ) | |||||||
Goodwill | 8,048,000 | (198,000 | ) | 7,850,000 | Indefinite | |||||||
Allocation of aggregate purchase price | $ | 10,000,000 | — | $ | 10,000,000 | |||||||
(1) As reported in the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 2019.
The acquired identifiable intangible assets are being amortized on a straight-line basis, which we believe approximates the pattern in which the assets are utilized over their estimated useful lives. The fair value of customer relationships was estimated based on the value of the discounted cash flows that the related intangible asset could be expected to generate in the future. The fair value of technology was estimated based on the discounted capitalization of royalty expense saved because we now own the assets. The preliminary fair value of other liabilities was based on the difference in discounted cash flows related to remaining performance obligations under a certain acquired contract as compared to current market terms for similar arrangements that a market participant would expect. Other liabilities will be credited against cost of sales over the remaining performance of the contract, which was 5.25 years as of the acquisition date.
Among the factors contributing to the recognition of goodwill, as a component of the purchase price allocation, were synergies in solution offerings and the addition of a skilled, assembled workforce. We currently estimate that approximately $7,100,000 of goodwill resulting from the acquisition will be tax deductible. This goodwill has been assigned to our Commercial Solutions segment based on specific identification.
We are currently finalizing a net working capital adjustment, pursuant to the terms of the purchase agreement. In August 2019, the seller proposed and requested an approximate $2,900,000 upward adjustment to the preliminary purchase price. We do not agree with their proposed adjustment and believe that we are entitled to a reduction of approximately $1,000,000 to the preliminary purchase price. As the parties could not reach an agreement during the stipulated period of time, the matter is now in arbitration.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The allocation of the preliminary purchase price shown in the above table was based on a valuation and estimates and assumptions that are subject to change within the purchase price allocation period (generally one year from the acquisition date). The primary areas of the purchase price allocation not yet finalized include the purchase price (due to a pending closing date balance sheet adjustment process under the purchase agreement) and residual goodwill.
Subsequent Event
On November 14, 2019, we entered into an agreement to acquire UHP Networks Inc. and its sister company (together, "UHP"), a leading provider of innovative and disruptive satellite ground station solutions, for a purchase price of approximately $40,000,000, of which we anticipate $5,000,000 to be paid in Comtech common stock with the remaining balance payable in cash. The purchase agreement also provides an earn-out up to an additional $10,000,000 payable, at our election, in cash and or shares of Comtech common stock, if certain agreed upon sales milestones are reached in the twelve-month period following completion of the acquisition. We believe that our acquisition of UHP will be a significant step in enhancing our solutions offerings for the satellite ground station market. The transaction is subject to customary closing conditions and is expected to occur late in the second half of our fiscal 2020.
(3) Adoption of Accounting Standards and Updates
We are required to prepare our condensed consolidated financial statements in accordance with the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") which is the source for all authoritative U.S. generally accepted accounting principles, which is commonly referred to as "GAAP." The FASB ASC is subject to updates by the FASB, which are known as Accounting Standards Updates ("ASUs"). During the three months ended October 31, 2019, we adopted:
• | FASB ASU No. 2016-02 Leases (Topic 842). See Note (12) - "Leases" for further information. |
• | FASB ASU No. 2017-11, which provides guidance on the accounting for certain financial instruments with embedded features that result in the strike price of the instrument or embedded conversion option being reduced on the basis of the pricing of future equity offerings (commonly referred to as "down round" features). On August 1, 2019, we adopted this ASU. Our adoption did not have any impact on our condensed consolidated financial statements and disclosures, as we did not have any financial instruments with such "down round" features. |
• | FASB ASU No. 2017-12, which expands and refines hedge accounting for both non-financial and financial risk components and simplifies and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. On August 1, 2019, we adopted this ASU. Our adoption did not have any impact on our condensed consolidated financial statements and disclosures, as we are not a party to any such hedging transactions. |
• | FASB ASU No. 2018-07, which expands the scope of Topic 718 to include certain share-based payment transactions for acquiring goods and services from nonemployees. On August 1, 2019, we adopted this ASU. Our adoption did not have any impact on our condensed consolidated financial statements and disclosures, as we did not have any outstanding share-based awards with nonemployees that required remeasurement. |
• | FASB ASU No. 2018-16, which expands the list of eligible U.S. benchmark interest rates permitted in the application of hedge accounting due to broad concerns about the long-term sustainability of the LIBO Rate. This ASU adds the Overnight Index Swap ("OIS") rate, based on the Secured Overnight Financing Rate ("SOFR"), as an eligible U.S. benchmark interest rate. On August 1, 2019, we adopted this ASU. Our adoption did not have any impact on our condensed consolidated financial statements and disclosures, as we are not a party to any such hedging transactions. |
10
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
(4) Revenue
In accordance with FASB ASC 606 - Revenue from Contracts with Customers ("ASC 606"), we record revenue in an amount that reflects the consideration to which we expect to be entitled in exchange for goods or services promised to customers. Under ASC 606, we follow a five-step model to: (1) identify the contract with our customer; (2) identify our performance obligations in our contract; (3) determine the transaction price for our contract; (4) allocate the transaction price to our performance obligations; and (5) recognize revenue using one of the following two methods:
• | Over time - We recognize revenue using the over time method when there is a continuous transfer of control to the customer over the contractual period of performance. This generally occurs when we enter into a long-term contract relating to the design, development or manufacture of complex equipment or technology platforms to a buyer’s specification (or to provide services related to the performance of such contracts). Continuous transfer of control is typically supported by contract clauses which allow our customers to unilaterally terminate a contract for convenience, pay for costs incurred plus a reasonable profit and take control of work-in-process. Revenue recognized over time is generally based on the extent of progress toward completion of the related performance obligations. The selection of the method to measure progress requires judgment and is based on the nature of the products or services provided. In certain instances, typically for firm fixed-price contracts, we use the cost-to-cost measure because it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost measure, the extent of progress toward completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion, including warranty costs. Revenues, including estimated fees or profits, are recorded proportionally as costs are incurred. Costs to fulfill generally include direct labor, materials, subcontractor costs, other direct costs and an allocation of indirect costs. When these contracts are modified, the additional goods or services are generally not distinct from those already provided. As a result, these modifications form part of an existing contract and we must update the transaction price and our measure of progress for the single performance obligation and recognize a cumulative catch-up to revenue and gross profits. |
For over time contracts using a cost-to-cost measure of progress, we have an estimate at completion ("EAC") process in which management reviews the progress and execution of our performance obligations. This EAC process requires management judgment relative to assessing risks, estimating contract revenue and costs, and making assumptions for schedule and technical issues. Since certain contracts extend over a long period of time, the impact of revisions in revenue and or cost estimates during the progress of work may impact current period earnings through a cumulative adjustment. Additionally, if the EAC process indicates a loss, a provision is made for the total anticipated loss in the period that it becomes evident. Contract revenue and cost estimates for significant contracts are generally reviewed and reassessed at least quarterly.
