UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20459 Form 10-Q (Mark One) (X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the period ended April 30, 2002 ( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to -------------------- -------------------- Commission File Number: 0-7928 COMTECH TELECOMMUNICATIONS CORP. (Exact name of registrant as specified in its charter) Delaware 11-2139466 (State or other jurisdiction (I.R.S. Employer of incorporation /organization) Identification Number) 105 Baylis Road, Melville, New York 11747 (Address of principal executive offices) (Zip Code) (631) 777-8900 (Registrant's telephone number, including area code) 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. (X) Yes ( ) No APPLICABLE ONLY TO CORPORATE ISSUERS: As of June 7, 2002, the number of outstanding shares of Common Stock, par value $.10 per share, of the Registrant was 7,486,952.
COMTECH TELECOMMUNICATIONS CORP. INDEX Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - April 30, 2002 (Unaudited) and July 31, 2001 2 Consolidated Statements of Operations - Three Months and Nine Months Ended April 30, 2002 and 2001 (Unaudited) 3 Consolidated Statements of Cash Flows - Nine Months Ended April 30, 2002 and 2001 (Unaudited) 4 Notes to Consolidated Financial Statements 5 - 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 - 14 Item 3. Quantitative and Qualitative Disclosures about Market Risk 14 PART II. OTHER INFORMATION Item 1. Legal Proceedings 14 Item 6. Exhibits and Reports on Form 8-K 14 Signature Page 15 1
PART I FINANCIAL INFORMATION COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS Item 1. <TABLE> <CAPTION> April 30, July 31, 2002 2001 ------------- ------------ Assets (Unaudited) <S> <C> <C> Current assets: Cash and cash equivalents $ 21,539,000 36,205,000 Accounts receivable, less allowance for doubtful accounts of $672,000 at April 30, 2002 and $845,000 at July 31, 2001 27,269,000 27,374,000 Inventories, net 33,875,000 36,732,000 Prepaid expenses and other current assets 1,055,000 1,151,000 Deferred tax asset - current 2,634,000 2,634,000 ------------- ------------ Total current assets 86,372,000 104,096,000 Property, plant and equipment, net 11,655,000 11,778,000 Goodwill and other intangibles with indefinite lives, net of accumulated amortization of $1,648,000 at April 30, 2002 and July 31, 2001 17,726,000 17,657,000 Other intangibles with definite lives, net of accumulated amortization of $2,310,000 at April 30, 2002 and $1,209,000 at July 31, 2001 9,152,000 10,162,000 Other assets, net 346,000 569,000 Deferred tax asset - non current 2,726,000 2,726,000 ------------- ------------ Total assets $ 127,977,000 146,988,000 ============= ============ Liabilities and Stockholders' Equity Current liabilities: Current installments of long-term debt $ -- 5,900,000 Current installments of capital lease obligations (including payable to related party of $155,000 at July 31, 2001) 1,064,000 1,097,000 Accounts payable 9,241,000 11,014,000 Accrued expenses and other current liabilities 12,250,000 13,615,000 Deferred service revenue 3,787,000 2,073,000 Income taxes payable 3,789,000 3,308,000 ------------- ------------ Total current liabilities 30,131,000 37,007,000 Long-term debt, less current installments 28,683,000 42,000,000 Capital lease obligations, less current installments 1,551,000 2,157,000 Other long-term liabilities 179,000 259,000 ------------- ------------ Total liabilities 60,544,000 81,423,000 Stockholders' equity: Preferred stock, par value $.10 per share; shares authorized and unissued 2,000,000 -- -- Common stock, par value $.10 per share; authorized 30,000,000 shares; issued 7,580,302 shares at April 30, 2002 and 7,511,105 shares at July 31, 2001 758,000 751,000 Additional paid-in capital 67,844,000 67,490,000 Accumulated deficit (514,000) (1,973,000) ------------- ------------ 68,088,000 66,268,000 Less: Treasury stock (93,750 shares at April 30, 2002 and 82,500 shares at July 31, 2001) (237,000) (184,000) Deferred compensation (418,000) (519,000) ------------- ------------ Total stockholders' equity 67,433,000 65,565,000 ------------- ------------ Total liabilities and stockholders'equity $ 127,977,000 146,988,000 ============= ============ Commitments and contingencies </TABLE> See accompanying notes to consolidated financial statements. 2
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) <TABLE> <CAPTION> Three months ended Nine months ended April 30, April 30, ------------------------------- -------------------------------- 2002 2001 2002 2001 ------------ ----------- ----------- ------------ <S> <C> <C> <C> <C> Net sales $ 29,262,000 32,322,000 90,832,000 105,279,000 Cost of sales 19,364,000 19,979,000 61,010,000 67,172,000 ------------ ----------- ----------- ------------ Gross profit 9,898,000 12,343,000 29,822,000 38,107,000 ------------ ----------- ----------- ------------ Operating expenses: Selling, general and administrative 5,531,000 5,646,000 16,408,000 18,030,000 Research and development 2,797,000 2,236,000 8,157,000 7,651,000 Amortization of intangibles 370,000 586,000 1,101,000 1,759,000 ------------ ----------- ----------- ------------ Total operating expenses 8,698,000 8,468,000 25,666,000 27,440,000 ------------ ----------- ----------- ------------ Operating income 1,200,000 3,875,000 4,156,000 10,667,000 Other expense (income): Interest expense 702,000 957,000 2,365,000 2,836,000 Interest income (90,000) (562,000) (370,000) (1,968,000) Other, net (10,000) 956,000 (17,000) 864,000 ------------ ----------- ----------- ------------ Income before provision for income taxes 598,000 2,524,000 2,178,000 8,935,000 Provision for income taxes 189,000 997,000 719,000 3,529,000 ------------ ----------- ----------- ------------ Net income $ 409,000 1,527,000 1,459,000 5,406,000 ============ =========== =========== ============ Net income per share: Basic $ 0.06 0.21 0.20 0.74 ============ =========== =========== ============ Diluted $ 0.05 0.19 0.18 0.69 ============ =========== =========== ============ Weighted average number of common shares outstanding - basic 7,474,000 7,396,000 7,450,000 7,324,000 Potential dilutive common shares 380,000 553,000 459,000 561,000 ------------ ----------- ----------- ------------ Weighted average number of common and common equivalent shares outstanding assuming dilution - diluted 7,854,000 7,949,000 7,909,000 7,885,000 ============ =========== =========== ============ </TABLE> See accompanying notes to consolidated financial statements. 3