The cost-to-cost method is principally used to account for contracts in our mission-critical technologies and high-performance transmission technologies product lines and, to a lesser extent, certain location-based and messaging infrastructure contracts in our public safety and location technologies product line. For service-based contracts in our public safety and location technologies product line, we recognize revenue over time. These services are typically recognized as a series of services performed over the contract term using the straight-line method, or based on our customers’ actual usage of the networks and platforms which we provide.
• | Point in time - When a performance obligation is not satisfied over time, we must record revenue using the point in time accounting method which generally results in revenue being recognized upon shipment or delivery of a promised good or service to a customer. This generally occurs when we enter into short term contracts or purchase orders where items are provided to customers with relatively quick turn-around times. Modifications to such contracts and or purchase orders, which typically provide for additional quantities or services, are accounted for as a new contract because the pricing for these additional quantities or services are based on standalone selling prices. |
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Point in time accounting is principally applied to contracts in our satellite ground station technologies product line (which includes satellite modems, solid-state and traveling wave tube amplifiers) and certain contracts for our solid-state, high-power amplifiers in our high-performance transmission technologies product line. Point in time accounting is also applied to certain contracts in our mission-critical technologies product line. The contracts related to these product lines do not meet the requirements for over time revenue recognition because our customers cannot utilize the equipment for its intended purpose during any phase of our manufacturing process; customers do not simultaneously receive and or consume the benefits provided by our performance; customers do not control the asset (i.e., prior to delivery, customers cannot direct the use of the asset, sell or exchange the equipment, etc.); and, although many of our contracts have termination for convenience clauses and or an enforceable right to payment for performance completed to date, our performance creates an asset with an alternative use through the point of delivery.
In determining that our equipment has alternative use, we considered the underlying manufacturing process for our products. In the early phases of manufacturing, raw materials and work in process (including subassemblies) consist of common parts that are highly fungible among many different types of products and customer applications. Finished products are either configured to our standard configuration or based on our customers’ specifications. Finished products, whether built to our standard specification or to a customers’ specification, can be sold to a variety of customers and across many different end use applications with minimal rework, if needed, and without incurring a significant economic loss.
When identifying a contract with our customer, we consider when it has approval and commitment from both parties, if the rights of the parties are identified, if the payment terms are identified, if it has commercial substance and if collectability is probable.
When identifying performance obligations, we consider whether there are multiple promises and how to account for them. In our contracts, multiple promises are separated if they are distinct, both individually and in the context of the contract. If multiple promises in a contract are highly interrelated or comprise a series of distinct services performed over time, they are combined into a single performance obligation. In some cases, we may also provide the customer with an additional service-type warranty, which we recognize as a separate performance obligation. Service-type warranties do not represent a significant portion of our consolidated net sales. When service-type warranties represent a separate performance obligation, the revenue is deferred and recognized ratably over the extended warranty period. Our contracts, from time-to-time, may also include options for additional goods and services. To date, these options have not represented material rights to the customer as the pricing for them reflects standalone selling prices. As a result, we do not consider options we offer to be performance obligations for which we must allocate a portion of the transaction price. In many cases, we provide assurance-type warranty coverage for some of our products for a period of at least one year from the date of delivery.
When identifying the transaction price, we typically utilize the contract's stated price as a starting point. The transaction price in certain arrangements may include estimated amounts of variable consideration, including award fees, incentive fees or other provisions that can either increase or decrease the transaction price. We estimate variable consideration as the amount to which we expect to be entitled, and we include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the estimation uncertainty is resolved. The estimation of this variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (e.g., historical, current and forecasted) that is reasonably available to us.
When allocating the contract’s transaction price, we consider each distinct performance obligation. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. We determine standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price taking into account available information such as market conditions, including geographic or regional specific factors, competitive positioning, internal costs, profit objectives and internally approved pricing guidelines related to the performance obligations.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Almost all of our contracts with customers are denominated in U.S. dollars and typically are either firm fixed-price or cost reimbursable type contracts (including fixed-fee, incentive-fee and time-and-material type contracts). In almost all of our contracts with customers, we are the principal in the arrangement and report revenue on a gross basis. Transaction prices for contracts with U.S. domestic and international customers are usually based on specific negotiations with each customer and in the case of the U.S. government, sometimes based on estimated or actual costs of providing the goods or services in accordance with applicable regulations. Sales by geography and customer type, as a percentage of consolidated net sales, are as follows:
Three months ended October 31, | ||||||
2019 | 2018 | |||||
United States | ||||||
U.S. government | 40.8 | % | 44.2 | % | ||
Domestic | 36.1 | % | 31.4 | % | ||
Total United States | 76.9 | % | 75.6 | % | ||
International | 23.1 | % | 24.4 | % | ||
Total | 100.0 | % | 100.0 | % | ||
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.