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> Nine months ended April 30, --------- 2002 2001 ------------ ----------- <S> <C> <C> Cash flows from operating activities: Net income $ 1,459,000 5,406,000 Adjustments to reconcile net income to net cash provided by operating activities: Loss on sale of marketable investment securities -- 990,000 Depreciation and amortization 3,925,000 4,909,000 Deferred income taxes -- (67,000) Reduction of bad debt allowance (173,000) (119,000) Provision for (reduction of) inventory reserve 778,000 (620,000) Changes in operating assets and liabilities, net of effect of acquisitions: Accounts receivable 278,000 (4,695,000) Inventories 2,079,000 (5,044,000) Prepaid expenses and other current assets 96,000 (697,000) Other assets 135,000 (47,000) Accounts payable (1,773,000) (1,273,000) Accrued expenses and other current liabilities (1,365,000) 1,403,000 Deferred service revenue 1,714,000 -- Income taxes payable 481,000 2,800,000 Other long-term liabilities (80,000) (81,000) ------------ ----------- Net cash provided by operating activities 7,554,000 2,865,000 ------------ ----------- Cash flows from investing activities: Purchase of marketable investment securities -- (1,330,000) Proceeds from sale of marketable investment securities -- 19,221,000 Purchases of property, plant and equipment (2,365,000) (2,113,000) Purchase of technology license (91,000) (2,063,000) Payment for business acquisitions, net of cash received (69,000) (2,885,000) ------------ ----------- Net cash (used in) provided by investing activities (2,525,000) 10,830,000 ------------ ----------- Cash flows from financing activities: Borrowings under loan agreement -- 10,000,000 Prepayment of principal under loan agreement (19,217,000) -- Principal payments on capital lease obligation (838,000) (294,000) Proceeds from exercises of stock options and warrants 360,000 656,000 ------------ ----------- Net cash (used in) provided by financing activities (19,695,000) 10,362,000 ------------ ----------- Net (decrease) increase in cash and cash equivalents (14,666,000) 24,057,000 Cash and cash equivalents at beginning of period 36,205,000 12,587,000 ------------ ----------- Cash and cash equivalents at end of period $ 21,539,000 36,644,000 ============ =========== Supplemental cash flow disclosure: Cash paid during the period for: Interest $ 1,758,000 1,849,000 Income taxes $ 238,000 729,000 Non cash investing activities: Acquisition of equipment through capital leases $ 199,000 326,000 </TABLE> See accompanying notes to consolidated financial statements. 4
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) General The accompanying consolidated financial statements at and for the three months and nine months ended April 30, 2002 and 2001 are unaudited. In the opinion of management, the information furnished reflects all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the unaudited interim periods. The results of operations for such periods are not necessarily indicative of the results of operations to be expected for the full year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the fiscal year ended July 31, 2001 and the notes thereto contained in the Company's Annual Report on Form 10-K, filed with the Securities and Exchange Commission. (2) Reclassification Certain reclassifications have been made to previously reported statements to conform to the Company's current financial statement format. (3) Acquisitions In April 2001, we acquired certain assets and product lines of MPD Technologies, Inc. ("MPD") for $12.7 million, including transaction costs of $.8 million. The acquisition was accounted for under the purchase method of accounting. Accordingly, we have recorded the assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition. The purchase price of $12.7 million was financed through $10.0 million of institutional secured borrowings and the balance from internal company funds. The Company's operating results for the nine months ended April 30, 2002 include MPD. (4) Accounts Receivable Accounts receivable consist of the following: <TABLE> <CAPTION> April 30, 2002 July 31, 2001 -------------- ------------- <S> <C> <C> Accounts receivable from commercial customers $ 12,964,000 18,336,000 Unbilled receivables (including retainages) on contracts-in-progress 9,214,000 5,939,000 Amounts receivable from the United States government and its agencies 5,763,000 3,944,000 ------------ ---------- 27,941,000 28,219,000 Less allowance for doubtful accounts 672,000 845,000 ------------ ---------- Accounts receivable, net $ 27,269,000 27,374,000 ============ ========== (5) Inventories Inventories consist of the following: April 30, 2002 July 31, 2001 -------------- ------------- Raw materials and components $ 16,727,000 18,718,000 Work-in-process 20,206,000 20,294,000 ------------ ---------- 36,933,000 39,012,000 Less: Reserve for anticipated losses on contracts and inventory reserves 3,058,000 2,280,000 ------------ ---------- Inventories, net $ 33,875,000 36,732,000 ============ ========== </TABLE> 5
(6) Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consist of the following: <TABLE> <CAPTION> April 30, 2002 July 31, 2001 -------------- ------------- <S> <C> <C> Customer advances and deposits $ 2,567,000 2,089,000 Accrued wages and benefits 3,056,000 3,663,000 Accrued commissions 1,024,000 1,021,000 Accrued warranty 3,402,000 4,336,000 Other 2,201,000 2,506,000 ------------ ---------- $ 12,250,000 13,615,000 ============ ========== </TABLE> (7) Long-Term Debt In August 2001, the Company prepaid $19.2 million of principal on the $40.0 million of debt incurred in connection with the EF Data acquisition. After the prepayment, the aggregate remaining amount of principal outstanding relating to the $50 million of borrowings associated with the EF Data and MPD Technologies acquisitions was $28.7 million. There was no prepayment penalty as a result of the pay down, which was funded by available cash balances. As a result of the prepayment, the next principal payment on such borrowings is not due until December 2003. (8) Earnings Per Share The Company calculates earnings per share ("EPS") in accordance with SFAS No. 128, "Earnings per Share". Basic EPS is computed based on the weighted average number of shares outstanding. Diluted EPS reflects the maximum dilution from potential common stock issuable pursuant to the exercise of stock options and warrants, if dilutive, outstanding during each period. (9) Segment and Principal Customer Information The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Reportable operating segments are determined based on the Company's management approach. The management approach, as defined by SFAS No. 131, is based on the way that the chief operating decision-maker organizes the segments within an enterprise for making operating decisions and assessing performance. While the Company's results of operations are primarily reviewed on a consolidated basis, the chief operating decision-maker also manages the enterprise in three segments: (i) Telecommunications Transmission, (ii) RF Microwave Amplifiers and (iii) Mobile Data Communications Services. Telecommunications Transmission products include modems, frequency converters, satellite VSAT transceivers and antennas and over-the-horizon microwave communications products and systems. RF Microwave Amplifiers products include high-power amplifier products that use the microwave and radio frequency spectrums. Mobile Data Communications Services include two-way messaging between mobile platforms or remote sites and user headquarters using satellite, terrestrial microwave or Internet links. Unallocated assets consist principally of cash, deferred tax assets and intercompany receivables. Unallocated losses result from such corporate expenses as legal, accounting and executive. Segment sales below for the three and nine month periods ended April 30, 2002 exclude inter-segment sales between the Telecommunications Transmission and RF Microwave Amplifiers segments aggregating $936,000 and $2,312,000, respectively, which were at approximately breakeven. 6
<TABLE> <CAPTION> Three months ended April 30, 2002 (in thousands) Mobile Data Telecommunications RF Microwave Communications Transmission Amplifiers Services Unallocated Total ------------ ---------- -------- ----------- ----- <S> <C> <C> <C> <C> <C> Net sales $ 18,065 5,415 5,782 -- 29,262 Operating income (loss) 1,551 185 258 (794) 1,200 Interest income 23 -- 3 64 90 Interest expense 477 225 -- -- 702 Depreciation and amortization 934 280 47 18 1,279 Expenditures for long-lived assets, including intangibles 384 400 72 7 863 Total assets 55,907 25,597 20,647 25,826 127,977 <CAPTION> Three months ended April 30, 2001 (in thousands) Mobile Data Telecommunications RF Microwave Communications Transmission Amplifiers Services Unallocated Total ------------ ---------- -------- ----------- ----- <S> <C> <C> <C> <C> <C> Net sales $ 25,297 3,766 3,259 -- 32,322 Operating income (loss) 4,583 (56) 74 (726) 3,875 Interest income 44 2 3 513 562 Interest expense 940 17 -- -- 957 Depreciation and amortization 1,258 220 53 24 1,555 Expenditures for long-lived assets, including intangibles 2,796 11,212 21 118 14,147 Total assets 68,416 24,251 12,092 41,347 146,106 <CAPTION> Nine months ended April 30, 2002 (in thousands) Mobile Data Telecommunications RF Microwave Communications Transmission Amplifiers Services Unallocated Total ------------ ---------- -------- ----------- ----- <S> <C> <C> <C> <C> <C> Net sales $ 58,219 17,557 15,056 -- 90,832 Operating income (loss) 5,336 922 372 (2,474) 4,156 Interest income 91 2 5 272 370 Interest expense 1,685 680 -- -- 2,365 Depreciation and amortization 2,784 941 146 54 3,925 Expenditures for long-lived assets, including intangibles 1,443 822 446 13 2,724 Total assets 55,907 25,597 20,647 25,826 127,977 </TABLE> 7
<TABLE> <CAPTION> Nine months ended April 30, 2001 (in thousands) Mobile Data Telecommunications RF Microwave Communications Transmission Amplifiers Services Unallocated Total ------------ ---------- -------- ----------- ----- <S> <C> <C> <C> <C> <C> Net sales $ 85,592 10,981 8,706 -- 105,279 Operating income (loss) 13,814 (128) (401) (2,618) 10,667 Interest income 175 6 3 1,784 1,968 Interest expense 2,777 59 -- -- 2,836 Depreciation and amortization 4,028 665 160 56 4,909 Expenditures for long-lived assets, including intangibles 3,635 11,629 101 122 15,487 Total assets 68,416 24,251 12,092 41,347 146,106 </TABLE> (10) Accounting for Business Combinations, Goodwill and Other Intangible Assets In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 specifies criteria that intangible assets acquired in a business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. This pronouncement also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". The Company adopted the provisions of SFAS No. 141 effective July 1, 2001 and SFAS No. 142 effective August 1, 2001. As of July 31, 2001, $4.6 million of intangibles, net of accumulated amortization of $.8 million, were reclassified