The following tables summarize our disaggregation of revenue consistent with information reviewed by our chief operating decision-maker ("CODM") for the three months ended October 31, 2019 and 2018. We believe these categories best depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors which impact our business:
Three months ended October 31, 2019 | |||||||||||
Commercial Solutions | Government Solutions | Total | |||||||||
Geographical region and customer type | |||||||||||
U.S. government | $ | 16,748,000 | 52,773,000 | $ | 69,521,000 | ||||||
Domestic | 53,354,000 | 8,041,000 | 61,395,000 | ||||||||
Total United States | 70,102,000 | 60,814,000 | 130,916,000 | ||||||||
International | 24,212,000 | 15,139,000 | 39,351,000 | ||||||||
Total | $ | 94,314,000 | 75,953,000 | $ | 170,267,000 | ||||||
Contract type | |||||||||||
Firm fixed price | $ | 92,548,000 | 50,724,000 | $ | 143,272,000 | ||||||
Cost reimbursable | 1,766,000 | 25,229,000 | 26,995,000 | ||||||||
Total | $ | 94,314,000 | 75,953,000 | $ | 170,267,000 | ||||||
Transfer of control | |||||||||||
Point in time | $ | 37,723,000 | 37,786,000 | $ | 75,509,000 | ||||||
Over time | 56,591,000 | 38,167,000 | 94,758,000 | ||||||||
Total | $ | 94,314,000 | 75,953,000 | $ | 170,267,000 | ||||||
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Three months ended October 31, 2018 | |||||||||||
Commercial Solutions | Government Solutions | Total | |||||||||
Geographical region and customer type | |||||||||||
U.S. government | $ | 14,220,000 | 56,824,000 | $ | 71,044,000 | ||||||
Domestic | 42,237,000 | 8,274,000 | 50,511,000 | ||||||||
Total United States | 56,457,000 | 65,098,000 | 121,555,000 | ||||||||
International | 21,516,000 | 17,773,000 | 39,289,000 | ||||||||
Total | $ | 77,973,000 | 82,871,000 | $ | 160,844,000 | ||||||
Contract type | |||||||||||
Firm fixed price | $ | 76,290,000 | 63,611,000 | $ | 139,901,000 | ||||||
Cost reimbursable | 1,683,000 | 19,260,000 | 20,943,000 | ||||||||
Total | $ | 77,973,000 | 82,871,000 | $ | 160,844,000 | ||||||
Transfer of control | |||||||||||
Point in time | $ | 37,945,000 | 52,623,000 | $ | 90,568,000 | ||||||
Over time | 40,028,000 | 30,248,000 | 70,276,000 | ||||||||
Total | $ | 77,973,000 | 82,871,000 | $ | 160,844,000 | ||||||
The timing of revenue recognition, billings and collections results in receivables, unbilled receivables and contract liabilities on our Condensed Consolidated Balance Sheet. Under typical payment terms for our contracts accounted for over time, amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., monthly) or upon achievement of contractual milestones. For certain contracts with provisions that are intended to protect customers in the event we do not satisfy our performance obligations, billings occur subsequent to revenue recognition, resulting in unbilled receivables. Under ASC 606, unbilled receivables constitute contract assets. There were no material impairment losses recognized on contract assets during the three months ended October 31, 2019 and 2018, respectively. On large long-term contracts, and for contracts with international customers that do not do business with us regularly, payment terms typically require advanced payments and deposits. Under ASC 606, payments received from customers in excess of revenue recognized to date results in a contract liability. These contract liabilities are not considered to represent a significant financing component of the contract because we believe these cash advances and deposits are generally used to meet working capital demands which can be higher in the earlier stages of a contract. Also, advanced payments and deposits provide us with some measure of assurance that the customer will perform on its obligations under the contract. Under the typical payment terms for our contracts accounted for at a point in time, costs are accumulated in inventory until the time of billing, which generally coincides with revenue recognition. Of the contract liability balance at July 31, 2019 and August 1, 2018, $18,609,000 and $23,127,000 was recognized as revenue during the three months ended October 31, 2019 and 2018, respectively.
We recognize the incremental costs to obtain or fulfill a contract as an expense when incurred if the amortization period of the asset is one year or less. Incremental costs to obtain or fulfill contracts with an amortization period greater than one year were not material.
As commissions payable to our internal sales and marketing employees or contractors are contingent upon multiple factors, such commissions are not considered direct costs to obtain or fulfill a contract with a customer and are expensed as incurred in selling, general and administrative expenses on our Condensed Consolidated Statements of Operations. As for commissions payable to our third-party sales representatives related to large long-term contracts, we do consider these types of commissions both direct and incremental costs to obtain and fulfill such contracts. Therefore, such commissions are included in total estimated costs at completion for such contracts and expensed over time through cost of sales on our Condensed Consolidated Statements of Operations.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Remaining performance obligations represent the transaction price of firm orders for which work has not been performed as of the end of a fiscal period. Remaining performance obligations, which we refer to as backlog, exclude unexercised contract options and potential orders under indefinite delivery / indefinite quantity ("IDIQ") contracts. As of October 31, 2019, the aggregate amount of the transaction price allocated to remaining performance obligations was $648,343,000 (which represents the amount of our consolidated backlog). We estimate that a substantial portion of our remaining performance obligations at October 31, 2019 will be completed and recognized as revenue during the next twenty-four month period, with the rest thereafter. During the three months ended October 31, 2019, revenue recognized from performance obligations satisfied, or partially satisfied, in previous periods (for example due to changes in the transaction price) was not material.
(5) Fair Value Measurements and Financial Instruments
Using the fair value hierarchy described in FASB ASC 820 "Fair Value Measurements and Disclosures," we valued our cash and cash equivalents using Level 1 inputs that were based on quoted market prices.
We believe that the carrying amounts of our other current financial assets (such as accounts receivable) and other current liabilities (including accounts payable, accrued expenses and the current portion of our favorable AT&T warranty settlement) approximate their fair values due to their short-term maturities. See Note (9) - "Accrued Expenses and Other Current Liabilities" for further discussion of the favorable AT&T warranty settlement.
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.
The fair value of our Credit Facility that we entered into on October 31, 2018 approximates its carrying amount due to its variable interest rate and pricing grid that is dependent upon our leverage ratio as of the end of each fiscal quarter.
As of October 31, 2019 and July 31, 2019, other than the financial instruments discussed above, we had no other significant assets or liabilities included in our Condensed Consolidated Balance Sheets recorded at fair value, as such term is defined by FASB ASC 820.
(6) Earnings Per Share
Our basic earnings per share ("EPS") is computed based on the weighted average number of common shares (including vested but unissued stock units, share units, performance shares and restricted stock units ("RSUs")), outstanding during each respective period. Our diluted EPS reflects the dilution from potential common stock issuable pursuant to the exercise of equity-classified stock-based awards, if dilutive, outstanding during each respective period. Pursuant to FASB ASC 260 "Earnings Per Share," equity-classified stock-based awards that are subject to performance conditions are not considered in our diluted EPS calculations until the respective performance conditions have been satisfied. When calculating our diluted earnings per share, we consider the amount an employee must pay upon assumed exercise of stock-based awards and the amount of stock-based compensation cost attributed to future services and not yet recognized.
There were no repurchases of our common stock during the three months ended October 31, 2019 or 2018. See Note (18) - "Stockholders’ Equity" for more information.
Weighted average stock options, RSUs and restricted stock outstanding of 382,000 and 279,000 for the three months ended October 31, 2019 and 2018, respectively, were not included in our diluted EPS calculation because their effect would have been anti-dilutive.
Our EPS calculations exclude 197,000 and 236,000 weighted average performance shares outstanding for the three months ended October 31, 2019 and 2018, respectively, as the performance conditions have not yet been satisfied. However, net income (the numerator) for EPS calculations for each respective period, is reduced by the compensation expense related to these awards.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The following table reconciles the numerators and denominators used in the basic and diluted EPS calculations:
Three months ended October 31, | |||||||
2019 | 2018 | ||||||
Numerator: | |||||||
Net income for basic calculation | $ | 6,388,000 | 3,468,000 | ||||
Numerator for diluted calculation | $ | 6,388,000 | 3,468,000 | ||||
Denominator: | |||||||
Denominator for basic calculation | 24,555,000 | 23,999,000 | |||||
Effect of dilutive securities: | |||||||
Stock-based awards | 182,000 | 376,000 | |||||
Denominator for diluted calculation | 24,737,000 | 24,375,000 | |||||
(7) Accounts Receivable
Accounts receivable consist of the following at:
October 31, 2019 | July 31, 2019 | ||||||
Receivables from commercial and international customers | $ | 82,140,000 | 85,556,000 | ||||
Unbilled receivables from commercial and international customers | 22,824,000 | 20,469,000 | |||||
Receivables from the U.S. government and its agencies | 55,590,000 | 38,856,000 | |||||
Unbilled receivables from the U.S. government and its agencies | 1,955,000 | 2,018,000 | |||||
Total accounts receivable | 162,509,000 | 146,899,000 | |||||
Less allowance for doubtful accounts | 1,465,000 | 1,867,000 | |||||
Accounts receivable, net | $ | 161,044,000 | 145,032,000 | ||||
Unbilled receivables as of October 31, 2019 relate to contracts-in-progress for which revenue has been recognized, but for which we have not yet earned the right to bill the customer for work performed to date. Under ASC 606, unbilled receivables constitute contract assets. Management estimates that substantially all amounts not yet billed at October 31, 2019 will be billed and collected within one year.
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.
(8) Inventories
Inventories consist of the following at:
October 31, 2019 | July 31, 2019 | ||||||
Raw materials and components | $ | 52,423,000 | 53,959,000 | ||||
Work-in-process and finished goods | 38,867,000 | 40,576,000 | |||||
Total inventories | 91,290,000 | 94,535,000 | |||||
Less reserve for excess and obsolete inventories | 19,480,000 | 19,696,000 | |||||
Inventories, net | $ | 71,810,000 | 74,839,000 | ||||
As of October 31, 2019 and July 31, 2019, the amount of inventory directly related to long-term contracts (including contracts-in-progress) was $4,661,000 and $4,053,000, respectively, and the amount of inventory related to contracts from third-party commercial customers who outsource their manufacturing to us was $1,395,000 and $1,513,000, respectively.
16
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
(9) Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following at:
October 31, 2019 | July 31, 2019 | ||||||
Accrued wages and benefits | $ | 21,261,000 | 23,295,000 | ||||
Accrued contract costs | 13,725,000 | 15,007,000 | |||||
Accrued warranty obligations | 16,068,000 | 15,968,000 | |||||
Accrued legal costs | 2,781,000 | 2,835,000 | |||||
Accrued commissions and royalties | 4,587,000 | 5,114,000 | |||||
Other | 14,385,000 | 16,365,000 | |||||
Accrued expenses and other current liabilities | $ | 72,807,000 | 78,584,000 | ||||
As discussed further in Note (12) - "Leases," on August 1, 2019, we adopted Topic 842 and, as required by the new standard, reclassified $2,934,000 of accrued expenses and other current liabilities as follows: (i) $2,366,000 of short-term deferred rent liabilities related to operating leases were offset against the respective operating lease right-of-use assets; and (ii) the remaining $568,000 of estimated facility exit costs were reclassified to the current portion of operating lease liabilities.
Accrued contract costs represent direct and indirect costs on contracts as well as estimates of amounts owed for invoices not yet received from vendors or reflected in accounts payable.
Accrued warranty obligations as of October 31, 2019 relate to estimated liabilities for assurance-type warranty coverage that we provide to our customers. We generally provide warranty coverage for some of our products for a period of at least one year from the date of delivery. We record a liability for estimated warranty expense based on historical claims, product failure rates, consideration of contractual obligations, future costs to resolve software issues and other factors. Some of our product warranties are provided under long-term contracts, the costs of which are incorporated into our estimates of total contract costs.
Changes in our accrued warranty obligations during the three months ended October 31, 2019 and 2018 were as follows:
Three months ended October 31, | |||||||
2019 | 2018 | ||||||
Balance at beginning of period | $ | 15,968,000 | 11,738,000 | ||||
Reclass to contract liabilities (see below) | — | (1,679,000 | ) | ||||
Provision for warranty obligations | 989,000 | 1,020,000 | |||||
Charges incurred | (1,191,000 | ) | (1,515,000 | ) | |||
Warranty settlement and reclass (see below) | 302,000 | 418,000 | |||||
Balance at end of period | $ | 16,068,000 | 9,982,000 | ||||
On August 1, 2018, in connection with our adoption of ASC 606, $1,679,000 of accrued warranty obligations presented in the above table were reclassified to contract liabilities, as they represented deferred revenue related to service-type warranty performance obligations.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Our current accrued warranty obligations at October 31, 2019 and July 31, 2019 include $3,781,000 and $3,999,000, respectively, of warranty obligations for a small product line that we refer to as the TCS 911 call handling software solution. This solution was licensed to customers prior to our acquisition of TeleCommunication Systems, Inc. ("TCS"). During the fiscal year ended July 31, 2018, we entered into a full and final warranty settlement with AT&T, the largest customer/distributor of this product line, pursuant to which we issued thirty-six credits to AT&T of $153,000 which AT&T can apply on a monthly basis to purchases of solutions from us, beginning October 2017 through September 2020. As of October 31, 2019, the total present value of these monthly credits is $1,611,000, all of which is included in our current accrued warranty obligations on our Condensed Consolidated Balance Sheet.
In connection with our acquisition of Solacom and the GD NG-911 business during the fiscal year ended July 31, 2019, we assumed warranty obligations related to certain contracts acquired. See Note (2) - "Acquisitions" for further information pertaining to these acquisitions.