as intangibles with indefinite lives. For the three and nine month periods ended April 30, 2001, the amount of amortization, net of income taxes, associated with goodwill and other intangibles with indefinite lives included in net income was $0.2 million and $0.6 million, respectively. If SFAS No. 142 had been adopted effective August 1, 2000, net income for the three and nine month periods ended April 30, 2001 would have been $1.7 million, and $6.0 million, respectively. Basic earnings per share for the three and nine month periods ended April 30, 2001 would have been $0.23 and $0.82 and diluted earnings per share would have been $0.22 and $0.76. Intangibles with indefinite lives by reporting unit as of April 30, 2002 are as follows: Telecommunications transmission $ 7,870,000 RF microwave amplifiers 8,422,000 Mobile data communications services 1,434,000 ----------- $17,726,000 =========== (11) Recent Accounting Pronouncements In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company is required to adopt SFAS No. 144 no later than August 1, 2002. The Company does not expect SFAS No. 144 will have a material impact on the Company's consolidated financial statements. In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The provisions of SFAS No. 145 shall be applied in fiscal years beginning, or for transactions occurring, after May 15, 2002. Early application of SFAS No. 145 may be as of the beginning of the fiscal year or as of the beginning of the interim period in which SFAS No. 145 is issued. The Company has not determined the effect, if any, that adoption of SFAS No. 145 will have on the Company's consolidated financial statements. 8
COMTECH TELECOMMUNICATIONS CORP. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We design, develop, produce and market sophisticated wireless telecommunications transmission products and systems and solid state high-power broadband amplifiers for commercial and government purposes. Our products are used in point-to-point and point-to-multipoint telecommunication applications such as satellite communications, over-the-horizon microwave systems, telephone systems and cable and broadcast television. Our broadband amplifier products are also used in cellular and PCS instrumentation testing and certain defense systems. Our business consists of three segments: mobile data communications services, telecommunications transmission, and RF microwave amplifiers. Our sales of mobile data communications services may increase substantially if, when and as orders are received under our contract with the U.S. Army and we penetrate other government and commercial markets for these services. Our sales are made to domestic and international customers, both commercial and governmental. International sales (including sales to prime contractors for end use by international customers) are expected to remain a substantial portion of our total sales for the foreseeable future due to the growing worldwide demand for wireless and satellite telecommunication products and services and our expanded line of RF microwave amplifier product offerings to meet these demands. At times, a substantial portion of our sales may be derived from a limited number of relatively large customer contracts, the timing of which cannot be predicted. Quarterly sales and operating results may be significantly affected by one or more of such contracts. Accordingly, we can experience significant fluctuations in sales and operating results from quarter to quarter. Sales consist of stand-alone products and systems. For the past several years we have endeavored to achieve greater product sales as a percentage of total sales, because product sales generally have higher gross profit margins than systems sales. In the future, as our installed base of mobile data communications terminals is established, we expect an increasing amount of our sales will be attributable to the recurring service revenue component of our mobile data communications services segment. We generally recognize income under contracts only when the products are shipped. However, when the performance of a contract will extend beyond a 12-month period, income is recognized on the percentage-of-completion method. Profits expected to be realized on contracts are based on total sales value as related to estimated costs at completion. These estimates are reviewed and revised periodically throughout the lives of the contracts, and adjustments to profits resulting from such revisions are made cumulative to the date of the change. Estimated losses on long-term contracts-in-progress are recorded in the period in which such losses become known. Since our contract with the U.S. Army for the Movement Tracking System is for an eight-year period, revenue recognition is based on the percentage-of-completion method. The gross margin is based on the estimated revenues and expenses for the entire eight-year contract. The amount of revenue recognized has been limited to the amount of funded orders received from the U.S. Army. The portion of such orders representing service time revenue is being deferred until the service time is used by the customer. Significant changes in the estimates used to derive the gross profit margin can materially impact our operating results and financial condition in future periods. The cumulative orders to-date under the Movement Tracking System contract have been far below the Army's initial requirements. The Company is currently in active discussions with the Army to address the funding shortfalls experienced to date on this program. The ultimate resolution of these discussions could result in, among other things, material changes to the estimates used in applying the percentage-of-completion method of accounting. Our gross profit is affected by a variety of factors, including the mix of products, systems and services sold, production efficiency, price competition and general economic conditions. Selling, general and administrative expenses consist primarily of salaries and benefits for marketing, sales and administrative employees, advertising and trade show costs, professional fees and amortization of deferred compensation. Our research and development expenses relate to both existing product enhancement and new product development. A portion of our research and development efforts is related to specific contracts and is recoverable under 9