(10) | Cost Reduction Actions |
During the three months ended October 31, 2018, we took steps to improve our future operating results and successfully consolidated our Government Solutions segment’s manufacturing facility located in Tampa, Florida with another facility that we maintain in Orlando, Florida. In doing so, during the three months ended October 31, 2018, we recorded $1,373,000 of facility exit costs in selling, general and administrative expenses in our Condensed Consolidated Statements of Operations. As discussed further in Note (12) - "Leases," on August 1, 2019, we adopted Topic 842 and, as required by the new standard, reclassified $568,000 of estimated facility exit costs to the current portion of operating lease liabilities.
During the second quarter of fiscal 2019, we began an evaluation and repositioning of our public safety and location technologies solutions in order to focus on providing higher margin solution offerings. To date, we have ceased offering certain solutions, have worked with customers to wind-down certain legacy contracts and have not renewed certain contracts. In connection with this ongoing evaluation and repositioning, during the three months ended October 31, 2019, we recorded $230,000 of estimated contract settlement costs in our Commercial Solutions segment.
(11) Credit Facility
On October 31, 2018, we entered into a First Amended and Restated Credit Agreement (the "Credit Facility") with a syndicate of lenders, replacing our prior Credit Agreement dated as of February 23, 2016 (as amended by that certain First Amendment, dated as of June 6, 2017 (the "Prior Credit Facility")). In connection with the establishment of our new Credit Facility, during the three months ended October 31, 2018, we wrote-off $3,217,000 of deferred financing costs primarily related to the Term Loan Facility portion of our Prior Credit Facility and capitalized deferred financing costs of $1,813,000 related to the new Credit Facility.
The Credit Facility provides a senior secured loan facility of up to $550,000,000 consisting of: (i) a revolving loan facility ("Revolving Loan Facility") with a borrowing limit of $300,000,000; (ii) an accordion feature allowing us to borrow up to an additional $250,000,000; (iii) a $35,000,000 letter of credit sublimit; and (iv) a swingline loan credit sublimit of $25,000,000.
The Credit Facility matures on October 31, 2023 (the "Revolving Maturity Date"). If we issue new unsecured debt in excess of $5,000,000 with a maturity date that is less than 91 days from October 31, 2023, the Revolving Maturity Date would automatically accelerate so that it would be 91 days earlier than the maturity date of the new unsecured debt.
The proceeds of the Credit Facility were used, in part, to repay in full the outstanding borrowings under the Prior Credit Facility, and additional proceeds of the Credit Facility are expected to be used by us for working capital and other general corporate purposes. As of October 31, 2019, the amount outstanding under our Credit Facility was $169,000,000, which is reflected in the non-current portion of long-term debt on our Condensed Consolidated Balance Sheet. At October 31, 2019, we had $2,632,000 of standby letters of credit outstanding under our Credit Facility related to guarantees of future performance on certain customer contracts and no outstanding commercial letters of credit. During the three months ended October 31, 2019, we had outstanding balances under the Credit Facility ranging from $142,000,000 to $169,000,000.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
As of October 31, 2019, total net deferred financing costs related to the Credit Facility were $2,943,000 and are being amortized over the term of our Credit Facility through October 31, 2023.
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.
The Credit Facility contains customary representations, warranties and affirmative covenants. The Credit Facility also contains customary negative covenants, subject to negotiated exceptions, including but not limited to: (i) liens, (ii) investments, (iii) indebtedness, (iv) significant corporate changes, including mergers and acquisitions, (v) dispositions, (vi) restricted payments, including stockholder dividends, and (vii) certain other restrictive agreements. The Credit Facility also contains certain financial covenants and customary events of default (subject to grace periods, as appropriate), such as payment defaults, cross-defaults to other material indebtedness, bankruptcy and insolvency, the occurrence of a defined change in control and the failure to observe the negative covenants and other covenants related to the operation of our business. In addition, under certain circumstances, we may be required to enter into amendments to the Credit Facility in connection with any further syndication of the Credit Facility.
The Credit Facility provides for, among other things: (i) no scheduled payments of principal until maturity; (ii) a maximum Secured Leverage Ratio of 3.75x trailing twelve months ("TTM") Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") and a Maximum Total Leverage Ratio of 4.50x TTM Adjusted EBITDA, each with no step downs; and (iii) a Minimum Interest Expense Coverage Ratio of 3.25x TTM Adjusted EBITDA.
As of October 31, 2019, our Secured Leverage Ratio was 1.75x TTM Adjusted EBITDA compared to the maximum allowable Secured Leverage Ratio of 3.75x TTM Adjusted EBITDA. Our Interest Expense Coverage Ratio as of October 31, 2019 was 13.07x TTM Adjusted EBITDA compared to the Minimum Interest Expense Coverage Ratio of 3.25x TTM Adjusted EBITDA. Given our expected future business performance, we anticipate maintaining compliance with the terms and financial covenants in our Credit Facility for the foreseeable future.
The obligations under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the "Guarantors"). As collateral security under the Credit Facility and the guarantees thereof, we and the Guarantors have granted to the administrative agent, for the benefit of the lenders, a lien on, and first priority security interest in, substantially all of our tangible and intangible assets.
On December 6, 2018, we entered into the first amendment to the Credit Facility. The purpose of the amendment is to provide for a mechanism to replace the LIBO Rate for Eurodollar borrowings with an alternative benchmark interest rate, should the LIBO Rate generally become unavailable in the future on an other-than-temporary basis.
Capitalized terms used but not defined herein have the meanings set forth for such terms in the Credit Facility and the Prior Credit Facility, which have been documented and filed with the SEC.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
(12) Leases
On August 1, 2019, we adopted ASU No. 2016-02 - Leases (Topic 842), which requires the recognition of lease rights and obligations as assets and liabilities on the balance sheet. Previously, operating leases were not recognized on the balance sheet. As we elected the modified retrospective adoption method, prior-period information was not restated. We also elected the transition package of practical expedients available in the standard, which permits us to not reassess under the new standard our prior conclusions about lease identification, classification and initial direct costs. As part of our adoption, however, we did not elect to use the hindsight or land easements practical expedients.