those contracts because they are funded by the customer. Such customer-funded expenditures are not included in research and development expenses for financial reporting purposes but are reflected in cost of sales. In July 2000, we acquired the business of EF Data, the satellite communications division of Adaptive Broadband Corporation for cash. The acquisition was accounted for under the "purchase method" of accounting. Accordingly, we allocated the purchase price to the assets purchased and the liabilities assumed based upon the estimated fair values at the date of the acquisition. The excess of the purchase price over the fair values of the net assets acquired was approximately $26.8 million, of which $10.2 million was allocated to in-process research and development and was expensed as of the acquisition date. Forty million dollars of the purchase price was supplied through institutional secured borrowings bearing interest at 9.25% due in installments through 2005, and the balance from internal company funds. In April 2001, we acquired certain assets and product lines of MPD Technologies, Inc. for cash. The acquisition was accounted for under the "purchase method" of accounting. Accordingly, we have recorded the assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition. The purchase price was financed through $10.0 million of institutional secured borrowings and the balance from internal company funds. The secured borrowing bears interest at a rate of 8.5% and requires interest only payments through June 2005 at which time the entire principal is due. We combined this operation with our Comtech PST Corp. operation in our RF microwave amplifiers segment. Critical Accounting Policies The Company considers certain accounting policies relating to revenue recognition on long-term contracts and impairment of intangible assets to be critical policies due to the estimation process involved in each. Revenue Recognition on Long-Term Contracts As discussed above, when the performance of a contract will extend beyond a 12-month period, revenue and related costs are recognized on the percentage-of-completion method of accounting. Profits expected to be realized on such contracts are based on total estimated sales for the contract compared to total estimated costs at completion of the contract. These estimates are reviewed and revised periodically throughout the lives of the contracts, and adjustments to profits resulting from such revisions are made cumulative to the date of the change. Estimated losses on long-term contracts are recorded in the period in which the losses become known. Some of the Company's largest contracts, including its contract with the U.S. Army for the Movement Tracking System, are accounted for using the percentage-of-completion method. If the Company does not accurately estimate the total sales and related costs on such contracts, the estimated gross margins may be significantly impacted or losses may need to be recognized in future periods. Any such resulting reductions in margins or contract losses could be material to the Company's results of operations and financial position. The cumulative orders to-date under the Movement Tracking System contract have been far below the Army's initial requirements. The Company is currently in active discussions with the Army to address the funding shortfalls experienced to date on this program. The ultimate resolution of these discussions could result in, among other things, material changes to the estimates used in applying the percentage-of-completion method of accounting. Impairment of Intangible Assets As of April 30, 2002, the Company's intangible assets, including goodwill, aggregated $26.9 million. In assessing the recoverability of the Company's goodwill and other intangibles, the Company must make various assumptions regarding estimated future cash flows and other factors in determining the fair values of the respective assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets in future periods. Any such resulting impairment charges could be material to the Company's results of operations and financial position. COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED APRIL 30, 2002 AND APRIL 30, 2001 Net Sales. Consolidated net sales were $29.3 million and $32.3 million for the three months ended April 30, 2002 and 2001, respectively, representing a decrease of $3.0 million or 9.3%. Sales during the three months ended April 30, 2002 continued to be adversely impacted by the weak economic environment. Particular softness was experienced in our telecommunications transmission segment as a result of the significant downturn in the telecommunications market. We believe sales in this segment will continue to be adversely impacted until economic conditions improve. Sales from our telecommunications transmission 10
segment were $18.1 million, or 61.8% of our total net sales, during the three months ended April 30, 2002 as compared to $25.3 million, or 78.3% of our total net sales, during the three months ended April 30, 2001. Sales from our RF microwave amplifier segment were $5.4 million and $3.8 million for the three months ended April 30, 2002 and 2001, respectively, or 18.4% and 11.8% of our total net sales. The increase of approximately $1.6 million was principally the result of the acquisition of certain assets and product lines of MPD Technologies, Inc. in April 2001. Sales from our mobile data communications services segment were $5.8 million, or 19.8% of our total net sales for the three months ended April 30, 2002, versus $3.2 million, or 9.9% of our total net sales for the three months ended April 30, 2001. The increase of approximately $2.6 million was due to increased sales of our Movement Tracking System, primarily to the U.S. Army. International sales represented 34.5% and 42.7% of total net sales for the three months ended April 30, 2002 and 2001, respectively. Domestic sales represented 21.8% and 27.6% of total net sales for the three months ended April 30, 2002 and 2001, respectively. U.S. government sales represented 43.7% and 29.7% of total net sales for the three months ended April 30, 2002 and 2001, respectively. Gross Profit. Gross profit was $9.9 million and $12.3 million for the three months ended April 30, 2002 and 2001, respectively. The decrease was partially due to the reduced total level of sales discussed above. In addition, gross margin, as a percentage of sales, decreased from 38.2% to 33.8%. The decrease in the gross margin percentage was driven by the significant decrease in telecommunications transmission segment sales which generally carry higher margins than sales from the other two segments. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $5.5 million and $5.6 million for the three months ended April 30, 2002 and 2001, respectively. The decrease was related to the decrease in sales during the three months ended April 30, 2002. Research and Development Expenses. Research and development expenses were $2.8 million and $2.2 million, respectively, during the three months ended April 30, 2002 and 2001. Despite the softness in sales discussed above, we are continuing to invest in the future by enhancing our existing products and developing new products and technologies. Whenever possible, we seek customer funding for research and development to adapt our products to specialized customer requirements. During the three months ended April 30, 2002 and 2001, customers reimbursed us $0.6 million and $0.3 million, respectively, which amounts are not reflected in the reported research and development expenses. Amortization of Intangibles. Amortization of intangibles decreased from $0.6 million to $0.4 million during the three months ended April 30, 2002 compared to the three months ended April 30, 2001 as incremental amortization expense relating to the acquisition of certain assets and product lines of MPD Technologies, Inc. was more than offset by the cessation of goodwill amortization in accordance with newly adopted accounting pronouncements (see note 10 to the consolidated financial statements). Operating Income. Operating income for the three months ended April 30, 2002 and 2001 was $1.2 million and $3.9 million, respectively. The decrease was primarily the result of the decrease in gross profit, discussed above. Interest Expense. Interest expense was $0.7 million and $1.0 million for the three months ended April 30, 2002 and 2001, respectively. Additional interest on borrowings in connection with the acquisition of certain assets and product lines of MPD Technologies, Inc. in April 2001 were more than offset by interest savings from the prepayment of $19.2 million of debt in August 2001. Interest Income. Interest income was $90,000 and $0.6 million for the three months ended April 30, 2002 and 2001, respectively. The decrease was the result of a lower level of investable funds during the three months ended April 30, 2002, as well as lower interest rates. Other, Net. Other income for the three months ended April 30, 2002 was $10,000 compared to other expense of $1.0 million for the three months ended April 30, 2001. The amount in the 2001 period was primarily due to the loss realized upon the sale in March 2001 of a short-term investment classified as available-for-sale. Provision for Income Taxes. The provision for income taxes was $0.2 million and $1.0 million for the three months ended April 30, 2002 and 2001, respectively. The provision reflects the estimated effective tax rates for each respective fiscal year. 11
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED APRIL 30, 2002 AND APRIL 30, 2001 Net Sales. Consolidated net sales were $90.8 million and $105.3 million for the nine months ended April 30, 2002 and 2001, respectively, representing a decrease of $14.5 million or 13.8%. Sales during the nine months ended April 30, 2002 continued to be adversely impacted by the weak economic environment. Particular softness was experienced in our telecommunications transmission segment as a result of the significant downturn in the telecommunications market. We believe sales in this segment will continue to be adversely impacted until economic conditions improve. Sales from our telecommunications transmission segment were $58.2 million, or 64.1% of our total net sales, during the nine months ended April 30, 2002 as compared to $85.6 million, or 81.3% of our total net sales, during the nine months ended April 30, 2001. Sales from our RF microwave amplifier segment were $17.6 million and $11.0 million for the nine months ended April 30, 2002 and 2001, respectively, or 19.4% and 10.4% of our total net sales. The increase of approximately $6.6 million was principally the result of the acquisition of certain assets and product lines of MPD Technologies, Inc. in April 2001. Sales from our mobile data communications services segment were $15.0 million, or 16.5% of our total net sales for the nine months ended April 30, 2002, versus $8.7 million, or 8.3% of our total net sales for the nine months ended April 30, 2001. The increase of approximately $6.3 million was due to increased sales of our Movement Tracking System, primarily to the