On August 1, 2019, in connection with our adoption of Topic 842, we recognized $35,825,000 of operating lease right-of-use ("ROU") assets (net of a $3,023,000 deferred rent liability that existed as of August 1, 2019 under prior applicable GAAP) and $38,848,000 of related liabilities. Except for the recording of the ROU assets and lease liabilities on our Condensed Consolidated Balance Sheet, and the expanded disclosures about our leasing activities, our adoption did not have a material impact on our condensed consolidated financial statements. Our adoption also did not result in any cumulative-effect adjustment to opening retained earnings.
Our leases historically relate to the leasing of facilities and equipment. We determine at inception whether an arrangement is, or contains, a lease and whether the lease should be classified as an operating or a financing lease. At lease commencement, we recognize an ROU asset and lease liability based on the present value of the future lease payments over the estimated lease term. We have elected to not recognize an ROU asset or lease liability for any leases with terms of twelve months or less. Instead, for such short-term leases, we recognize lease expense on a straight-line basis over the lease term. Certain of our leases include options to extend the term of the lease or to terminate the lease early. When it is reasonably certain that we will exercise a renewal option or will not exercise a termination option, we include the impact of exercising or not exercising such option, respectively, in the estimate of the lease term. As our lease agreements do not explicitly state the discount rate implicit in the lease, we use our incremental borrowing rate ("IBR") on the commencement date to calculate the present value of future lease payments. Such IBR represents our estimated rate of interest to borrow on a collateralized basis over a term commensurate with the expected lease term.
Some of our leases include payments that are based on the Consumer Price Index ("CPI") or other similar indices. These variable lease payments are included in the calculation of the ROU asset and lease liability using the index as of the lease commencement date. Other variable lease payments, such as common area maintenance, property taxes, and usage-based amounts, are required by Topic 842 to be excluded from the ROU asset and lease liability and expensed as incurred. In addition to the present value of the future lease payments, the calculation of the ROU asset would also consider, to the extent applicable, any deferred rent upon adoption, lease pre-payments or initial direct costs of obtaining the lease (e.g., such as commissions).
For all classes of leased assets, we elected the practical expedient to not separate lease components (i.e., the actual item being leased, such as the facility or piece of equipment) from non-lease components (i.e., the distinct elements of a contract not related to securing the use of the leased asset, such as common area maintenance and consumable supplies).
Certain of our facility lease agreements (which are classified as operating leases) contain rent holidays or rent escalation clauses. For rent holidays and rent escalation clauses during the lease term, we record rental expense on a straight-line basis over the term of the lease. As of October 31, 2019, none of our leases contained a residual value guarantee and covenants included in our lease agreements are customary for the types of facilities and equipment being leased.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The components of lease expense are as follows:
Three months ended October 31, 2019 | |||
Finance lease expense: | |||
Amortization of ROU assets | $ | 108,000 | |
Interest on lease liabilities | 2,000 | ||
Operating lease expense | 2,637,000 | ||
Short-term lease expense | 863,000 | ||
Variable lease expense | 993,000 | ||
Sublease income | — | ||
Total lease expense | $ | 4,603,000 | |
Additional information related to leases is as follows:
Three months ended October 31, 2019 | |||
Cash paid for amounts included in the measurement of lease liabilities: | |||
Operating leases - Operating cash outflows | $ | 2,843,000 | |
Finance leases - Operating cash outflows | 2,000 | ||
Finance leases - Financing cash outflows | 198,000 | ||
ROU assets obtained in the exchange for lease liabilities: | |||
Operating leases | $ | 598,000 | |
The following table is a reconciliation of future cash flows relating to operating and finance lease liabilities presented on our Condensed Consolidated Balance Sheet as of October 31, 2019:
Operating | Finance | Total | ||||||||
Remaining portion of fiscal 2020 | $ | 8,192,000 | 109,000 | $ | 8,301,000 | |||||
Fiscal 2021 | 8,619,000 | — | 8,619,000 | |||||||
Fiscal 2022 | 7,387,000 | — | 7,387,000 | |||||||
Fiscal 2023 | 5,877,000 | — | 5,877,000 | |||||||
Fiscal 2024 | 4,170,000 | — | 4,170,000 | |||||||
Thereafter | 6,555,000 | — | 6,555,000 | |||||||
Total future undiscounted cash flows | 40,800,000 | 109,000 | 40,909,000 | |||||||
Less: Present value discount | 3,827,000 | 2,000 | 3,829,000 | |||||||
Lease liabilities | $ | 36,973,000 | 107,000 | $ | 37,080,000 | |||||
Weighted-average remaining lease terms (in years) | 4.59 | 0.22 | ||||||||
Weighted-average discount rate | 4.05 | % | 4.21 | % | ||||||
We lease our Melville, New York production facility from a partnership controlled by our President, CEO and Chairman. Lease payments made during the three months ended October 31, 2019 were $160,000. The current lease provides for our use of the premises as they exist through December 2021 with an option for an additional ten years. The annual rent of the facility for calendar year 2020 is $657,000 and is subject to customary adjustments. We have a right of first refusal in the event of a sale of the facility.
As of October 31, 2019, we do not have any rental commitments that have not commenced.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
As we have not restated prior year information given our method of adopting the new standard, the following represents our future minimum lease payments for operating leases and capital leases as of July 31, 2019 under ASC Topic 840 and as reported in our Form 10-K filed with the SEC on September 24, 2019:
Operating | Capital | Total | |||||||||
Fiscal 2020 | $ | 11,812,000 | 789,000 | $ | 12,601,000 | ||||||
Fiscal 2021 | 8,723,000 | — | 8,723,000 | ||||||||
Fiscal 2022 | 7,343,000 | — | 7,343,000 | ||||||||
Fiscal 2023 | 5,776,000 | — | 5,776,000 | ||||||||
Fiscal 2024 | 3,430,000 | — | 3,430,000 | ||||||||
Thereafter | 7,130,000 | — | 7,130,000 | ||||||||
Total | $ | 44,214,000 | 789,000 | $ | 45,003,000 | ||||||
Less amount representing interest | * | 32,000 | 32,000 | ||||||||
Present value of net minimum lease payments | * | $ | 757,000 | $ | 44,971,000 | ||||||
*Not applicable for operating leases
(13) Income Taxes
At October 31, 2019 and July 31, 2019, total unrecognized tax benefits were $7,839,000 and $7,215,000, respectively, including interest of $31,000 and $12,000, respectively. At October 31, 2019 and July 31, 2019, $2,298,000 and $325,000, respectively, of our unrecognized tax benefits were recorded as non-current income taxes payable on our Condensed Consolidated Balance Sheets. The remaining unrecognized tax benefits of $5,541,000 and $6,890,000 at October 31, 2019 and July 31, 2019, respectively, were presented as an offset to the associated non-current deferred tax assets on our Condensed Consolidated Balance Sheets. Of the total unrecognized tax benefits, $7,259,000 and $6,670,000, at October 31, 2019 and July 31, 2019, respectively, net of the reversal of the federal benefit recognized as a deferred tax asset relating to state reserves, would favorably impact our effective tax rate, if recognized. Unrecognized tax benefits result from income tax positions taken or expected to be taken on our income tax returns for which a tax benefit has not been recorded in our condensed consolidated financial statements. We do not expect that there will be any significant changes to our total unrecognized tax benefits within the next twelve months.
Our federal income tax returns for fiscal 2017 and 2018 are subject to potential future Internal Revenue Service ("IRS") audit. None of our state income tax returns prior to fiscal 2015 are subject to audit. TCS's federal income tax return for the tax period from January 1, 2016 to February 23, 2016, the date we acquired TCS, is subject to potential future IRS audit. None of TCS's state income tax returns prior to calendar year 2015 are subject to audit. Future tax assessments or settlements could have a material adverse effect on our consolidated results of operations and financial condition.
(14) Stock-Based Compensation
Overview
We issue stock-based awards to certain of our employees and our Board of Directors pursuant to our 2000 Stock Incentive Plan, as amended, (the "Plan") and our 2001 Employee Stock Purchase Plan (the "ESPP"), and recognize related stock-based compensation in our condensed consolidated financial statements. The Plan provides for the granting to employees and consultants of Comtech (including prospective employees and consultants): (i) incentive and non-qualified stock options, (ii) restricted stock units ("RSUs"), (iii) RSUs with performance measures (which we refer to as "performance shares"), (iv) restricted stock, (v) stock units (reserved for issuance to non-employee directors) and share units (reserved for issuance to employees) (collectively, "share units") and (vi) stock appreciation rights ("SARs"), among other types of awards. Our non-employee directors are eligible to receive non-discretionary grants of stock-based awards, subject to certain limitations.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
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.
As of October 31, 2019, we had granted stock-based awards pursuant to the Plan representing the right to purchase and/or acquire an aggregate of 8,723,732 shares (net of 4,031,305 expired and canceled awards), of which an aggregate of 6,286,882 have been exercised or settled.
As of October 31, 2019, the following stock-based awards, by award type, were outstanding:
October 31, 2019 | ||
Stock options | 1,503,295 | |
Performance shares | 217,839 | |
RSUs and restricted stock | 476,036 | |
Share units | 239,680 | |
Total | 2,436,850 | |
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.
Stock-based compensation for awards issued is reflected in the following line items in our Condensed Consolidated Statements of Operations:
Three months ended October 31, | |||||||
2019 | 2018 | ||||||
Cost of sales | $ | 59,000 | 58,000 | ||||
Selling, general and administrative expenses | 743,000 | 905,000 | |||||
Research and development expenses | 77,000 | 83,000 | |||||
Stock-based compensation expense before income tax benefit | 879,000 | 1,046,000 | |||||
Estimated income tax benefit | (189,000 | ) | (228,000 | ) | |||
Net stock-based compensation expense | $ | 690,000 | 818,000 | ||||
Stock-based compensation for equity-classified awards is measured at the date of grant, based on an estimate of the fair value of the award and is generally expensed over the vesting period of the award. At October 31, 2019, unrecognized stock-based compensation of $11,885,000, net of estimated forfeitures of $1,085,000, is expected to be recognized over a weighted average period of 3.3 years. Total stock-based compensation capitalized and included in ending inventory at both October 31, 2019 and July 31, 2019 was $48,000. There are no liability-classified stock-based awards outstanding as of October 31, 2019 or July 31, 2019.
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COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Stock-based compensation expense (benefit), by award type, is summarized as follows:
Three months ended October 31, | |||||||
2019 | 2018 | ||||||
Stock options | $ | 82,000 | 171,000 | ||||
Performance shares | 352,000 | 406,000 | |||||
RSUs and restricted stock | 698,000 | 547,000 | |||||
ESPP | 57,000 | 52,000 | |||||
Share units | (310,000 | ) | (130,000 | ) | |||
Stock-based compensation expense before income tax benefit | 879,000 | 1,046,000 | |||||
Estimated income tax benefit | (189,000 | ) | (228,000 | ) | |||
Net stock-based compensation expense | $ | 690,000 | 818,000 | ||||
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.
The estimated income tax benefit as shown in the above table was computed using income tax rates expected to apply when the awards are settled. Such deferred tax asset was recorded net as part of our non-current deferred tax liability on our Condensed Consolidated Balance Sheet as of October 31, 2019 and July 31, 2019. The actual income tax benefit recognized for tax reporting is based on the fair market value of our common stock at the time of settlement and can significantly differ from the estimated income tax benefit recorded for financial reporting.
Stock Options
The following table summarizes the Plan's activity during the three months ended October 31, 2019:
Awards (in Shares) | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value | ||||||||||
Outstanding at July 31, 2019 | 1,555,555 | $ | 28.72 | ||||||||||
Exercised | (51,460 | ) | 28.45 | ||||||||||
Expired/canceled | (800 | ) | 27.35 | ||||||||||
Outstanding at October 31, 2019 | 1,503,295 | $ | 28.73 | 3.27 | $ | 9,346,000 | |||||||
Exercisable at October 31, 2019 | 1,431,765 | $ | 28.83 | 3.14 | $ | 8,761,000 | |||||||
Vested and expected to vest at October 31, 2019 | 1,477,967 | $ | 28.76 | 3.23 | $ | 9,148,000 | |||||||
Stock options outstanding as of October 31, 2019 have exercise prices ranging from $20.90 - $33.94, representing the fair market value of our common stock on the date of grant, a contractual term of five or ten years and a vesting period of three or five years. The total intrinsic value relating to stock options exercised during the three months ended October 31, 2019 and 2018 was $305,000 and $561,000, respectively.
During the three months ended October 31, 2019 and 2018, at the election of certain holders of vested stock options, 40,860 and 72,830, respectively, of stock options were net settled upon exercise. As a result, 4,764 and 9,345 shares of our common stock were issued during the three months ended October 31, 2019 and 2018, respectively, net of shares retained to satisfy the exercise price and minimum statutory tax withholding requirements.