U.S. Army. International sales represented 41.6% and 47.4% of total net sales for the nine months ended April 30, 2002 and 2001, respectively. Domestic sales represented 26.2% and 30.5% of total net sales for the nine months ended April 30, 2002 and 2001, respectively. U.S. government sales represented 32.2% and 22.1% of total net sales for the nine months ended April 30, 2002 and 2001, respectively. Gross Profit. Gross profit was $29.8 million and $38.1 million for the nine months ended April 30, 2002 and 2001, respectively. The decrease was partially due to the reduced total level of sales discussed above. In addition, gross margin, as a percentage of sales, decreased from 36.2% to 32.8%. The decrease in the gross margin percentage was driven by the significant decrease in telecommunications transmission segment sales which generally carry higher margins than sales from the other two segments. Selling, General and Administrative Expenses. Selling, general and administrative expenses were $16.4 million and $18.0 million for the nine months ended April 30, 2002 and 2001, respectively. The decrease is related to the reduction in sales during the nine months ended April 30, 2002. Research and Development Expenses. Research and development expenses were approximately $8.2 million and $7.7 million, respectively, during the nine month periods of 2002 and 2001. Despite the softness in sales discussed above, we are continuing to invest in the future by enhancing our existing products and developing new products and technologies. Whenever possible, we seek customer funding for research and development to adapt our products to specialized customer requirements. During the nine months ended April 30, 2002 and 2001, customers reimbursed us $1.5 million and $0.6 million, respectively, which amounts are not reflected in the reported research and development expenses. Amortization of Intangibles. Amortization of intangibles decreased from $1.8 million to $1.1 million during the nine months ended April 30, 2002 compared to the nine months ended April 30, 2001 as incremental amortization expense relating to the acquisition of certain assets and product lines of MPD Technologies, Inc. was more than offset by the cessation of goodwill amortization in accordance with newly adopted accounting pronouncements (see note 10 to the consolidated financial statements). Operating Income. Operating income for the nine months ended April 30, 2002 and 2001 was $4.2 million and $10.7 million, respectively. The decrease was the result of the decrease in gross profit, discussed above, partially offset by reduced selling, general and administrative expenses. Interest Expense. Interest expense was $2.4 million and $2.8 million for the nine months ended April 30, 2002 and 2001, respectively. Additional interest on borrowings in connection with the acquisition of certain assets and product lines of MPD Technologies, Inc. in April 2001 were more than offset by interest savings from the prepayment of $19.2 million of debt in August 2001. Interest Income. Interest income was $0.4 million and $2.0 million for the nine months ended April 30, 2002 and 2001, respectively. The decrease was the result of a lower level of investable funds during the nine months ended April 30, 2002, as well as lower interest rates. 12
Other, Net. Other income for the nine months ended April 30, 2002 was $17,000 compared to other expense of $0.9 million in the nine months ended April 30, 2001. The amount in the 2001 period was primarily due to the loss realized upon the sale in March 2001 of a short-term investment classified as available-for-sale partially offset by other income of approximately $0.1 million for royalty income received. Provision for Income Taxes. The provision for income taxes was $0.7 million and $3.5 million for the nine months ended April 30, 2002 and 2001, respectively. The provision reflects an estimated effective tax rate of 33% for the fiscal 2002 period compared to 39.5% in the fiscal 2001 period. The lower estimated effective rate is the result of the impact of permanent differences on a lower level of expected pre-tax income for fiscal 2002. LIQUIDITY AND CAPITAL RESOURCES Our cash and cash equivalents decreased to $21.5 million at April 30, 2002 from $36.2 million at July 31, 2001. The decrease of $14.7 million was primarily the result of the prepayment in August 2001 of $19.2 million in borrowings related to the acquisition of EF Data. As a result of the prepayment, our next principal payment on long-term debt is not due until December 2003. Net cash provided by operating activities was $7.6 million for the nine months ended April 30, 2002. Such amount reflects (i) net income for the period plus the impact of non-cash items such as depreciation and amortization and (ii) the changes in working capital balances. Net cash used by investing activities was $2.5 million for the nine months ended April 30, 2002. Substantially all of the cash used related to capital expenditures aggregating $2.4 million. Net cash used by financing activities was $19.7 million for the nine months ended April 30, 2002. We prepaid $19.2 million of borrowings in August 2001. In addition, principal payments on capital lease obligations amounted to $0.8 million during the nine months ended April 30, 2002. These uses of cash were offset by proceeds from the sale of stock and exercise of stock options aggregating approximately $0.3 million. We believe that our cash and cash equivalents will be sufficient to meet our operating cash requirements for at least the next year. In the event that we identify a significant acquisition that requires additional cash, we would seek to borrow additional funds or raise additional equity capital. In the normal course of business, we routinely enter into binding and non-binding purchase obligations primarily covering