24
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Performance Shares, RSUs, Restricted Stock and Share Unit Awards
The following table summarizes the Plan's activity relating to performance shares, RSUs, restricted stock and share units:
Awards (in Shares) | Weighted Average Grant Date Fair Value | Aggregate Intrinsic Value | |||||||||
Outstanding at July 31, 2019 | 954,676 | $ | 22.40 | ||||||||
Granted | 219,425 | 27.69 | |||||||||
Settled | (199,466 | ) | 16.80 | ||||||||
Forfeited | (41,080 | ) | 21.00 | ||||||||
Outstanding at October 31, 2019 | 933,555 | $ | 24.91 | $ | 32,628,000 | ||||||
Vested at October 31, 2019 | 328,791 | $ | 24.92 | $ | 11,491,000 | ||||||
Vested and expected to vest at October 31, 2019 | 890,374 | $ | 25.06 | $ | 31,119,000 | ||||||
The total intrinsic value relating to fully-vested awards settled during the three months ended October 31, 2019 and 2018 was $5,806,000 and $4,210,000, respectively.
The performance shares granted to employees since fiscal 2014 principally vest over a three-year performance period, if pre-established performance goals are attained or as specified pursuant to the Plan and related agreements. As of October 31, 2019, the number of outstanding performance shares included in the above table, and the related compensation expense prior to consideration of estimated pre-vesting forfeitures, assume achievement of the pre-established goals at a target level.
RSUs and restricted stock granted to non-employee directors prior to July 31, 2019 have a vesting period of three years and are convertible into shares of our common stock generally at the time of termination, on a one-for-one basis for no cash consideration, or earlier under certain circumstances. RSUs and restricted stock granted to non-employee directors after July 31, 2019 have a vesting period of five years. RSUs granted to employees have a vesting period of five years and are convertible into shares of our common stock, generally at the time of vesting, on a one-for-one basis for no cash consideration.
Share units granted prior to July 31, 2017 were vested when issued and are convertible into shares of our common stock, generally at the time of termination, on a one-for-one basis for no cash consideration, or earlier under certain circumstances. Share units granted on or after July 31, 2017 were granted to certain employees in lieu of non-equity incentive compensation and are convertible into shares of our common stock on the one-year anniversary of the respective grant date. Cumulatively through October 31, 2019, 431,142 share units granted have been settled.
The fair value of performance shares, RSUs, restricted stock and share units is determined using the closing market price of our common stock on the date of grant, less the present value of any estimated future dividend equivalents such awards are not entitled to receive and an applicable estimated discount for any post vesting transfer restrictions. RSUs, performance shares and restricted stock granted since fiscal 2013 are entitled to dividend equivalents unless forfeited before vesting occurs. Share units granted since fiscal 2014 are entitled to dividend equivalents while the underlying shares are unissued.
Dividend equivalents are subject to forfeiture, similar to the terms of the underlying stock-based awards, and are payable in cash generally at the time of settlement of the underlying award. During the three months ended October 31, 2019, we accrued $56,000 of dividend equivalents (net of forfeitures) and paid out $285,000. Accrued dividend equivalents were recorded as a reduction to retained earnings. As of October 31, 2019 and July 31, 2019, accrued dividend equivalents were $548,000 and $777,000, respectively.
25
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
With respect to the actual settlement of stock-based awards for income tax reporting, during the three months ended October 31, 2019 and 2018, we recorded income tax benefits of $612,000 and $457,000, respectively, which primarily represent the net excess income tax benefits upon settlement of stock-based awards during each of the respective periods.
(15) Segment Information
Reportable operating segments are determined based on Comtech’s management approach. The management approach, as defined by FASB ASC 280 "Segment Reporting" is based on the way that the CODM organizes the segments within an enterprise for making decisions about resources to be allocated and assessing their performance. Our CODM, for purposes of FASB ASC 280, is our Chief Executive Officer and President.
Our Commercial Solutions segment offers satellite ground station technologies (such as modems and amplifiers) and public safety and location technologies (such as 911 call routing and mapping solutions) to commercial customers and smaller government customers, such as state and local governments. This segment also serves certain large government customers (including the U.S. government) that have requirements for off-the-shelf commercial equipment.
Our Government Solutions segment provides mission-critical technologies (such as tactical satellite-based networks and ongoing support for complicated communications networks) and high-performance transmission technologies (such as troposcatter systems and solid-state, high-power amplifiers) to large government end-users (including those of foreign countries), large international customers and domestic prime contractors.
Our CODM primarily uses a metric that we refer to as Adjusted EBITDA to measure an operating segment’s performance and to make decisions about resources to be allocated. Our Adjusted EBITDA metric for the Commercial Solutions and Government Solutions segments do not consider any allocation of indirect expense, or any of the following: income taxes, interest (income) and other, write-off of deferred financing costs, interest expense, amortization of stock-based compensation, amortization of intangible assets, depreciation expenses, estimated contract settlement costs, settlement of intellectual property litigation, acquisition plan expenses, facility exit costs or strategic alternatives analysis expenses and other expenses that relate to our Unallocated segment. These items, while periodically affecting our results, may vary significantly from period to period and may have a disproportionate effect in a given period, thereby affecting the comparability of results. Any amounts shown in the Adjusted EBITDA calculation for our Commercial Solutions and Government Solutions segments are directly attributable to those segments. Our Adjusted EBITDA is also used by our management in assessing the Company's operating results. Although closely aligned, the Company's definition of Adjusted EBITDA is different than the Consolidated EBITDA (as such term is defined in our Credit Facility) utilized for financial covenant calculations and also may differ from the definition of EBITDA or Adjusted EBITDA used by other companies and, therefore, may not be comparable to similarly titled measures used by other companies.
26
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Operating segment information, along with a reconciliation of segment net income (loss) and consolidated net income to Adjusted EBITDA is presented in the tables below:
Three months ended October 31, 2019 | ||||||||||||||
Commercial Solutions | Government Solutions | Unallocated | Total | |||||||||||
Net sales | $ | 94,314,000 | 75,953,000 | — | $ | 170,267,000 | ||||||||
Operating income (loss) | $ | 9,841,000 | 7,083,000 | (7,664,000 | ) | $ | 9,260,000 | |||||||
Net income (loss) | $ | 9,867,000 | 7,095,000 | (10,574,000 | ) | $ | 6,388,000 | |||||||
Provision for income taxes | ||||||||||||||