anticipated purchases of inventory and equipment. We do not expect that these commitments as of April 30, 2002 will materially adversely affect our liquidity. FORWARD-LOOKING STATEMENTS Certain information in this Quarterly Report on Form 10-Q contains forward-looking statements, including but not limited to, information relating to the future performance and financial condition of the Company, the plans and objectives of the Company's management and the Company's assumptions regarding such performance and plans that are forward-looking in nature and involve certain significant risks and uncertainties. Actual results could differ materially from such forward-looking information. The Company's Form 10-K filed with the Securities and Exchange Commission identifies many of such risks and uncertainties, which include the following: o the impact of a continued domestic and foreign economic slow-down on the demand for our products and services, particularly in the telecommunications industry; o risks associated with our mobile data communications business being in an early stage; o our potential inability to keep pace with rapid technological changes; o our backlog being subject to customer cancellation or modification; o our sales to the U.S. government being subject to funding, deployment and other risks; o our fixed price contracts being subject to risks; o our dependence on component availability, subcontractor availability and performance by key suppliers; o the highly competitive nature of our markets; o our dependence on international sales; o the adverse effect on demand for our products and services that would be caused by a decrease in the value of foreign currencies relative to the U.S. dollar; o the potential entry of new competitors in all of our segments; 13
o uncertainty whether the satellite communications industry or infrastructure will continue to develop and the market will grow; o uncertainty whether the Internet will continue to grow in international markets; o the potential impact of increased competition on prices, profit margins and market share for the Company's products and services; o the availability of satellite capacity on a leased basis needed to provide the necessary global coverage for our mobile data communications services; o whether we can successfully implement our satellite mobile data communications services and achieve recurring revenues for such services; and o whether we can successfully combine and assimilate the operations of acquired businesses and product lines. Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company's earnings and cash flows are subject to fluctuations due to changes in interest rates primarily from its investment of available cash balances. Under its current policies, the Company does not use interest rate derivative instruments to manage exposure to interest rate changes. When applicable, the Company may enter into foreign currency contracts solely to hedge foreign currency receivables. It has established policies, procedures and internal processes governing the management of this hedging to reduce market risks inherent in foreign exchange. Any change in these markets would not materially affect the consolidated financial position, results of operations or cash flows of the Company. PART II OTHER INFORMATION Item 1.Legal Proceedings In or about December 2000, two former employees, Shiv Verma and Robert Levin, commenced an action in the United States District Court, District of New Jersey, against the Company and others asserting, among other things, breach of certain restricted stock agreements and seeking unspecified monetary damages, specific performance of the restricted stock agreements, including the issuance of an aggregate 225,000 shares of the Company's Common Stock for a purchase price of $.10 per share, and other relief. The Company believes it has meritorious defenses to all the claims asserted, and interposed certain counterclaims and third-party claims against NJL, Inc., a company then controlled by Mr. Verma. The plaintiffs moved to dismiss the counterclaims and third-party claims and to strike certain of the Company's affirmative defenses. The Company opposed the motion and cross-moved to dismiss Mr. Verma's claims. In April 2002, Mr. Levin dismissed his claims against the Company, and the Company in return dismissed its counterclaims against him, without payment of any monies by either party, with both the Company and Mr. Levin executing general releases. On or about April 9, 2002, the Company moved to dismiss Mr. Verma's claims with prejudice due to his failure to comply with a Court Order requiring him to provide certain discovery materials. On May 15, 2002, the Magistrate Judge assigned to the litigation issued a Report and Recommendation recommending that the Court grant the Company's motion and that Mr. Verma's claims be dismissed with prejudice. Mr. Verma has filed written objections to the Magistrate Judge's Report and Recommendation. We are subject to certain legal actions, which arise, in the normal course of business. Although we believe that the outcome of these actions, including the matter described above, will not have a material adverse effect on our consolidated financial position, legal costs incurred in conjunction with these matters could materially impact our results of operations, particularly within a quarterly period. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None (b) Reports on Form 8-K None 14
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMTECH TELECOMMUNICATIONS CORP. (Registrant) Date: June 12, 2002 By: /s/ Fred Kornberg ----------------------------- Fred Kornberg Chairman of the Board Chief Executive Officer and President Date: June 12, 2002 By: /s/ Robert G. Rouse ----------------------------- Robert G. Rouse Senior Vice President and Chief Financial Officer 15